Simply to "roll over" or refinance maturing short-term notes, the city had to borrow, on the average, $500 million each month by issuing yet another series of notes. For this task, it usually enlisted the aid of the major New York banks, particularly First National City, Chase Manhattan, and Morgan Guaranty. They underwrote the note issues by organizing syndicates of dealers who bought the notes from the city and sold them—mainly to institutional investors—at a markup. The New York banks also were important city-note purchasers themselves and owned an estimated $1.5-billion worth. The banks held perhaps another $1.5 billion in customers' trust accounts.
For years, the banks had tolerated the city's fiscal practices with only occasional complaints. Underwriting city debt was a lucrative business; the more debt the city issued, the more money the banks made. "Bankers have even shorter time horizons than politicians," said one City Hall financial expert. "As long as the shit moves off their shelves, they don't want to know anything."
In the fall of 1974, however, the shit began to pile up. Analysts for institutional investors became alarmed at the rapid increase in New York short-term debt—in part the result of inflation and the recession—and the absence of significant economy moves by City Hall. The budget deficit in fiscal 1974-75 was projected as high as $370 million. Preliminary figures put the 1975-76 deficit at $1.68 billion. Despite interest rates as high as 9.5 per cent, underwriters found city notes harder and harder to sell. (Since the interest on city debt is exempt from federal, New York State, and New York City taxes, a 9.5 per cent note offers affluent local investors yields comparable to 18-20 per cent on taxable investments.) In some cases, the underwriters had to unload city paper for even less than they paid the city. Distress sales of a $475.6-million bond offering last October cost underwriters $15 million to $20 million. After unloading city notes during sales last February and March only with great difficulty, the banks refused to bid on a proposed $450-million note issue in early April.
Thus commenced the game of chicken. In order to pay bills and redeem maturing note issues through June 30, the city needed over $1 billion more than it expected to receive in revenues. When a note issue matures, note-holders are supposed to be paid off. Absent outside assistance and the willingness of the banks to "roll over" the expiring debt by underwriting new issues, the city had only two choices. It could renege on payrolls or other bills. Or it could default on the expiring notes, i.e., refuse to pay off their holders.
The city appealed to the federal and state governments for more aid and to Albany for permission to raise city taxes. Washington declined. Albany gave the city a $400-million advance on welfare payments due the city later in 1975 but, with its own budget deficit at $500 million, refused further help. The city then appealed to President Ford and Congress for a federal guarantee of a city note issue. That request was denied also. Accommodating New York, federal officials said, would elicit a spate of similar requests from other financially strapped cities.
But the most important reason behind the federal and state refusal was to put pressure on the city to engage in a painful but necessary exercise in serious budget-cutting. If the city refused, federal officials were certain the state, which after all had direct legal responsibility for the city, would ultimately come up with enough money to tide the city over. State officials were certain that if the city refused, the federal government, which after all had rescued Lockheed and Penn Central, would come up with a guarantee or the necessary aid. No one believed the city would actually default. As part of their strategy against the city, administration officials publicly argued that a default, much as they hoped the city would avoid it, would have only "negligible" national impact. Privately, though, they were far more anxious, and they were certain city officials were even more so. Not since the Depression had a major municipality defaulted on its debt, and such an act by a city like New York, they thought, would be unthinkable.
The reasoning of the banks, which continued to decline city requests for financing, paralleled that of Washington and Albany. Basically antiunion and antiwelfare, the banks were even less tolerant of the swollen city expense budget and the exorbitant union contracts than the federal and state governments. Pressed on the point, some bankers actually believed that a city should behave fiscally just like a corporation and finance itself solely through its own resources. They were certain that unless the city could eliminate the projected deficit in the 1975-76 expense budget—reduced in April to $641.5 million—always-cautious institutional investors would refuse to buy any more city notes. And the gap would have to be eliminated by genuine expense-cutting, not accounting tricks or confiscatory new taxes. Like everyone else, the banks dismissed the chance of a default. If it came down to that, they believed, the federal and state governments would rescue the city.