Assignment
Analyze the cases presented in chapter 8 of the text, Looking Back for
Future Lessons: Some Important Cases, located on pages 311-316.
Provide brief summaries, 200-250 words each, of the New York City and Orange County cases.
Explain how the New York City and Orange County financial crises impacted:
1 Each government
2 Other local governments
3 The bond market, including prospectus requirements
Explain what the financial crises implied about the operational and/or capital budgeting processes in each case.
Explain what government can do to anticipate and remedy financial crisis. Apply these actions to each of the cases.
Instructors will be using a rubric to grade this assignment; therefore, students should review the rubric prior to beginning the assignment to become familiar with the assignment criteria and expectations for successful completion of the assignment.
Prepare this assignment according to the APA guidelines found in the APA Style Guide, located in the Student Success Center.
LOOKING BACK FOR FUTURE LESSONS: SOME IMPORTANT CASES
New York City Financial Crisis
In April 1975, New York City hovered on the brink of default on its obligations. With help from New York State, the federal government, and others, it averted default, but two significant consequences emerged after the crisis. The first was that state and local governments now paid higher interest rates. The second was the financial community now required more elaborate financial disclosures.
The nation felt the effects of the New York crisis, and North Carolina is one example.
In Southern City Kenneth Murray (1976, 6) reported that a study by the Municipal
Finance Officers Association (MFOA) showed "that the New York City financial crisis already cost local governments in North Carolina $424,000 in first year added interest costs on bonded indebtedness and $5.1 million total in interest over the life of municipal bonds issued in 1975."
Exhibit 8-6 shows the credit rating change for New York City. Notice from 1965 to 1975 the remarkable drop to a low of Caa. Also note that since 1977 the rating has improved. In the precrisis era, state and local governments sold their bonds without revealing much about their financial situation. Since the crisis, investors have demanded greater disclosure of facts about the community and bonds.
Washington State Public Power Supply System (WPPSS)
In 1983, the WPPSS defaulted on its revenue bonds because the revenue from the nuclear power electric generation did not meet debt service requirements. WPPSS defaulted on payments of $2.3 billion in bonds issued to finance two nuclear power plants in the state of Washington. Epple and Spatt argued that the default of the WPPSS raised that state's general obligation borrowing costs. Because the market held the jurisdiction responsible for repayment of principal and interest of this revenue bond default, potential GO bondholders viewed the revenue bond default as evidence that the jurisdiction managed itself poorly. Epple and Spatt posited that reputation costs affect borrowing across all jurisdictions within a state when a local bond default occurs. Moreover, following years of contentious bankruptcy proceedings, the jurisdiction did make some $500 million in payments to bondholders.
Orange County, California
The more significant local government financial crisis was the Orange County situation discussed earlier in this chapter. Orange County, one of the wealthiest local governments in the world, defaulted on general obligation bonds. Prior to that time, American local government, with very few exceptions, considered GO debt "sacred," with governments going to great lengths to protect their GO bond rating. Overnight, Orange County changed the rules and traditional financial emergency signals, which this chapter explains later, were inadequate in dealing with poor financial management using derivatives.
What are the consequences of Orange County? Fortunately, investors did not abandon the municipal market, which investors had considered about the safest place to invest. Interest rates did not spike up, except for California issuers. Most of Orange County bond investors were money market fund managers, and they reacted by either buying at par or by acquiring letters of credit or portfolio insurance with the permission of the U.S. Security Exchange Commission. Fortunately, the bond fund managers sold off their shares to investors because they realized that the Orange County median family income was a full 20 percent higher than that of the state as a whole. Unfortu nately, the county's voters rejected a half-cent increase in the county sales tax to address the debt problem, but the county did divert other revenues to debt service, did radically cut services (41 percent), and selectively did refinance portions of the debt.
Unlike when other cities fell into fiscal disgrace, California State government did nothing due to its own weak fiscal situation and the antigovernment citizen attitude in the state. One clear consequence is that Orange County and California taxpayers in general shall pay many millions more for debt service for many years in the future.
Lynch, T. D., & Smith, R. W. (2004). Public budgeting in America. Upper Saddle River, NJ: Pearson.