Jefferson County, Alabama, declared the largest municipalbankruptcy in U.S. history, capping a more than three-year sagathat turned it into one of the biggest casualties of Wall Street'scredit crisis.

The move yesterday by Alabama's most-populous county came afterstate lawmakers failed to back a September agreement with creditorsled by JPMorgan Chase & Co. that would have reduced itssewer-system debt of more than $3 billion. Governor Robert Bentleyand local leaders worked unsuccessfully for two months to rallysupport for the deal, which fell apart anyway.

“We've reached that last resort,” Commissioner Joe Knight saidyesterday at the meeting before the 4-1 bankruptcy vote. “We couldcontinue and keep kicking this can down the road, but I think thepeople of Jefferson County have had enough.”

The Chapter 9 filing leaves creditors including JPMorgan, thebiggest U.S. bank by assets, facing hundreds of millions of dollarsin losses and may revive concern that defaults may rise in the $2.9trillion municipal bond market. The move also leaves residents ofthe county that's home to Birmingham, Alabama's largest city,facing uncertainty over how much they may have to spend on sewagefees to repay the debt that led to the debacle.

The September accord provided $1.1 billion in concessions. Italso called for annual sewer-rate increases for the first threeyears of as much as 8.2 percent, which drew opposition fromlawmakers concerned about the burden that would place on the poor.The county also couldn't get signed commitments from creditors,said Commission President David Carrington.

The size of sewer-fee increases became a hurdle because manyresidents, particularly in Birmingham, can ill afford higher costs,according to Commissioner George Bowman, who represents one ofcounty's two poorest districts and cast the sole vote againstbankruptcy. He has said that almost 70 percent of sewer usersreside in the two districts with the lowest average incomes.

Bentley, a Republican, said he was disappointed by the county'smove to seek court protection.

“The Jefferson County sewer-debt crisis has been an impedimentto economic growth in the state, and the bankruptcy filing will nowbe an even greater challenge to overcome,” he said in a statement.“Now we must rise to this new challenge, move forward to bringeconomic growth and stability to the Birmingham region, and doeverything in our power to limit the impact of this decision.”

Toxic Bonds

Jefferson's bankruptcy is the legacy of a sewer project doggedby political corruption. In 2009, JPMorgan agreed to a $722 millionsettlement with the Securities and Exchange Commission overpayments its bankers allegedly made to people tied to countypoliticians in order to win business. Former Commissioner LarryLangford was convicted on charges of accepting bribes and theshenanigans behind the financing inspired elements of theDodd-Frank law to protect municipalities.

In 2008, the derivate-laden refinancing set up by JPMorganunraveled as fallout from the subprime-mortgage market collapserippled through Wall Street, sending debt costs soaring. The crisisthat spurred led some county residents and businesses to press forbankruptcy, rather than bear the full cost alone.

Jefferson commissioners' efforts to close the settlement dealwere frustrated by recent sales of sewer debt to investors whodidn't want to restructure the bonds under the agreement's proposedterms, according to the bankruptcy filing.

JPMorgan didn't want the county to enter bankruptcy, said JustinPerras, a bank spokesman. The company held more than $1.2 billionof the county's sewer debt as of May, according to a documentprovided by Bentley's office in September. It had offered $750million in concessions in the proposed settlement.

“We offered very substantial financial concessions to make thedeal happen while keeping sewer rates within the parametersproposed by the county,” Perras said by e-mail. “While we'redisappointed by the county's decision to file, we will continue towork toward a fair and reasonable solution.”

The vote by officials in Alabama's most populous county occurredabout a month after Pennsylvania's capital of Harrisburg soughtcourt protection, citing millions in overdue bond payments tied toa trash-to-energy incinerator. On Aug. 1, Central Falls, RhodeIsland's smallest city, entered bankruptcy, citing pension costs itcan't afford.

