Yesterday, a democratic jurisdiction that is part of a much larger and deeply interconnected political federation declared bankruptcy. This bankruptcy promises to have a significant disruptive effect across the larger federation. Think I’m talking about Europe? Think again.
Jefferson County, Alabama, filed the largest municipal bankruptcy in United States history this past Wednesday. The filing was precipitated by a $3.1 billion bond debt (related to the county's sewer system) could not be re-financed in the court of negotiations with creditors.
Negotiations between the county and its creditors had been ongoing for months, with creditors pushing for large rate hikes to county residents, to offset the large debt payments owed by the county. In the end, the parties were more than $140 million apart in trying to renegotiate the debt, prompting the county to take advantage of a little-used provision of United States Bankruptcy Code.
For many people, the idea of a corporation, individual or even a financial institution filing for insolvency is fairly well understood. The idea of a city or municipality filing for protection from its creditors, however, is unheard of. The ability to file is contained in the little-known 'Chapter 9’ of the US Bankruptcy Code (Chapter 11 deals with corporate rescue, while Chapter 7 deals with liquidation). While Chapter 11 is knows as being amongst the most 'debtor-friendly' bankruptcy statutes in the world, Chapter 9 is even "friendlier" for the municipality seeking protection. for example, the presiding court cannot force the municipality to sell assets
While Chapter 9 is not well known, this is actually the 12th filing under Chapter 9 by a municipality in the US this year. In each case, as will be the case in Jefferson County, banks and bondholders have been forced to accept hundreds of millions of dollars in 'haircuts' and access to credit for defaulting municipalities has become severely constrained, in the form of far higher borrowing costs. This has the effect of imposing severe austerity (in the form of drastic reductions in services, including so-called 'essential' services like firefighters and police) on these defaulting municipalities. All over the United States, however, the evidence appears to be that investors are dumping municipal bonds, forcing borrowing costs higher and possibly precipitating further municipal bankruptcies. This has the potential to have a devastating impact on people's lives as municipalities are forced to cut police forces, firefighter brigades, libraries and public service pensions.
In his new book, Boomerang: Travels in the New Third World, Michael Lewis draws parallels between states and municipalities in the US and some European countries, arguing that, in each case, individuals operated on the basis of very short-term thinking, trying to grab what they could for themselves or their constituencies (in this regard, he picks on public service unions in US cities and on recalcitrant taxpayers in parts of Europe). This may be an oversimplification, as there is plenty of blame to go around.
What is becoming clear, is that over the last 20 years, individuals, banks, companies, countries and even cities all appear to have conspired, perhaps unwittingly, to enter into a giant mortgage of their collective futures...and the time to pay may finally have arrived.