MuniLand

A municipal bankruptcy does not ruin a state

Chart source: Bonddesk

State politicians in Alabama, Pennsylvania and Rhode Island have lambasted municipalities within their borders that have either declared, or attempted to declare, bankruptcy. The politicians gripe that when a municipality in their state goes into Chapter 9 bankruptcy, it affects the cost of borrowing for the state and other issuers located there. But this rests on the false assumption that markets do not discriminate between different borrowers. Municipal bond issuers, like public companies, are looked at individually because every entity has its own story. After all, when American Airlines went bankrupt, it was not as if all airlines suffered.

Alabama Governor Robert Bentley explicitly used the increased cost of borrowing for other Alabama towns as a bludgeon against Jefferson County officials who declared bankruptcy last November. The Birmingham News wrote:

He [Governor Robert Bentley] said the county’s situation already has affected borrowing throughout the state and he expects the bankruptcy to increase the cost of borrowing even more. “The credit rating of Jefferson County is terrible already so it can’t get much worse, but certainly filing bankruptcy does not help,” he said. “I know they were frustrated but at some point, you have to step up and have to be a leader and have to be a statesman and you have to do what’s right. Bankruptcy is not right.”

I remember thinking at the time that the governor seemed to be exaggerating the effect Jefferson County’s bankruptcy filing would have on the state. In discussions with Chris Shayne, the senior market strategist at Bonddesk, the leading alternative trading platform, I asked if it would be possible to compare the yields of a bankrupt municipality with those of  its state. Chris and his team were able to pull six years of trade data and construct the chart above. Some amount of Jefferson County bonds and warrants are floating rate, so they have been excluded from the analysis. But you can still see that yields for the bankrupt county spiked way over the state’s borrowing cost. In his analysis Bonddesk’s Shayne said:

The main reason that the JeffCo bankruptcy was a non-event outside of Alabama is that it was not a surprise. The county has had well-documented financial troubles going back to the Great Recession of 2008. They were afflicted with a combination of serious problems, including heavy exposure to derivatives, fraudulent city officials, and difficulty raising new taxes. By the time they finally filed for bankruptcy protection last month, most observers were expecting the announcement. (It is also worth pointing out that neither JeffCo nor Harrisburg is large enough to roil the markets by themselves.)

How Jefferson County trips up national reporters

The New York Times really needs to improve the quality of its reporting on the municipal bond market. Mary Williams Walsh makes such a terrible hash of the situation in Jefferson County, Alabama, that she is bound to set off another muniland hysteria in the mold of Meredith Whitney.

In the opening paragraphs, Walsh contends that general obligation bonds (GO) issued by state and local governments and with the pledge of their “full faith and credit” may not be as creditworthy as always assumed. About half of the $3.7 trillion municipal bond market is general obligation bonds. She dramatically states that investors who own GO bonds might be in for a “surprise:”

People who own what is considered the safest type of municipal bond may be in for a surprise.

The cost of kleptocracy

Gary White, a former official of Jefferson County, Alabama, had his conviction on conspiracy and bribery charges affirmed by the U.S. 11th Circuit Court of Appeals today. White, a former county commissioner, is already serving a ten-year term in a South Carolina federal prison for his involvement in the sewer scandal that ended in the largest municipal bankruptcy ever. He’s just another piece of detritus from one of the largest cases of municipal corruption in recent American history. The Birmingham News reported the courts decision:

The opinion issued by the court, however, begins with stinging criticism of a period of corruption that included White and other Jefferson County commissioners.

“‘Kleptocracy’ is a term used to describe “[a] government characterized by rampant greed and corruption,” the court’s opinion began, citing three dictionaries. ”To that definition dictionaries might add, as a helpful illustration: “See, for example, Alabama’s Jefferson County Commission in the period from 1998 to 2008.”

Make Jefferson County’s receiver its salesman

The story of Jefferson County, Alabama filing the largest municipal bankruptcy ever last week is well-known. The county went into hock for about $3 billion to build an EPA-mandated sewer system. On the way to completing the system, every local crook and corrupt politician piled onto the project to skim off some pork. Many of these players ended up in prison and left the taxpayers saddled with a sewer system they really can’t afford.

Last year, amid the county’s fiscal and political meltdown, the Russell County Circuit Court appointed a water system professional, John Young, to take over the management and operation of the sewer system. This action came at the request of the bond indenture trustee, the Bank of New York, which wanted the bond payments protected. Now the county is fighting with the receiver and creditors for control of the sewer system in bankruptcy court. My advice to Jefferson County Commissioners is to stop fighting John Young and change his role into a salesman for the system. The sewer system is an albatross, and it should be sold and creditors repaid with the sale proceeds.

The Russell County Circuit Court’s mandate covered raising sewer rates and lowering costs but did not grant Mr. Young a role in facilitating a settlement with sewer debt creditors. According to Young, he took on that responsibility “unofficially.” He claimed to have traveled many times to New York City to negotiate potential haircuts on the outstanding debt, meeting repeatedly with JP Morgan, the biggest creditor, and other Wall Street banks. Young had a lot of experience dealing with Wall Street as the former president of the publicly-held American Water Works Company.

Jefferson County goes kaboom

Crushed by sewer debt and stripped of 48 percent of its general fund revenues by a state court, Alabama’s Jefferson County filed the largest municipal bankruptcy in history yesterday. The filing brings three years of financial chaos to an end and represents the largest default of municipal bonds and derivatives ever.

