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Sin Will Find You Out

You may be wondering who was lending all this money to the city. Both Wagner and Lindsay issued debt “publicly,” meaning they borrowed on Wall Street. This is the normal way for cities to borrow and New York did so until April of 1975 when, as the phrase goes, “the market shut on the city.” A city borrows like this: It decides how much money it needs and for how long. It may need “seasonal” funds to tide it over from, say, January through May while it waits for federal or state aid owed it. In this case, it will issue notes. Or it may need “capital” funds, borrowed over thirty years to build, say, a bridge. It will then issue bonds. The city selects a “managing underwriter,” usually a Wall Street investment banking house, to head up a group of other Wall Street firms willing to buy the debt from the city at one price (say 98 cents on the dollar) and sell it to investors at a higher price—they hope at 100 cents on the dollar, or par. This difference, the “spread,” is their profit.

If the debt is issued publicly, anyone can buy the debt or, to put it less crudely, invest in city paper. Big banks can buy for their own portfolios; small investors can buy for their retirement. Traditionally, banks and insurance companies have dominated the municipal market. People with small amounts to invest were not active until fairly recently. But by 1974, banks no longer needed the tax exemption provided by municipals and began ridding themselves of tax-exempt paper in favor of taxable paper, which carries a higher yield. Wall Street began marketing tax-exempts more aggressively to the small investor, in part because the Street had lost its traditional, institutional investor.

At the same time as the marketplace was changing, New York City was plunging toward its fiscal crisis, issuing more and more debt at higher and higher yields. These high yields scared the banks—and lured the individual, but not necessarily very smart, speculator. Since municipal debt takes the form of unregistered “bearer bonds,” no one knows for sure who held New York City’s debt in 1975. The president of Morgan Guaranty said the six largest New York City banks held $1.2 billion of city securities—20 percent of their aggregate net capital—in March of 1975. The Securities and Exchange Commission (SEC) concluded that the banks held onto at least part of this debt because they couldn’t sell it—no one would buy it. The SEC also concluded that a large amount of city paper was held by small investors who did not understand what they were buying and who could not afford the loss that a city default would bring. The SEC’s conclusion is unproven.

Today we can look back at the city’s burgeoning expenditures careening ahead of its modestly growing revenues and ask: Was the city totally mad in those days? How did it think it could get away with such vast short-term borrowing? How did it expect to pay off the cumulative deficits, which were growing so dramatically that they totaled $5.1 billion at the end of fiscal 1975?

The answer is simple: The city believed in its future as a perpetual attraction to both business and middle-class residents. Mayor Lindsay and his advisers—along with a lot of other New Yorkers—thought that if they could just hold on, continuing to spend for all those wonderful programs they and the federal government had created, the city’s economy would eventually generate enough money to pay for the deficits they were racking up.

The city was wrong, as Auletta points out with unbecoming satisfaction. The resilience was no longer there. The local economy was in deep trouble. Surely Lindsay’s advisers knew the approximate figures. Between 1958 and 1974, the city lost 347,000 or 36 percent of its manufacturing jobs while the country at large gained 4.1 million or 26 percent. Almost a third of this loss was in the clothing business, but most other decentralized industries lost as well: printing down 22 percent; leather down 43 percent; food processing down 53 percent. Nearly every manufacturing sector in the city lost jobs. (Some of this loss was made up in services; finance, insurance, and real estate gained 54,000 jobs.) The data showed that the city was losing jobs in precisely the small-manufacturing industries that had made it great.

The crucial statistics—payroll jobs, number of employed residents, and the unemployment rate—from 1970 onward make the city’s downward spiral gruesomely clear. Payroll jobs declined every year without fail, from 3.74 million in 1970 to 3.17 million in March 1978. (The latest figure, joyfully received by the city, is 3.2 million, still 500,000 fewer jobs than in 1970.)

But while payroll jobs are increasing, the number of employed residents is not. The figure stood at 3.15 million in 1970 and stands at 2.79 million today. In 1970, the unemployment rate stood at 4.8 percent, high for the time. It increased steadily until it hit a staggering 11.6 percent in July 1976. It has bounced around since then, settling at 8.5 percent in the latest figures.

These and other data mean that the city’s economy has probably hit bottom and is on its way to a modest recovery. It does not mean that the city will return to its relatively prosperous postwar economy. Too many things have changed. Too many large businesses have moved out; too many small ones have closed. Too many New Yorkers have left for the suburbs or the “Sunbelt.” The service economy has replaced the manufacturing economy. The New York of the future will bear little resemblance to the New York of the past.

