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Excellent History of an Averted Financial Disaster
on December 1, 2010
The authors argue that Governor Hugh Carey's leadership was a major factor in resolving financial difficulties that almost, within hours, bankrupted New York. Carey negotiated with the parties involved, such as bankers, union leaders, and elected officials. He successfully brought all to agree on difficult actions that resolved the crises.
The book serves as a warning on preventing such a situation from happening again or elsewhere. Cautions are provided by the authors that city governments should stop spending on special interests. This spending accumulates and grows over time and, when debt accumulates to where debt is used to pay debt, a city may discover it can't obtain any more credit and the due bills can't be paid, causing bankruptcy. Overspending, especially on items which are not much needed, can lead to debt accumulations that grow until repaying them is unaffordable. Further, a city budgets is often at the whims of external economic forces beyond its control. An economic downturn can drive a city's budget over the financial brink by shrinking available credit, so leaner budgets will better survive the downtown,
Carey, at much political risk to himself, interjected the state government into New York City's financial crisis. He convinced bankers to moderate their demands upon the city government and convinced union leaders to risk buying city bonds with union pension funds. These purchases were chancy as the bonds could have sunk to little value and jeopardized the pension funds. The city government was able to balance its budget, which met the Carter Administration's requirements that allowed the city to return to the credit market to repay its debts.
Carey also led getting the Federal government to help during the Presidency of Gerald Ford. Ford had publically spoken out against helping New York City. Carey convinced the Ford Administration to provide special loans to four New York state agencies that were near financial ruin. Had Carey not stabilized the state government's finances, he likely would have been unable to save New York City.
New York City increased its sale of short term bonds in 1974 as they could not find buyers for their long term bonds. Bankers warned that the market had too many long term city bonds and they would no longer buy them. Short term bonds have higher interest rates and cost the city more money to issue then. These increased costs further strained the city's financial resources.
On the state level, the state government had created the Urban Development Corporation (UDC) to build new housing in areas where "red lining" had led banks to not give housing loans to low income racial minority applicants. The construction on these affordable housing units began before loans were secured. U.S. Housing and Urban Development Secretary George Romney decided to place a moratorium on the providing such loans, leaving the projects underway without sufficient financing. UDC owed $1 billion in bonds on unfinished projects that were not producing any revenue. Banks refused to loan UDC more money to meet its bond payments that were due February 1975. This situation was aggravated by the facts that the banks underwriting these loans, who had hoped to profit by reselling them, chose not to harm the resale value by warning the public of their increased risks.
When Carey became Governor and learned of UDC's problems, he decided it was important to act and win cooperation of the Republican legislators who controlled the State Senate. He could have chosen to blame the Republican White House and HUD whose policies led to the crisis or blame the previous Republican Governors Wilson and Nelson Rockefeller who were in office when this crisis developed. Carey sent an emergency budget bill to the legislature. He briefed the legislative leaders on the crisis and how this could affect the entire state's bond rating. The legislature responded and approved a $30 million loan from an underwriter. This also allowed the legislature to study, grasp the problem, and approve $178 million of appropriations to meet debt payments to bond holders and to approve $50 million to be appropriate to the reserve fund.
Carey brought in a new leader, Richard Ravitch, to direct UDC. Carey met with banking executives to obtain their advice. Their reply was only for the state to repay its' debts. The legislature balked at providing further assistance. State Comptroller Arthur Levitt began refusing to invest state employee pension funds in UDC. In February 1975, UDC defaulted on its' loans, something no sizeable government had done since the Depression. Interest rates on state government bonds across the nation increased. Cary led the legislature in allocating $105 million to cover UDC mortgages. This persuaded banks to make available $140 million in credit.
Carey then learned that New York City, with an $11.5 billion annual operating budget, had $6 billion in short term debt as well as a $1 billion deficit. An advisor to Carey suggested New York restructure its' debt. It was noted that doing so would require the cooperation of the state, the city, the Federal government, banks, and labor unions. Carey realized it is a political rule that a Governor does not meddle in a Mayor's policies and he was initially reluctant to get involved in the city's crisis. He realized the seriousness of the problem and decided his involvement was important.
New York City had about 8 million people with about 1 million people receiving government cash assistance. It also had the highest per capita taxes in the nation. The city lost 500,000 jobs from 1969 to 1976. Unable to fully pay for its social needs, the city increased borrowing. As Mayor Robert Wagner, Jr. had commented, "a good loan is better than a poor tax." City Controller Abraham Beame warned that using debt to pay for operating expenses would lead to "a day of reckoning". Even when Beame became Mayor, the city placed $750 million of operating expenses into the capital budget and used financial help from the Federal and state governments to continue services.
