# Reading a government's fiscal health like a rating agency
In 2013, Detroit filed the largest municipal bankruptcy in US history, $18 to $20 billion in debt, and the warning signs were visible in its financial statements years before. Fund balances had been shrinking, cash reserves were nearly gone, and long-term liabilities kept climbing while revenue stagnated. Anyone who knew which ratios to check could have seen the stress coming. This lesson teaches you those ratios.
Credit rating agencies (Moody's, S&P Global Ratings, Fitch) score government and public agency debt so investors know the risk of buying municipal bonds (debt issued by cities, states, or public authorities) or sovereign bonds (debt issued by national governments).
Unlike a company, a government can't be "acquired" or liquidated easily, but it can run out of cash, default, or need external bailout support (as Greece did in 2010). Rating agencies focus on liquidity, debt burden, and structural balance rather than profit.
A "fund balance" is the difference between a government fund's assets and liabilities, roughly its savings cushion. The unrestricted fund balance ratio compares that cushion to annual spending:
Formula: Unrestricted Fund Balance ÷ Total General Fund Expenditures
Worked example: A mid-size US city has $18 million in unrestricted fund balance and $90 million in annual general fund expenditures.
Benchmark (estimate, as of 2024 guidance): The Government Finance Officers Association (GFOA) recommends US local governments hold at least two months of operating expenditures, roughly 16.7%, in unrestricted reserves. Moody's tends to view ratios above 25 to 30% as strong, and below 5 to 10% as a stress signal. Our example city, at 20%, sits comfortably in the "adequate" zone but isn't exceptional.
This measures how much debt a government carries relative to what it takes in annually, similar to a debt-to-income check for a household.
Formula: Total Direct Debt ÷ Total Operating Revenue
Worked example: A regional transit authority has $450 million in outstanding bonds and $150 million in annual operating revenue.
450 ÷ 150 = 3.0x
Benchmarks (estimates): Moody's US local government methodology often flags debt-to-revenue above 3x to 4x as elevated. For US states, net tax-supported debt as a percentage of revenue above roughly 30 to 40% draws scrutiny (estimate, varies by state economic profile). In the Eurozone, the Maastricht Treaty's convergence criteria set a national government debt-to-GDP (Gross Domestic Product) benchmark of 60%, a very different scale but the same underlying logic: can revenue realistically service the debt load?
Borrowed from hospital and utility finance but increasingly used for public agencies, this measures liquidity survival time.
Formula: (Unrestricted Cash and Investments ÷ Annual Operating Expenses) × 365
Worked example: A public hospital authority holds $40 million in unrestricted cash against $200 million in annual operating expenses.
(40 ÷ 200) × 365 = 73 days
Benchmarks (estimates): S&P Global Ratings generally treats fewer than 30 days cash on hand as weak for a municipal enterprise, 60 to 150 days as medium, and above 250 days as strong. Our hospital authority's 73 days would land in the "medium," slightly cautious range, worth watching if trending downward.
A single ratio tells you a moment in time. Rating agencies weight direction heavily. A fund balance ratio of 15% that's been rising from 8% over three years signals recovery. The same 15% falling from 30% signals deterioration, even though the current number looks identical.
This is why Moody's and S&P publish multi-year historical tables in their rating reports, and why analysts building fiscal dashboards always chart at least three to five years of data, not one.
# Simple trend flag example
years = [2022, 2023, 2024, 2025]
fund_balance_ratio = [0.28, 0.22, 0.17, 0.15] # percent as decimal
def trend_flag(ratios):
delta = ratios[-1] - ratios[0]
if delta < -0.05:
return "Deteriorating: down more than 5 points"
elif delta > 0.05:
return "Improving"
return "Stable"
print(trend_flag(fund_balance_ratio))
# Output: Deteriorating: down more than 5 pointsUnited States: Fragmented system. Roughly 90,000 units of local government (estimate, US Census Bureau), each rated individually. Ratings hinge heavily on fund balances, pension liabilities (unfunded obligations to retired public employees), and debt-to-revenue. GASB (Governmental Accounting Standards Board) sets the accounting rules that produce these numbers.
Europe: More centralized. National governments dominate the credit story, and EU fiscal rules (the Stability and Growth Pact) set reference thresholds: government deficit under 3% of GDP, debt under 60% of GDP, though many member states, including Italy and France, have exceeded these thresholds for years without immediate crisis, showing thresholds are guidelines, not hard triggers. Sub-national European borrowing (German Länder, French régions) is smaller relative to national debt than in the US.
Knowledge check
1. Why do rating agencies evaluate governments using different criteria than they use for corporations?
2. A city's unrestricted fund balance ratio has been steadily declining for several years while its long-term liabilities have been rising and revenue has stayed flat. What does this pattern suggest?
3. A government has a strong unrestricted fund balance ratio in a given year. What is the most accurate conclusion an analyst should draw from this single data point?
4. Select ALL correct answers about the unrestricted fund balance ratio.
Select all the correct answers.
5. Select ALL correct answers about situations where a government (rather than a corporation) faces fiscal distress.
Select all the correct answers.
When you look at any government or public agency's financials, run this three-question filter:
1. Cushion: Fund balance ratio above 15 to 20%? (US local government comfort zone, estimate)
2. Burden: Debt-to-revenue below 3x? (rough caution line, estimate)
3. Liquidity: Days cash on hand above 60? (medium-safe zone, estimate)
A government failing two or more of these, especially with a worsening trend, is the kind of profile that triggers a rating agency "negative outlook" or downgrade watch. You can check real examples in Moody's and S&P's published municipal credit reports, many summarized for free by the Pew Charitable Trusts' state fiscal health project.
🎬 [VIDEO: "How Credit Rating Agencies Rate Municipal Bonds" - https://www.youtube.com/results?search_query=how+credit+rating+agencies+rate+municipal+bonds - Search results for explainer videos covering the muni bond rating process and key agency criteria]
Fund balance and debt-to-revenue ratios can look healthy while a government still carries a massive unfunded pension liability (the gap between promised retiree benefits and money set aside to pay them). Illinois and Chicago are frequently cited examples of governments with adequate short-term liquidity but severe long-term pension stress. Always check pension funded ratios (plan assets ÷ liabilities) alongside the three core metrics; below 60% funded is widely treated as a red flag (estimate, varies by actuarial assumptions).