Jefferson County, Alabama, is trying to put its terrible fiscal woes behind it after coming to a deal to exit the largest municipal bankruptcy in the nation’s history earlier this month. The county’s crushing debt load can mostly be traced back to a number of dodgy deals struck with J.P. Morgan to finance improvements to the sewer system. The deals landed several corrupt county officials in jail, led to substantial fines for J.P. Morgan, and left the city in disastrous fiscal shape.But according to the Wall Street Journal, Jefferson County may not be out of hot water yet. As part of the bankruptcy deal struck with the hedge funds holding most of the sewer system’s bonds, the county needs to raise $1.9 billion to refinance old bonds. It is proposing doing so in large part with capital-appreciation bonds, which allow borrowers to put off interest payments for years as long as they are willing to accept exorbitant interest rates—often two or three times the initial amount.
Such bonds have been derided by California’s treasurer as “terrible” for their backloaded payments, and Michigan has banned their sale by municipalities.All told, Jefferson County taxpayers would stand to repay nearly $6.9 billion over the four-decade term of the financing, more than three times the amount the county initially plans to borrow. That is perhaps billions more than they would pay under a plan whose payments would be more evenly distributed, said a potential investor.
The county is planning to pay for this borrowing by increasing the cost of sewer usage, but many analysts note that sewer revenue has been decreasing in recent years. If these trends hold, the county will have serious trouble paying back the bonds when they come due in 40 years and may face the same problems that sent it into bankruptcy in the first place.When local governments turn to exotic financial instruments peddled by Wall Street to paper over school funding gaps, fund construction projects, or keep pension plans afloat, they rarely come out ahead. Capital appreciation bonds are among the worst financial instruments for municipal governments, letting politicians avoid making tough decisions and handing down the consequences of their actions to future generations.