The Imperfect Art of Tracking Local Government Financial Stress

When the California auditor’s office recently rolled out a new online system that tracks and ranks local governments based on their levels of financial risk, David Dale, the city manager in Calexico, was caught somewhat off-guard when he found his town listed as fifth worst-off.

The city of 40,000 about 100 miles east of San Diego has certainly had its share of problems. 

Its police department was raided by the FBI back in 2014 amid allegations of various criminal conduct by officers and other city staff. Just a couple years later, Dale said  poor financial management led the city to the brink of bankruptcy.

“The city was a complete mess politically, financially,” Dale said. “It was bad all around.” Lately, however, he said that things within Calexico’s city government are improving. “We've made a lot of strides and sacrifices,” Dale said. “People are doing two jobs, pay cuts.”

Calexico’s designation as financially at risk appeared on a list along with the release of California’s new “local government high-risk dashboard,” a system that is designed to provide a snapshot of how 471 cities around the state are doing financially.

Information for it is pulled from publicly available, audited financial statements, which cover past years. The dashboard currently shows where cities stood as of June 30, 2017—part of the reason the progress Dale touts in Calexico isn’t necessarily reflected in the rankings.

“When this came out in the news,” he said, “they painted the picture that the city was currently in a financial debacle.”

California is the latest state to develop a public facing program that provides a way to monitor the finances of local governments statewide. New York has had a system like this for about six years now and Michigan has done similar work since before the Great Recession.

“It definitely is a trend,” said Justin Marlowe, a professor who specializes in public finance at the Daniel J. Evans School of Public Policy and Governance at the University of Washington, and who advised California on its program.

“You've seen, I think, a big uptick in interest," he added.

There are a number of ways that the systems can prove useful. But they also have limitations, including issues like Dale keyed in on concerning the timeliness of the data.

Dale explained that during the bad years Calexico’s general fund was $4 million in the hole and the city borrowed $3.5 million from its own wastewater account to backfill it.

He said the city is now on track to pay back the loan about a year early and ended the last fiscal year with a roughly $1 million surplus. The city’s total general fund budget is about $16 million annually. 

“We’ve gotten so far,” Dale said, which is why he says it was frustrating to unexpectedly see the city in the No. 5 spot on a list of the state’s most fiscally distressed municipalities.

Marlowe agreed that a dashboard like California’s is going to fail to capture all information. “The perfect system does not exist,” he said.

California’s dashboard was built as part of the high-risk local government audit program within the state auditor’s office. That team is responsible for identifying local governments that may have troubled finances, and in some cases auditing them.

“We thought it was important to do a comprehensive analysis of all the cities as opposed to looking at a subset,” said Mike Tilden, a deputy state auditor who was involved in the project. 

The dashboard and the rankings it presents rely on a set of 10 “financial indicators” meant to assess how well a city can cover its near-term and long-term costs. Some indicators include a city’s cash position, debt burden, financial reserves and revenue trends. 

Cities receive points based on how well they perform on each of these indicators, adding up to an overall risk score. A lower score means a city has a higher risk ranking. An interactive online map color codes each city based on its risk level, with high risk cities marked red.

In selecting the indicators, Tilden said the auditor’s office examined cities in California that had filed for bankruptcy in the past, analyzing their finances in the years before they did so, to find metrics that were warning signs these places were on a path toward insolvency.

One rationale for these sorts of monitoring programs is that they can offer people an easy to digest overview of the financial status of cities across an entire state. The big picture view that the information provides can cut two ways in the sense that it highlights places having problems, while also potentially underscoring that many local governments in a state are in decent financial shape.

Tilden said the California project is meant to be useful for the public and local government officials, but is also helpful for audit staff deciding where to focus their efforts.

“It was really a dual purpose,” he said. Additionally, the auditor’s office views the project as a way to provide greater transparency into how it is selecting the localities that it ends up auditing. 

Another reason the systems can make sense from a state’s perspective has to do with municipal bond investors and borrowing costs.

Marlowe says there’s evidence that when one local government in a state gets into deep financial trouble, there can be “contagion” effects, where investors begin to demand higher interest rates from other local governments in the state seeking to borrow money.