Mayor Beame had issued much debt in anticipation of the economy improving. He knew the city's debt was intermingled with banks' financial outcomes. He figured banks would continue helping New York City to protect their interests. Beame didn't plan for the economic turnaround to not occur.
In October to November 1974, the city borrowed $2.5 billion, increasing its total short term debt to $4.5 billion. The city issued short term loans in anticipation of interest rates increased that would attract buyers to purchasing the city's long term bonds instead. When interest rates did not increase, more short term debt was issued to cover current short term debt repayment. New York City held 29% of all short term loans nationwide.
Carey persuaded Felix Rohatyn, known derisively on Wall Street as "Felix the Fixer" to help. Carey knew Rohatyn was not enamored with government after appearing before a confrontational Congressional hearing. Carey persuaded Rohatyn that he could rebrand himself as "Felix the Savior" for saving New York City. Carey realized if the city defaulted that its' connections to state finance could then lead to the state facing default.
Critics argued other parts of the state had needs and they were not happy having state government focus on helping one city, Carey exploded, explaining "if one of my children came to me and said he's broke, I'm not going to put him on the street." Carey advanced the city $400 million with state issued short term notes he technically wasn't supposed to issue without voter ballot approval. This allowed the city to avoid defaulting on April 1975.
Carey considered New York City defaulting as "unthinkable". In it went bankrupt, the judiciary would administer city government and the authority of elected officials would be vastly diminished. Labor contracts, city rules, and city regulations could be set aside for financial stability goals. Employee backlash could be expected. If there were fewer fire, police, and sanitation workers, these shortages could disrupt the city and upset the public. Increased crime and a possible return of recent lootings and civil disobedience were feared. In addition state bonds and bonds in other municipalities across the state and nation could sharply increase, which would aggravate statewide financial problems. There were further fears some banks could suffer from the default non-payments enough that they could fold, further thus further escalating an economic crisis.
The city sought to issue $537 million of bonds. No one sought to underwrite it. The city had lost credibility in the financial markets. The city managed to issue $375 million at a relatively high 8% interest rate repayable in 102 days. The bond counsel warned of adverse conditions with the issue. David Rockefeller and other bankers announced they would no longer loan the city any more money.
New York had $80 billion in taxable real estate and $100 billion in annual business transactions. This raised for the city $7 billion in local tax revenue. Beame tried to show bankers he was cutting city expenses and he lowered the city's 330,000 employees by 1,000. Banking officials were not much impressed by these cuts.
Carey and Beame asked the Federal government for $1 billion in credit. The Gerald Ford Administration declined this request. Republican leaders in the State Senate also opposed giving the city more assistance, insisting the city first increase tolls, subway fares, and make significant workforce reductions including paying city workers to work four days (thus cutting their salaries 20%).
Carey created a commission with Rohatyn and financial experts to give him advice. The commission members asked to see the city's financial records only to learn the city didn't keep financial records. What the city knew to do what issue new kinds of debt to pay due debt.
The state government created the Municipal Assistance Corporation (MAC) to buy short term city debt and exchange it for lowered interest long term debt. MAC would have authority over city finances. State House Speaker Stanley Steingut helped guide passage of legislation creating MAC but with lesser authority over the city than Carey wanted. MAC did have the authority to audit city finances.
MAC was able to keep New York solvent through August when $792 million in note repayments were due. Carey asked for a city wage freeze, higher transit fares, reductions at the City University, and labor rule changes to increase employee productivity. Beame added an increase in the State Island Ferry fare, which had been 5 cents since 1898. Union leaders countered by proposing deferring wages instead of freezing them. They also asked for reducing employees by attrition instead of layoffs, but they did not receive this.
It soon was obvious even MAC would not be enough to keep the city solvent. Emergency measures would be necessary. Carey called the state legislature into emergency session. He invited legislators to meals and drinks where he explained the situation and his proposal for more control over the city's finances and the ability to alter existing union agreements. Several conservative Republican legislators who previously opposed Carey's financial proposals now supported this more financially prudent plan.
Carey met with labor leaders. He convinced some to invest union pension funds in MAC bonds. The unions had an interest in not letting the city fail. The city's bankruptcy could have resulted in having all collective bargaining agreement nullified.
There were supporters of bankruptcy. Some liberals argued that bankruptcy would allow the city to better restructure its debt. Some conservatives supported bankruptcy in hopes it would destroy unions and cut public spending.
The city agreed to yield financial decision making authority for three years, and possibly more, in return for MAC assistance. MAC had the ability to provide as much as $5 billion in bonds.
Carey realized Federal government assistance was unlikely. President Ford was being challenged by a more conservative Governor Ronald Reagan and anti-New York bias was strong in politically key conservative states.
