U.S. News

Bond Deals Push Counties Close to Bankruptcy

Kyle Whitmire and Mary Williams Walsh|The New York Times

In 2002, a banker named Charles E. LeCroy arrived in Birmingham, Alabama, with a novel pitch to ease taxpayers’ burden. Some Wall Street wizardry, he said, could lighten their load.

Susan Walsh

Six years on, officials here are still struggling to untangle the financial web that Mr. LeCroy and his fellow bankers spun. Jefferson County is teetering on the brink of bankruptcy after a series of exotic bond deals that the bankers concocted went wrong, and the interest on its debts, rather than shrinking as the bankers had promised, has ballooned like a bad subprime mortgage.

Officials from Birmingham, the county seat, are trying to persuade Wall Street creditors to let them soften the terms of the deals. If they fail, the county could sink into in one of the biggest public bankruptcies in American history.

The running credit crisis and looming recession are squeezing communities across the country. But perhaps nothing else comes close to the financial fiasco unfolding here.

During the last few years, Jefferson County entered into a series of complex transactions, called swaps, worth a staggering $5.4 billion. The accusations and recriminations are flying. Talk of Wall Street tricks — and local corruption — has captivated residents and left many wondering how the county will pay its bills.

"There are 101 messes up there, and they are not all cleaned up yet," said Jim White, the  resident of the Birmingham law firm of Porter White, which is advising the county on its  finances.

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At the heart of this story are Mr. LeCroy, who arranged many of the transactions; a Montgomery investment banker, William Blount, whose firm, Blount Parrish & Company, earned larger fees than any other adviser on the transactions; and Larry P. Langford, the local official who signed off on the deals.

As a managing director at JPMorgan Chase, Mr. LeCroy persuaded the county to convert its debt from fixed interest rates to adjustable rates. He also recommended that the county use interest-rate swaps that he said would protect it if interest rates rose.

Mr. LeCroy, however, is no longer in the bond business. He landed in prison for three months in 2005 in connection with a municipal corruption case in Philadelphia. He has left JPMorgan Chase and declined to comment for this article.

Mr. Langford, now the mayor of Birmingham, previously oversaw the county’s finances. He says he had no idea what Mr. LeCroy and the many other bankers on the deals were doing, and he asked for Mr. Blount’s help in vetting their proposals.

"I needed somebody to be able to tell me what all that stuff was," Mr. Langford said in a deposition in June. "And even when they told me, I still don’t understand 99 percent of it."

Mr. Langford, though, faces legal troubles of his own. The Securities and Exchange Commission is investigating whether he steered bond underwriting business to Mr. Blount’s company in return for payments, a claim he has denied.

Negotiating with Creditors

Mr. Langford has a history of financial problems, including an ill-fated plan to build a local amusement park called VisionLand, and a self-professed propensity to shop. "I like clothes," Mr. Langford said in his deposition.

Bettye Fine Collins, who succeeded Mr. Langford as commission president in 2006, says Jefferson County is negotiating with its creditors, but the results are still uncertain.

"Those at the poverty level, those parents on the free lunch programs, I don’t know how much they can bear," Ms. Collins said. "They’re probably paying $4 a gallon for regular gas, and everything in sight is going up except their salaries or their Social Security checks."

The troubles in Jefferson County, which is perched on the foothills of the Appalachian Mountains, began more than a decade ago. The county’s sewers were discharging raw sewage into the Black Warrior and Cahaba Rivers during heavy rains. In 1996, a federal court ordered the county to refurbish the system.

Mr. LeCroy, first as a swap adviser and broker with Raymond James and later with JPMorgan, helped the county sell bonds to pay for the upgrade. But in 2002, after Mr. Langford was elected county president and vowed to rein in costs, Mr. LeCroy urged the county to reduce its interest payments by refinancing its debt and switching to adjustable rates from fixed rates. As a hedge, he recommended swaps.

The county ended up with 18 different swaps at one point, an extraordinary number for a county government. The notional value of the swaps surpassed the value of the bonds they were supposed to hedge.

Mr. Langford agreed to the plan — and in the process locked Jefferson County into borrowings that may ruin the county, even though they have richly rewarded its bankers.

Last week, the county warned that it did not have enough money to cover the hedges, which ended up costing it money when rates moved in unexpected ways. The situation became critical when the insurance companies standing behind the bonds had their own credit ratings downgraded. Officials are trying to work out a stabilization plan, but the outcome is far from certain.

Legal Questions

The county’s financial dealings have also raised thorny legal questions, which in turn may make it harder to negotiate with its creditors. The S.E.C. deposed Mr. Langford last year in an effort to learn whether any securities laws had been broken when Jefferson County refinanced its bonds — particularly the laws that bar bankers and others from "buying" lucrative municipal bond business by giving gifts to the officials who control the bond deals.

Instead of letting these bankers compete for the county’s business in an open bidding, the five county commissioners divided up the deals among the people they knew.

Mr. Langford said he chose people who had responded to his calls for money to send children to Bible camp and to support a charitable skeet shoot-off, as well as people who had helped him pay off his many debts. One of his donors was Mr. Blount. The S.E.C. also asked Mr. Langford about an e-mail message in which Mr. Blount warned Mr. LeCroy that the county commissioner was "hitting us up" for contributions to a ministry project.

Mr. Langford said he chose the people he did because he knew they were capable and he trusted them. He said that Mr. LeCroy did not make any unusual payments to him. The S.E.C. also questioned him about payments that Mr. Blount had made to a local lobbyist who had paid off one of Mr. Langford’s delinquent loans at about the same time. Mr. Langford said he did not know where the lobbyist got his money.

Jefferson County’s case is an extreme one, but its missteps are not unique. Other communities around the country have also found themselves holding complex financial instruments that did not perform as advertised. As the troubles in the credit markets continue to spread, more such problems are likely to surface. Nor do many local governments hold open, competitive biddings when they issue bonds.

"I don’t think there’s anyone who has been involved in the swaps and derivatives market to the extent that the Jefferson County sewer system was," said Paul Maco, director for the Securities and Exchange Commission’s office of municipal securities during the Clinton administration.

Of 11 swaps and similar contracts Jefferson County went into from 2001 to 2003, eight were with JPMorgan Chase. A spokesman for the bank declined to comment.

For now, the residents of Jefferson County are bearing the burden of the ill-fated deals. Residents’ sewer rates have tripled. And, residents say, the sewers still do not work properly.