Taking a Risk: Explaining the Use of Complex Debt Finance by the Chicago Public Schools

In the decade leading up to the global crisis of 2007-2008, local governments in the United States used increasingly complex financial structures to underwrite major capital projects. These structures offered potentially lower borrowing costs while also carrying greater financial risk, and in most cases, the bond structures imploded when the crisis hit. Why did some local governments gravitate toward this part of the risk spectrum while others did not? This article develops several explanations for local government risk-taking with a case study of the Chicago Public Schools’ use of auction rate securities and interest rate swaps. We argue that the school district’s exceptional use of these instruments was due to administrators’ familiarity with these instruments, Chicago’s long history of using creative techniques to defer tax increases and service cuts, and lack of knowledge about the extent to which investment banks were propping up these securities markets.