Birmingham on the brink (cont.)

Former Birmingham city employee Larry Lavender, now Republican staff director for the House Financial Services Committee, told that story at a conference on the Jefferson County budget crisis in Washington this fall. "It's hard to steal as much as you can waste," he concluded. Perhaps, although there was lots of stealing too. Most of the convictions to date have been variations on the age-old theme, hardly unique to Alabama, of graft: public officials "taking care" of their friends in the construction business.

When all was said and done, Jefferson County had its sewer system. But the commission found itself staring down $3.2 billion in debt - or roughly 100 times the sewer department's annual capital budget. County officials knew they couldn't lay that whole burden on the system's 146,000 customers, many of whom live in Birmingham's blighted western neighborhoods. So they decided to delay the payments. Hence the highly unusual debt-service trend line, which rose sharply over the first ten years, leveled off for a couple of decades, then shot up again beginning in 2037. "They knew they were constructing a time bomb," says Kyle Whitmire, a columnist with the Birmingham Weekly who's been covering this story for five years. "But it wasn't gonna go off on their watch."

The most charitable interpretation is that the county officials were foolishly optimistic. Optimism does run deep in Birmingham, the Magic City, which rose from nothing after the Civil War to become a major industrial town.

Blessed with all the natural elements for making steel, Birmingham was once considered so vital to the nation's industrial might and capacity to wage war that it was said to be second after Pittsburgh on the Japanese list of bombing targets. Parts of Birmingham have yet to recover from the collapse of the steel industry in the '70s. But elsewhere there's plenty of growth. The city has reshaped itself as a regional banking center and has a booming healthcare industry. And the county's largest employer, the University of Alabama at Birmingham, continues to expand.

When construction started on the sewer system, half the county was still using septic tanks. Wasn't it reasonable to assume that those customers would eventually come onboard? And wouldn't the population of Jefferson County grow? And wouldn't water demand grow with it?

Alas, those assumptions proved false. As sewer bills shot up - more than 300% since 1997 - demand for sewer services proved surprisingly elastic. And somewhere around 2002, says Bill Slaughter, the county's former bond counsel, officials "had their 'Oh, s**t' epiphany. We borrowed too much money! And in order to borrow all this money we've had to backload the maturity schedule. And the foreseeable rate increases on top of what we've already had are just going to be politically horrendous. So what can we do to reduce rate increases?"

The county needed to refinance. And Wall Street, not surprisingly, had a few suggestions. In the years since Jefferson County embarked on the sewer project, a quiet revolution had swept through the sleepy world of municipal bonds. No longer were local governments reliant on boring but reliable fixed-rate debt. Starting in the mid-1990s, Wall Street banks sold tens of billions of dollars' worth of exotic variable-rate and auction-rate securities into the muni market that promised lower short-term interest rates for the long-term borrower- and oh, by the way, higher fees for the underwriter. Those fees were then multiplied several times over by adding in complicated hedging strategies that were sold as part of the package.

One of Jefferson County's bond advisors, Jim White of Birmingham investment bank Porter White, has no doubt about the big banks' motivation. "Some of these deals just made no sense or were not done effectively," he says. "There was every indication that they were done principally to run up the fees."

NEXT: Birmingham on the brink (cont.)

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