Municipal Fiscal Strain: Indicators and Causes

By Clark, Terry Nichols | Government Finance Review, June 1994 | Go to article overview

Municipal Fiscal Strain: Indicators and Causes

Clark, Terry Nichols, Government Finance Review

Ratios of indicators both internal and external to government are used to determine if a city is fiscally strained in this model, which conceives of fiscal stress as a lack of adaptation by a government to its private-sector environment.

Twenty years ago, no one spoke of fiscal strain, but now it is a central concern for American cities. The history of fiscal strain goes back to the depressions, especially the 1930s. There were a few studies of defaults then, but from the 1930s to the New York fiscal crisis in the mid-1970s, municipal bonds were so safe that no one wanted serious analysis. Yet with the New York fiscal crisis, it became clear that if New York City could default, so could any government. Risk was real.

The New York City fiscal crisis surprised and shocked many observers. Defining what happened and why, however, has been controversial. The most visible indicator was inadequate cash to pay bills in 1975. The city borrowed more and more for the short term to meet such expenses, and its short-term debt mounted considerably, as did its long-term debt. This led the banks to refuse to continue short-term loans and to press for more sound fiscal management. The mayor and union leaders held that substantial changes, especially staff cuts, were impossible. Months of conflict and negotiation continued until the state created the Municipal Assistance Corporation and the New York State Financial Control Board. These bodies pledged financial support to the city and imposed tighter fiscal management. This assistance was not sufficient to pay the bills, however, and the city then turned to Washington for aid, arguing that much of the crisis was not of its own making but was driven by the loss of jobs and population found in many other older cities. The federal government eventually loaned the city more than $2 billion, which was repaid over several years. The turbulence and controversy these measures generated led to questions that had not been asked since the Great Depression of the 1930s. How is support justified for one city and not for others? What sorts of similar aid should be provided more generally? What criteria should be used to assess fiscal strain?

In the summer of 1975, New York City officials were lobbying Congress for funds, and people were asking how many "New Yorks" might occur. How fiscally strained were large U.S. cities, and how many might follow a similar course? Answering these questions demanded 1) measuring fiscal strain and 2) specifying its causes for U.S. cities. No one in the country had the tools to do this: not the U.S. Treasury nor investment banks nor CPA firms. Municipal strain was almost unstudied. The disease seemed extinct--in sharp contrast to private firms, whose defaults and risk were common and more studied.

What Is Fiscal Strain?

The few people who had spent their careers on municipal risk, such as analysts at the top bond houses, often advocated using one single variable, like cash flows or housing starts. Others said to look at everything and use sound judgment; but when asked how, they could not answer except in vague generalities.

The lack of data on fiscal strain and the absence of systematic procedures for measuring it prompted the author and several students to research and analyze its causes. The first step was to create 28 indicators for a national sample of cities and to analyze causes of strain with systems of regression equations. The study showed that New York City ranked far above any other city on most strain indicators. The study had a widespread impact and became the foundation for additional research that culminated in an approach to fiscal strain that differed from several past approaches while incorporating some of their elements.(1)

One approach that had been used to measure fiscal strain was the internal-to-government approach of accountants and others who look, for example, at changes in debt--short-term, long-term, gross or net--or flow-of-funds indicators--debt coverage or quick ratios of cash on hand. …

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