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The Muni Market Shrugs off Jefferson County

Last Wednesday, Jefferson County, Alabama filed the largest municipal bankruptcy in U.S. history. At $4 billion, this filing is double the previous record set by Orange County, California in 1994…and the muni market didn’t even sneeze.

The county’s problems started in 1996 when it agreed to rebuild its sewer system to settle a lawsuit claiming that during heavy rain untreated sewage was being released into rivers. The following year bonds were sold to finance the project; the bonds were revenue bonds, and would be backed by sewer fees.

The rebuild was supposed to cost $1.5 billion, but ended up increasing to $2.2 billion…and putting the system more than $3 billion in debt.

The county needed a solution. And Wall Street had one. The debt was refinanced into auction-rate securities, which would allow them to pay lower short-term interest rates on long-term debt so their financing costs would be less.

But then came the financial crisis. And the ratings of two companies that insured Jefferson County’s debt were cut… leaving it compromised without top ratings on its insurers. As a result, the debt was sold off, and the county’s borrowing costs increased… to the point that they would have paid a lower rate if they had never refinanced the debt.

Last week’s filing came after an agreement could not be reached.

The muni market had no reaction to last week’s news. And the reason for that is it really wasn’t news at all. The filing was well anticipated, and came in the wake of problems that have been festering for years. And it wasn’t just Wall Street financing maneuvers gone awry…there was rampant political corruption surrounding the sewer system. Twenty one people have plead guilty or been convicted of corruption related to the project or its financing.

Jefferson County is a casualty of the financial crisis. But it was also an isolated incident…based on circumstances unique to the county. It was absolutely not systemic in nature. For that reason, the bankruptcy doesn’t portend more trouble ahead for the muni market.

That said, state and local governments are facing some serious long-term challenges. And this year states have been more dependent on federal funding than ever. And spending is at an unsustainable level… which will mean more service cuts and asset sales.

There are good reasons to step carefully around the muni market…but Jefferson County isn’t one of them.


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