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J. OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 25 (1), 158-234
SPRING 2013
THE IMPACT OF THE GREAT RECESSION ON THE FINANCIAL
MANAGEMENT PRACTICES OF STATE AND LOCAL GOVERNMENTS:
PART I
Symposium Editor: Martin J. Luby
Copyright © 2013 by PrAcademics Press
J. OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 25 (1), 159-164
SPRING 2013
SYMPOSIUM INTRODUCTION
Martin J. Luby*
There is no doubt the Great Recession has inflicted severe
financial pain on private sector firms, individuals, non-profits and all
levels of government. It has also provided substantial “grist for the
mill” for public finance and public administration researchers who
have tried to determine the causes and consequences of the recent
financial crisis as well as develop potential preventive remedies to
mitigate the effect of such a financial event in the future. Specifically,
the public administration academic community in the United States
has produced several special journal issues and symposiums devoted
to this topic. For example, the Municipal Finance Journal has
devoted two special issues to the financial crisis’ impact on the
municipal bond market and on large municipalities’ budgets (see vol.
29 no. 4 and vol. 32 no. 1), Public Budgeting & Finance ran an entire
issue on the impact of the Great Recession on state budgets (see vol.
30 no. 1) while Public Administration Review published a symposium
examining issues related to financial market regulatory reform in light
of the global financial crisis (see vol. 69 no. 4). This journal, the
Journal of Public Budgeting, Accounting and Financial Management,
recently published a symposium entitled “Beyond the Fiscal Storm:
Surmounting Challenges of the New Public Finance” which details
new approaches governments will have to employ to deal with the
substantial fiscal challenges caused partly by pre-Great Recession
public financial management practices.
This symposium fits into this larger body of research but is
distinctive in that it focuses mostly on the public financial
-------------------------* Martin J. Luby, Ph.D., is an Assistant Professor, School of Public Service,
DePaul University. His teaching and research interests are in state and local
government capital markets, public financial management, and public
management.
Copyright © 2013 by PrAcademics Press
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management practices of state and local governments rather than on
subnational public revenue and public budgeting topics. These
practices include issues related to financial condition analysis,
financial statement disclosure, debt management, risk management,
and pension funding. These are areas of study that have generally
been overlooked by the academic community in its scholarly research
into the Great Recession but have had significant impact on
subnational finances drawing heavy media attention as evidenced by
the substantial press coverage of the recent bankruptcy filing by
Jefferson County, Alabama. Thus, the symposium fits nicely into the
aforementioned Journal of Public Budgeting, Accounting and
Financial Management symposium in that much of the symposium’s
descriptive analysis shows the need for such a “new public finance”
while offering some policy suggestions that could populate this
emerging public finance paradigm.
The symposium aims for a “story arc” of sorts in approaching the
study topic. That is, the symposium papers track the development of
several “innovations” in financial management practices employed by
state and local governments before the Great Recession, evaluate
the impact of the Great Recession on the usage and efficacy of these
practices, and analyze some of the responses by federal and
subnational governments related to these financial management
practices in this current era of severe fiscal stress. Specifically, the
symposium includes papers covering debt-related derivatives,
variable rate securities, municipal bond insurance, pension funding
and financial market reform. The symposium begins with an
assessment of the financial condition of state governments before
and after the Great Recession to set the context, then proceeds with
several papers detailing innovative financial management practices
and the Great Recession’s impact on these practices, and concludes
with the seminal federal response to the financial crisis as it relates
to state and local governments, the Dodd-Frank financial reform law.
The remaining paragraphs in this introductory essay provide a brief
overview of each of the papers and their overall fit into the
symposium.
The symposium begins with Kioko’s “Reporting on the Financial
Condition of the States 2002-2010” which examines the fiscal
performance and financial health of state governments in the period
before, during, and after this Great Recession. This paper sets the
SYMPOSIUM INTRODUCTION
161
general financial context for state and local governments in the
period under study in this symposium. As has been generally
reported in the financial press, Kioko finds through GASB 34 financial
statement analysis a significant weakening of most states’ finances
as measured by various financial indicators culminating in the Great
Recession period of 2008 through 2010. However, smaller states
generally outperformed larger states while most states’ liquidity
positions remain strong and debt levels sustainable.
The second paper, Moldogaziev’s “The Collapse of the Municipal
Bond Insurance Market: How Did We Get Here and Is There Life for
the Monoline Industry Beyond the Great Recession,” details the
explosion in the use of municipal bond insurance by state and local
governments in the years before the Great Recession and the causes
for the sudden collapse of the monoline bond insurance industry
during the Great Recession. Moldogaziev specifically details the
growing and substantial exposure each of monoline bond insurance
companies had to US structured finance and international finance
products in their portfolios which ultimately led to the demise of every
bond insurance firm save one as a result of the undercurrents
associated with the recent financial crisis. The paper concludes with
a set of policy implications and observations about the potential
future impact of an industry that state and local governments relied
so heavily on in the past but which now consists of only “one and a
half firms.”
