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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 160 LUBY 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 162 LUBY 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, 164 LUBY 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.