The dangers of financially illiterate politicians
When the city of South Miami decided to build a new parking garage to the tune of $12 million, the officials behind the project undoubtedly meant well.
But in 2005, when they turned the project over to a private developer, they embroiled themselves in a financial deal that attracted the disapproving gaze of the Securities and Exchange Commission. After a long tussle with a jumble of financial regulations, critical regulators and angry investors that dragged on for years, what had seemed like a straightforward project had become a mess, with the city owing the IRS $260,345.
The story of what happened in South Miami, Fla., isn't that unique. In fact, cities all over the country have found themselves in hot water in recent years over public works projects that ran over cost or became boondoggles. And experts say that shouldn't come as a surprise to anyone. After all, government officials are not always financial wizards.
"I'm not being critical," says Scott D. Pattison, executive director of the National Association of State Budget Officers based in Washington, D.C. "You put a social worker as head of the department of social services, you don't put in a financial management person."
A governor might be expected, for example, to put in a highly regarded physician as the head of a state's health department — a physician who may or may not be familiar with government finances.
"I can understand that if you focus on substantive issues," Pattison says of government leaders, "you might not be tracking the numbers."
And that can lead to trouble.
The need to understand budgeting processes, spending procedures, fiscal years and other basics is something that all public officials, not just agency heads, need to understand. Public officials at the state and municipal levels bring a wide variety of skill sets to their positions — and even people familiar with money management may be daunted at some of the complex finances of things like conduit issuer bonds, revenue streams, federal grants and interest swaps.
"I was surprised," says Pattison, who was Virginia's budget director from 1997 to 2001, "at how often I would have to call some agency heads in early January and say, 'I just want to let you know, I hope you are tracking things, because we are only half way through the fiscal year, but you've spent 65 percent of your appropriation. So you don't have half of your money even though you still have half the year left. You need to try and manage that.’ ”
Public officials and agencies have finance and budget directors, auditors, governmental accountants or other financial officers. This means they can solve about 90 percent of the problems brought on by an official's lack of financial knowledge, Pattison says.
But not always.
For years, California's Department of Parks and Recreation underreported how much money it already had when submitting requests for more money from the state. The idea was likely to exaggerate the need for money so it would be easier to get what parks officials wanted. According to the state auditor, Elaine Howle, last year, the Parks Department's budget officer noticed this problem but was told by upper management to continue the practice.
"I have trouble speculating exactly why these problems happen," Pattison says. "Sometimes the boss overrules the finance person, or the finance person is reluctant to speak truth to power. I don't want to criticize those people, it is hard to say exactly why some things happen, but they do."
More for less
Other financial problems come not from lack of simple financial understanding, but from increasing complexity. "We are trying to live a contradiction," says Justin Marlowe, a professor of public affairs and public finance at the University of Washington in Seattle. "People want government to do more and more, yet they are told they can pay less and less on property and income taxes. So government is expanding programs and services or offering the same services with less resources."
So municipal and state governments come up with very sophisticated and complicated ways for borrowing money and financing obligations such as pensions, Marlowe says.
"They come up with technical solutions to political problems," he says. "And every time you do that, it becomes more and more complex."
This complexity causes problems when political officers either take action without understanding everything involved (or without consulting the best experts on the question) or do not take the action required because of a lack of political will to do what is necessary, Marlowe says.
Marlowe points to Wenatchee, Wash., where Wenatchee and surrounding municipalities issued $42 million in bonds in 2008 to build an ice hockey facility. An independent consultant didn't think the facility would generate enough cash to support itself — and pay back the bonds' interest and principal.
Government leaders, however, let their optimism push the project forward; they lacked the will to back down on a popular project and the information for bond buyers hid the consultant's negative assessment. The Securities and Exchange Commission fined the bond issuers in late 2013 for "misleading investors."
Part of the solution would be for citizens to also have a better sense of what is going on financially, Marlowe says.
"If people are engaged even a little bit, if they don't like what they see, they vote them out," he says. "But it doesn't seem to happen all that often. Usually it takes a scandal."
One way of getting people more informed, and presumably more engaged, is to give them more information, says Relmond Van Daniker, executive director of the Association of Government Accountants, based in Alexandria, Va.
"One of the key players in the whole gamut of decision are citizens," Van Daniker says. "It is incumbent upon us to provide information to citizens that they can understand."
Based in part on something Mike Leavitt did when he was governor of Utah, Van Daniker is pushing for governments, municipalities and agencies to periodically produce a concise four-page breakdown of their financial condition. The report, called a "Citizen Centric Report," has one page for demographics, one page for performance indicators (i.e., did the government achieve its goals), one for financial statements (using graphs and so forth) and one for the challenges the entity faces.
Van Daniker contrasts the Citizen Centric Report with the standard audits required by law — huge book-like documents that are basically good for legal action, but are difficult for the average citizen to understand. The Citizen Centric Report also has advantages for elected officials heading government agencies.
"It makes it easier for the politicians to go out and talk to the people in language they can understand," he says.
And, presumably, make better decisions.
Pattison of the National Association of State Budget Officers doesn't think that solutions to the problems of governmental financial illiteracy are hard to implement. He suggests elected officials meet regularly with their financial people.
"The budget process is a year-long process," Pattison says. "But a lot of agency department people (for example), only pay attention to finances at the end of the fiscal year or during the legislative session. They need to pay attention throughout the year."
For example, if an agency head knows how much money is going to print various reports, he or she may decide in a budget pinch to cut one of those reports to save money. Without that type of knowledge, Pattison says, the agency head might just implement a general 1 or 2 percent reduction in the agency's budget across the board.
Having briefings and keeping closer track of what is going on makes politicians better decision-makers, Pattison says. "It is not sexy or huge, but briefings make for a smoother process."
And understanding the basics will also help officials to know how to better work with, and not override, financial experts when things do get too complex.
"I've recently sat through briefings on the government accounting standards for pensions," Pattison says. "The standards are highly technical. I wouldn't expect anyone outside of the finance side to understand them. (What government officials need to know) is more of the basics, to just be aware of the processes."
Marlowe, of the University of Washington, can easily give examples where better financial literacy may have prevented municipal or state problems, but he says they are the exception.
"Despite the cynical things we have been saying, a key point to keep in mind is that fundamentally, most local governments and most state governments are generally well run," Marlowe says. "They get the job done. They deliver the services on time. They pick up the trash. They educate the kids. They do whatever it is they are supposed to do. Fundamentally, most governments are doing more with less and are generally run by competent people who are trying to do the right thing."
Financial literacy training: The State Budget
The National Association of State Budget Officers produced a series of "State Budget Basics Videos" to help state officers become more financially literate. This is "Part 1: The State Budget Process" that provides concepts and information on the process of building and approving a state budget.
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