Jefferson County, Alabama’s elected leaders voting to settle with creditors averted what would have been the biggest municipal bankruptcy in U.S. history.
The deal approved by a 4-1 vote in Birmingham today caps more than three years of negotiations between public officials in Alabama’s most populous county and creditors led by JPMorgan Chase & Co.
The county was pushed into crisis in 2008 after the cascading blows of Wall Street’s credit crisis hit it with unforeseen costs on $3.14 billion of bonds that are paid for with revenue from its sewer system.
Jefferson County was the municipality hardest hit by the 2008 financial unraveling. Adding to the county’s challenges were a sewer project marred by public corruption and political pressure to restrain rising sewer bills.
Below is a timeline of events leading up to the agreement:
December 1996: Jefferson County agrees to repair and rebuild its sewer system for collecting and cleaning water overflows to settle a lawsuit alleging that untreated sewage was being discharged into rivers during heavy rains, violating the federal Clean Water Act.
February-March 1997: Jefferson County sells bonds to finance the project, raising $555 million in offerings led by underwriter Raymond James & Associates. The county purchased a derivative in connection with some of the fixed-rate debt.
The bonds were so-called revenue bonds, backed by the proceeds of the customer bills instead of a general pledge on the county’s tax collections. Documents from the bond offering estimated the sewer project would cost about $1.5 billion. The expanding scope of it subsequently pushed the cost to $2.2 billion, leaving the sewer system more than $3 billion in debt. Sewer rates rose more than fourfold over 10 years to pay for it.
November 1997: Republican Commissioner Bettye Fine Collins sends a letter to the U.S. Securities and Exchange Commission asking it to investigate the derivative transaction “in which Jefferson County was abused.”
The financing -- which refinanced floating-rate debt with fixed-rate debt, and then used the derivative to essentially convert it back to floating-rate again -- left it with a higher interest cost than when it began, she said. She estimated it raised the county’s expense by some $1.2 million a year, creating alarm about cronyism, excessive fees and fraud.
“I had proposed a competitive sale but was outvoted by my colleagues who wanted to dispense political patronage,” she said.
October 2002-December 2003: JPMorgan Chase & Co. (JPM) serves as lead banker on the financings at the center of the county’s collapse. Before the transactions, more than 95 percent of the sewer bonds were traditional fixed-cost securities.
By the end of it, 93 percent carried interest rates that fluctuated along with the market, including $2.1 billion of so- called auction-rate securities. The county tried to mitigate the risk of rising expenses with interest-rate swaps, under which it received adjustable payments meant to cover the bonds and paid a fixed rate in return. The county entered into 18 swap trades with a notional value of $5.6 billion, with JPMorgan the dominant provider, according to the SEC. Such structured deals involved multiple bank fees for resetting the interest rates on the bonds, providing credit support, and selling the swaps.
The bank’s fees on the swaps weren’t disclosed; rather, they were embedded in the interest rates the county paid. JPMorgan overcharged the county on the swaps to cover the cost of more than $8 million in secret payments made to friends of county commissioners who worked for local companies, a step to secure JPMorgan’s lead role, according to the SEC.
When a colleague objected that “randomly paying off people that have nothing to do with the deal just doesn’t sit well,” he replied: “That’s the deal -- that’s just the price of doing business,” according to SEC records.
March 2004: LeCroy is fired by JPMorgan for requesting the bank pay a law firm for services that weren’t rendered, according to regulatory records.
June 2005: LeCroy is sentenced to three months in jail after pleading guilty to wire fraud in connection with an investigation into whether Philadelphia bond business was steered to supporters of then Mayor John Street.
August 2005: Bloomberg News reveals that JPMorgan charged Jefferson County fees almost twice what was typical in transactions of that size and documenting payments to William Blount, a longtime friend of Commissioner Larry Langford, and other politically connected consultants. Langford, who oversaw finance and was later elected Birmingham mayor, dismissed questions about the risk.
“You know, I get the impression that people think a bunch of rubes in Alabama shouldn’t be smart enough to utilize these swaps,” Langford said. “And let there be an understanding: As long as this is a legal instrument, and it drives down costs, if we have to do one tomorrow, I’ll do it again.”
April 2007: Porter, White & Co., a financial adviser brought in to analyze the swaps, estimates that the $120 million in swap fees it was charged were as much as $100 million more than warranted.
