Wanted: An Early Warning System for Local Governments

This article originally appeared in The Capitol Weekly.

Back in 2012, then Treasurer Bill Lockyer called for an early warning system that would give state officials time to proactively address local government fiscal emergencies before they wound up in bankruptcy court. We are now five years closer to the next recession and its attendant set of local government financial crises, but the state has made little progress toward implementing Lockyer’s proposed system.

Lockyer offered his suggestion in the wake of bankruptcy filings by Stockton, Mammoth Lakes and San Bernardino. But after the summer of 2012, the parade of high profile Chapter 9 filings ended, and, with it, the political will to monitor local government financial health. That’s a shame because a repeat of the fiscal meltdown we witnessed in the wake of the Great Recession is almost inevitable.

Agencies are coming under increasing pressure from CalPERS rate increases, and revenue growth for many inland cities has been weak. Even during California’s growth spurt, we have witnessed two Chapter 9 filings – by Palm Drive Healthcare District in 2014 and West Contra Costa Healthcare District in 2016.

Since 2012 California state agencies have made some moves in the right direction, with much of the credit belonging to John Chiang, first as state controller and now as state treasurer. At the state controller’s office, Chiang introduced ByTheNumbers, a system that allows analysts to retrieve large volumes of local government fiscal information in spreadsheet form. Unfortunately, the controller’s data does not reconcile to audited financial statements that local governments publish – thus limiting its value.  While the controller’s office collects local government audited financial statements, it does not post them on its web site. Instead, fiscal watchdogs like me must obtain them from the controller through public records act requests.

As treasurer, Chiang launched DebtWatch, which shows all local and state government debt issued over the last 30 years. Thanks to SB 1026 introduced by state Sen. Robert Herzberg and enacted last year, DebtWatch will be enhanced in 2018 to show how much agencies still owe on the bonds they’ve issued.

In 2015, California State Auditor Elaine Howell initiated a Local Government High Risk program and has now audited two cities – Maywood and Hemet. Although the auditor’s program was motivated by a desire to root out local corruption in the wake of the Bell scandal, enabling legislation allows her to select agencies that have “challenges associated with economy, efficiency, or effectiveness.”. While my research on distressed cities concurs with the auditor’s choice of Maywood, I did not find concerns with Hemet.

It appears that the auditor is not using a rigorous, consistently applied algorithm for choosing high risk agencies. The failure to use a fully transparent selection method opens the auditor to suspicions of bias. In that way, her office faces the same criticism leveled against credit-rating agencies: that their ratings are assigned in an opaque, and apparently arbitrary manner.

In my last two surveys, I found Compton to be a highly distressed city. Among its risk factors are a large negative general fund balance, late filing of audited financial statements and a qualified opinion on its most recently published statements. Other distressed cities identified by the California Policy Center’s review of 2015 financial statements were Atwater, Coalinga, Marysville, Maywood, Soledad, Vernon and Victorville.

The state has many of the elements in place needed to implement a local government early warning system. But further legislation or greater initiative from a state agency will be needed to get a best practice program running in time for the next recession. Simply posting all local government financial statements in one place would be a great start.