Bonds

• Cities, when raising money, sell bonds. These are debt certificates that promise the investor that he will receive the stated amount on the bill -- the par value -- and the interest accumulated over time. The investor gets a safe, yet low yielding, investment, and the city gets its cash. An escrow account is, in this case, set up, usually in Treasury bonds, that, since they earn a slightly higher rate of interest than city bonds, will be cashed in to pay the interest on the city's bondholders.
  
  

Projects

• A city can also use an escrow account as a set of investments that service the fees of its projects. If a city wants to build a new airport, for example, an escrow account will be established, administered by a neutral third party, that will take care of all the fees involved in such a project. Fees here might include any federal taxes, lawyers and accountant's fees and fees paid to various consultants. The escrow account will be, itself, cash that has been invested in safer securities like blue chip stocks or treasury bonds. It might not be able to pay for everything, but it serves as a financial cushion to pay these fees as they come due.
  
  

Administrators

• The people running this account are critical. Ideally, they are supposed to be neutral. This just means that they have no specific interest in the projects under construction. It is, of course, public money sent to a private purpose. Such a fund, if it is large enough, can be a temptation for administrators and corrupt politicians to use for their own purposes. Because public ignorance on the nature of such escrow accounts is common, politicians will be even more tempted because abuses can be quickly justified using an incomprehensible dialect combining accounting and legal jargon.
  
  

Problems

• In terms of urban bonds, the issuer, the city, can lose money if the interest rates increase. This is because the bonds already issued at a lower rate are much less valuable. Everyone wants the newer bonds with the higher rates. The escrow investments are designed to make up this difference. However, because no guarantee exists that the escrow investments will appreciate in the same way that the present interest rate is, this account itself might be insufficient to pay off bondholders, meaning that the city has now lost money. It often must borrow again for the sake of paying off investors. Sometimes, the administrator might be tempted to invest this cash in higher risk, yet higher yielding areas such as currency or commodity speculation.