Innovative Distress Study

In response to the number of municipal bankruptcies and ongoing local fiscal distress in the Golden State, the California treasurer’s office has embarked on a project aimed at predicting municipalities’ likelihood of default. Treasurer Bill Lockyer has hired San Francisco-based research organization Public Sector Credit Solutions and San Jose State University economist Matthew Holian to head up the effort, which aims to create a “default probability model for city bonds” by means of a model which will generate “numeric scores” that will seek to quantify the likelihood of defaults, with the projected model and default predictions for more than 200 California cities expected to be ready by next May. The Treasurer hopes the project will help give the state an early warning of local governments in financial distress and help “raise red flags” at the state level. The effort is also intended to help make the financial conditions of municipalities more transparent to investors and the public. Subsequently, in an effort comparable to the focus underway at George Mason University at our Center for State and Local Leadership, California will work to create a “response system” to help assist troubled municipalities. The California effort will test the tensions between the state and its cities—the state constitution largely prohibits the state from meddling in cities’ financial affairs, and the effort appears to be outside of any partnership with the California League of Cities. The calculation for each city will be based on financial data found in the city’s financial statements, budgets, and projections—with the key data focused upon being interest expense, revenue, and annual change in revenue.