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The Domino Scenario: The Day New York City Defaulted

There was a brief discussion, during a meeting of senior bankers Thursday evening, about a large outright loan to the city by all the major banks. In 1932, when New York faced a similar cash-flow crisis, the city's banks had extended just such a loan. To protect their investment, the banks the following year required the city to sign what came to be known as the Bankers' Agreement. Under it, the banks maintained tight supervision over city finances for four years and forced adoption of austere budget cuts. (For their trouble, the banks had the city drop proposed business taxes they opposed.)

The notion of a 1975 Bankers' Agreement, though, was soon dropped. For one thing, the dimensions of the city's problems were far greater now than in 1933, when short-term debt was only $500 million and only a $131-million loan was required to permit the city to meet its immediate obligations. Second, unlike 1933, the banks now had an alarming amount of their money already out at risk in city loans. Finally, the sort of control exercised by the banks over the city during the 1930's would now be politically impossible. Saving New York, the bankers concluded, was the responsibility of Washington and Albany, and the bankers remained confident that, in the end, that responsibility would not go unmet. Though publicly proclaiming they were still assessing market conditions, the banks privately agreed not to bid.

Informed of the decision by Ellmore Patterson, chairman of Morgan Guaranty and head of the mayor's financial liaison committee, Mayor Beame called Treasury Secretary William Simon. Simon said the administration's position remained unchanged: it was up to the city to restore investor confidence. Congress, Simon added, concurred.

Frantically, Beame called Governor Carey. A late sounding of Albany's legislative leaders, Carey told the mayor, indicated no chance of an aid package without massive city budget reductions.

Though it was now close to midnight, Beame summoned the city's top labor officials for an emergency meeting at Gracie Mansion. His message was blunt: unless they agreed to a complete freeze on wages and hiring for the next fiscal year and to layoffs of at least 25,000 existing workers—measures which would close the 1975-76 budget gap—the banks would not bid on the note issue the following morning and the city would be out of money. Speaking for the unions, Victor Gotbaum was equally blunt. The unions had not caused the crisis, he said, and he saw no reason why they should be the ones to suffer. If the mayor went ahead with the freeze and cutbacks, he threatened, every city employee would walk off his job within an hour.

After the labor leaders had left, the mayor and his aides gathered to discuss their rapidly dwindling options. Slowing bill payments would buy only a few days of time. A large purchase of notes by the city's pension fund, which already owned $588-million in city paper and whose fiscal soundness had been under attack by the State Pension Commission, seemed certain to subject the fund's trustees to lawsuits. And, again, it would only buy time until the next note issue had to be rolled over. Under Chapter IX of the Federal Bankruptcy Act, the city could conceivably file for bankruptcy, which would permit it legally to abrogate existing labor contracts. Yet the procedures under Chapter IX, which was enacted during the Depression and has been previously used only by small municipal organizations, were cumbersome for a large city. Merely filing a bankruptcy petition, for instance, would require approval of holders of not less than 51 per cent of the city's total outstanding debt. Approval would have to be obtained from thousands of bond and note investors.

The last option was a default. Not long before, city officials had angrily upbraided reporters who even brought up the idea. In recent months, the officials had used it as a threat. But privately, as all of the other players in the chicken game well knew, they had always regarded it as unconscionable.

Yet now, as they talked about it, default came to possess some allure. If the threat of a default could not move Washington, Albany, and the banks, the fact certainly would. Nothing, indeed, could more graphically dramatize the city's financial plight and need for more outside aid. The $220-million worth of notes coming due the next morning were "general obligation" issues backed by the "full faith and credit" of the city. As an expected surge of lawsuits by debt-holders would point out, the state constitution decrees that holders of such notes have "first lien" on all city revenues. They must be paid off, if necessary, even before the city pays salaries and other bills. The actual dimensions of the responsibilities of issuers of municipal paper in the case of a default, however, have never been firmly established. And courts have often held above other obligations a municipality's duty to preserve its "police power" and maintain local order. No court, the mayor's aides figured, would order payment to well-heeled institutional-note holders while payrolls went unmet, city workers walked off their jobs, and city services collapsed.


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  • Archive: “Features
  • From the Jun 2, 1975 issue of New York
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