Jefferson County has $3.2 billion of bond debt, not including fees, interest and penalties. That’s enough money to buy Larry Langford a $2,000 suit every day and a $10,000 Rolex every week — for the next 2,500 years. If Langford put $3.2 billion into a slot machine 16 hours a day, one quarter every four seconds with the typical 95 percent payout, it would take him a little less than 50,000 years to blow that much money.
That’s how much money Jefferson County owes, but of course, the county can’t pay it.
Most of the county’s bond debt is the result of a decade-long boondoggle premised upon the rehabilitation of the county’s sewers. Originally projected to cost about $1 billion, the court-ordered rehab was inflated by disguised expansion work, including the infamous Super Sewer under the Cahaba River, and compounded with petty corruption and no-bid contracts. Commissioners, county bureaucrats and sewer contractors have been convicted of public corruption, but until recently, the financial arm of this disaster had gone legally untouched.
The county is now arguing that it was duped, swindled even, by Wall Street bankers, local free agents and freewheeling politicians. In a lawsuit filed last week in Jefferson County Circuit Court, the county accuses its largest creditor, JPMorgan Securities, of conspiring with local politicians and investment bankers to sell the county extremely complicated derivatives called interest rate swaps. Further, the county says the same banks convinced it to use an unstable debt structure of variable-rate demand warrants and auction-rate securities, sometimes converting safe fixed-rate debt to these floating-rate instruments. The result was a debt structure that quickly imploded and left the county financially ruined.
That the debt structure was a disaster was unquestioned. The new aspect is the now-official assertion that corruption and fraud were contributing factors.
Certainly there has been reason to suspect foul play, but in recent weeks, three things have occurred to give the county a legitimate claim that it was the victim of fraud.
First, the public corruption trial of Larry Langford proved that at least one firm, Blount Parrish & Co., acted as a sort of Wall Street bagman, locking banks into work with the county in exchange for millions in fees for no real work. Portions of those fees then went to Langford, who served as county commission president and chairman of the finance committee.
Second, the county’s swap advisor, CDR Finance Products, was indicted on federal charges that it rigged similar deals. Federal prosecutors have accused CDR of colluding with banks to inflate fees in exchange for more lucrative business. The indictment does not accuse CDR of acting improperly in Jefferson County, but the association has been conspicuous.
Third, after years of investigation, the Securities and Exchange Commission finally filed suit against JPMorgan Securities and two of its bankers, Douglas MacFaddin and Charles LeCroy. According to the lawsuit, which the county cribs from heavily, LeCroy and MacFaddin conspired with Jefferson County commissioners to direct millions in fees for bogus work to the commissioners’ pet bankers. These bankers never really did any work, and on at least one occasion, LeCroy and MacFaddin struggled to concoct a bogus title for these bankers in the public disclosures.
Little did LeCroy and MacFaddin know at the time, but they were suspects in a federal corruption investigation. Federal investigators probing public corruption in Philadelphia had wiretaps on the bankers’ phones. Recorded conversations among the two bankers and some of their coworkers suggest blatant acceptance of and participation in public corruption here in Jefferson County and possibly elsewhere.
In 2005, LeCroy pleaded guilty to two counts of wire fraud in connection to public corruption in Philadelphia. He has since spent time in prison and been released.
Some believe that the bankers were part of a much wider and prolific scheme to hopscotch the country, selling municipalities on these complex derivatives and risky debt instruments. Indeed, the same bankers involved in Jefferson County performed similar services in Pennsylvania, Georgia, New Mexico and even elsewhere in Alabama.
Retired investigators have told the media about a massive multi-agency investigation into JPMorgan and CDR, but that investigation has yet to result in any indictments other than CDR. Were an investment bank, such as JPMorgan, to be an indicted, it could lose its securities licenses in most, if not all, states. Were JPMorgan to be indicted, it could pose an unthinkable threat to the bank itself and, in turn, the economy.
Elsewhere in the world, prosecutors are not letting the bank’s precarious circumstances keep them from pursuing legal action. In Milan, Italy, prosecutors are accusing JPMorgan, among other banks, of engaging in practices conspicuously similar to what transpired in Jefferson County. Public officials there are accused of conspiring with investment bankers to sell the city derivatives it didn’t need, swaps that created a tumultuous debt structure. The Italian government has seized JPMorgan’s assets in that country until the matter has been settled in court.
When the SEC sued JPMorgan two weeks ago, the bank simultaneously settled the lawsuit. It agreed to forfeit $647 million of swap termination fees and also agreed to pay fines of $25 million to the SEC and $50 million to Jefferson County. However, JPMorgan did not concede in the settlement that it had done anything wrong, and the settlement did little to help Jefferson County deal with its crushing debt.
