updated 8/15/2008 3:32:31 PM ET 2008-08-15T19:32:31

Alabama's largest county appeared to be headed for the biggest municipal bankruptcy in U.S. history, a $3.2 billion mess created by the nation's credit crunch and a colossal, corruption-riddled sewer project.

Politicians in Jefferson County — which has 658,000 residents and includes the state's biggest city, Birmingham — continued to struggle to find a way out of the jam, but they had mostly abandoned talk of raising taxes and fees after running into fierce opposition at raucous public meetings.

On Thursday, with their options running out, the county commissioners all but threw up their hands and decided to let the voters weigh in on Election Day in November with a nonbinding referendum on whether to file for bankruptcy.

"The entire nation is watching to see how we handle this," said Jeff Sewell, an assistant county attorney. "This is a question of character as well as one of finance."

A bankruptcy filing by Jefferson County would shatter the previous record of $1.7 billion, set by Orange County, Calif., in 1994.

A Chapter 9 bankruptcy filing would put interest payments and lawsuits against the county on hold, giving it time to put its finances in order and negotiate more favorable terms with its creditors.

But it could also lead to tax increases, spending cuts and layoffs among the county's 4,000 employees.

And it could damage the county's credit rating for years to come, making it more expensive to borrow money and more difficult to finance the infrastructure improvements that can draw industries to Birmingham, a banking and medical-research center once known as the Pittsburgh of the South, back when it was a steelmaking powerhouse.

Burdened by sewer project
The county got into trouble after it was forced by the courts to undertake a huge upgrade of its sewage system to meet federal water standards and stop raw and partially treated waste from being dumped into streams.

Acting at the suggestion of outside advisers, the county borrowed money for the project on the bond market in a complex and risky series of transactions. When the mortgage crisis hit and banks began tightening up on their lending, the interest rates on the debt ballooned.

The nearly completed sewer project, under construction since 1996, is now burdened with a debt of $3.2 billion.

The crisis has come amid a federal bribery-and-kickback scandal involving contracts awarded on the project. Twenty-one people have been convicted in the still-unfolding case, including contractors, engineers and two former county commissioners.

Federal investigators say some of the deals by which the project was financed were corrupt, with politicians suspected of steering investment business to friends for kickbacks. But they said the corruption did not directly lead to the runaway debt.

Because of the project's costs, water rates have gone up 329 percent since 1997, with the average customer now paying about $65 a month. Those increases, combined with the investigation of possible sweetheart deals, have left taxpayers angry and distrustful.

"I'm just really disgusted with the incompetency of these officials," said resident Frank Denney, an engineering consultant.

Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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