The North Carolina model is more relevant
than ever to US local government finance
By Mayraj Fahim, Local government adviser*

5 March 2013: North Carolina’s municipal finance and oversight system demonstrates how to limit the number of fiscal crises. As a result of its local government default history in the issuance of municipal bonds during the Great Depression, the State of North Carolina developed a system that continues to influence others in following the path it took in the early 20th Century. Today when a number of US states are forced to take over the financial management of municipalities and school boards, North Carolina’s system of state supervision of local government finances has become more relevant than ever.

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In January 2013, the Comptroller of the State of New York launched a new monitoring system to track fiscal stress in local governments and school districts. Under the new system the Comptroller’s Office will publish "fiscal stress" scores put together by evaluating nine financial indicators and broader demographic information. The intention is that these will serve as an early warning system the State can use to help local governments from sinking further into financial decline.

New York State is no stranger to takeover of local governments in fiscal distress as New York (2 times), Yonkers, Buffalo, Troy, Nassau County (2 times) and other local entities’ experience has demonstrated. However, since the Great Depression, local governments have not faced financial strains as severe as those experienced at the onset of the global financial crisis of 2008. The monitoring system combined with the takeover power moves New York closer to the North Carolina example. New York has thus joined the fourteen other states that since 1980s “have informal determinations or indicators used to identify when fiscal crises are probable” as noted in the November 2009 Memo of the Ohio State Auditor, Mary Taylor, in entitled “Fiscal Indicators: A Proactive Approach to Local Government Financial Assistance.” On 10 August 2012, an editorial article published in New York Newsday entitled “Editorial: Help NY's local governments manage money woes” had suggested the state follow in the footsteps of North Carolina. By taking this step, the state is certainly taking steps in that direction.

However, other features in the North Carolina system render its system both more proactive and more supportive. Ms Taylor’s memo also acknowledges what makes North Carolina unique. It “has the most extensive powers to monitor and intervene in the financial affairs of a local unit of government. Its Local Government Commission is empowered to perform adequate and frequent financial reviews, has a broad set of control powers that allow it to intercede in the financial affairs of local government, and has been allowed to do what is needed to maintain the financial health of its local units of government.”

As Detroit is to follow five other municipalities in Michigan, to be placed under direct state oversight, these local governments and their residents are paying the price for the state’s failure to follow a recommendation made in 2000 by the Citizens Research Council of Michigan to follow North Carolina’s example. Already Pontiac, Flint, Ecorse, Allen Park and Benton Harbor have emergency financial managers in place as do Detroit, Highland Park and Muskegon Heights as well as some public school districts.Going through such an experience is traumatic and may not solve underlying economic weaknesses. It can also leave scars that have difficulty in healing. Heading off the problem is a more constructive alternative.

Through regular checks of local finances, it has succeeded in minimizing the type of fiscal distress that has occurred with increasing frequency within local governments of other states lacking a similar framework. This has also facilitated lower tax rates and thereby saved taxpayers money. Furthermore, the state’s role in supporting and guiding its municipal bond issuers has delivered superior credits. And the state’s mechanism of educating local government officials has enabled the state to provide an enduring and sterling example of superior performance that has led to calls for its emulation.

An analysis of the system’s various components reveals that systemic information-sharing is the key driving force of the North Carolina system that builds compliance on the foundation of the administrative and financial laws for local government in North Carolina. This is especially true in relation to The Local Government Budget and Fiscal Control Act, and other statutes related to local government finance that together establish the framework of conduct for government units within the state of North Carolina. The financial discipline of its local governments, state oversight and technical assistance thus play a key role in the national reputation of North Carolina’s local governments for strong financial management.

The state's system of local government has relied on this method to lead the nation in the number of AAA-rated local governments (constituting as much as 25 per cent of the units in this premier category). Local issuers are generally the recipients of better reception than the national average, with local issuers also paying less interest on their debt than equally rated issuers from other states, in a state that is remarkable for the fact that it is one of a few states with a majority of both small units and rural units.

The Institutional Components of the North Carolina System
The Local Government Commission
The Local Government Commission (the “LGC”) was established in 1931 to address the problems in local government finance caused by the Great Depression. At that time more local governments in North Carolina defaulted on their debts than any other state in the nation, except Florida. 

While the formal policy-making authority is held by the LGC, its day-to-day operations are carried out by staff, who are divided respectively into sections pertaining to fiscal and debt management. 

The role of the LGC has evolved as changes in financial management have taken place. More financing methods, investment securities, and automation methods have all become readily available to local government officials. However, its basic statutory responsibilities remain unchanged. 

The Fiscal Management Section
This Section’s most important objectives are to see that debt service and other payments are made in a timely manner, and to ensure adequate financial reporting.

The Competitive Bond Sales and State and Local Government Debt Records Section
This Section handles the sale and delivery of general obligation bonds as well as all state and local government debt records.

The Authorizations and Negotiated Bond Sales Section
The role of this section expanded significantly owing to an increase in the variety of the types of bond issued by North Carolina municipal bond issuers. Although this section handles a variety of types of financing, such as industrial revenue bonds, bond issues for private colleges and universities, and bond issues for private not-for-profit hospitals, its primary responsibility lies in direct financings for local governments.

The School of Government at the University of North Carolina
Originally established as the Institute of Government (the “SOG)” plays a major part in the maintenance of the system. Since 1931, the IOG has conducted schools and short courses for city, county and state officials. In 2001, the University created the School of Government, which encompasses the work of the former Institute of Government. The Institute has been a source of inspiration for institutions in other states, including those in Georgia, New Jersey and New York. Its successor continues to attract national and international interest. The School frequently shares information about state and local government structure and issues with delegations of visiting international officials.

Public Finance Benefits Offered By Decentralization
The US municipal bond market demonstrates its virtue of maximizing capital-raising capacity within the system. Hence, a primary practical reasoning behind the decentralization of the North Carolina system during the Reconstruction period, was the realization that decentralization maximizes the capital-raising capacity of the system. Because of the state’s extreme need for capital to finance reconstruction, decentralization was the optimal route to take. By this time, the municipal bond market in the US (which New York City opened with the floating of the first bond of that genre in 1812) had already been active for more than 50 years. State leaders were well aware that the depression of 1837-43 was caused by the issuance beyond capacity of bonds by state governments within the United States, after which point limits were constitutionally imposed upon the borrowing levels of state governments - the first systemic safeguarding feature put in place in this market.

Consequently, North Carolina arrived at the logical conclusion that decentralization was the obvious route for maximizing the capital-raising capacity of the system. In fact, the state’s unique local government finance system (put in place during the Great Depression) reflects its continued commitment to maximizing capital-raising capacity within the system. In the process, the system has delivered the added benefit of minimizing local government fiscal distress - maintaining its source of inspiration on that ground as well. It should be kept in mind that North Carolina is a poor state and is constituted of a majority of small rural local governments. As a result, careful money management has been a constructive necessity for local governments to be able to access the municipal bond market without higher interest penalties they can ill afford or be unable to obtain direct market access altogether.

Other US states, as demographic change gets underway, are due to feel greater financial pressures on their local governments in due course of time. Perhaps they will over time also expand their monitoring to more closely follow the path already taken in North Carolina. But, already this state offers an example for developing countries to consider as their local governments begin issuing municipal bonds. There is a reason why international visitors have made their way to the School of Government to learn about this unique state system.

Acknowledgements to ‘State and Local Government Relations in North Carolina: Their Evolution and Current Status’, Edited by Charles D. Liner [Publisher: Institute of Government, University of North Carolina at Chapel Hill.]