"Chapter 11" is the all too familiar shorthand for corporate bankruptcies. A rarity, "Chapter 9", is what US municipalities, like Vallejo, California, invoke when they declare bankruptcy. In Vallejo, the city is using Chapter 9 to rewrite labor contracts.
Jefferson County, Alabama is facing a different problem. The local government bought interest rate swaps which "broke down" last year (presumably, Lehman Brothers was the counterparty), leaving Jefferson County with US$3.2 billion in debt it can't pay and can't refinance. If Jefferson County opts for Chapter 9, it will test whether bonded debt, like labor contracts, can be re-structured when a local government files for bankruptcy. Alabama's governor has written to Treasury and the Fed asking for their help in stretching out the debt in an effort to avoid repudiating it.
State governments in the US defaulted on debt in the mid-nineteenth century, to the chagrin of their foreign creditors. If the financial crisis isn't contained and if the economy doesn't bottom out, it's conceivable that Vallejo won't be the only city to seek Chapter 9 protection.
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