The biggest U.S. bank by assets agreed to forgive $842 million of debt owed to it by Jefferson County, Alabama, where it took the lead in arranging risky securities deals that pushed the county into the largest U.S. municipal bankruptcy, in November 2011.
That agreement follows a $722 million settlement in 2009 with the U.S. Securities and Exchange Commission related to the Jefferson County financing. JPMorgan’s total costs amount to a quarter of the $6.2 billion trading loss in 2012 from corporate-credit bets by a trader known as the London Whale.
Elizabeth C. Seymour, a bank spokeswoman, had no comment on the accord announced Tuesday. If accepted by the court, it would cap almost a decade-long fiscal disaster in Alabama’s largest county, where JPMorgan initially reaped substantial fees arranging interest-rate swaps that subsequently proved tainted by municipal corruption and devastating to taxpayers during the 2008 credit crisis.
“Everybody thought there was a free lunch and they could all take advantage of it at the same time,” said Christopher Taylor, the former executive director of the Municipal Securities Rulemaking Board. “It burned them all.”
The Jefferson County deals were arranged while Chief Executive Officer Jamie Dimon, 57, was running rival Bank One Corp., which New York-based JPMorgan acquired. They also resulted in a prison sentence for former County Commissioner and Birmingham Mayor Larry Langford for bribery.
Neither the Jefferson County nor London Whale episodes have prevented JPMorgan from reporting a third consecutive year of record profit in January. Dimon survived a shareholder vote in May that could have forced him to give up his role as chairman.
JPMorgan fell 1.9 percent to $53.03 at the close in New York. The shares have gained 21 percent this year.
Jefferson County, which encompasses Birmingham, the state’s largest city by population, Tuesday said the agreement was made with holders of about $2.4 billion of its $3.1 billion in sewer-system debt, which would be refinanced, and may help it emerge from bankruptcy by year-end. Along with JPMorgan, the accord includes three insurance companies that guaranteed the county’s bonds, and hedge funds that own the securities.
The agreement would increase residents’ sewer fees by 7.4 percent annually in the first four years
JPMorgan would forgive about 70 percent of the $1.2 billion in sewer debt it holds, according to a statement from the county.
Other creditors would take smaller hits. Hedge funds owed about $872 million will collect more than 80 cents on the dollar, according to the agreement.
Court approval for the deal would put an end to Jefferson County’s more than five-year struggle with its debts, which began with the effects of the subprime mortgage crash that cascaded in unexpected ways through complex financing arranged for the county by Wall Street banks led by JPMorgan.
The arrangements left almost all of the county debt taken on to pay for a new sewer system with interest rates that reset periodically, similar to adjustable-rate mortgages. JPMorgan and other banks also sold the county related derivatives to protect against the risk posed by the securities, earning undisclosed fees of about $120 million, according to the county’s former financial adviser.
Business with the county was so lucrative that JPMorgan bankers agreed to pay local counterparts, including Bill Blount, a friend of Langford, for doing little or no work to secure its place in the deals, according to the SEC.
“I got to get the politics lined up. And, of course, we have to pick the partners who are going to get free money from us this time,” JPMorgan banker Charles LeCroy said to an associate at the time, according to the SEC’s complaint against him.
Blount was later sentenced to 52 months in prison for paying bribes of cash, clothes and jewelry to Langford. LeCroy is planning to fight the SEC’s civil claims against him, according to his lawyer, Lisa Mathewson.
The transactions backfired on the county during the financial crisis of 2008. When credit dried up on Wall Street, investors dumped Jefferson County’s sewer bonds and their yields soared, pushing the county’s costs sharply higher. Derivatives that were supposed to protect against such an event added to the costs as central banks cut interest rates. Lenders that were paid fees to buy back some of the debt had the right to force early redemptions from the county, which it couldn’t afford.
Officials spent years unsuccessfully seeking an agreement to resolve the impasse. In 2011, after a court ruling struck down a local tax that was a key revenue source, Jefferson County sought court protection under Chapter 9 of U.S. bankruptcy law.
Jimmie Stephens, chairman of the county commission’s finance committee, said the agreement announced yesterday will “form the backbone” of a plan to pare down debt.
“I look forward to restoring Jefferson County to its former position of leadership,” he said.
The county was the municipality hardest hit by the unraveling of derivative deals arranged by Wall Street banks for government borrowers. In other cases, which included the operator of the San Francisco Bay Bridge and Pennsylvania school districts, borrowers paid at least $4 billion in fees to back out of the contracts.
Such trades weren’t limited to the U.S. Italian Judge Oscar Magi in Milan ruled that JPMorgan, Deutsche Bank, UBS and Depfa Bank tricked his city into agreeing to a financing deal that didn’t meet its objective of cutting borrowing costs, and misleading the city about derivative counterparties. The banks have said they will appeal the February decision.
In 2008, under Dimon, JPMorgan decided to get out of the business of selling derivatives to municipalities. In 2009, without admitting or denying wrongdoing, the bank agreed to pay $75 million and forgive $647 million in derivative fees owed by Jefferson County to settle with the SEC over the undisclosed payments made to local bankers.
In 2011, JPMorgan agreed to a $228 million settlement with federal and state regulators for allegedly rigging bids on investments that state and local governments buy with the proceeds of municipal bonds, which allowed the bank to pick up added profits. The employees involved had left JPMorgan by that time.
Bank of America, UBS and Wells Fargo agreed to similar accords in connection with such investment contracts, which were typically handled by the same bankers who arranged municipal derivative trades.
Regulators tightened their grip on the derivative business under a law signed by President Barack Obama in 2010. That measure seeks to protect municipal-debt issuers from being misled into risky derivatives deals.
It was too late to help Jefferson County.
“Everyone came in and wanted to suck that place dry,” said Taylor, the former regulator. “Everybody looks bad in this. And everybody should look bad.”
With assistance from Steven Church in Wilmington, Margaret Newkirk in Atlanta and Martin Z. Braun in New York.