MSU Extension Center for Local Government Finance & Policy

The Great Recession of 2007-2009, nearly a decade ago now, was the catalyst for a series of major financial problems in American local governments.  These problems saw the advent of over seven major municipal bankruptcies and dozens of other local emergencies and crisis situations.  While these problems now appear to be safely in the rearview mirror, they have exposed deeper fault lines in the stability and resilience of local governments across the country.  For many states, these problems have heralded a new era, which has resulted in the search for proactive strategies to prevent and mitigate financial instability before it becomes a crisis.

There is a long history of attempts to measure and identify local fiscal problems going back to the crisis of New York city in the 1970’s.  At that time, it became popular to attempt to use ratio analysis, as first used in the private sector for credit analysis, to use a series of ratios to identify local fiscal problems.  These ratios were seen as predictive of potential problems that may arise in the ability of a local government to pay its bills as they come due.

As computing power and data have improved, more states have joined in attempting to predict fiscal distress using ratios.  Generally, these strategies have focused on a series of current ratio and long-term ratios to match up the scale and scope of problems that may exist.  The International City/County Management Association (ICMA) developed the Financial Trend Monitoring System (FTMS) and pioneered the terminology of cash solvency, budgetary solvency, long-run solvency and service-level solvency.  These terms are still in wide use today. They reflect the fact that one may wish to consider a range of time frames within which to measure fiscal distress. Generally speaking, these four types of solvency categories have been perceived to fully encompass the universe of local fiscal and service indicators.

For a variety of reasons, states have chosen a wide mix of indicators and indexes from which to construct a fiscal early warning system.  Some states may be focused strictly on short term cash and liquidity and the avoidance of payment problems.  Other states have chosen based on a need to balance long-term interests and service provision with budget solvency.

This report surveys four state early warning systems: Pennsylvania, Ohio, Louisiana, and Colorado. After presenting an overview of each state system in Section IV, it analyzes the ratio indicators used in each system in Section V by comparing the data and results for each state and provides observations and recommendations. The ultimate purpose of this report is to add depth to the literature around fiscal early warning systems by (1) presenting detailed explanations of four existing systems and (2) analyzing the tradeoffs and implications of the four ratio indicator approaches. This report asserts that there is no one optimal system, only the right system based on the perceived needs of policymakers in that particular location.