Jefferson County, Ala., Falls Off the Bankruptcy Cliff | G7Finance ...

David Bundy for The New York Times

Birmingham, above, has been struggling in recent years and its county, Jefferson, is grappling with the realities of bankruptcy.

ONE county jail here is so crowded that some inmates sleep on the floor, while the other county jail, a few miles down the road, sits empty.

There is no money for the second one anymore.

The county roads here need paving, and the tax collector needs help.

There is no money for them, either.

There is no money for a lot of things around here, not since Jefferson County, population 658,000, went bankrupt last fall. There is no money for holiday D.U.I. checkpoints, litter patrols or overtime pay at the courthouse. None for crews to pull weeds or pick up road kill ? not even when, as happened recently, an unlucky cow was hit near the town of Wylam.

?We don?t do that any more,? E. Wayne Sullivan, director of the roads and transportation department, said of such roadside cleanup.

This is life today in Jefferson County ? Bankrupt, U.S.A. For all the talk in Washington about taxes and deficits, here is a place where government finances, and government itself, have simply broken down. The county, which includes the city of Birmingham, is drowning under $4 billion in debt, the legacy of a big sewer project and corrupt financial dealings that sent 17 people to prison.

If you want to take a broad view, the trouble really began with the Constitutional Convention of the State of Alabama in 1901. The document that emerged there ? written to empower business interests and disenfranchise African-Americans and poor whites ? gives towns and counties little authority over local issues. Local taxing power rests with the state, though state lawmakers are loath to wield it today, in an age of anti-tax populism. Last summer, the Supreme Court of Alabama struck down a tax that was a crucial source of revenue for Jefferson County, finally pushing the county over the brink.

Officials here have only begun to grapple with the implications of life under Chapter 9 of the federal bankruptcy code, a municipal form of debt adjustment, rather than reorganization or liquidation. Until now, the most famous example was Orange County, Calif., which filed for Chapter 9 in 1994, after risky investments went horribly wrong. Many local governments are struggling to pay their bills these days, but hardly any have filed for bankruptcy. Notable exceptions include Harrisburg, the capital of Pennsylvania, Vallejo, Calif., and Central Falls, R.I.

?This is really a journey without a road map,? said John S. Young, the civil engineer who was appointed by an Alabama court to figure out how to fix Jefferson County?s sewer system. Today he is that project?s official receiver in name only: a federal bankruptcy court has suspended his powers, ruling that the federal bankruptcy law trumps state laws that protect bondholders.

Ordinary citizens can?t do much at this point. Jefferson County has even canceled municipal elections scheduled for this August. It seems that there?s no money for voting booths, either.

IN late 2010, a Wall Street analyst, Meredith Whitney, caused a stir during an appearance on ?60 Minutes.? The $4 trillion market for municipal bonds, Ms. Whitney said, was headed for trouble. Within 12 months, 50 to 100 sizable defaults, possibly more, would rattle the market, she predicted.

The reaction was stunning. In a blink, billions of dollars flew out of the muni market. Mutual funds that specialized in such bonds were hit especially hard.

Ms. Whitney?s prediction hasn?t come to pass, and the muni market ? usually a dull-as-dishwater corner of Wall Street ? has since recovered.

Many muni experts called Ms. Whitney an alarmist, but she clearly touched a nerve. States, counties, cities and towns issue many billions of dollars worth of new munis every year, and those bonds pay for all sorts of things. Government bodies nationwide can borrow those billions at a low cost because munis are traditionally considered among the most conservative of investments. Without quick and easy access to this market, local government as we know it would fall apart.

That?s why the developments in Jefferson County are so unnerving. About 300 municipalities nationwide are in default on their debt, but most of them are so tiny that they draw little attention. What is more, after New York City ran into financial trouble in the ?70s, and Cleveland fell into a hole in the ?80s, the federal bankruptcy code was changed to ensure that certain types of muni bonds would keep paying interest and principal even if the issuing government authority sought bankruptcy.

Yet Chapter 9 bankruptcies have been so rare, and Chapter 9?s involving lots of bonded debt rarer still, that there is almost no legal precedent for what is happening in Jefferson County. Its lawyers are negotiating with roughly 4,000 creditors, from suppliers to hedge funds. The federal bankruptcy judge in the case is exerting enormous influence. By the time this is over, the lines between state and federal power may be redrawn when it comes to who, if anyone, can force a community to make good on its promises.

?It could set a precedent for the whole market,? said Matt Fabian, a managing director at Municipal Market Advisors, a research firm.

Kyle Whitmire contributed reporting from Birmingham.

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