I had given no thought to Jefferson County, Alabama since my post six weeks ago. Then, yesterday, Calculated Risk mentioned that Vallejo, CA has filed for Chapter 9, thus becoming the largest municipal bankruptcy in the history of California. The executive summary is pretty simple: Housing boom -> increased tax revenues -> public worker unions demand (and receive) higher compensation and benefits.  Boom unwinds -> revenue falls. Compensation/benefit obligations remain. Kaboom.
The trillion-dollar question, of course, is whether Vallejo is an isolated incident or the beginning of a trend. I do not know the answer to that question, but it did get me wondering whatever happened in Jefferson County, Alabama. And that led me to this remarkable Bloomberg article:
JPMorgan Swap Deals Spur Probe as Default Stalks Alabama County
It is long, but read it anyway. The story is magnificent. It features:
- Elderly people forced to choose between heat and working toilets
- Heavy-handed EPA mandates
- Corrupt politicians
- Corrupt and greedy bankers
- Derivatives so complex you will have no idea what they are talking about
- A typically anti-prescient “hilarious in retrospect” Greenspan quote
If this tale could be more revolting, I do not see how; it is already perfect.
I am not even sure where to begin, so I will begin at the beginning.
The U.S. Environmental Protection Agency in 1994 joined the taxpayers who filed the complaint. In December 1996, the county settled the case by agreeing to build a sewer system for collecting overflows and cleaning the water.
“I am from the government, and I am here to help you.”
The officials took JPMorgan’s advice, and in 2002 and ’03 Jefferson County issued $3 billion of adjustable-rate bonds, including $2.2 billion of auction-rate securities, bonds whose interest rates reset at periodic auction sales by banks.
…
When those auctions failed because no one bought the securities, Bank of America and JPMorgan, seeking to shore up their own capital, didn’t step in and buy the Alabama debt, as banks that had run such auctions had in the past. That forced Jefferson County to almost double the interest payments on its auction-rate bonds.
A couple of years back, I read somewhere, “This is not a housing bubble; it is a credit bubble.” I think I am finally starting to understand what that means. But who convinced Jefferson County to get involved in such risky instruments?
Then JPMorgan banker Matthew Roggenburg quoted Federal Reserve Chairman Alan Greenspan, who lauded derivatives because they create a more flexible and efficient financial system.
“New financial products have enabled risk to be dispersed more effectively to those willing, and presumably able, to bear it,” Greenspan said in an April 2002 speech. “Shocks to the overall economic system are accordingly less likely to create cascading credit failure.”
Well, that’s good to know.
Although it is hard to place all the blame on Easy Al, what with the corruption/collusion thing:
On April 30, the SEC sued Larry Langford, the former county commission president and now Birmingham’s mayor, for fraud in allegedly accepting $156,000 from a local banker while refinancing the sewer debt.
…
“It was a political witch hunt from day one,” he says. “Blount and I have been friends for 30 years. He wouldn’t have had to buy no involvement in no bond deal from me.”
Let me get this straight. His defense is that it was nepotism, not bribery, that has resulted in grandma choosing between heat and running water? Oh, what I would give to sit on that jury…
Meanwhile, the payments the county received under its swap agreements, which were supposed to cover the interest payments on its floating-rate bonds, went down. The payments were supposed to track the county’s bonds, covering any increase to its bills. Instead, they added to them.
I see.
No, wait, I don’t see. So the banks sold some instrument that was advertised as insuring against interest rate risk, but it actually did the opposite? Who the hell works at these banks, Milo Minderbinder?
But wait, there’s more. Jefferson County is on the verge of becoming the largest municipal default in U.S. history… But why has it not happened yet?
“The big boys don’t want to pull the trigger,” Taylor says. “Then they might end up upsetting the whole derivatives apple cart because of what a judge may do in a court case.”
That’s right. Lehman Brothers, J. Bear Morganstearn, etc. are afraid to let a court look too carefully at whatever the hell happened here. And so they keep granting extensions on the debt. My, what friendly neighborhood bankers they are!
Reading the whole story, I am not sure whether to laugh or to cry. Then I re-read the intro:
As nighttime temperatures plunged in Birmingham, Alabama, last October, Dora Bonner had a choice: either pay the gas bill so she could heat the home she shares with four grandchildren, or send the Birmingham Water Works a $250 check for her water and sewer bill.
Bonner, who is 73 and lives on Social Security, decided to keep the house from freezing.
“I couldn’t afford the water, so they shut it off,” she says.
Then I think about how Lehman Brothers’s debt is effectively guaranteed by the Fed (cf. Bear Stearns), while Jefferson County’s is effectively guaranteed by people like Dora Bonner.
And then I wonder if I should get mad.
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