It’s been a long road for the county. In 1996 a federal judge ordered it to upgrade its sewer and waste water systems. To comply with that mandate, Jefferson County has issued over $3 billion in sewer debt, some of which was done in a blatantly illegal manner. The former Birmingham mayor and county commission president are now serving prison terms for bribery. Twelve others were convicted of bribery and conspiracy, and over twenty people involved in construction of the project have served jail time. The lead underwriter of the sewer debt, JP Morgan, also made the largest derivatives-related settlement with the SEC for an illegal payments scheme, although the bank admitted no fraud.

Jefferson County has been the poster child for muniland corruption for years as its residents have born the cost of the illegalities. Sewer rates have been raised 329 percent in the past decade. 500 county employees have been terminated. The county’s reserve funds have been depleted. Because of the crushing cost of the fraud the county has nowhere to turn but to the protection of federal bankruptcy court. With this filing, the county brings all court cases it is facing to a standstill and can halt debt payments until its massive liabilities have been adjusted.

When national and state data diverge

In our turbulent times, middle-income households are falling behind and national data depicts an economy that’s stagnating. But tax revenue data for many states hints that some earners have had substantial increases in their incomes.

Let’s start with the national numbers. There has been a lot of reporting this week about median personal income dropping since the official end of the recession in June 2009. Robert Pear wrote in the New York Times:

Between June 2009, when the recession officially ended, and June 2011, inflation-adjusted median household income fell 6.7 percent, to $49,909, according to a study by two former Census Bureau officials. During the recession — from December 2007 to June 2009 — household income fell 3.2 percent.

Municipal bonds are not just for rich people

This Bloomberg interview with John Miller, co-head of fixed-income at Nuveen Asset Management, is a good overview of the current state of muniland although I disagree with his comment that “many, if not most municipal bond holders are in the highest tax bracket”.

Actually IRS data tells us that about 75% of filers who claim exclusion for tax-exempt municipal interest earn less than $200,000 per year. As with all financial assets the richest own the most by quantity but municipal bonds are held pretty broadly. It’s not just a rich persons asset class.

Further: Citibank: US Municipal Strategy Special Focus

Big, big day for Jefferson County, Alabama

The Jefferson County Commission will hold a meeting today to determine whether to accept their creditors proposal for settlement of defaulted sewer bond debt or declare bankruptcy. My opinion is that they will settle and creditors will take a haircut of about 33 cents on the dollar. This will be a very important precedence for muniland workouts. Stay tuned. Here is some of the coverage:

“We don’t have a deal”

The Jefferson County Commission met last Friday to decide if they would accept a proposed settlement from creditors led by JP Morgan on their $3 billion of sewer debt. After many hours of meeting in executive session and in public, the Commission voted to reject the proposal, remove the court appointed receiver and directly negotiate with the creditors.

I watched the live webcast of the meeting and it was actually one of the most open and informed county commission meetings that I’ve ever seen. I give the Commissioners a lot of credit for their efforts to clean up a problem which they did not create. In the meeting there was a lot of indignation against JP Morgan and their role in burdening the county with several billion dollars of derivatives. Several Commissioners felt especially that there had been fraud in these transactions and were not willing to release their right to sue JP Morgan and other banks for these problems. There were also calls for increased transparency in the process. There was a lot of drama in the meeting.

The drama was only heightened when county commissioner, T. Joe Knight, saw a message on his mobile device in the middle of the meeting that said the Wall Street Journal was running a headline announcing that an agreement had been reached. You can see the video of Commissioner Knight above shouting, “We don’t have a deal”. When I clicked over to the WSJ.com the paper was running a story that quoted the state finance director and said that the Commission had accepted the proposal although the Commission had not yet voted. The Wall Street Journal eventually yanked the false story and replaced it with this account which makes their error seem less odious:

Watch Jefferson County Commission hearing live

The Jefferson County Commission is meeting now to review a counter-proposals from creditors lead by JP Morgan and decide whether to accept it or file for Chapter 9 bankruptcy. Live feed via the Birmingham News.

To recap, Jefferson County, Alabama is getting a lot of attention as it negotiates with the holders of $3 billion of sewer bonds. The county would like to pay $2 billion to settle the $3 billion of bonds outstanding and limit the rate increases county residents would have to pay. This arrangement would pay bondholders (led by JP Morgan) 66 cents on the dollar — not a great recovery but not outrageous either. Bondholders want the state to guarantee this new arrangement and stand ready to pay in the event of another default.

Update on creditor offer terms (August 12, 2011) via the Birmingham News:

THE CREDITORS’ NEW PLAN

> Refinance a principal amount of $2.326 billion, with $233 million going into a debt service reserve, $23.3 million paying issuance costs and $2.07 billion to redeem all outstanding sewer warrants based on negotiated concessions.

Geeks for democracy

Geeks for democracy

“How do you enable people to have a louder voice within their communities?” asks Conor White-Sullivan. He answered his own question by developing Localocracy, a platform that hosts community-focused discussion boards seeking participants who are registered to vote and who use their real names. Localocracy gives citizens an opportunity to generate discussions to influence each other, their government and journalists.

Conor is one of 16 winners of “Champions of Change,” a contest the White House hosted in June that showcased the potential of Web apps that utilize data sets made available by federal, state and local agencies. Developers who were chosen to attend created applications that enable users to find and organize pick-up games at public facilities, guide citizens through zoning ordinances and direct parents to child-friendly locations, as well as numerous other services. See more of this wonderful project at GovTech.com.

Jefferson County part 6

According to the Birmingham News the court-appointed receiver over the Jefferson County sewer system, John S. Young, announced late Wednesday that the bondholders had a counter-proposal for the county commission. This was a few short hours before the commission’s 1:00pm meeting today to decide to declare bankruptcy.

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