How to Know if Your City is About to Go Bankrupt

"People don't pay attention until cities talk about bankruptcy, but by then the frog has already been boiled to death." So says David Crane, a lecturer in the Public Policy Program at Stanford University who is president of the advocacy group Govern for California and a member of the Volcker-Ravitch State Budget Crisis Task Force, writes Mark Funkhouser at Governing Magazine.

Here's Funkhouser reporting on an interview with Crane:

So what does this mean for those of us who care about cities and pay attention to politics, governance and finance? A conversation with Crane, who was a special adviser to California Gov. Arnold Schwarzenegger from 2003 to 2011, offers some fresh and useful insights.

For cities, he says, social and cultural bankruptcy come long before financial bankruptcy. At first, street cleaning is cut back from once a week to once a month, library hours are cut and some libraries are closed. Street repairs, building maintenance and vehicle maintenance are reduced. Arts and cultural programs are eliminated, park maintenance is cut back and some parks are closed, and community centers are open for fewer hours or shut down. Then come the cuts to public safety as police officers and firefighters are let go. By the time cities declare bankruptcy, services already have declined steeply and the time has come to make really hard choices--pay police or pay creditors?

Filing for bankruptcy is a legal event, with a public declaration occurring on a precise date. Insolvency, however, is a financial condition that creeps in unannounced. Cities like Stockton and Central Falls were insolvent long before they declared bankruptcy. A government that is solvent has sufficient revenue to cover its operating costs and have sufficient access to capital to be able to acquire and maintain the equipment and infrastructure needed to sustain a level of efficient and effective services that meets the expectations of its citizens. A city is insolvent when it has to reduce services below this "market" level-what San Jose Mayor Chuck Reed refers to as "service-level insolvency." Cities compete for businesses and residents. Providing services at levels lower than the market level will drive residents and businesses away, reducing the tax base and further aggravating the deteriorating financial condition....

Local-government finances are complex and are impacted not only by decisions within the government itself but also by conditions in the community and by the larger regional, state and national economies. Bond ratings tell you virtually nothing about whether or not a city is on the verge of service-level insolvency. A government's bond rating is a lagging indicator of its financial condition. Waiting for a downgrade to adopt more prudent financial practices is like waiting until your car slams into a tree before you hit the brakes. 

However, tools are available that allow professional managers, good-government groups, academic policy centers, government auditors and others to undertake an analysis of a government's financial condition and present the results in plain language that citizens and policymakers can understand and use. One of the more widely used such tools is the system laid out in the International City/County Management Association publication "Evaluating Financial Condition: a Handbook for Local Government." This approach uses more than 40 indicators, some of them derived from the local government's financial information and others based on broader economic and demographic data. A second approach is a fiscal analysis tool developed by faculty at the University of North Carolina School of Government, which uses fewer indicators and only data derived from the government's audited financial statements. Lots of examples of analyses using some variation of one or both of these approaches are available on the Internet.

Evaluating Financial Condition: a Handbook for Local Government is online at Google books, here. A paper listing top ten ratios of financial condition for governments is here

(ht David Waring).