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Bankrupt City Prepares New Debt Sale


Will the market still lend to cities after they’ve gone bankrupt? Jefferson County, Alabama is looking to find out, announcing plans to sell nearly $2 billion in new debt on its sewer system, only two years after filing for bankruptcy in 2011. Many investors are skeptical that this is a good investment—after all, 2011’s bankruptcy ended with creditors forgiving $1.4 billion in sewer debt. Yet despite the skepticism, S&P has rated the debt as investment-grade, and some are speculating that the higher yields (possibly above 6 percent) could lure pensions and hedge funds to get in on the action.

But as the WSJ notes, the biggest question here is what message this will send to other cities on the verge of bankruptcy:

“You always hear the threat that if you default on your debt, the market will freeze you out,” says Matthew Dalton, chief executive of Belle Haven Investments, which manages $1.8 billion in municipal bonds and is considering whether to buy the new Jefferson County debt. “This deal washes that away.” […]

Such deals are helping bolster arguments by lawyers and officials in formerly or currently bankrupt cities in Rhode Island, California and Michigan that Chapter 9 is an effective tool for cities and other municipalities to right-size their debts. Chapter 9 of the federal bankruptcy code allows cities and other municipalities to seek protection from creditors.

“I would rather lend to someone who has cleaned up their balance sheet rather than someone who hasn’t,” said John Knox, a lawyer at Orrick, Herrington & Sutcliffe LLP who advised Stockton and Vallejo on recent bond deals.

It’s still not clear whether this will work—S&P may be sold on the value of this debt, but Fitch and Moody’s are unconvinced, and are warning investors away. And it’s still not clear whether more borrowing is what the city needs. But if the debt sale goes ahead without a hitch, the fact that a municipality could sell new debt so shortly after entering bankruptcy would make bankruptcy a more attractive option for struggling cities, especially with the pension crisis continuing to take its toll on their budgets.

[Birmingham skyline photo courtesy of Shutterstock]

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  • Bruce

    Eventually, the laws of mathematics and debt will impose themselves at all levels of society. The implosion will not be pleasant.

    • WeirdLore

      I don’t know much about Jefferson County, but if it is like Detroit – it will tend to continue policies that have hightly policies.

  • free_agent

    I can see some of these cities going through a series of bankruptcies. It wouldn’t be the first time that a mess of debt was gradually transferred to over-optimistic investors.

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