While the county was eager to have that $50 million, officials said early last week that the settlement didn’t let JPMorgan off the hook. In the absence of criminal action against JPMorgan, the county has been left to take action in state civil court.
Since the county’s debt structure imploded in early 2008, bankruptcy has loomed as a last-ditch alternative for fighting off creditors. Conceivably, in bankruptcy court, the county could elicit testimony from the same bankers it is suing today. If JPMorgan’s agents, including LeCroy and MacFaddin, were forced to invoke their Fifth Amendment rights on a witness stand, that bit of courtroom showmanship would work well for Jefferson County. As the theory goes, if JPMorgan had engaged in illegal activities in Jefferson County, it might be best for the bank to walk away from its debt here rather than have those illicit acts exposed in open court.
In effect, bankruptcy would be a game of chicken between Jefferson County and one of the largest financial institutions in the United States.
However, the SEC’s lawsuit takes some pressure off the county to choose that tactic. In the lawsuit, the SEC revealed things that had long been rumored but never provably shown. In particular, during the Langford investigation, it had been rumored that there were wiretaps on JPMorgan’s trading desk. The SEC lawsuit has not only confirmed that those wiretaps existed, but it has also disclosed some of the contents.
In the coming weeks and months, it will be crucial for the county to insist on one thing —
that beyond speculation and conjecture it had no concrete reason to believe it was a victim of a fraud until the Langford trial and SEC lawsuit.
In Alabama, the civil statute of limitations for fraud is two years from when the plaintiff first knows a fraud has occurred. The county has to show that happened in recent weeks, not earlier.
That might explain why one current commissioner, Shelia Smoot, and two investment banks she directed business to are not defendants in the county’s lawsuit. The SEC lawsuit alleges that JPMorgan directed bogus fees to two firms, Gardnyr Michael and ABI Capital, at Smoot’s insistence. Both firms hired a close friend of Smoot as a so-called consultant.
JPMorgan could argue that Smoot, and hence the commission, had reason and means to know of the fraud earlier than the last month.
What’s more, testimony in the Langford trial indicated that the county’s bond counsel, Bill Slaughter, directed investment banks to disclose payments to local agents in so-called “side letters.” These letters were not included with the other typical public disclosures and, in effect, kept the roles of Blount Parrish and other agents hidden from the public. Slaughter has denied the allegation. Regardless, it could serve as fodder for JPMorgan as it defends itself in court. If the bank could show in court that Jefferson County forced it to behave the way it did, then the county’s case becomes much less convincing.
For the time being, the county is treading water with its debt obligations. On its sewer debt, the county is contractually obligated to pay its net sewer revenues — the money left over after operating expenses. The county has shown repeatedly and clearly that raising sewer rates is not an option. Doing so would exceed federal guidelines. Unless the county’s creditors can convince a state judge to appoint a receiver with rate-making authority, which is doubtful, then the county can continue as it is indefinitely. It cannot be forced into bankruptcy and it has little reason anymore to go into bankruptcy on its own volition.
What remains to be seen is how hard JPMorgan will fight the lawsuit against it. Several commissioners have indicated that a so-called “cram-down” of the county’s debt to between $1.2 billion and $1.5 billion would make it possible for the county to make its debt service. For that to happen, the county’s creditors would have to walk away from nearly two-thirds of what’s owed them.
Making matters more problematic are the county’s bond insurers. If the county doesn’t pay all of its debt, those bond insurers might be left on the hook for the remainder. Considering the financial conditions of those insurers, having to eat Jefferson County’s debt would probably break them. The insurers were heavily invested in mortgage-backed securities. When those securities tanked two years ago, the insurers were downgraded by ratings agencies. Those downgrades, in turn, triggered a chain reaction that left Jefferson County liable for outrageous interest rates it couldn’t pay, sometimes as high as 10 percent or greater. The count’s debt structure was incredibly vulnerable, but it is widely agreed that the insurers hastened the collapse.
Nonetheless, those same insurers are now lobbying Alabama state legislators to extend the sunset on a Jefferson County sales tax meant for schools and to redirect that new tax toward paying the debt. In short, the insurers who triggered this calamity want taxpayers to pay the county’s debts so they won’t have to.
To hasten some sort of deal, the county might have to quit signing forbearance agreements in order to bankrupt the bond insurers. By breaking the bond insurers, the county can simplify its negotiations and increase the likelihood of a settlement.
For nearly two years, Jefferson County has seemingly sat on its hands while its citizens have stewed impatiently, demanding some kind of action. Well, that period now seems to be over. What happens next might not have the glitz and pizzazz of the Langford trial, but it will be far more important to the taxpayers and sewer rate payers. Jefferson County has declared war on JPMorgan. In one sense or another, Jefferson County is going to break the bank.
War on Dumb is a column about political culture. Write to email@example.com