What Happens When Local Governments And School Districts Miss Bond Payments?

The Chicago Tribune has an interesting story today that discusses what happens if the financially-strapped Chicago Public Schools misses a bond payment on the $6 billion in outstanding debt it is currently carrying. The short answer is Chicago's property taxpayers. An owner of a $750 home, for example, would automatically be socked with a higher annual property tax bill of $750.

The part about the explanation that should get people's attention is the fact that CPS' accumulated debt occurred without approval of voters at a referendum. In Illinois, local governments and school districts can use alternative revenue bonds rather than general obligation bonds to borrow money. Repayment of the debt is pledged by a revenue source as opposed to the full faith and credit of the borrowing entity. Revenue bonds, unlike general obligation bonds, can be approved through a backdoor referendum process where the borrowing is automatically authorized once approved by the borrowing governmental entity unless enough property taxpayers petition for the debt measure to be placed on the ballot for approval by voters.

The Tribune explains how CPS began borrowing billions of dollars to replace old schools after the school system was placed under the control of the city's former mayor, Richard Daley. The alternative revenue bonds issued by the Daley administration pledged state aid doled out to school districts as the revenue source for repayment of the debt. To meet a $474 million debt payment earlier this year, CPS officials had to issue more debt to finance the old debt. It barely missed a deadline for payment of the old debt when the initial deal failed to attract enough investors. CPS finally raised the necessary funds with only a couple of weeks to spare before the deadline. Moody's Investor Service made the bond deal its top story of the day because of growing concerns in the financial markets the school district was going to default on its debt.

The Tribune notes that, while unusual, automatic property tax increases triggered by defaults have occurred elsewhere. It cites a recent case in Littlefield, Texas where officials built a 300-bed prison it expected to fill up from contracts with the state and private prison operators. As a result of changes in Texas' sentencing law, the prison sat empty. Property taxpayers got socked with a hefty tax increase to make up for the insufficient revenue stream that had been pledged when the bonds for the prison project were originally issued. The steps for how the automatic tax increase take effect are laid out in the fine print of the bond indentures. Revenue bonds are commonly used by local governments. Carmel Mayor James Brainard relies upon them all the time to finance his pet projects that were never subject to approval by voters at a referendum. In fact, backdoor referendum procedures were the rule in Indiana until the property tax reform law was passed in 2008, but even that law has provided big enough loopholes to local government officials through which you can drive an 18-wheeler.