Using Fiscal Indicator Systems to Predict Municipal Bankruptcies

U.S. state governments over the years have developed a number of methods for predicting fiscal distress and defaults by their local governments. These systems encompass a range of conceptual understanding and practical approaches, and involve varying data requirements and analytic demands. A widespread prediction strategy is to compute indexes of fiscal stress based on financial and other indicators. This chapter assesses the predictive accuracy of three well-documented and carefully argued indicator systems, by computing indicator scores for a sample of three bankrupt general-purpose local governments and six matched jurisdictions that did not declare bankruptcy, over a ten-year period that included the years leading up to the three bankruptcy proceedings. The goal was to answer two primary questions. First, are the indicators all measuring the same thing? How closely do different indicator systems agree in their scoring of a given jurisdiction? Second, to what extent are the indicators predictively valid? How good a job do they do of predicting severe fiscal distress and of distinguishing between cities that did and did not enter bankruptcy? The system developed and currently used by Ohio’s Auditor of State performed well. The system developed in 2002 for Michigan’s State Treasurer (no longer used) and a system subsequently proposed by academic researchers as a potential improvement to it (not implemented) both performed less well.