One of the horrorshows that has been moving along in the background is the disaster of the funding of a sewer project in Birmingham, Alabama, which looks pretty likely to produce the biggest municipal bankruptcy since Orange County back in the mid 1990s.
Orange County did have one Robert Citron to blame for its woes. By all accounts (Frank Partnoy in Infectious Greed is particularly good here) Citron was WAAAY over his head, and not the brightest bulb to begin with.
The South has an even more combustible mix: a proud history of political corruption, plus even less-than-normally finance savvy bunch of officials (if such a thing is possible). There is a very good piece up at Bloomberg, so you can do some one-stop shopping and catch up on this sorry saga. A quick overview:
Jefferson County, Alabama,…anchored by Birmingham, is staring at what one local politician calls financial “Armageddon.”
The spectacle — a tax struck down, about 1,000 county employees furloughed, a politician indicted over $3 billion in sewer debt that may lead to the largest municipal bankruptcy in history — has elbowed its way up the ladder of county lore….
One target of their anger is Larry P. Langford, who was the county commission’s president in 2003 and 2004 and is now mayor of Birmingham. The 61-year-old Democrat goes on trial today, charged in a November 2008 federal indictment with taking cash, Rolex watches and designer clothes in exchange for helping to steer $7.1 million in fees to an Alabama investment banker as the county refinanced its sewer debt….
Under Langford’s stewardship, the county bet on interest- rate swaps, agreements that a representative of New York-based JPMorgan Chase & Co. told commissioners could reduce their interest costs. Instead, the swaps — covering more than $5 billion in all — blew up during the credit crisis after ratings for the county’s bond insurers fell…
Thousands of public borrowers across the U.S. chose a similar strategy, and many are now paying billions of dollars to escape the contracts….Even Harvard University, the world’s richest academic institution with an endowment of $26 billion, fell for Wall Street’s financing in the dark: It paid $497.6 million to investment banks during the fiscal year ended June 30 because it chose to cancel $1.1 billion of interest-rate swaps.
Yves here. I am clearly an old fart. Jefferson County had floating rate and switched to supposedly cheaper fixed rate debt. Remarkably (and insanely) they had a massive maturity mismatch, funding a lot of the program…in auction rate securities! The rest was in floating rate debt dependent on credit enhancement (apparently for the swap) that got whacked in monoline downgrades:
In 2003 and 2004, with Langford as president, the commission plunged into interest-rate swaps with JPMorgan, Bear Stearns Cos., Bank of America Corp. and Lehman Brothers Holdings Inc. Over time, the county, whose fiscal 2010 operating budget is $808.6 million, entered swaps on more than $5 billion in bonds.
Langford said in 2005 that the swaps would save $214 million — an assumption based on the county and its bond insurers maintaining their credit ratings…
The county later hired financial adviser James White of Birmingham-based Porter, White & Co., who estimated that the commission’s cost for the swaps, $120.2 million, was as much as $100 million too high, based on prevailing rates.
Then, in 2007-08, credit ratings for bond insurers that backed the variable-rate bonds plummeted to junk status because of unrelated losses in mortgage-backed securities. The reduction in credit quality killed demand for the bonds they insured.
Banks were forced to buy the securities, kicking in contract provisions that accelerated to four years from 40 the county’s payment schedule on more than $800 million of the debt. The insurers’ fall also affected more than $2 billion in auction-rate securities in late 2007 as bidders’ interest evaporated.
Some of the county’s variable rates more than tripled, to as high as 10 percent. Meanwhile, the bank payments it received were decreasing. In March 2009, when JPMorgan canceled its swap agreements, a county filing said they were worth more than $650 million to the bank, which has agreed to waive termination fees under negotiations on how to restructure the county’s debt.
Worse, the local authorities don’t bother with bids, which sets them up to be fleeced:
Less than 15 percent of $391 billion in new debt offerings were sold last year on the basis of public bidding — down from 83 percent of new sales in 1970. Most issues are now negotiated, meaning borrowing costs are set in private bargaining sessions.
In Jefferson County, the resulting opacity was a gateway to corruption, according to documents filed in Langford’s case. The Securities & Exchange Commission began probing the county’s swaps in 2004; the Federal Bureau of Investigation started inquiring later. In June 2007, SEC investigators deposed Langford in Miami about whether he used the sewer-debt refinancings to pay off political friends.
And that’s just the bond issues, so the transparency of swaps has to be even worse.
Readers may recall that this sorry drama has been going on for well over a year. So why hasn’t the county filed for bankruptcy, or prepared a filing and gotten into a stare-down with the swaps counterparties to negotiate a settlement? Get a load of this:
Carns and Commissioner Bobby Humphryes, both Republicans, say they reluctantly favor bankruptcy, in part to prevent the appointment of a receiver who might seek increases. “We need a cram-down on the debt,” says Carns, adding that the county can afford to service less than half the obligations, about $1.4 billion worth. A bankruptcy court would have authority to reduce the amount owed.
Democrat Shelia Smoot, along with Democrat William Bell and commission President Collins, opposes filing voluntarily.
“It would be detrimental to our community for the next 50 years,” she says.
Yves here. The last statement is utter hogwash. The idea that not filing for BK is a good idea is as big a bill of goods as the original swaps deals.
The county is nuclear waste NOW due to the unsupportable debt burden. By contrast, lenders are happy to fund post bankruptcy companies, and municipalities even more. They have decent cash flows and have delevered! They might well look like a much better credit than the average municipal borrower post bankruptcy.
The reluctance to file for bankruptcy suggests there is even more dirty laundry the local officials do not want aired.
The story is very well done, and you will find it here.