JPMorgan Swap Deals Spur Probe as Default Stalks Alabama CountyMay 22 (Bloomberg) -- As nighttime temperatures plunged in Birmingham, Alabama, last October, Dora Bonner had a choice: either pay the gas bill so she could heat the home she shares with four grandchildren, or send the Birmingham Water Works a $250 check for her water and sewer bill.
Bonner, who is 73 and lives on Social Security, decided to keep the house from freezing.
``I couldn't afford the water, so they shut it off,'' she says.
Bonner's sewer bills have risen more than fourfold in the past decade. So have those of others in Jefferson County, which has 659,000 residents and includes Birmingham, the state's largest city.
What's threatening to increase them even more isn't the high cost of treating waste; it's the way county officials chose to finance the $3.2 billion in debt they took on to build a new sewer system. The county relied on advice from a bank, JPMorgan Chase & Co., to arrange its funding, rather than use competitive bidding.
Like homeowners who took out mortgages they couldn't afford and didn't understand, Jefferson County officials rejected fixed- rate debt and borrowed instead at rates that varied with the market.
The county paid banks $120 million in fees -- six times the prevailing rate -- for $5.8 billion in interest-rate swaps. That was supposed to protect the county from rising rates for their bonds. Lending rates went the wrong way, putting the county $277 million deeper into debt.
Interest Rate Soared
In February, the county's interest rate soared to as much as 10 percent, up from 3 percent just weeks earlier. The swaps have now compounded the risk that Jefferson County will file for bankruptcy as it faces its worst financial crisis since it was founded in 1819.
The same subprime chaos that has felled chief executive officers on Wall Street and forced banks to write off $322 billion has plowed into Jefferson County and other municipalities. That means local officials now have to pay to banks money that otherwise might have been used to build schools, hospitals or public housing.
Meanwhile, the U.S. Securities and Exchange Commission and the Justice Department are now investigating bankers and officials involved in Jefferson County's swap agreements.
Bankers who worked for New York-based Bear Stearns Cos. and JPMorgan when Jefferson County bought its swaps have been told they might face criminal charges under an antitrust investigation of the municipal derivatives industry, according to records filed with the Financial Industry Regulatory Authority Inc.
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Standard & Poor's downgraded Financial Guaranty's credit rating to AA from AAA on Jan. 31. The next week, Moody's Investors Service cut XL Capital six levels to A3. Moody's then downgraded Financial Guaranty to A3.
When a bond insurer takes a ratings hit, so do the bonds it has guaranteed; the insurer effectively lends its high rating to the bond issuer.
That's what happened to about $3 billion of Jefferson County's debt, causing its interest rate to balloon to as high as 10 percent in February and March from 3 percent in January. That helped increase its total monthly debt payments to $23 million from $10 million.
``It happened overnight,'' County Commission President Bettye Fine Collins says. ``It became a situation that worsened every day.''
The turmoil in Jefferson County might be just the beginning of a new, painful chapter in the subprime debacle.
``The Jefferson County crisis could have national implications,'' says U.S. Representative Spencer Bachus, who represents the county and is the top Republican on the House Financial Services Committee. ``Large defaults in the municipal bond market could have a ripple effect on the larger U.S. financial system, again causing systemwide financial stress.''
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