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Will 1970s Haircuts Ever Come Back into Style?

Wednesday, May 4, 2011

We have a lot to learn from Gerald Ford’s response to New York City’s fiscal crisis.

Alex Pollock recently argued against municipal debt bailouts, citing the 1970s' New York City fiscal crisis as a major default that did not wreck the financial markets. The full story is more complex, with even more lessons for today. New York City got no bailout per se, but creditors got a layered 1970s-style shag haircut (held in place with some Dry Look federal hairspray).

The city had taken on unsustainable new Medicaid, hospital, and higher education obligations in the Mayor John Lindsay/Governor Nelson Rockefeller/Great Society years, through its own volition and unfunded mandates. The 1973-75 recession—then the worst since the Great Depression—triggered solvency and liquidity problems. New York City increasingly funded its out-of-control spending with short-term debt, which peaked in 1975 at about $6.1 billion ($25.3 billion in current dollars), or more than 40 percent of U.S. short-term municipal borrowing.1 By comparison, today's fiscally stressed State of California—a much larger entity—issued $10 billion in short-term debt last November. (My previous American Magazine article on today's hidden municipal short-term debt bomb is here.)

President Gerald Ford warned that a bailout would set a ‘dangerous precedent’ and demanded that New York City face its ‘day of reckoning.’

The markets stopped rolling over the city's short-term debt, as they did in 2008 with Bear Stearns and Lehman Brothers. New York State, which had already taken over the city's finances, asked for aid. President Gerald Ford warned that a bailout would set a "dangerous precedent" and demanded that the city face its "day of reckoning." He threatened to veto any "bailout of New York City to prevent a default."2  But contrary to the legend created by the famous "Ford to City: Drop Dead" Daily News headline, the Ford administration (including Rockefeller, ensconced as vice president after abandoning his governorship in the nick of time) had spent months internally debating how to respond to the city’s fiscal crisis.

In the end, the federal government came forward with loan guarantees—but Ford was true to his word. The city defaulted on $2.4 billion of short-term debt (it was styled a "moratorium"); the banks, unions, and government pension funds extended maturities, cut interest rates, and acquired more debt; and the state imposed further tax hikes, fee increases, service reductions, and layoffs.3 Only then did the federal government grant a three-year guarantee of $2.3 billion in seasonal loans to be repaid at the end of each fiscal year—about 25 percent of the city's peak budget.4 (States and municipalities inherently need access to short-term debt markets because tax revenues are unpredictable and lumpy, with high percentages arriving around a few due dates.)

New York City’s short-term debt peaked in 1975 at about $6.1 billion ($25.3 billion in current dollars), or more than 40 percent of U.S. short-term municipal borrowing.

No sooner did the federal government approve the New York City guarantees than the market froze for about $2.6 billion in Rockefeller-era "moral obligation" debt of four New York State public authorities.5 (Because the state did not formally back the bonds, Rockefeller, famed for his "edifice complex," had been able to evade state debt limits and go on a building spree.) Here, too, the state and creditors did the bulk of the restructuring, but the federal government insured $260 million in authority housing project debt.

In contrast, the post-Ford pattern has been for the feds to pay 100 cents on the dollar with no creditor concessions. Think Fannie Mae and Freddie Mac's implied federal guarantee (originating in the Rockefeller era with the same off-the-books motivation), investment bank credit backstops, and AIG's credit default swaps. Just as bad is after-the-fact insurance for hot-money depositors who chase yield in uninsured, lightly regulated instruments—jumbo savings and loan CDs in the 1980s, money market funds after the Reserve Fund insolvency in 2008. (America leads a coalition of the willing: the governments of Ireland and Iceland guaranteed themselves into insolvency with ex post facto insurance for the obligations of their bloated private-sector banks.)

In the 1970s’ New York City and State fiscal crises, the federal government offered limited guarantees only after creditors and debtors took hits. Today's bailout-binging culture fuels moral hazard—like holding a match to that Dry Look aerosol hairspray.

Jay Weiser is an associate professor of law and real estate at Baruch College.

FURTHER READING: Weiser has also written "Fool's Gold" and "The Next Sovereign Debt Crisis." Andrew Biggs discusses "The Challenges of State and Municipal Debt," Desmond Lachman provides "Lessons from the U.S. from the European Sovereign Debt Crisis," and John Makin says "Tighten Your Seatbelts: 2011 Could Be Worse Than 2010."

Image by Darren Wamboldt/Bergman Group.

Footnotes

1. Charles R. Morris, The Cost of Good Intentions: New York City and the Liberal Experiment, 1960-1975 (McGraw Hill paperback, 1981), pp. 229, 223.

2. Seymour P. Lachman and Robert Polner, The Man Who Saved New York: Hugh Carey and the Great Fiscal Crisis of 1975 (SUNY Press Excelsior Editions 2010), p. 156.

3. Morris p. 234.

4. Lachman and Polner pp. 164-65.

5. Lachman and Polner pp. 167-73.

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