A statewide fiscal stress monitoring system is one way to show the extent to which a single city with financial difficulties is an outlier, rather than a harbinger of wider problems.

New York’s state comptroller began scoring governments in 2013 under a fiscal stress monitoring system that state Comptroller Thomas DiNapoli asked his staff to come up with.

Around that time, there were a number of concerning developments in the world of local government finance. Between 2011 and 2013, places like Jefferson County, Alabama, Stockton, California and Detroit had all filed for Chapter 9 bankruptcy.

“The question was being asked: ‘Can those bankruptcy situations emerge in New York state and what are we doing to be proactive to help local governments stay fiscally healthy?’” said Tracey Hitchen Boyd, an assistant deputy comptroller for local government and school accountability in New York.

New York’s monitoring system tracks local governments other than just cities, including villages, towns and school districts.

The program also differs from California’s in that it factors in not only financial indicators, but also “environmental” indicators that can affect local government revenues and demand for services—like population, unemployment and property values.

Hitchen Boyd said the effort is not only about measuring fiscal stress, but also helping local officials better understand what’s influencing the finances of their jurisdictions, and providing information that can help them with management and planning. 

“We always talk about the system in terms of it starting the local conversation about local financial conditions,” she said. “It’s not possible for our system to take into consideration all the specific mechanics of what’s happening at the local level,” she added.

Marlowe flags a few things that state government officials considering systems like the ones in California and New York should keep in mind.

One is that any system based on audited, annual financial statements is going to be backwards looking, and by the time a state monitoring system identifies a problem using this sort of data, it might already be too late to do anything to solve it.

In some cases, Marlowe noted, “you're talking about decisions that were made three, four, five years ago.” 

An alternative would be to use newer and more frequently reported data, perhaps pulled from budget-related documents. Ideally, Marlowe said, states seeking to monitor local government financial conditions would build a simple, forward-looking forecasting model of some sort.

“It's not that difficult to do,” he added, “But to my knowledge no state has really built out that kind of capability.”

The other question that the systems raise is that if states are going to flag financial problems at the local level, what obligation do they have to help the places they tag as troubled? 

This kind of assistance could take different forms. For example, a state could relax restrictions on raising local tax revenue, or provide greater flexibility in how state aid is used. Another option would be to provide experts who can assist with straightening out budget issues. 

“In many cases these fiscal problems have very basic underpinnings,” Marlowe said. A city, he explained, might be struggling to manage its cash flow, or maybe infusions of reimbursed state money don’t match up with local budgeting, resulting in short-term borrowing.

In New York, the comptroller’s office provides details about the fiscal stress scores to local government officials for them to review in advance of releasing the information publicly, according to Hitchen Boyd. “We give them an opportunity to comment,” she said. 

“They can tell us, ‘well, you’re interpreting things in a way that we might not,’” she added. “It helps our office better understand their perspective and it also helps them.” New York also incorporated feedback from local governments about two years ago when it refined the scoring used in its program, Hitchen Boyd noted.

Dale, in Calexico, said that he didn’t get any heads up from the auditor’s office that the scoring system would be published online and that his city would be included on a prominent list of the 18 cities with the most severe financial challenges.

The auditor’s office confirmed that they didn’t notify cities that the dashboard was coming out. But Tilden said for most cities that landed on the high-risk list, it shouldn’t have been a surprise. “We’re using their own publicly available financial statements,” he said.

He also pointed out that this is “version one” of the dashboard and that future updates would include multiple years of data to help show trends, and possibly additional indicators as well.

Dale acknowledges that Calexico still has a hard path ahead as it seeks to restore its finances, particularly as it grapples with growing pension payments. With the financial dashboard, he said he’d appreciate it if the state would emphasize more that the information is for past years.

This is noted in multiple places on the web pages where the material is published, but could be overlooked if someone is just looking at the list of the 18 most-challenged cities, or at the cities that are marked with the red high-risk color code on the interactive map.

Even though the dashboard may put the city in a harsh light, Dale said an upside with it is that it should help show the progress Calexico is making. “It tells the story of where the city was,” he said.