The scale of financial incompetence in Hackney was disclosed in an interim report by a "hit squad" appointed by the Government after schools inspectors said that the education service was "in disarray".
The report criticises education staff in strong terms, noting that they failed to realise the size of the budget deficit until half-way through the following financial year.
Among a catalogue of errors was their failure to realise until December last year that schools had not been charged for gas supplies for up to three years. This could result in a bill of nearly pounds 1m for head teachers.
The inquiry team also highlighted a shortfall of pounds 966,000 between the amount of money allocated for staff in 1997-98 and the actual cost of posts that were already established and filled.
"The financial processes were so weak that the difference went unnoticed for three months, and remained uncorrected for a further six months," the report says.
It says that where savings have been made, it was not a result of "decisive management", but of keeping posts vacant when staff left. In the education finance department, for instance, the number of staff had dropped from 25 to six.
The team also expresses reservations about plans to devolve financial planning. "Though the reorganisation is planned to ensure value for money of public funds, we have considerable doubts whether this will be the final outcome," it says.
The borough recently appointed a new director of education, Elizabeth Reid, filling a job that had been vacant for more than two years. The Government has threatened to use its powers to run Hackney schools from Whitehall unless standards are raised.
The hit squad will work with Ms Reid to produce its final report in June. In its interim report, it suggests that she should commission a comprehensive financial review when she arrives.
Stephen Byers, the schools minister, said that the Government backed yesterday's report and recommendations. "I am encouraged to note that progress is being made," he said.