• Jefferson County, Alabama, poised to default on loans • Downgrade threat to Maryland, New Mexico, South Carolina, Tennessee and Virginia

This article is more than 9 years old

This article is more than 9 years old

Alabama's Jefferson County was last night poised to become the largest municipal bankruptcy in US history after a three-year battle with creditors over a $3.2bn (£1.9bn) loan.

The local authority, possibly the first of many US counties and cities to default on loans, convened a special session to consider terms for a settlement or a 30-day extension to talks. Councillors were also asked to assess whether bankruptcy is the best option after a failure to find a settlement since 2008.

Jefferson county, home to Alabama's largest city, Birmingham, has found itself teetering on the brink after talks broke down with creditors, including the investment bank JP Morgan Chase. A previous extension to talks on the $3.2bn sewer bond expires tomorrow.

Jefferson heads a list of municipal borrowers that could find themselves in deep financial trouble in the next few years.

Earlier this week, five states were notified by the credit-rating firm Moody's that they were in danger of losing their AAA ratings because of their reliance on federal revenue, mainly from locally based offshoots of government agencies.

Maryland, New Mexico, South Carolina, Tennessee and Virginia were placed on review for possible downgrade following Moody's warning to the US government that it faced losing its AAA rating because of the inability in Washington to raise the debt ceiling.

California, New Jersey and about 44 other states have spent much of the year trying to close a $130bn budget gap. These gaps come on top of large fiscal shortfalls in 2009 and 2010, following a collapse in tax revenues following the rise in unemployment and a drop in property taxes.

California is expected to face a shortfall next year of $23bn or 27% of its budget, while New Jersey has a 36% shortfall.

Meredith Whitney, a Wall Street analyst who famously likened municipal bonds to ticking time-bombs, reaffirmed her belief last month that many would go bust.

In a report she said municipal bonds, which are commonly used by local authorities and states to fund infrastructure projects and large capital expenditure, will wreak havoc in the US economy in the next five years. She has predicted hundreds of billions of dollars in defaults between now and approximately 2016.

Whitney's analysis shows half of the Nevada budget is absorbed by debt servicing. In Michigan, where the governor has battled public-sector unions over job cuts and reduced pay and benefits, paying back debt absorbs 40%.

Jefferson commission president David Carrington has hired a law firm that helped Orange County, California, through its bankruptcy in 1994.