A Tale of Three Defaults

Part I: The New York City Debt Crisis of 1975
On October 17, 1975, at exactly 4pm, New York City was going to default on $419,000,000 worth of debt.

At face value, this statement is very clear, and very precise. Figuring out how the City got to this point, however, is much less clear, and even less precise.

To start, it was not just a case of poor fiscal management, though no one who has dug through the City’s awe-inspiringly unrealistic budget predictions over the decade prior will disagree that it played a large part. After all, City officials frequently engaged in the ill-advised practice of using revenue anticipation debt – or debt issued upon revenue forecasts, which were overly-generous and never seemed to actually materialize – to cover chronic deficits and operating expenses. Ask any financier, and they will tell you that that decision is akin to budgeting blasphemy.

But as with all situations, some of the problem was out of the City's hands. The City, for example, could not help that the entire U.S. economy was weak. Nor could it help that residents with higher incomes were flocking to the suburbs to escape urban density and crime all across America, leaving it with much less revenue and a much higher poverty rate. Nor could it really help that federal and state social service mandates were large, and said governments were only willing to bear the burden for half or less of those costs. As the number of people on welfare grew, so too did its need to pay for their social services.

Instead of reigning in spending as deficits loomed large, however, City officials just continued to spend more. The City borrowed against pension funds to meet operating deficits for the public transit system. While private sector jobs disappeared in response to the weakening economy, the City continued to expand the public sector. Mayor Robert Wagner, circa 1961-1965, used deficit spending to solidify political support, and quiet unions that had taken to consistent striking for systematic change. Mayor John Lindsay, circa 1966-1973, followed suit. He granted generous contracts to public employees in the hopes of quelling public and union unrest, all the while borrowing money to meet the needs of the City’s ever-increasing and strained welfare system.

While revenue forecasts remained deceitfully high, and revenue yields stayed pitifully low, bond underwriters for City debt placated investors by promising that the City’s financial troubles were temporary and inconsequential… they were simply a financial hiccup. The City was good for the money, and it would pay off its debts.

By 1974, however, the City paid hefty interest to issue its bonds. Big investors refused to purchase more of its debt, because it was clear the City was in dire financial straits, and it was not doing anything to fix its situation. If it were to default, investors may not get paid, and no one was willing to invest in bonds that may not result in a return in investment.

By 1975, investors had lost faith in the City’s ability to pay off its debt, and no market was willing to purchase it.

The fact that it took until October for this day to come is actually a bit surprising, since the City was supposed to default on its debt in April. Then-Governor Hugh Carey refused to allow the City to become insolvent, however, and offered it state assistance on the condition that the state get more say in its financial affairs. Out of this agreement the Municipal Assistance Corporation (MAC) was born; a public authority with the power to issue bonds to pay off City debt.

Between April and October, MAC issued bonds to cover the City’s debt obligations, but every bond issuance came at a substantial loss. While authorized to sell $3 billion in bonds, they only managed to sell $2 billion. Furthermore, each sale came with an 11% interest commitment; almost double the going rate for stable municipal bonds – 6.9%.

Part of the MAC deal required the City to trim its spending, and expand its revenues. To this end, the City implemented a wage freeze, laid off public employees, increased subway fares, and charged tuition for the first time at the City University of New York. Concurrently, City and State officials created multiple advisory boards and regulatory bodies to oversee the City’s finances, and the State passed a law requiring the City to have its budget balanced in the following three years.

These financial changes were not enough to put the City on sound enough fiscal footing, however, and the City’s deficit continued to grow. Soon public pensions, to that point the main – and almost only – investors in MAC bonds, stopped buying them. As elaborated by the Teacher’s Retirement System, investors in those systems believed that continued investment in City debt constituted a breach of their “fiduciary responsibility” to their clients.

Aid for the City stopped at the state, because the federal government did not see it as too big to fail. In fact, President Ford categorically refused to aid the City. In a scathing speech about fiscal irresponsibility, Ford stated that it was “prepared to veto any bill that has as its purpose a federal bailout of New York City to prevent a default.” Most Senate Republicans at the time agreed with it as well, stating that the City “must face the reality that it no longer has the resources to meet its obligations.”

But a City default would not simply be a local hit. Hundreds of national and international banks owned its debt; if it defaulted, it would take at least a hundred banks with it.

In the prelude to the Main Event, the morning of October 17 saw the stock market drop by ten points, the municipal bond market come to a virtual halt, and municipal bond values – even bonds issued by those municipalities deemed very creditworthy – drop.

City officials prepared for the worst. Lawyers were sent to the State Supreme Court so they could file a bankruptcy petition when the time came. State police were at the ready, waiting to deliver the news to banks where City debt was held. New York City Mayor Abraham Beame had his public statement ready, announcing its emergency plan to keep only vital public services like police and firefighters funded.

Thanks to the Teacher’s Union, however, the default never happened. Citing a Catch-22 that they perceived as tantamount to extortion, the Union had to choose between two evils: compromising their duty to protect their members’ pensions, or seeing their members put out of work. At 2:07PM, the Union agreed to purchase the outstanding MAC bonds.

With State assistance exhausted, and no hope of Federal help, the City was forced to make harsh financial decisions. Eventually, and to the disappointment of President Ford, the Federal government did step in to help, and a period of economic austerity ensued.

It was not an easy path, but the City eventually recovered, a series of hard lessons learned: do not borrow to cover operating deficits, do not rely upon short-term borrowing, and bring everyone to the table to discuss the path to recovery.

But the aftermath of its near-default still plagues New York State today. As of 2016, the City’s MAC debt is still outstanding, and after the 2001 recession, the State needed to come to the City’s aid again – this time to refinance the debt, and assume responsibility for the $2.6 billion remaining. Refinancing this MAC debt extended its shelf-life an additional 30 years, giving the State until 2033 to pay off the debt: 58 years after the debt was originally issued.

Now, every year until 2033, the State must appropriate $170 million into their annual budget, in the hopes of paying off debt accumulated more than half a century ago, during a decade of mismanagement, political, and economic unrest.

The City may not have defaulted on its obligations, but by coming so close it, and we, have paid a heavy, heavy price.

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