We have seen the bankruptcy of the City of Detroit and now the insolvency of Puerto Rico. But municipal debt crises are hardly new. Consider the historic New York City financial crisis and what we may learn from it.
Library of Congress
Forty years ago today, the media, politicians, intellectuals and bankers of New York City were in despair. It looked like their city government, which was dead broke, wasn’t going to get the bailout from the taxpayers of the rest of the country that New York so fervently wished. President Gerald Ford correctly was not going, in then-Treasury Secretary William Simon’s words, to “tolerate the foisting of New York’s debt on the rest of the nation”-debt created by many years of running constant deficits, irresponsible financing, and cooking the books. The President’s rational position evoked this famous headline in the New York Daily News of October 30, 1975:
“FORD TO CITY: DROP DEAD”
At that point, New York City had not been able to borrow in its own name in the municipal debt market since March. A Municipal Assistance Corporation (“MAC”) had been set up, but its bonds in turn became dubious. So shouldn’t New York City get a federal bailout?
Many prominent New Yorkers thought of course it should. Their rhetoric pursuing other people’s money reached the hysterical. Financier Felix Rohatyn, who had come up with the MAC borrowing structure earlier in the year, but was now out of non-bailout ideas, said a New York City default would be an “inexcusable tragedy” and evidence of “the failure of capitalism.” An odd description for the failure of municipal politics. New York Governor Carey predicted without a bailout there would be riots and announced, “Federal funds or federal troops!” Diplomat George Ball thought a default would be “a victory for world communism.” David Rockefeller, chief executive of the Chase Manhattan Bank, whose bank just happened to hold very large amounts of New York City debt, “rushed about,” according to Simon, “frantically warning financial leaders all over the world that the entire international financial system would disintegrate if New York defaulted.” New York bankers testified to the Senate Banking Committee that lending to the city was a profit opportunity for the U.S. Treasury. One senator calmly asked, “Then why aren’t you making the loans?”
New York City did default. It did not pay as promised on $1.6 billion of its debt ($7 billion in 2015 dollars). This was called a “moratorium,” but by any other name it was a huge default. Capitalism did not fail. No federal troops arrived. Communism did not get a victory. The world financial system did not collapse.
The default was actually part of a deal worked out among the White House, the Treasury Department, and New York State and City officials, “under steady White House pressures,” as then-New York Senator James Buckley wrote. New York State enacted special legislation declaring the “moratorium.” President Ford agreed to lending federal funds to the New York City government, but only when the financial help was tied to correction of the problems, creation of strict financial controls, honest accounting, and working out a path back to municipal solvency. The controls included takeover of the financial management of the city by the Emergency Financial Control Board which New York State had established, which had veto power over the city’s budget and could issue orders to city officials.
With this deal in hand, in December Congress passed and the President signed legislation authorizing the Treasury to make short-term loans to meet seasonal cash needs of up to $2.3 billion ($10 billion in 2015 dollars) a year until 1978. The revenues of New York City and New York State were pledged for repayment. In Simon’s summation, “In return for the loan, the city and state were required to make decisions of a type they had heretofore refused to make.” That’s what happens to you when you run out of money and the music stops. Intensely needed reforms of the city’s spending and financial controls actually did follow.
Writing in 1977, by then former-Senator Buckley concluded, “In my judgment, the people of the City of New York owe Gerald Ford a great debt of gratitude. By maintaining a hard line, he kept the pressure on the city and state that assured the adoption of measures that I believe will place the city back on its feet.” As they did. “Gerald Ford had done New Yorkers a substantial favor.”
That, not the notorious Daily News headline, is the real lesson and what should be remembered.
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