Luby and Kravchuk’s “An Historical Analysis of Debt-Related
Derivatives by State Governments in the Context of the Great
Recession” provides a comprehensive and systematic analysis of the
use of financial derivatives by state governments, one of the areas of
public financial management that has come under heavy scrutiny by
the mainstream and financial press during the Great Recession. The
paper details the amount and types of debt-related derivatives used
by state governments as well as usage as a percentage of the size of
these government entities’ bond portfolios. Luby and Kravchuk found
that large, sophisticated users of debt finance were most active in
executing debt-related derivatives while many states did not employ
these financial products at all during the period of study. In addition,
while states did escalate their use of debt-related derivatives in
recent years, the level of usage did not generally comprise an overly
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large part of their bond portfolios thus evincing a relatively
conservative use of these financial instruments.
Denison and Gibson’s “Adjustable Rate Debt Overwhelms
Jefferson County, AL Sewer Authority: A Tale of Market Risk, False
Hope and Corruption” provides a case study on the potential severe
impacts that debt-related derivatives (as analyzed in the preceding
paper by Luby and Kravchuk) and variable rate debt can have on
state and local government finances. The paper details how the bond
finance decisions made by Jefferson County, Alabama related to the
use of auction rate securities and interest rate swaps for the purpose
of lowering the escalating cost of repairing its sewer system led the
county to financial bankruptcy in the wake of the recent financial
markets collapse. Denison and Gibson offer a number of “lessons
learned” from this case as it relates to debt limits, financial oversight,
debt-related derivatives regulation, credit rating agencies activity, and
debt finance disclosures to the public.
Seligman’s “State Pension Funding and the Great Recession of
2007 to 2009” investigates one of the most salient and currently
controversial areas of public financial management, the sustainability
of government retirement plan funding. The paper looks at state
pension funding levels, historic asset returns, and business cycle
data to analyze the performance of these funds for the period 2001
to 2009 (i.e., pre and post Great Recession). Seligman finds that,
contrary to much recent conventional wisdom, funding ratios are not
as bad as advertised and not any worse than they were in 1990 right
before the sizable improvement in pension funding seen throughout
the 1990s. This finding casts doubt on the necessity at this time of
taking more draconian actions such as closing or freezing pension
funds. Based on his findings and analysis, Seligman offers some
policy implications and specific recommendations related to plan
administration, asset allocation, and plan participant contribution
levels that would go a long way towards making sure states continue
to honor their current and future pension commitments without
having to close or freeze funds.
The symposium concludes with Johnson’s “Understanding DoddFrank’s Reach into Main Street’s Financial Market” which provides an
overview of the seminal financial regulation legislation enacted partly
as a result of some of the public financial management practices
discussed earlier in this symposium. Johnson specifically focuses on
SYMPOSIUM INTRODUCTION
163
the legislation’s “reach” into the regulation of municipal advisors and
the credit rating agencies couching Dodd-Frank in the context of its
theoretical rationale based on previous finance literature on
securities certification and monitoring. Johnson raises several
concerns related to Dodd-Frank’s impact on the municipal securities
industry including issues surrounding the supply and quality of
municipal advisors, past and future borrowing costs as a result of
under-rated municipal bonds, and increased federal intrusion into the
public financial management practices of state and local
governments.
The papers in this symposium offer a contribution to the public
financial management literature in two ways. First, the six papers in
this symposium advance our understanding of the various financial
management practices employed prior to the Great Recession and
the impact the recent financial crisis had on such practices as well as
the overall finances of state and local governments. In addition to
this descriptive information, the empirical conclusions found in these
papers offer numerous relevant policy implications for finance
managers and public financial management practices. Second, many
of the symposium papers move the public finance literature forward
across a wide range of theoretical strands such as public choice
theory, certification, financial intermediation, and fiscal federalism.
Thus, the symposium strives to achieve the primary mission of the
Journal of Public Budgeting, Accounting and Financial Management
by focusing on bridging both the theories and practices that undergird
the field of public finance, including the subfield of public financial
management.
ACKNOWLEDGEMENTS
In closing, I would like to thank the symposium authors for their
outstanding work in creating the symposium’s content and
developing and refining their individual papers. All papers included in
the symposium were submitted to full, blind peer review and selected
for publication from a larger number of papers than published. I am
also most grateful to editor Khi Thai for his support and
encouragement of this symposium from initial conception to
completion. Finally, I would like to extend a sincere thank you to the
following individuals who served as anonymous manuscript referees:
Woods Bowman, Neal Buckwalter, Beverly Bunch, Jean Harris,
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Rebecca Hendrick, Alfred Ho, Jonathan Justice, Josie LaPlante, Justin
Marlowe, Christine Martell, Clifford McCue, Charles Menifield,
Lawrence Miller, Beth Neary, Jun Peng, Mark Robbins, Bill Simonsen,
Dan Smith, Louis Stewart, Samuel Stone, Janey Wang, Yonghong Wu,
Wenli Yan, and Kurt Zorn. The work of these referees significantly
improved the quality of the individual manuscripts and the
symposium as a whole.