Out of Control Policy Blog

Jefferson County, AL Declares Bankruptcy - Muni Bankruptcy Wave Coming?

This week Jefferson County, Alabama filed the largest government bankruptcy in American history. The cash-strapped municipality, faced with a burgeoning $4.23 billion debt, has taken the option of last resort after failing to reach a compromise with it’s creditors. The Birmingham News reports three quarters of the county’s debt, or $3.14 billion, lies in a mismanaged sewer construction project, $814 million in school-construction debt, and the final $305 million in general-obligation warrants. According to bankruptcy filings, the county owes more than 5,000 creditors, the largest being JPMorgan Chase & Co. JPMorgan Chase & Co. owns one third of the sewer construct debt, or $1 billion.

Regular readers of Reason Foundation’s Out of Control Policy Blog should not be surprised by today’s news. Last month when the Harrisburg, Pennsylvania City Council controversially voted to declare bankruptcy I posted analysis of the top nine municipalities most likely to face bankruptcy next. Jefferson County ranked third on that list.

Some have suggested recent high-profile municipal bankruptcies confirm Meredith Whitney’s dire prediction that a wave of municipal bankruptcies would sweep the country. Was Meredith Whitney right? In short: not yet.

Local governments are feeling the squeeze of the prolonged economic malaise. Specifically, officials are struggling with falling revenue, evaporating state aid, and structural deficits that beget chronic overspending. According to the National League of Cities (NLC) 26th Annual City Fiscal Conditions Report, general city revenues have declined for five straight years, and are projected to fall another 2.3 percent by the end of 2011. NLC traces this dip to lagging property and income taxes, while sales taxes have rebounded and leveled off. Further, for most municipalities, the prospect of federal or state aid is dim. NLC reports 57 percent of city finance officers report their cities are less able to meet their financial needs in 2011 than 2010, and the current condition may be the “new normal” according to Michael A. Pagano, Dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago.

No municipality represents this better than Central Falls, Rhode Island. Central Falls would be the most apt “canary in the coalmine” for Whitney’s prediction. Falling revenue combined with spending was problematic, but it was the city’s underfunded public employee pension fund that drove Central Falls into bankruptcy and receivership. Rosy pension predictions were flat wrong and the controversial government accounting standards board (GASB) metrics may lead to similar problems for other municipalities. This is leading many to argue that a U.S. pension crisis is pending. However underfunded pensions are not what forced Jefferson County or Harrisburg into bankruptcy.

When did it start for Jefferson County? It goes as far back as 1996 when a federal judge ordered Jefferson County to repair and rebuild its sewer system, citing county sewage polluting rivers and streams. County officials then proceeded to engage in an eight-year borrowing binge. The Birmingham News reports:

(By) 2007 most of Jefferson County’s sewer debt is tied up in several 2002-03 refinancing deals, championed by then-Commission President Larry Langford, that include complex, sophisticated derivatives meant to save money – auction-rate securities, variable-rate bonds and embedded interest rate swaps. No other local government has as great reliance on such derivatives as Jefferson County, and these soon prove to be a crucial flaw.

(In) 2008 the national subprime mortgage crisis and Great Recession (hit) -- the financial collapse plunges the county's debt to junk bond status because of failure of the derivative markets. This triggers penalties and higher interest rates for Jefferson County sewer debt. The county begins technical default. Bond insurers sue.

Jefferson County's bankruptcy was fairly foreseeable from 2008 forward. Further, the county’s regular operating budget faced a structural deficit. According to The Birmingham News, lawmakers already cut spending by 30 percent, or $95 million, and faced another $40 million in cuts by December 1, 2011. The Alabama Supreme Court struck down an occupational licensing tax, which cost the county $66 million, and afterwards county lawmakers could not reach a compromise for state aid or sufficient relief from creditors.

Similarly when Harrisburg filed for bankruptcy the city faced $242 million in total guaranteed debt, five times its general fund budget, $65 million of which was overdue. Harrisburg's debt is primarily linked to the city’s decision to overhaul and expand an incinerator. Pennsylvania’s capital city has since gone into state receivership.

The Jefferson County and Harrisburg bankruptcies are unsettling, however each municipality made poor fiscal policy decisions that hung like millstones around their necks. If nothing else, these bankruptcies send a clear message to local governments that in this “new normal” period, boondoggle projects become cans that are far too big to kick down the road.

Two of the nine municipalities I highlighted in my previous post have gone bankrupt, which ones—if any—will be next?

Harris Kenny is Policy Analyst


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