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New York City, May - October 1975 (3)
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The original documents are located in Box 78, folder "New York City, May - October
1975 (3)" of the L. William Seidman Files at the Gerald R. Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald R. Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
remain with them. If you think any of the information displayed in the PDF is subject to a valid
copyright claim, please contact the Gerald R. Ford Presidential Library.
Digitized from Box 78 of the L. William Seidman Files at the Gerald R. Ford Presidential Library
PROPOSED ATTENDANCE FOR MEETING ON NEW YORK CITY:
September 2, 1975 - 6:45 p.m.
Governor Hugh L. Carey
David Burke, Secretary to the Governor
Peter Goldmark, Budget Director of the State of New York
John Hiemann, Superintendent of Banking
Felix Rohatyn, Advisor
Judge Simon Rifkind
Arthur Leavitt, State Controller
Bill Ellinghaus, Chairman of the Board, MAC
Michael Nadel, Asst. Counsel to the Governor
Administration:
The President
Donald Rumsfeld
L. Wm. Seidman
Alan Greenspan
Edwin Yeo
Richard Dunham
Rod Hills
FORD is LIBRARY 07V839
9/2/75
Attendance list for 6:45 p.m. meeting:
Governor Hugh L. Carey, NYC
David Burke, Secretary to the Governor
Peter Goldwank, awh Budget Director of the State of New York
John Hiemann, Superintendent of Banking in the state
Fekix Rohatyn, Advisor
Judge Simon Rifkind
Arthur Leavitt, State Controller
/
Michael Nadel, Asst. Counsel to the Governor
Bill Ellinghaus, Chairman of the Board, MAC
NY State Security Officer
LUS
(VYC)
FORD & LIBRARY GERALD
Revised:
9/2/75
8:00 p.m.
STATEMENT OF PR ESIDENT GERALD R. FORD
For the past six months, the President has been increasingly
concerned about the financial conditions of New York City. At his
request, Treasury Secretary William Simon and other Administration
officials have been monitoring the situation.
Governor Carey and his associates from New York met this evening
with the President and Administration officials and described the
financial circumstances of New York City and his recommendations
for the New York State Legislature.
Governor Carey described the difficult period of adjustment
that will be needed to restore confidence in the City's financial
practices and its long term economic well-being.
As their efforts to restore the city's economic health proceed,
the President said he would ask Federal Departments and agencies to
continue to stay in close touch with the officials involved and to
report to him as appropriate.
However, the President indicated that he continues to believe
that Federal financial assistance is not a solution to New York
City's problem. Under our system of Government, it is not, and
should not be, the job of the Federal Government to manage the
FORD GRANT
finances of State and local governments. If funds were provided to
New York, equity would require the Federal Government to provide
assistance to other cities, a process that could lead to the Federali-
zation of city affairs. In addition, the Executive Branch has no
authority to provide additional direct financial assistance.
NYC
9/2
STATEMENT OF PRESIDENT GERALD R. FORD
For the past six months, I have been increasingly
concerned about the financial conditions of New York
City. At my request, Treasury Secretary William Simon and
Chairman Arthur Burns have been closely monitoring the
situation. They and their senior advisers have spent,
and are continuing to spend, a large portion of every day
seeking sound and workable approaches to the problem.
Governor Carey informed me today that in his opinion,
the City of New York may have no alternative but to
default on the payment of its obligations next week, un-
les the New York State Legislature enacts new legislation
at its emergency session called for Thursday, and a pro-
posed financing plan can be subsequently implemented.
Such a default would be a major tragedy not only
for the people of the City and State of New York, but also
for all of us throughout the Nation. What is even more
tragic is that the circumstances which have given rise
to the situation could have been anticipated and corrected.
But now is not the time for recrimination. Indeed
as the Governor of New York, the State Legislature, and all
those involved seek to work out a solution, it is a time
for constructive effort.
