Were Bailouts a Bad Idea? Alabama Bankruptcy Could Provide Test Case

PHOTO: The city of Birmingham, Ala., the biggest city in Jefferson County, is seen in this undated file photo.
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Alabama's Jefferson County, home of the state's largest city and 650,000 Alabamians, filed for Chapter 9 bankruptcy in federal court after defaulting on a massive and corrupt sewer project dating back two decades.

The record $4 billion bankruptcy filing dwarfs the $1.7 billion Orange County bankruptcy in California in 1994.

County officials say the filing is a fresh start and a way for Jefferson County, the city of Birmingham, and the state of Alabama to put one of its biggest fiascoes behind it. Some 22 local officials were found guilty for taking sweetheart deals spun by gung-ho Wall Street speculators.

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But others say the bankruptcy could be a drag on the Alabama economy for years to come.

Indeed, what happens now is, in some ways, uncharted territory.

The bankruptcy is a test of whether the Republican-controlled state Legislature's tough-love ploy – refusing to bail out the county – will work or backfire. And the bankruptcy is the biggest test yet of Chapter 9 laws devised after the Depression precisely to help indebted cities manage the conflicting priorities of paying back creditors while still providing public services and benefits to taxpayers.

"The last time we saw a situation with a lot of insolvent states was during the Depression, but the current Chapter 9 laws didn't exist then," says Melissa Woodley, a finance professor at Samford University in Birmingham. "So the extent to which bankruptcies can allow you to reorganize, nobody really knows because the current law is untested. That's why a lot of people are going to be really looking at how this process works."

The ordeal started in 1991 when the Environmental Protection Agency ordered the county to upgrade its sewage system. In the early 2000s, Larry Langford, the county commission chairman who later became mayor of Birmingham, colluded with a former Democratic politician-turned-investment broker to put together a risky bond deal that involved derivatives and interest-swaps – the exact kind of murky instruments that led to the Wall Street crash of 2008.

Mr. Langford was arrested, tried, and found guilty on a variety of corruption charges, including taking bribes and gifts from JP Morgan Chase, a major Wall Street bank. The company paid a $722 million fine to the Securities and Exchange Commission in 2009 as a result.

After coming close to a deal with its chief creditors several times, the county broke off talks and the court-appointed receiver this week, opting to declare bankruptcy. The decision could shake the municipal bond markets, affect Alabama's ability to borrow money at good rates, and affect confidence among corporate developers eyeing Alabama for investment.

It comes as the state is already taking flak for implementing the toughest anti-immigration law in the US, which has caused hardship for Hispanic migrants, farmers, and construction companies.

"The Jefferson County sewer-debt crisis has been an impediment to economic growth in the state, and the bankruptcy filing will now be an even greater challenge to overcome," Gov. Robert Bentley said in a statement.

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