Bankruptcies, defaults, and other local government financial emergencies Page: 26
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banks required the city to draw the money only as needed,
thus giving the banks an opportunity to monitor and
control city spending during the year.
The 1979 default was caused by several factors. The
city started the year with a deficit of about $379,000
resulting from prior unbalanced budgets. In January
1979, the voters of the city enacted a $3 million limit on
local property taxes with a 2% annual increase allowed
for inflation. The effect of the tax limit was to reduce
expected revenues for 1979 by about $600,000, and thus
add to the city's problem in balancing its budget. In early
June-five months after the start of the fiscal year-the
city finally adopted a budget that was in apparent balance.
The budget provided reductions in most departments
and required a layoff of nearly 20% of the school
teachers and custodians.
Because the city's property taxes to finance the year
starting January 1, 1979, were not due until September,
the city borrowed $2.1 million in January in anticipation
of the tax payments. With a $3 million tax levy, it was
expected there would be ample revenues to repay the
notes by their due date of December 31, 1979.
Unfortunately, the city encountered problems keeping
its expenditures within the $3 million budget set by
the tax limitation. In addition, the city completed a sewer
project which it had expected to finance by the sale of
bonds, but it found itself unable to sell the bonds in 1979
because of the uncertainty about the condition of the
city's finances. Instead of setting aside sufficient tax revenues
from the September tax collections to cover the
tax anticipation notes, the city used these revenues to
cover the budget deficit and the unfinanced sewer project
costs. As a result, there was insufficient cash on
December 31 to pay the notes.
The principal cause of the Saco financial emergency
was the usual problem of not balancing its budgets, but
in this case the problem was aggravated by a tax limitation
approved after the budget year had actually started.
Contributing to the problem was bad cash flow caused
by a single property tax payment date late in the fiscal
year, construction expenditures made prior to selling
the necessary bonds, and failure to segregate the tax
revenues needed to pay tax anticipation notes.
Since the emergency, several of these problems have
been corrected. The city now requires property tax payments
in two installments so it gets cash earlier in the
year and, as required by the new state law, it segregates
tax revenues to keep them available to pay tax anticipation
Cleveland Board of Education
The default of the Cleveland Board of Education on
tax anticipation notes was really only technical because
a federal court ordered the bank holding the notes to
extend them beyond the due date. However, the school
system did not have sufficient money on hand to pay the
notes when due and it would have defaulted on
The school system's problems occurred during the
period when it was under the control of a federal court
because of a desegregation lawsuit. Its problem had no
direct relationship to those of the City of Cleveland because
each has separate taxing authority. The school
system issued tax anticipation notes in 1977 to fund its
current operations. Because its budget was not balanced,
the school board planned to close the schools for
part of the year to the extent necessary to balance its
budget and provide the money needed to pay the notes.
However, the federal court refused to permit such closing,
thereby placing the school district in a default position
when the tax anticipation notes came due. The
court then ordered the banks to renew the district's
The ACIR search for defaults occurring between 1972
and 1983 found 36 defaults on government-purpose
debt. One of these was a default on a long-term general
obligation; ten were defaults on general obligation
notes; and the remaining 25 were defaults on government-purpose
revenue bonds. Compared to the 294 defaults
recorded between 1960 and 1969, the number of
recent defaults is very low.
However, in terms of dollar volume the defaults occurring
in the 1972-83 period may exceed that of earlier
periods because of three defaults involving very large
amounts-New York City, Cleveland, and the Washington
Public Power Supply System (WPPSS). The WPPSS
default on $2.25 billion came close to the total indebtedness
of all defaulting state and local units ($2.85 billion)
during the Depression period 1929-37.8 Except for the
three major government-purpose defaults, the dollar
amounts involved in all the government-purpose defaults
were quite small.
Case studies reviewing the causes of default in four
cities-New York, Cleveland, Parlier (CA), and Saco
(ME) show a common thread in both large and small
cities with default eventually occurring as a result of a
series of years of unbalanced budgets and snowballing
deficits. In most cases the seriousness of the city's financial
situation was masked by poor accounting.
rAsherman, Georgette, Industrial Revenue Bonds and The Disclosure
Exemption, [unpublished working paper], May 1984,
2ACIR, Significant Features of Fiscal Federalism, 1982-83 Edition,
M-132, December 1981, p. 74.
3ACIR, Significant Features of Fiscal Federalism, 1982-83 Edition,
M-137, January 1984, p. 131.
4U.S. General Accounting Office, Trends and Changes in the
Municipal Bond Market, GAO-PAD 83-46, September 12,
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United States. Advisory Commission on Intergovernmental Relations. Bankruptcies, defaults, and other local government financial emergencies, book, March 1985; Washington, D.C.. (digital.library.unt.edu/ark:/67531/metadc1317/m1/36/: accessed November 19, 2018), University of North Texas Libraries, Digital Library, digital.library.unt.edu; crediting UNT Libraries Government Documents Department.