The State Role in Local Government Financial Distress

QUICK SUMMARY

Note: In April 2016, this report was updated to include revised information about Louisiana’s intervention practices and to improve the clarity of citations.

What role, if any, should states play in helping cities, towns, and counties recover from serious financial trouble, what officials generically call “intervention?”

The Pew Charitable Trusts conducted a study examining the range of state involvement in local government finances that drew on current literature, statutes, a survey of state officials, and interviews with government finance analysts.

"The State Role in Local Government Financial Distress" examines various intervention practices, identifies challenges, and elaborates on three key policy guidelines.

The analysis and state profiles can help inform state decision making about whether, when, and how to assist municipalities facing fiscal stress, the likely outcomes of various approaches, and the implications for cities, counties, states, and taxpayers.

Overview

Within a two-week span in the summer of 2012, three California cities moved to file for bankruptcy protection. By the end of the year, nine others had declared financial emergencies. The state government offered no help, sticking to a long-standing tradition of leaving it up to local officials to fix their broken finances.

Rhode Island, by contrast, responded aggressively when Central Falls filed for bankruptcy protection in 2011. State officials appointed a financial manager, called a receiver, to make sure the city could pay its bills by cutting spending, raising taxes, slashing employee retirement benefits, and paying investors on the bonds they bought. The state’s action was a reason for Central Falls’ exit from bankruptcy last year after only 13 months, the shortest of several recent, high-profile municipal bankruptcies.

The difference between hands-off California and hands-on Rhode Island illustrates two sides of a discussion that is increasingly taking place in statehouses and city halls around the country because of cities’ particularly slow recovery from the Great Recession of 2007-09. The question comes down to what role, if any, states should play in helping cities, towns, and counties recover from serious financial trouble—what officials generically call intervention.

Against this backdrop, The Pew Charitable Trusts conducted a study that examined the range of state involvement in local government finances, drawing on current literature, statutes, a survey of state officials, and interviews with government finance analysts. It focused on identifying the characteristics of local financial distress, how those difficulties can escalate to state intervention or, in extreme cases, bankruptcy, and the relevant laws that states have in place. The research also considered the history of state intervention in the financial practices of embattled cities, why it matters to states, and how their practices differ. The findings are explored in detail in this report, but, briefly, Pew’s research shows:

• Fewer than half of the states have laws allowing them to intervene in municipal finances.
• Intervention practices vary among the 20 states that have such programs.
• In most cases, states react to local government financial crises instead of trying to prevent them.
• States intervene to protect their own financial standing and that of their other municipalities, to enhance economic growth, and to maintain public safety and health.
• Among states that intervene, some are more aggressive about stepping in to help.
• Local officials often resent state officials infringing on their right to govern their affairs.

Not every state may find that it needs to set up programs to intervene in local government finances. Of those that do, differences such as economic structure and political traditions underscore that there is no single model to follow in designing an intervention program.

Some states claim success from interventions. Most recently, Rhode Island’s effort helped to bring a quick end to Central Falls’ bankruptcy. Pew’s analysis found other promising approaches as well. Most notable among them is monitoring the financial condition of cities to mitigate and contain local budget stress. When state and local officials are vigilant in identifying local budget trouble early, they can act decisively to prevent a crisis that could force the state to step in. For example, North Carolina, despite high unemployment, has managed to escape serious local government budget problems in part because of its strong centralized system of monitoring and oversight.

Whatever approach state policymakers consider, it is important to design the intervention so that state officials turn the day-to-day management of city finances back to local officials as quickly as practical. In this way, state officials can reduce the tension between the city and the state that often accompanies interventions. Despite Rhode Island’s relative success in Central Falls, for example, there was lingering resentment over how long the state overseers would stay in the city to monitor its actions. The dispute went to a mediator, and the state returned control to city officials in April 2013.

Pew researchers also conducted a series of quantitative analyses to determine whether state intervention programs are correlated with strong local government financial health in the aggregate and found no such relationship, highlighting the largely reactive nature of state policy.

This report presents the findings of Pew’s analysis and also profiles seven states with and without oversight programs. By examining these individual states, Pew researchers were able to understand the patterns of state and local experiences with financial distress, including what motivates states to intervene or not, how political and economic conditions can affect a state’s decision on whether to get involved, and what results the state efforts have yielded. The following cases were studied:

• Alabama, with the largest county bankruptcy in U.S. history, and California, where Stockton’s bankruptcy has generated recent attention, were chosen as examples of states that historically do not assist local governments. New Jersey pared back on financial aid to troubled cities, including its capital, Trenton, during the Great Recession, and is trying to figure out the state’s role going forward.
• North Carolina has the oldest intervention program in the country, emphasizing state-level monitoring to detect early signs of trouble.
• Michigan, where Detroit filed for bankruptcy in July 2013 and five other cities are under emergency managers, and Pennsylvania, where Harrisburg is run by a receiver, are deeply involved in their local governments’ finances but are similarly affected by changing economic conditions that are out of their control and make it harder for cities to rebound.
• Rhode Island strengthened an existing weak program after the budget emergency in Central Falls, including a first-of-its-kind provision protecting investors in the city’s bonds.

State differences aside, Pew’s research did find a set of principles for states considering intervention programs:

1. States and cities should be proactive in detecting and tackling local government financial challenges through oversight of local finances and offering technical advice. Monitoring local government finances can result in early warnings and the avoidance of crises as well as send a positive signal to bond markets. This has been seen in states such as New York and North Carolina. Pew also suggests that states and cities adopt multiyear financial plans, a practice that compels governments to match expenses and revenues over several years.
2. In difficult economic times, creating state intervention programs could come with costs during a period when states are facing limited funds and staffing, which tests their ability to monitor local government fiscal trends or offer direct aid to struggling cities. As a result, state policymakers must understand the trade-offs within their own budgets and determine both whether to intervene and what level of support they can afford. Officials in Massachusetts and New Jersey have engaged in such balancing by choosing the extent to which they bail out struggling local governments, and policymakers in New York have found ways to provide assistance without providing direct aid.
3. States, when possible, should design interventions to involve all stakeholders in discussions, to be transparent with financial information, and to return control to local officials quickly. This promotes better cooperation between all concerned parties as a local government recovers from a crisis. In Michigan, for example, several cities, including Detroit, have pushed back against what they consider to be state interference. Throughout the Detroit financial crisis, city and community leaders tried to resist state intervention, fearing it could lead to long-term state control, as in other Michigan cities such as Pontiac.

This paper examines various intervention practices, identifies challenges, and elaborates on these three key policy guidelines. The analysis and state profiles can help inform state decision-making about whether, when, and how to assist municipalities facing fiscal stress, the likely outcomes of various approaches, and the implications for cities, counties, states, and taxpayers.