Alabama county has filed largest U.S. municipal bankruptcy

For months, they labored to cut a deal with their creditors. But $4 billion is a deep hole to negotiate out of.

And so, with a settlement seemingly out of reach, Jefferson County, Ala., relented this week, and now is tagged with a long-dreaded superlative: On Tuesday, it filed the largest municipal bankruptcy in U.S. history.

“It just became one of those situations were we had to decide what we were going do,” County Commissioner Joe Knight said. “Was this deal going to get done? Probably not. The inevitable was probably going to happen.”

Financial experts say the bankruptcy filing is likely to increase the cost of borrowing for other municipalities in Alabama, but is not expected to have many ramifications outside the state. Higher sewage fees appear inevitable for a county that has already suffered cutbacks as a result of the debt crisis.

The Chapter 9 filing joins a rash of municipal bankruptcies across the United States this year, filed by frustrated local officials struggling to balance their books in the dragging economy. In a filing last month, Harrisburg, Pa., listed debts of over $400 million that were largely tied to a trash incinerator project. Central Falls, R.I., filed in August because of problems funding its pension system.

Other fiscally strained governments will be watching the massive Alabama case closely. Some may be tempted to enter bankruptcy court too if, in the end, they determine that Jefferson County ends up with a palatable deal.

Jefferson County’s declaration dwarfs that of the previous record holder, California’s Orange County, which owed creditors $1.7 billion when it filed for bankruptcy protection in 1994.

It also opens a murky chapter in a drama that has engulfed Alabama’s most populous county in scandal for years.

Much of the debt stems from exotic refinancing deals cut with big Wall Street banks that backfired with the 2007 mortgage-lending crisis. The deals resulted in the fraud-related convictions of more than 20 Alabama officials, contractors and others.

A second, separate problem emerged this year when the state Supreme Court struck down a county tax on workers’ earnings that accounted for 40% of annual unrestricted revenue. By law, the county’s tax policy is set by the state Legislature. Local lawmakers were unable to pass a law in the last session to replace the lost funding.

Jefferson County, which is required by law to pass a balanced budget, responded by laying off 550 employees, closing four courthouses, suspending road maintenance and using cash reserves to fund operating shortfalls and pay for repairs after devastating April tornadoes. This resulted in what commissioners describe as “dangerously low” rainy-day funds.

In mid-September, the five-member commission approved the terms of a tentative out-of-court settlement that would have wiped $1 billion in debt off the books, refinanced much of the remainder, and called for substantial water rate hikes in a county that had seen a 329% increase over the last decade, according to Commissioner George Bowman.

But Knight said creditors brought a different, harsher agreement to the table this week, and the two sides found themselves at an impasse.

Knight said the commission had also lost faith in the state Legislature, which, the commissioners feared, would be unable to agree on a plan to replace the revenue from the lost occupational tax. Democrats in the local delegation, he said, generally favored a new tax, whereas Republicans wanted to plug the hole by freeing up existing revenue reserved for medical programs for the poor.

Robert Brooks, a finance professor at the University of Alabama, predicted that the filing would end up working in the county’s favor. In the out-of-court settlement talks, an Alabama municipality was facing off against powerful banking entities, including JPMorgan Chase & Co., a major creditor that in Brooks’ estimation the county had good reason not to trust.

JPMorgan reached a multimillion-dollar settlement with the Securities and Exchange Commission after being accused of pay-to-play schemes related to refinancing deals.

Brooks likened the settlement talks to the University of Alabama playing a high school football team. Now, with a federal judge overseeing the matter, Jefferson County will at least have a referee.

richard.fausset@latimes.com