January-March 2008: As the effects of the housing-market crash sent ripples through the financial system, the credit ratings of two companies that insured Jefferson County’s bonds, Financial Guaranty Insurance Co. and XL Capital Assurance Inc., are cut because of losses suffered on securities tied to home loans.
Without top credit ratings, buyers including money-market funds couldn’t hold the bonds. Concerned investors dumped them en masse. Banks, seeking to shore up their own cash reserves, stop stepping in to buy unwanted auction-rate securities. Many auctions fail, leaving Jefferson County with penalty interest rates. As central banks slash rates, the payments received under the swaps fall instead of increasing, adding to the costs.
JPMorgan and other banks that agreed to buy a portion of the bonds in return for a fee are protected by contracts that required the county to pay off $850 million of the debt in four years, instead of as long as 40 years, as the county had planned. When the bonds were cut to junk, the county faced the risk they could be forced to pay hundreds of millions in fees to escape from the swaps. On Feb. 29, Standard & Poor’s rated the sewer bonds below investment grade. “Once we got cut to junk status, we couldn’t go any lower without just leaving the scene and turning over a corpse to somebody,” then County Commissioner Jim Carns said.
Bankruptcy became a possibility as the county begins relying on a series of standstill agreements with banks to stave off financial collapse.
August 2008: JPMorgan reaches agreements with state regulators to repurchase auction-rate securities sold to some investors to settle an industrywide probe of whether Wall Street banks misled prospective buyers about the risks. JPMorgan served as the sole broker-dealer for $1.8 billion of Jefferson County’s auction- rate bonds, according to county records.
September 2008: Jefferson County’s trustee declares it to be in default under agreements covering the $3.2 billion of sewer bonds for failing to make $46 million of principal payments.
January-August 2009: The county suffers a financial setback when an Alabama Circuit Court Judge strikes down the legality of a local job and business tax. A new tax for the county is authorized by the state in August, although it is later challenged in court.
October 2009: The former commissioner in charge of finance, Larry Langford, is convicted of accepting bribes in exchange for giving more than $7 million in sewer-bond business to Blount. Langford is later sentenced to 15 years in jail.
November 2009: JPMorgan agrees to a $722 million settlement with the SEC over allegations that LeCroy and the bank’s former municipal derivatives chief, Douglas MacFaddin, paid more than $8 million in undisclosed payments to Blount and two other local-broker dealers that performed no known role in the deals.
Part of the settlement includes forfeiting $647 million in fees Jefferson County would owe to escape from the swaps, which had kept officials from refinancing as other borrowers stung by similar deals did since 2008. That was of little help because the county’s creditworthiness was already in doubt after it was declared in default and unable to borrow on its own.
LeCroy and MacFaddin, also facing SEC civil actions, challenged them, saying the SEC lacks authority to pursue them under federal antifraud statutes because the interest-rate swaps aren’t securities. The case is pending.
Meanwhile, former Jefferson County Commissioner Mary Buckelew received a sentence of three years probation and is fined $20,000 after pleading guilty to charges she lied to a federal grand jury about accepting designer shoes, a purse and a spa trip from Blount during bond-related trips to New York.
February 2010: Blount is sentenced to 52 months in jail after pleading guilty to paying bribes of cash, clothes and jewelry to Langford to get $7.2 million of the county’s bond and derivatives business.
July 2010: Gary White, a former commissioner who oversaw the county’s environmental services department, is given 10 years in prison for accepting bribes from an engineering company that worked on the sewer system. As of today, 21 people have been convicted or pleaded guilty to corruption-related charges in connection with the sewer construction and financing, including three other onetime commissioners.
July 2010: President Barack Obama signs the Dodd-Frank law in response to the regulatory failings underpinning the financial crisis. It includes provisions, inspired in part by Jefferson County, seeking to protect municipalities from excessive fees and risks posed by derivative trades sold by Wall Street banks.
March 2011: The new Jefferson County tax is struck down by the state’s Supreme Court, which said it was approved without sufficient public notice, plunging the county back into fiscal crisis. Earlier that month, while in Washington, County Commissioner James Stephens’ chief of staff had said such a court decision would make bankruptcy “almost inevitable.”
August 2011: After preparing to file for bankruptcy and publicly debating it, county commissioners decide to extend talks through mid-September with a view toward reaching a resolution.
Sept. 16, 2011: Jefferson County’s commission votes 4-1 to accept a tentative deal with creditors.
To contact the editor responsible for this story: Mark Tannenbaum at email@example.com