Upstate legislators, many of whom had districts financially struggling due to industrial decline, wondered why they should help New York City when the state was not helping their part of the state. The legislative Black Caucus and Puerto Rican Caucus saw these moves as the state aiding wealthy banks. Downstate legislators who were more impacted by New York City's troubles supported Carey's legislation on New York City. It passed the Assembly 80 to 70 with all Republicans and eight upstate Democrats voting against it. It then passed the State Senate by 35 to 26. The bill was passed in the middle of the night, implying support was sought from legislators for many hours. Carey signed it at 4:47 am.
Bankers increased their demands. They wanted a political sacrifice and demanded Beame resign as Mayor. Carey pointed out that the law would then make liberal Paul O'Dwyer Mayor and the bankers withdrew this demand. The bankers then insisted Beame's Deputy Mayor Jim Cavanagh be fired. Carey sent Beame the distressing order and Cavanaugh was dismissed and then replaced with John Zuciotti, who had more trust from business leaders.
Teachers discovered their class sizes increased sharply. They went on strike. In the past, a mediator was called in to settle strikes. This time, the city saw a financial benefit in not paying for schools,. The teachers' union leader Albert Shanker asked for the strike to end observing "a strike is a weapon you use against a boss than has money. This boss has no money". The union members voted to end the strike after five days.
Shanker knew how to fight back effectively. He announced he was withholding a promise to use teacher retirement funds to buy $225 million of MAC bonds. The city was hours away from missing a payroll without the funds Shanker had promised. Beame called President Ford for help but aides wouldn't let the call go through. Carey was aware that Richard Ravitch knew Shanker and asked Ravitch to act. Shanker explained he had a fiduciary duty to protect the retirement fund. Ravitch argued that hospitals, child care centers, and other social services the city operated would not be able to obtain credit and people would suffer. The city prepared a bankruptcy declaration to deliver to the courts. Beame asked other labor leaders to intervene. Some report Victor Gotbaum physically threatened Shanker.
Negotiations with Carey, Ravitch, Shanker, and others were help in person. Carey offered to steer a teachers' contract dispute towards a pro-labor mediator. Shanker agreed to make the payments with two hours to spare. Realizing the time to physically make the transactions occur before defaulting may have passed, Ravitch convinced the banks to say open an additional two hours so Shanker's union could buy the bonds and then the money could be sent to the city. The banks agreed. Shanker's decision saved New York City from bankruptcy but his union suffered as 19,000 teachers, or 20% of his union's members, lost their jobs. Also, a new contract with teachers was not approved until 17 months later.
Carey learned the Federal government still was not likely to help. Mayor Richard Daley and White House Chief of of State Donald Rumsfeld, who was from Illinois, hoped New York City would default. They hoped this would drive financial services business to Chicago. Carey received confirmation that if New York City defaulted then Chicago would become the nation's new financial center.
A state board saved two agencies to avoid default by accounting actions. Their debt that was almost defaulted on was shifted onto other budgetary lines. No money transacted but the accounting moves avoided defaults.
President Ford remained unmoved by the efforts New York City was making to resolve its problems. He stated he would veto any legislation to help New York avoid default. The Joint Economic Committee of Congress projected that a New York City default could lowed GNP by 1%.
Carey met with Republican Rep. John Rhodes who recommended a helpful bill could pass Congress if it did not contain a provision specifically for bailing out New York City. Carey met with other Congressional leaders who agreed with this strategy. The actions the state and city took were noticed in Washington. Congress approved $2.4 billion of loans to New York City over three years. It passed the House 213 to 203 and the Senate by 57 to 30.
Carey convinced the state legislature to give holders of New York City's short term bonds of $1.6 billion a choice of two options. They could either exchange their short term debt for ten year MAC bonds at 8% or they could keep the short term bonds but the principal would be suspended for at least three years. The legislation was a negotiated compromise between legislators from both political parties, bankers, business leaders, bond counsels, and city officials.
Carey then helped convince the legislature to approve a 25% increase in the city personnel increase tax, a 50% surcharge on the state estate tax, and increases in services and cigarette taxes. He convinced the Republican Majority Assembly Leader Perry Dureau to support this as there were not enough Democratic voters to pass this. It then passed the Senate 31 to 27. Passage of this helped convince banks to allow over $1.6 billion of loans to mature longer.
State Budget Director Peter Goldmark met with officials of 150 banks that held New York bonds. Four state authorities had $2.6 billion falling due, an amount that was about 20% of the state's operating budget. He convinced many banks to hold back on demanding repayments as the funds wouldn't be there. They would only receive partial repayments if an Authority went bankrupt. Goldmark also met with insurance executives for assistance. Several authority projects were sold to private developers or county government for $400 million.