Bankruptcy Rarely Offers Easy Answer for Counties
By CAMPBELL ROBERTSON, MARY WILLIAMS WALSH and MICHAEL COOPER
Published: November 10, 2011 - New York Times
BIRMINGHAM, Ala. — When Alabama’s Jefferson County filed for the largest
municipal bankruptcy in American history this week, it looked a little like
another domino had fallen.
Harrisburg, the capital of Pennsylvania, filed for bankruptcy last month. The
tiny city of Central
Falls, R.I., filed in the summer. Hamtramck, Mich., tried to
declare bankruptcy last year but was stopped by the state. From coast to
coast, cities have had to cut services, lay off workers and raise taxes as the
downturn has lingered.
Municipal bankruptcies remain extremely rare, and each of these cases can be
viewed as unique, a one-off: Jefferson County was undone by a major sewer
project marred by corruption, Harrisburg by borrowing more than it could repay
for a disastrous incinerator project, Central Falls by pension problems, and
Hamtramck by the woes of the auto industry. Viewed another way, though, they
show how the downturn has left the nation’s most distressed cities with few
options for papering over huge problems, and left some desperate elected
officials placing their hopes in bankruptcy judges.
Their desire for simple solutions may be in vain, though: for constitutional
reasons, the part of the federal bankruptcy code that municipalities use,
Chapter 9, sharply limits the power of bankruptcy judges to intervene in local
governance.
“Chapter 9 really puts the judge more in the position of being a referee than
somebody who can really run the county,” said Paul S. Maco, a partner with the
firm of Vinson & Elkins who led the Office of Municipal Securities at the
Securities and Exchange Commission during the bankruptcy of Orange County,
Calif. — the nation’s largest municipal bankruptcy until this week. “Chapter 9
doesn’t take away the difficult political decision-making needed to address a
financial credit problem.”
Jefferson County has been plagued by distrust for years. The state, under
Gov. Robert Bentley, had tried to broker a deal to avert bankruptcy. It fell
apart, county officials said, over a failure to reach agreements with creditors.
County officials decided that the county’s credit was so bad that filing for
bankruptcy risked little.
By any measure, Jefferson County, home to nearly 700,000 people and to the
city of Birmingham, is an extreme case. The seeds of its fiscal collapse were
planted more than a decade ago when the county was ordered to rebuild its
dilapidated sewer system, which had been sending raw sewage into rivers. The
county, which had long sought to avoid paying the true cost of its sewer system,
signed off on a series of complex financial deals that officials barely
understood. The deals had hidden risks, and they went bad.
Several officials were convicted of taking bond-related bribes, including a
former county commission president and Birmingham mayor. Two bankers are
fighting federal accusations that they made secret payments. And in 2009, J. P.
Morgan Securities forfeited $752 million to
settle a fraud complaint by the S.E.C.
The complicated bond-and-derivative structures did not work out for the
county: they failed during the financial turmoil of 2008, leaving the county
with a $3.2 billion debt, to be repaid faster than planned.
The debt crisis was then compounded by a budget crisis when one of the
county’s biggest sources of revenue, an occupational tax, was struck down in
court and Alabama’s Legislature balked at letting the county replace it with a
new tax. That forced Jefferson County to slash its budget by nearly a third: it
laid off more than 500 workers, closed several court houses, and stopped
maintaining its roads.
Now officials say they will have to come up with an additional $40 million in
cuts by Jan. 1. Given that the sheriff’s department is no longer responding to
car accidents on county roads, county officials said, there seems little left to
trim.
“All of the areas that are not constitutionally mandated are next to be cut,”
said James A. Stephens, a county commissioner, mentioning senior citizen
services, building inspectors and economic development expenditures. In other
words, he said, Jefferson County, home to the largest city in the state, will
have the bare-bones services of a sparsely populated rural county.
Many in the county are pinning their hopes on the bankruptcy: by the time the
county filed this week, faith that the various players could arrive at a fair
deal had sunk as low as ever.
The corruption of the previous county commissioners, the political failures
of the Legislature and the legacy left by Wall Street had resulted in an
atmosphere of distrust. “I favor bankruptcy frankly because I don’t trust the
Alabama Legislature,” said U. W. Clemon, a retired federal judge whose law firm
was hired by the Birmingham City Council last month to find ways to block
increases in sewer rates.
Bankruptcy was also supported by Arthur Payne, a Republican state lawmaker.
Mr. Payne, who strongly opposed allowing Jefferson County to raise revenue to
replace the occupational tax, said he considered the proposed settlement, which
would have resulted in years of sewer rate hikes, “unconscionable.”
“The people on the Jefferson County sewer system can’t pay more than they’ve
got,” he said.
But those hoping for quick or easy solutions may be disappointed. After the
city of Vallejo, Calif., recently emerged
from a lengthy bankruptcy, some officials said they wished that they had
untangled their problems on their own. Ultimately much of the power to bring
Jefferson County out of its bankruptcy will rest with the same state and local
officials who have been at odds in recent years.
A debtor in Chapter 9 does not necessarily have to get court approval before
spending money, the way a corporation in Chapter 11 would. The court lacks
authority to control a municipality’s budget, taxation, provision of services or
other activities. Creditors have less power, too, than in a corporate
bankruptcy: they can’t foreclose on government buildings and demand that they be
sold to pay debts.
Some governments have discovered that once they entered Chapter 9 it did not
make much difference in their ability to solve their problems. Mr. Maco, the
former S.E.C. official, said Orange County’s case showed the difficulties of the
procedure. “Their path out of bankruptcy was difficult,” he said.
For instance, he said, before the county could issue new securities — an
essential step — it had to get voters to approve a new tax, but the voters shot
it down.
“It was not smooth sailing for them at all, but a lot of work,” he said.
“There’s a lot of work ahead for Jefferson County.”
Campbell Robertson reported from Birmingham, and Mary Williams Walsh and
Michael Cooper from New York.