Municipal governments’ (mis)governance

Abstract

Since the 1970s, major financial disasters have occurred frequently in the public finance sector leading to taxpayers bearing the losses and paying higher taxes for many years. During the past few decades public entities such as New York City, California's Orange and San Diego Counties, Ohio's Cuyahoga County, and many public funds, local governments and public pension pools have suffered losses due to financing strategies involving excessive leverage and risky derivative trades, and public officials relying on investment bankers’ sales presentations without understanding the underlying risks. Jefferson County, Alabama, is the latest case of a large municipal entity at the edge of municipal bankruptcy caused by poor investment policies. Cities including Chicago, Detroit, Denver, Philadelphia, Los Angeles, Oakland and Richmond are experiencing financial distress. The states of Massachusetts, New Jersey, New York and Oregon and entities such as Bay Area Toll Authority are losing money on poorly designed interest rate swaps, and are trying to exit the contracts by paying hefty exit fees. Issues related to fraud and poor internal control procedures are surfacing in municipal entities of all sizes. While public entities have performed quite well in their risk management efforts relating to disasters and terrorist threats, risk management practices relative to financial assets have been quite inadequate. This article reviews some of the reasons leading to the financial disasters, and discusses key components of regulatory reforms proposed to strengthen the municipal securities market and the roles and responsibilities of audit committee members in government entities. It offers a suggested implementation template for public entities’ risk management practices based on COSO Enterprise Risk Management and Internal Control frameworks and for meeting their strategic objectives combined with better governance and stewardship of taxpayer assets.