Auletta goes on at length about the fall of New York but gives short shrift to its salvation, temporary as that may be. The city was on the verge of catastrophe in June 1975, when it faced default on $4.5 billion in outstanding short-term debt owed to both a few big banks and to thousands of unidentifiable small investors. It had nowhere to turn for help. The city couldn’t possibly pay off $4.5 billion in one year. But even without trying to pay it off, the city could not meet ordinary, day-to-day operating expenses.

Today the city has paid off all but a tiny amount of notes, and these are secured by an escrow account. It is back in the short-term market. Default is remote. What happened? In 1975, the Municipal Assistance Corporation (MAC) was created by the state to save the city by forcing or cajoling—whichever worked—investors to trade in their short-term debt for long. They did. MAC solved the city’s financing, though not its budgetary, problems.

Anyone unfamiliar with MAC will not understand how it works from Auletta’s description. Here are the facts. The state legislature, whipped into line by Governor Carey (D) and Senator Warren Anderson (R), had set up MAC in June of 1975 to refinance and stretch out the city’s absurdly short and onerous debt, keep an eye on the city, and provide it with some funds to operate. The subdued city agreed, in principle, to institute a number of budgetary and accounting reforms. (That the city was not sufficiently chastened to institute these reforms in practice became clear as the summer went on and the city balked at every specific reform proposal.)

In July and August MAC issued $1.88 billion in MAC bonds. With this money, it redeemed $771 million in city notes and advanced $1.046 billion to the city for daily operations. By the end of August, however, neither the public nor the banks would buy more MAC securities.

This was MAC’s first great crisis and by no means the last. Banks and individual investors feared the lack of controls on city spending. When Carey had proposed MAC to the legislature in early summer, he found that Mayor Beame had gotten there first and had talked key legislators into passing a “toothless” MAC, one that gave MAC directors no real power to control city spending. In September Carey summoned Beame to Albany, gave him a copy of legislation creating the new Emergency Financial Control Board (EFCB), and told him it would be passed the next day. It was. In thirty-six hours, the city’s sovereign power to spend and borrow had been turned over to a state agency, the EFCB.

This was an impressive use of power, notwithstanding Auletta’s disparaging view of it. A Democratic governor from Brooklyn, politically unknown to upstate Republicans, asked them for emergency legislation to save that symbol of moral decay and economic profligacy on the Hudson. And they did.

The alternative, for those who think the legislature had no choice, was the one recently followed in Cleveland, Ohio: Let the city default. Do nothing. In the field of finance, there is always the Do-Not-Act Alternative. That is the dark possibility that would-be rescuers of any financially troubled institution must forestall. If the creditors—old ones or proposed ones—are willing to sit by and do nothing while the institution’s cash runs dry, then the choice to do nothing can become the choice to kill the institution. And look who New York City’s creditors were: the commercial banks and a couple of big investment banking firms, who were identifiable, and the small investors, who were not. The state could only deal with creditors it could identify, and the banks were unwilling to invest more money in the sinking city unless they were assured that they’d get their new money back.

The banks had good reason to fear they might not get their money, either from their old city investments or their new MAC investments. MACs were selling well below par (and, indeed, continued to do so until January of 1977 when most MACs began selling at a premium). Of course the banks were scared. They watched MACs dip lower and lower in the summer of 1975. They were afraid this was the end of the line for MAC and for their money invested in MAC. They were afraid that stockholder suits might challenge their past investments in city paper as well as their entanglement with MAC.

The banks and the state wanted to spread the risk around among a few more players. They hit on two untapped investors: the city employee pension funds and the federal government. Both had capital available to invest—though neither one relished the idea—and both had a clear stake in keeping the city solvent. In September 1975, the pension funds bought an initial $370 million in MAC bonds (they ended up taking 40 percent of city and MAC debt between fiscal 1976 and 1978). In November, the federal government agreed to a $2.3 billion yearly seasonal loan program to begin in fiscal 1976 and end in fiscal 1978.

By Christmas of 1975, the city had an odd assortment of partners yoked together by necessity: banks, pension funds, state and federal governments. Each partner, to save itself, had to save the city, but no partner wanted to do more than it had to. They spent the next three years haggling and fighting, but their partnership held the MAC structure together and kept the city going.

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