Is Jefferson County the canary in the coal mine for the municipal market?
That’s what you might think, the day after the county commissioners voted 4-1 to file the largest US municipal bankruptcy ever. The seat of the State’s capital city Birmingham, Jefferson County is mired in over $3 billion in sewer debt. Its bankruptcy filing is emblematic of a culture of corruption that has plagued municipal finance for decades. Hotshot bankers, corrupt County officials, and sleazy local brokers combined to saddle ratepayers with an unsustainable debt burden while enriching themselves.
Back in 1996 Jefferson County entered into a consent decree with the US EPA to materially improve its sewer system. The County financed the improvements by issuing sewer bonds. In 2002 the FBI launched an investigation into the construction program which resulted in the conviction of 21 people, including contractors, county commissioners, and county employees, mainly related to bribes paid to local officials to obtain construction contracts.
But the bribes didn’t end there. JP Morgan and Goldman Sachs competed to issue the bonds. They would pay millions of dollars to local “advisory” firms in order to influence elected officials. These firms would turn around and wire the money directly to the commissioners’ campaign contributors. Both of the large banks entered into interest rate swap agreements with the county while they brokered their bonds. The banks earned millions in fees.
The SEC began a formal investigation in 2006, and things really fell apart in 2008 when the auction rate securities market collapsed. A series of restructurings still left the county with over $3 billion in debt, though—over $6000 per user. Many of the principals in the fraud have been indicted, convicted, and imprisoned. JP Morgan agreed to a $722 million settlement.
Calling Jefferson County a typical municipal credit is like calling Bernie Madoff a typical money manager, or Enron a typical corporation. When fraudsters run wild, people get hurt.
Douglas R. Tengdin, CFA
Chief Investment Officer
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