Rare Occurrence

Municipal bankruptcies are rare: Over a period of more than 60years since 1937 there were fewer than 500, according U.S. courtdata. The filing eclipses the previous record, set in 1994 byOrange County, California. The suburban Los Angeles county wasdriven into bankruptcy by $1.7 billion in losses on interest-ratebets. It had about $2.2 billion in debt outstanding, according to aJune 1995 financial report.

Less than an hour after the late-afternoon filing, an investorbought more than $1 million of Jefferson's sewer debt for 58 centson the dollar, down from about 74 cents a month earlier, accordingto Municipal Securities Rulemaking Board trade data.

Jefferson's bankruptcy may reignite investor concern thatmunicipal defaults will rise, which earlier this year led investorsto pull more than $30 billion from municipal-bond mutual funds.

“It's going to create attention-grabbing headlines, and thequestion is how retail investors react,” Peter Hayes, a managingdirector at BlackRock Inc., the world's largest asset manager andthe owner of $95.6 billion of municipal bonds, said before thefiling.

This year through September, the number of municipal defaultsfell to 42, totaling $949 million, from 79 in the first nine monthsof 2010, amounting to about $2.89 billion, according to theDistressed Debt Securities Newsletter, published by Miami Lakes,Florida-based Income Securities Advisor Inc.

The collapse of both Harrisburg and Central Falls, whoseproblems also were long brewing, failed to rattle municipal bondinvestors, and the same may apply with Jefferson County. Officialsthere have been considering Chapter 9 since 2008.

“I don't think it will have a huge impact,” said Alan Schankel,director of fixed-income research for Janney Montgomery Scott LLCin Philadelphia. “Certainly it's not a secret. It's been floatingaround for quite some time.”

The county can't impose a tax or raise existing levies withoutlegislative approval. Its money struggles intensified in March whenthe state's highest court struck down a local wage tax thatgenerated $70 million annually, or almost a quarter of Jefferson'sgeneral fund.

'Catastrophic Mistake'

The bankruptcy is a “catastrophic mistake” that will lead torate increases for sewer customers, said John Young Jr., thereceiver appointed to run the system.

“This utterly irresponsible act makes the dark cloud hangingover Jefferson County even darker,” Young said yesterday in astatement. He said increases would be “significantly higher” thanthe 8.2 percent called for in the proposed deal.

The bankruptcy also may affect bond insurers Financial GuarantyInsurance Co. and Syncora Guarantee Inc., which guaranteed thesewer debt. Michael Corbally, a spokesman for Syncora, declined tocomment on the filing.

Along with its sewer debt, Jefferson owes about $1 billion,including $201 million of general-obligation securities andschool-construction bonds totaling $814 million, according to itsbankruptcy petition. The county listed the top three unsecuredcreditors related to the its general-obligation debt as BayerischeLandesbank in Munich, a unit of JPMorgan and the Depository TrustCo., both based in New York.

The county now must show a federal judge that it can't pay itsbills and then draw up a plan for meeting obligations, which thecourt may reduce. Unlike corporate cases, creditors can't try toseize or sell off county assets, and the court can't appoint atrustee to run the county.

Municipalities have more leverage with creditors under Chapter 9of the U.S. Bankruptcy Code than corporations have whenreorganizing debt in Chapter 11 protection, said Marc Levinson, alawyer who represented Vallejo, California, when that city wentbankrupt.

“About the only thing a judge has the power to do is dismiss thecase,” Levinson said.

The bankruptcy makes Jefferson County the biggest municipalvictim of the unforeseen effects of the credit crisis. In 2008,investors dumped Jefferson county's bonds in the wake of thesubprime mortgage-market meltdown. Jefferson's floating-ratesecurities were coupled with interest-rate swaps, a money-savingstrategy pitched by banks that backfired. As credit marketsconvulsed in 2008, the county's interest costs soared. When banksdemanded early payoffs of the bonds, the county defaulted.

The uncertainty that has reigned since 2008 has led somebusinesses, politicians and residents to be thankful for any routethat would bring the saga to a close.

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