State Oversight: the New York Approach

CRC Notes 2012-02 A publication of the Citizens Research Council of Michigan March 2012 STATE OVERSIGHT: THE NEW YORK APPROACH The oversight mechanism in the proposed consent agree- resolve a financial emergency in New York City in 1975. ment developed by State Treasurer Andy Dillon and de- This report describes that 1975 emergency and the New livered to the Review Team and Detroit officials in March York State response, and draws comparisons to Detroit, of 2012 was in large part modeled on the Emergency and the initial proposal developed by State Treasurer Andy Financial Control Board established by New York State to Dillon to address Detroit’s fiscal crisis in 2012. New York City in 1975 In October of 1975, as the City of New York neared de- out, and banks began selling the city-issued notes that fault, a city attorney was ready to officially initiate the they had previously purchased. largest municipal bankruptcy case in history. A state- ment had been prepared announcing that the city had Mayor Beame announced layoffs, then failed to fully imple- insufficient cash on hand to meet debt obligations. ment them (the city’s workforce actually expanded during an announced hiring freeze). The city also began to issue The city’s financial problems were attributed to loss of tax debt in small denominations, and small investors and re- base, particularly manufacturing; rent control and tax ex- tirees began purchasing comparatively large amounts of emptions; demographic changes; an oversized municipal city debt that paid relatively high interest rates. workforce (340,000 municipal employees, including school and university personnel, in 1975) and generous collec- By March, underwriters (who themselves held large tive bargaining agreements; generous welfare benefits, amounts of city debt) were so concerned about the city’s one-quarter of which were funded by the city, and grow- tepid response to the financial problems and the increasing welfare rolls (998,000 New Yorkers were on public ing risks associated with the city’s debt that they were assistance in November 1975); free tuition at city univer- unwilling to facilitate more note and bond sales. The sities; uncompensated care at the extensive system of city itself was trying to restructure outstanding debt and city hospitals; increasing tax rates and increasing reliance to establish a separate legal entity to hold its debt (this on borrowing; and a national recession caused by the oil plan was successfully challenged as an unconstitutional embargo of 1973. The city government added to its prob- attempt to avoid the debt limit). There was uncertainty lems by consistently overestimating revenues, about the rights bondholders would have if the city en- underfunding pensions, employing deceptive accounting tered bankruptcy. practices, using special revenue funds to balance budgets, engaging in excessive borrowing, and employing an array Underwriters tried to pressure the city to improve ac- of other financial gimmicks. counting and budgeting practices and to acknowledge large deficits. The mayor responded with a media cam- In the years prior to 1975, New York City municipal gov- paign. In April, the city ran out of cash and received a ernment had reported substantial operating deficits, al- three-day loan from banks and pension funds to make though the inadequate financial and accounting system payroll and meet other critical obligations. The state left many wondering what the actual numbers were (a advanced revenue sharing funds to the city to provide reported $600 million deficit was suspected to actually short term relief. The mayor asked city workers to forego be about $2.2 billion). NYC’s debt rating was downgraded a six percent wage increase that was scheduled to take in the mid 1960s, and the city had to pay high interest effect July 1, 1975, and unionized workers responded rates on its debt. Though the city had relied on short with protests, sick-outs, strikes, and walkouts. Layoffs term borrowing for cash flow ($14 billion of outstanding sparked more protests; laid off police officers blocked debt included almost $6 billion of short-term notes), by the Brooklyn Bridge. the spring of 1975 it was unable to sell short-term debt. A sale of tax anticipation notes scheduled for February, The potential impact of a New York City bankruptcy on 1975 had to be cancelled when the underwriter backed the city, state, nation, and beyond could not be predicted, CITIZENS RESEARCH COUNCIL OF MICHIGAN MAIN OFFICE 38777 West Six Mile Road, Suite 208 n Livonia, MI 48152-3974 n 734-542-8001 n Fax 734-542-8004 LANSING OFFICE 124 West Allegan, Suite 1502 n Lansing, MI 48933 n 517-485-9444 n Fax 517-485-0423 CRCMICH.ORG CRC Notes but the effects were expected to be pals were selling at 6.89 percent). well be less likely now than it was a very serious. If bondholders pre- MAC insisted that the city freeze generation ago: local banks in New vailed, services would be devas- employee wages, lay off workers, York City, as in Detroit, were then tated, potentially resulting in strikes increase subway fares, and institute much more likely to be headed by and social disorder (the civil disor- tuition at city universities. These leaders who were personally and ders of the late 1960s were a clear actions resulted in labor unrest dur- professionally invested in the com- memory in 1975). If services were ing the summer of 1975. In 1975- munity. Furthermore, many small protected, bondholders would not be 76, however, city government ex- investors had bought NYC debt, as paid and the financial markets could penditures were almost $700 million had the state, so a municipal bank- be affected. The potentially ruin- more than the authorized expense ruptcy would have triggered an ava- ous effects of municipal bankruptcy budget. lanche of other bankruptcies. And convinced New York Governor Hugh the size and prominence of New York Carey to seek alternative ways to The New York State Legislature in City — the largest city in the U.S. address the city’s financial crisis. special session in September adopted and a world financial hub — meant the Financial Emergency Act (FEA) that its crisis could have had inter- The New York State legislature cre- to create the Emergency Financial national financial repercussions. ated the Municipal Assistance Cor- Control Board (EFCB) composed of poration (MAC) based on recom- the Governor, Mayor, state and city President Gerald Ford’s initial threat mendations from an advisory Comptrollers, and three private indus- to veto a federal bailout may have committee appointed by the Gover- try experts. The EFCB had control of cost him the election (A Daily News nor to monitor the city’s finances. the city’s bank accounts, could issue headline screamed “Ford to City: MAC, an independent legal entity orders to city officials, and could re- Drop Dead”), but in December created by the state, was authorized move city officials from office. It 1975, the President finally signed to issue new debt for the city and to could review and reject the city’s fi- the New York City Seasonal Financ- convert outstanding short-tem debt nancial plan, operating and capital ing Act (passed in the House by only to more secure long-term debt. The budgets, collective bargaining agree- ten votes), which extended to the majority of appointees on the MAC ments, and borrowing. Most impor- city a $2.3 billion line of credit each board were appointed by the Gov- tantly, the EFCB forced city officials year through 1978. The interest ernor. The city’s sales and stock to take politically unpopular actions rate was set at one percent above transfer taxes were converted to (and conveniently provided a scape- the cost of money to the federal state revenues and used to guaran- goat for those actions). government, assuring that the loan tee the MAC bonds. Over a number would be profitable to the federal of months, obligated banks pur- The state also created an Office of government and unattractive to chased new MAC bonds and agreed the Special Deputy Comptroller for other municipalities that might be to renegotiate city debt to extend New York City (OSDC) in the state considering appealing to the federal maturities and lower interest rates. Comptroller’s Office to audit the government for assistance. These Some city notes were exchanged for city’s books (this office was made federal loans had to be repaid within MAC securities. (MAC eventually permanent in 1986). A Mayor’s the year they were made. sold over $10 billion of debt, ser- Management Advisory Board com- viced it all, and voted itself out of posed of business representatives Requirements placed on the city in- existence in 2008.) was created to advise the mayor on cluded balancing its budget using management practices and the new generally accepted accounting prin- Unfortunately, the city itself contin- Commission on City Finances was ciples by 1978 and fully funding the ued to deny that there was a seri- established to advise on taxation and pension fund. The First Deputy ous problem and failed to make the expenditure policies. Mayor, Deputy Mayor for Finance, financial and operational changes and Budget Director were forced to needed to restore confidence. One Eventually, with the assurance pro- resign and were replaced with offi- consequence of the city’s failure to vided by establishment of the Finan- cials deemed more trustworthy. make significant changes and of in- cial Control Board that the city’s fi- vestors’ discomfort with MAC was nances would be brought under In New York as in Michigan, public that MAC was initially only able to control, local banks, the federal gov- pension benefits are effectively guar- sell bonds worth $2 billion of the $3 ernment, and municipal unions cre- anteed by the state constitution.

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