Lacking the means to effect improvements, distressed local governments appeal to the state for grants, "spin ups," taxing authority, deficit financing and like measures that are not structural. While a better economy alleviates stress, poor fiscal practices, population losses, aging infrastructure and shifting economic realities continue.
Financial control boards have been successful in certain circumstances, but they represent drastic action, are ad hoc, can be very long term, require careful management and pose risks.
Their value is to preserve access to credit markets, accomplished by controlling labor costs and withholding approval of collective bargaining agreements. Public employees are singled out. Control boards do not generate revenues and give primacy to creditors, who have the greatest bargaining leverage and the least incentives to bargain.
The largest threat to creditors is default and Chapter 9 of the U.S. Bankruptcy Code, but bankruptcy is an ephemeral venture into the unknown that represents failure. Equitable means that emphasize consensus should be pursued.
The infamous New York City fiscal crisis offers a helpful model of indirect management.
In November 1975, the federal government promulgated the Seasonal Financing Act, whereby the Treasury managed a $2.3 billion revolving credit line to alleviate New York City's lack of cash flow with periodic draw downs. The draw downs had requirements and benchmarks.
A requirement of loan eligibility was implementation of accrual (GAAP) accounting and a balanced budget by 1978. Another was periodic audits and regular financial reporting.
The city and its labor organizations were required to reform the pension laws and the funds were required to invest 40 percent of their assets in city securities.The city and its underwriters had to negotiate terms to purchase, retire or stretch city debt. This led to the MAC Swap whereby banks exchanged their short-term city notes for long-term MAC bonds.
Finally, the city was required to raise taxes and fees, to fund its pension systems fully, and to replace certain officials. Loans had to be repaid in the year in which they were incurred at 1 percent higher than the cost of funds.
The conditions were onerous. But, importantly, they were optional. The city did not have to request draw downs. The banks did not have to restructure their credits. The pension funds did not have to invest in city securities. Rather, they had incentives to act in their best interests.
The fiscal crisis is now described as a time of business/labor cooperation, remarkable gubernatorial leadership, and legislative accomplishment. All true. But it was also a time of skillful indirect management that provided the opportunity to succeed.
There is a state analog that could induce business, labor and government cooperation and avoid impositions of state power. A government that requests "spin ups" needs the market discipline of short-term lenders. A government that seeks to issue deficit bonds is failing to make structural reforms, relying on long-term debt to address immediate needs without creating new assets.
A pool of short-term cash could be made available by the state to be drawn by distressed governments pursuant to strict conditions that would necessitate consensual actions.
There was a carrot-and-stick approach in New York City without being overbearing and singling out any constituency for harsh treatment. Every affected group had to cooperate. The theme of a seasonal loan pool would be to put discipline into local governing without imposing it.
Local governments can't enact fiscal discipline on their own. But if the state were to require reforms, and reward them, local consensus might emerge.
Peter J. Kiernan is of counsel to the law firm of Schiff Hardin LLP. He previously served as counsel to Gov. David Paterson.