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The Domino Scenario: The Day New York City Defaulted

The next morning, Friday, May 30, 1975, a few minutes after the nine o'clock deadline for submission of bids in a small green tin box in the comptroller's office, Mayor Beame called a press conference in City Hall. By the expression on his face as he began reading a statement in front of the cameras, experienced City Hall reporters knew no bids had been received. Unable to obtain any money from Washington, Albany, or the banking community but unwilling to abandon the city's obligation to meet the needs of the people of New York, the mayor said in a wavering voice, the city had no choice but to default. The city would continue, he added, to meet payrolls and pay other bills.

Within minutes after the news appeared on the Dow Jones and Reuters news wires, the huge and growing $2.7-trillion superstructure of government, corporate, and individual debt which supports the U.S. economic system began to crack. The stability of what Business Week recently termed our "debt economy" depends on faith: confidence by lenders that their money will be paid back on time. The system easily tolerates occasional bankruptcies as long as they are regarded as isolated faults in an otherwise sound structure. But just as public order is occasionally revealed as a surprisingly thin veneer over a propensity toward panic and violent self-protection and assertion, so also is the nation's credit system, as the near panic that followed the collapse of the Penn Central showed, susceptible to dangerous losses of confidence from events judged to be indicative of pervasive weakness. To participants in the financial markets, New York City's default seemed an ominous harbinger of much more trouble to come.

First to be hit was the municipal bond market. States, cities, and towns all over the United States live off continual access to the credit markets. If it could happen in New York, investors asked themselves, why not anywhere else? The unthinkable had become only too possible. Debt obligations of such debt-ridden upstate communities as Rochester, Syracuse, and Buffalo, then such large Eastern cities as Newark, Boston, and Pittsburgh, then such states as Pennsylvania, Massachusetts, and Michigan were dumped in such large blocks they became unsalable at almost any price. Officials of several small cities, who had expected to roll over maturing debt the following week, indicated they also would probably have to default. Hundreds of small communities began preparing bankruptcy petitions. By late morning, some $200-million in municipals had been reduced to little more than pieces of paper.

". . . The last option was a default. Not long before, city officials angrily rejected the idea. Now, they used it as a weapon . . ."

With alarming speed, the panic moved to the banks. The widely publicized collapse of Franklin National and several other major banks over the past year or two has highlighted what many analysts, including officials of the Federal Reserve, feel to be a serious overextension by the banking community. At one time, banks financed most loans with deposits. But to meet booming corporate loan demands, the large banks resorted to issuing their own paper debt, mainly certificates of deposit (C.D.'s). Bank liabilities soared beyond often meager capital reserves. And a major share of those reserves was invested in municipal obligations.

It did not take long for investors in C.D.'s to calculate that the $1.5-billion in city debt held by the large New York banks not only exceeded the banks' 1974 net earnings, but constituted perhaps 25 per cent of their total equity capital, which recently had been depleted by loan losses on real-estate investment trusts and other ventures. Total municipal holdings by the banks are nearly as large as their equity capital. Corporate treasurers rushed to sell their C.D.'s in New York banks and withdraw their deposits. Other large money-center banks, who also hold large amounts of debt issued by local municipalities, came under pressure. Arab money managers, who had invested billions of dollars in C.D.'s and had billions more in demand deposits, hurriedly withdrew their funds.

By midafternoon, the dimensions of the panic were becoming clear. On the New York Stock Exchange, some 47 million shares changed hands and the Dow Jones Industrial average dropped 85 points before trading was suspended at 11:30 A.M. Despite massive infusions of cash by the Federal Reserve, several large banks, their liquidity exhausted, closed their doors. Fresh cash investments to help the Chase Manhattan Bank remain open were reported to have been possible only through personal guarantees by the Rockefeller family. A number of large corporations, dependent on a steady flow of bank credit, seemed headed for insolvency. In the foreign-exchange markets, the dollar plummeted despite Treasury support efforts. Treasury issues, which are held by many wealthy foreigners, including Arab money managers, came under fierce selling pressure. Some $10-billion, Federal Reserve analysts estimated late in the afternoon, had left the United States for safer havens.


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