How to Dig a Four Billion Dollar Hole

By Cameron Smith

Recently, Jefferson County, Alabama filed the largest municipal bankruptcy in U.S. history. However, the filing is only the latest chapter in a sad story for the county as well as the state. More importantly, many Alabamians have little idea how a county of less than 700,000 residents was able to accumulate more than $4 billion in debt.

In 1993, three Alabama citizens filed suit alleging that Jefferson County was polluting the Cahaba and Black Warrior Rivers in violation of the Clean Water Act. This case ultimately merged with a similar lawsuit filed by the EPA in 1994. In 1995, the judge in the case granted summary judgment for the EPA and plaintiffs because the facts, even viewed in a manner most favorable to Jefferson County, clearly demonstrated that the county had violated federal law. Instead of challenging the ruling further, Jefferson County agreed to negotiate a settlement known as a consent decree.

A consent decree is a judge’s order based on a voluntary agreement between parties in a lawsuit, which is enforceable by contempt and can be modified only by court order. In this case, the consent decree provided a mechanism for remedying flaws in the sewer system. The decree called for the county to provide the EPA with a series of evaluations of the sewer system which, in turn, resulted in an implementation plan to correct the offending features of the system.

Unfortunately, the decree also contained a provision that the county could, at its own discretion, make modifications to the implementation plan for “projects not specifically covered by [the] [c]onsent [d]ecree.” This provision permitted Jefferson County to add projects to their sewer improvement plans while giving the impression the improvements were necessitated by the initial consent decree.

In a comprehensive doctrinal dissertation at Auburn University entitled Jefferson County, Alabama: A Perfect Storm of Ethical, Financial, Political, and Market Failures, Louis Ray Morris, Jr. notes that Jefferson County’s 1997-1998 capital budget contained 50 projects required by the consent decree as well as 54 additional sewer-related projects, twice as many projects as actually necessary.

As the cost of the sewer system ballooned, Jefferson County engaged in the risky practice of municipal interest rate swaps as a means to protect against higher future interest rates on the county’s variable rate debt. These swaps were supposedly going to save the county more than $200 million. A Bloomberg Markets article released in 2008 noted that Jefferson County paid banks “$120 million in fees-six times the prevailing rate-for $5.8 billion in interest-rate swaps.” Instead, rates changed direction and the county piled on almost $300 million in additional debt.

The construction and financing of the sewer system were also fertile ground for criminal activity. The flexibility and lack of transparency afforded by the consent decree enabled more than two dozen Jefferson County commissioners, employees, and contractors to engage in a wide range of illegal activities.

To make matters worse, Jefferson County’s occupational tax, which accounted for around $66 million in fiscal year 2010, was struck down as unconstitutional. Legislators in Montgomery have been unable to reach an agreement to replace the lost tax revenue, in part because of concerns over the county’s recent history of poor management, lack of planning, and criminal activity. But even if those revenues remained consistent and were entirely allocated to paying Jefferson County’s debt obligation, it would take more than sixty years to pay off the principal owed without accounting for interest.

In the bankruptcy filing, Jefferson County acknowledged more than $3 billion in outstanding sewer warrants, more than $800 million in school capital improvement warrants, and more than $200 million in general obligation warrants. With accelerated payment and penalty interest provisions, the county’s debt could increase exponentially.

Jefferson County residents now face bankruptcy and a $4 billion hole that translates to more than $6,500 in debt for every resident of the county. Jefferson County leaders dug that hole the same way the federal government dug a $15 trillion one: nobody held government officials accountable for playing fast and loose with borrowed money. If this pattern continues in Alabama and across the country, Jefferson County’s fall will be just the beginning.

Cameron Smith is General Counsel for the Alabama Policy Institute, a non-partisan, non-profit research and education organization dedicated to the preservation of free markets, limited government and strong families, which are indispensable to a prosperous society.

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