Almost fifty years ago, America’s largest city was on the brink of bankruptcy, about to default on a massive debt repayment with only one-tenth of the cash on hand required to make good on it. The day of reckoning had come after years of high spending relative to depressed revenues. New York City was billions of dollars in debt and this was mostly short-term in nature, having to be refinanced regularly. In 1975, a confluence of factors combined to lock the city of New York out of the debt markets. A rescue was needed, and it arrived, but when it came it changed the city’s economic and fiscal future nevertheless.

Fiscal Decay

           As with any tale of fiscal trouble, high spending in relation to revenues is due some part of the blame. In New York, the city had to fund all the same services any other American city provided, fire and police departments, roads, courts, and schools. However, New York had other drains on its budget that were either nonexistent or less expensive elsewhere. The city subsidized its transportation infrastructure to a large degree, low fares on public transit and low or no tolls were collected on city bridges and highways. The city also funded free public universities and delivered services not usually under direct public control in American cities, from municipal hospitals and healthcare clinics to childcare facilities.

           By the start of 1975, the costs of these services and simultaneous pressures on city revenues posed a challenge for the new mayor, Abraham Beame. Mayor Beame was, appropriately enough, an accountant by trade and had previously served as the city’s comptroller, its chief accountant. The mayor was elected fewer than two years earlier with the slogan, “If you don’t know the buck, you don’t know the job.” The accountant took over a city plagued by two corrosive trends, suburbanization and deindustrialization, trends that drove well-paid jobs and well-paid wage-earners away from the city. He also took over as mayor in the immediate aftermath of the Recession of 1972-74, which put pressure on government budgets everywhere.

           New York’s problems were degrees greater though. The city had roughly $4 billion in debt outstanding, the product of fifteen years of budget deficits. It also had a peculiar reliance on rolling short-term bills to fund the debt, essentially giving the city access to only a variable floating debt which rising interest rates was making very expensive to service. New York’s continued access to the bond market was uncertain altogether and soon enough it was about to close off almost entirely.

           In March 1975, the Urban Development Corporation (UDC) defaulted on ‘bond anticipation notes’ it had issued. This was a harbinger and even a direct cause of what was soon to afflict the city. The UDC was not a city organization, to be sure, but a corporation formed by the State of New York to finance urban renewal projects and its bonds were not even guaranteed by the state, hence the default. However, it too came to its knees on short-term debt; the ‘bond anticipation notes’ it defaulted on were, as the name implies, issued as a short-term funding source prior to being refinanced with the issuance of longer-dated municipal bonds. In the end, the UDC received a $100 million bailout and was a sign of trouble that curtailed investor demand for New York municipal bonds altogether.

           A further attribute of New York’s fiscal decay was a lack of quality financial information available for the public and even insiders, the result of bad accounting. For example, the city had masked operating expenses as capital investment to justify borrowing and make the city finances look more secure by pretending that recurring expenses could be eliminated as easily as a capital project.

           By 1975, this was becoming increasingly unacceptable. To start, Standard & Poor’s withdrew the city’s A+ credit rating, citing inadequate information to continue its coverage of the issuer. Investment banks marketing the city’s bonds were now also protesting the lack of transparency into the city finances, going so far as to call off bond sales, refusing to be on the hook for unsold bonds from such an astonishingly shady borrower.

Drop Dead     

           By now, the city’s fiscal troubles were common knowledge and so its bonds became unmarketable. So much had the situation deteriorated that even the city’s public sector unions were refusing to invest any more pension money in its debt. The banks and the investing public also found further issuances unappetizing. The city was locked out of the bond market, unable to borrow in its own name since March 1975, the month of the UDC default. This was especially troublesome for a city with hefty deficits and reliant on rolling over short-term debts when they came due.

