municipalities Default Risk Increases

Jefferson County, Ala., which is struggling with the turmoil in the municipal-bond market, rebuffed demands by four banks yesterday to come up with $200 million to back a derivatives trade gone bad. The banks have demanded that the county post additional collateral because of losses on derivatives contracts it entered into over the past several years. The contracts, known as interest-rate swaps, were meant to lower the county's borrowing costs and protect it from spikes in interest rates. But critics say the county was speculating. Jefferson County's financial troubles show how borrowers that took on additional risk in the normally staid tax-exempt municipal bond market are suffering as these corners of the debt markets are tainted by fallout of subprime losses Moody's Investors Service recently downgraded the county to B3 from A3. Rating firms yesterday also downgraded the county's general debt, its school warrants and various other municipal issues. Many other municipalities have entered into similar swaps, but Jefferson County was particularly aggressive. Typically, however, a municipality looking to hedge risk holds no more in swaps than its total amount of debt. But Jefferson County holds 13 interest-rate swaps with a value of $5.4 billion, compared with its $3.2 billion in debt. Durham County, N.C., has also used these derivatives.