Jefferson County’s problems were unique. Unlike Detroit, Vallejo and Stockton, it does not have any union contracts (Alabama has a “right to work” law prohibiting agreements between labor unions and employers). Also, the county’s statutory pension program for public workers is fully funded. Rather, a massive, unanticipated tax revenue shortfall combined with more than $3 billion in sewer-related debts brought it to its knees.
The tax-revenue deficit occurred swiftly, when the Alabama Supreme Court in March 2011 struck down the county’s occupational tax as unconstitutional. “The tax [0.45 percent on wages of all workers in the county] provided about 40 percent of the general fund’s revenue,” says Patrick Darby, a partner at the Birmingham-based law firm Bradley Arant Boult Cummings, one of two firms representing the county in the bankruptcy proceedings. “Although a replacement tax was enacted, that, too, was struck down as unconstitutional.”
The sewer debacle is more nuanced. “We were under an EPA mandate to do an extraordinary volume of work on the sewer system, and we borrowed heavily to fund it,” Darby says. “The county was sold some faulty derivative financial products, a process that was tainted by fraud and corruption. Ultimately, some elected officials and contractors were sent to jail and we defaulted on the sewer debt.”
Jefferson County wasn’t the only municipality playing with fire. “Orange County and other local governments also used and abused exotic financing tools like derivatives,” says Marc Pfeiffer, assistant director of the Local Government Research Center at Rutgers University’s Bloustein School for Planning and Public Policy. “Such tools are not appropriate for government agencies, and we’ve fortunately seen a real reduction in these practices.”
These warnings came too late for Jefferson County, however. “Without getting any assistance from the Alabama legislature to replace the tax, and without making any progress to renegotiate the sewer debt,” Darby says, “the county determined there were no options left other than Chapter 9.”
When Bankruptcy Makes Sense
One can argue that there are always options to avoid bankruptcy. But when there is no money left in the till to service outstanding debts or pay for ongoing operations, a city can’t print money like the federal government — something has to give. Chapter 9 does just that. It gives municipalities needed freedom from creditors and union contracts until a repayment plan between the parties is created to resolve outstanding debts and contractual issues.
While Pagano argues that Chapter 9 should always be a last resort, he believes that Detroit, Stockton, Vallejo and other municipalities had no recourse — not that he lets them off the hook for their financial messes. “Detroit operated in denial for decades, failing to diversify its economic base even though it was apparent that the Big Three automakers that put it on the map were pulling back,” he says.