           Events came to a head when the city came within hours of default on October 17, 1975. The city even prepared a bankruptcy filing to be submitted to the state’s Supreme Court that very day. That day, still two weeks before President Gerald Ford’s infamous ‘drop dead’ speech, the city had $453 million in debt coming due compared to just $34 million in cash on hand. In preparation for what they increasingly saw as inevitable, the staff of New York Governor Hugh Carey and the Mayor’s administration were combing through the city’s budget, isolating essential spending from non-essential spending to preserve the city’s functioning post-bankruptcy to the greatest degree possible. That Friday, paychecks did not go out for some employees and at least one bank was refusing to cash city payroll checks unless the funds were drawn from money left by the city in that particular bank. In the end, a rescue came.

“I have been advised by the Comptroller that the City of New York has insufficient cash on hand to meet debt obligations due today … To accomplish the primary use of the City’s funds for life support and other necessary services, I am, under State law, required to file a petition in State court seeking the protection of the court from the City’s creditors … I will, of course, continue to press for immediate assistance in Washington …” – Press release prepared for Mayor Beame in the event of a bankruptcy filing

           Curiously, the most remembered moment of the whole saga, a speech by President Ford rejecting a bailout, is so far absent from this story. This is because those comments came after the closest brush with bankruptcy. The President’s remarks came on October 29th in a speech before the National Press Club.

           Rejecting federal government participation in a rescue package, Ford instead suggested that the city cut spending and raise taxes and if needed, file for bankruptcy, expressing willingness to reform bankruptcy laws to make that easier for the city. The speech came to be known by the New York Daily News’s cover the next day summarizing the address with “Ford to City: Drop Dead”. By that day though, the gravest moment of the crisis had already passed.

“I can tell you, and tell you now, that I am prepared to veto any bill that has as its purpose a federal bailout of New York City to prevent a default.” – Gerald Ford, National Press Club Speech, October 29, 1975

Rescue

           In truth, however hopeless the situation on October 17th may have seemed, a bailout of the city had already been well underway. Indeed, the continued troubles occurred in spite of assistance being given to the city, or because of its insufficiency, and not because of its absence. Some of this assistance had been coming from the State of New York for months. Since March, the state government had been advancing municipal aid payments intended to support the city months earlier than when they were due. For instance, aid appropriated for 1976 was given to the city a year early. However, faced with the need to roll large short-term debt issuances in a frozen market, these measures did little to help.

           Then there was the creation of the Municipal Assistance Corporation, a state entity formed in June that year. The organization, which oversaw some of the tough measures implemented to reform the city’s fiscus, was led by Felix Rohatyn, a former Lazard Frères banker. The Municipal Assistance Corporation, known then as ‘Big MAC’ had been authorized to refinance up to $3 billion in city debt. To this end, MAC issued long-term bonds on behalf of the city in exchange for the ability to veto spending decisions. To support the bonds, which were viewed more favorably than other New York City issues, certain city tax revenues were diverted by the state to secure the debt.

           Nonetheless, the city’s fiscal situation was so dire, and so publicly known, that this too was not enough to save the city from default. MAC was having trouble selling the city’s bonds and this was how the city still found itself in trouble in October. The bonds that were issued began trading at discounts almost as soon as they were in public hands, spoiling the market’s appetite for more. A massive $1 billion issue of MAC bonds, the largest municipal bond issuance in American history up to that time, had tax-exempt yields of over 11% on the secondary markets. Attempting to throw everything conceivable, yet politically palatable, at the situation, the state created yet another new agency, the Emergency Financial Control Board, in September 1975 which put still more power over the city’s finances into the state government’s hands.

           Later on, the federal government did lend assistance to the city. President Ford began to change his position within weeks of the ‘Drop Dead’ speech and a full reversal was cemented two months later when the federal government committed to providing financing. Up to $2.3 billion in short-term financing to be provided through June 1978 was arranged conditional on fiscal reform. It came at a favorable cost for the city at just 1% over the rates on benchmark Treasury bonds. When this program was set to expire in 1978, it was replaced with the New York City Loan Guarantee Act which continued to provide a federal guarantee for city bonds, once again conditional on further fiscal reforms.

