What's Orange?

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.