           However, what saved the day on October 17th specifically was intervention, not by the state or federal governments, but by the city’s public sector unions, particularly the United Federation of Teachers. Use of pension fund money to purchase city bonds was secured at 2pm that day, plugging a $150 million shortfall at the last minute. The union was opposed up until that very day to more bond purchases, understandably so, to say the least. It was truly an unexpected resolution. To prevent a missed payment, Manufacturers Hanover Trust, the bond’s payment agent, and the Federal Reserve, both stayed open later that day to ensure payment was delivered under the bonds.                                  

Fiscal Reform and Recovery

           Over the subsequent few years, the city was required to make significant budget cuts and address its economic challenges in an entirely new way. Under Felix Rohatyn, Big MAC insisted on reforms. Those implemented included the introduction of tuition fees at the City University of New York and increased transit fares, with subway fares rising over 40%, from 35 cents to 50 cents, and tolls on bridges rising as well. There were also rounds of staff cuts in the tens of thousands and wage freezes for city workers. In some instances, unions agreed to deferred wage increases in lieu of a freeze altogether.

           Some of the challenges that afflicted the city over the subsequent twenty years have been attributed to the fiscal crisis back in 1975. These included rising crime, increased homelessness, and public health crises from AIDS to tuberculosis. Of course, none of these were directly caused by the fiscal crisis and these were problems that afflicted other American cities, and indeed cities abroad, at the same time. However, the weaker capacity of local authorities to foresee and address the crises could not have helped.

           In the end though, the city returned to a solid fiscal footing. There was no bankruptcy, either in 1975 or thereafter. Such a favorable resolution looked extraordinarily unlikely back in October that year and is something of a surprise to this day. Of course, the exact consequences of things that did not occur are invisible but, for a matter like this, they would no doubt have been great. The requirement of the city’s rescuers for balanced municipal budgets based on sound accounting was a noble cause, restoring a proper relationship, based on trust, between borrower and creditor.

           The fiscal crisis also changed the way the city addressed economic issues, turning away from expensive public sector remediations and towards private sector solutions. The latter of these approaches led to initiatives as varied as incentivizing firms to relocate to New York to leveraging private philanthropy for public purposes. The changes to New York City’s public finances and economic strategy during the mid-1970s foreshadowed changes that would change the country and the capitalist world more broadly in the subsequent years.

Lesson

            Not all governments are so lucky as to escape an immanent bond default as New York was. On the morning of October 17, 1975, the presumption among all was that New York would miss its principal repayment and file for bankruptcy protection. However, the city was more fortunate still. After the rescue, it set about on a fiscally sustainable course and a default was averted altogether, not just on that mid-October day but ever since. It is never left to the bankrupt borrower to decide how a default would be handled, at least not immediately. Seen in that light, the path taken in 1975 was perhaps the best of all possible paths.

More from the Tontine Coffee-House

Historical fiscal restructurings, in the context of a bankruptcy or not, are numerous. Read about the restructuring of the public finances of cities like late-medieval Venice and of countries like England, France, and Greece.

Further Reading

1.      Larkin, Richard. New York City 1975-1981: The Granddaddy of Muni Distressed Credit. Herbert J. Sims & Co., Inc., 19 Apr. 2012.

2.      New York City’s Financial Crisis: An Evaluation of Its Economic Impact and of Proposed Policy Solutions. Joint Economic Committee, Congress of the United States, 1975.

3.      Nussbaum, Jeff. “The Night New York Saved Itself from Bankruptcy.” The New Yorker, 16 Oct. 2015.

4.      Phillips-Fein, Kim. Fear City: New Yorks Fiscal Crisis and the Rise of Austerity Politics. St Martins Press, 2018.

5.      Rosenfeld, Neill S. United Federation of Teachers: 50 Years: 1960-2010, United Federation of Teachers, 2010.

6.      Van Riper, Frank. Ford to City: Drop Dead in 1975. New York Daily News, 29 Oct. 1975.

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