LIBRARY
2
Governor Carey has asked the Federal Government to
assist the City and the State during the difficult period
of adjustment that is needed to restore confidence in
the City's financial practices and its long term economic
well-being. We will do what we can but we continue to
believe that Federal financial assistance would not
solve New York City's problem. Under our system of
Government, it is not, and should not be, the job of the
Federal Government to manage the finances of State and
local governments. If funds were provided to New York,
equity would require the Federal Government to provide
assistance to every other city, a process that would
inevitably lead to the virtual Federalization of city
affairs. I can not recommend such a policy.
In addition, the Executive Branch has no power to
provide direct financial assistance without congressional
action. This could not be accomplished in the time avail-
able even if it were desirable.
I encourage the efforts of the State and city to
work out their problems. As their efforts to restore
the city's economic health proceed, I have asked all
Federal Departments and agencies involved to assist the
city and the State in any way which is consistent with
existing Federal laws and regulations.
GERALE FORD LIBRARY
THE WHITE HOUSE
WASHINGTON
September 2, 1975
MEMORANDUM FOR THE PRESIDENT
FROM:
L. WILLIAM SEIDMAN
SUBJECT: New York City Situation
This memorandum reports on the current financial situation in
New York City and reviews the impact of the possible default
by New York City and the appropriate actions by the Adminis-
tration at this time.
Current Status
Last night, at the request of New York State and New York City
officials, a group of Administration officials met with Messrs.
Rohatyn, Burke, Goldmark, Hyman and Haynes of New York at the
Department of the Treasury. Representing the Administration
were William Seidman, Alan Greenspan, Ed Yeo, Rod Hills, Rich-
ard Dunham, Gerald Parsky, Robert Gerard, and Roger Porter.
It was agreed at the outset that the meeting was informal and
off-the-record.
Mr. Burke stated that default would take place about September
11 unless further financing was made available. He reported
that Governor Carey has called a special session of the New
York State Legislature for this Thursday, September 4. In
expectation of the special session, Felix Rohatyn, for MAC,
has put together a Financial Borrowing Package for about
$2 billion that would provide funds to the city through the
end of November. MAC has also proposed a three-year plan to
bring the New York City budget into balance. A description
of the elements of the financial borrowing package and the
MAC statement is attached at Tab A.
However, Burke indicated that it was doubtful if the package
could be accomplished since it involves many uncertain pieces
including use of both city and state pension funds. Governor
Carey must decide whether to propose the financial package
and/or an orderly default plan. Burke indicated that he con-
sidered the proposal of an orderly default plan the most likely
because the financial package does not seem practical nor does
it provide a long-term solution.
FORD
GERALD
LIBRARY
2
Mr. Rohatyn, for MAC, intends to send a letter to Governor
Carey indicating that the financial package entails a high
risk position for the State, that no one is confident that
the market will be reopened in December, and that the package
could put the State's credit in jeopardy. Absent federal
assistance, either direct or in guarantees, he does not be-
lieve that there is any way to avoid the pending default.
Mr. Yeo asked whether New York State and MAC were and had
been operating under the assumption that there would be no
direct federal assistance. All present agreed that this
was the assumption under which they had operated.
Mr. Burke also indicated that Governor Carey intends to meet
with Chairman Burns at 4:00 p.m. today and that Governor Carey
has requested a meeting with you.
Action Required in the Event of a Default
Our overall objective is to minimize the adverse impact of a
default. Specifically we will be prepared:
(1) To provide a workable mechanism to deal with the
City's financial affairs;
(2) To insure public order and provide essential ser-
vices;
(3) To provide for the continuing flow of federal pay-
ments;
(4) To protect the banking system;
(5) To provide for the continued operation of essential
financial institutions;
(6) To insure order in the capital markets, including
access to credit for issuers which may be tainted by
a default with particular regard to New York State.
Actions underway to implement these objectives are reviewed at
Tab B.
New York City Actions: Promises and Performance
A summary of the actions taken by New York City, those actions
promised but not yet performed, and those proposed actions on
LIBRARY
3
which we have not been able to obtain information is attached
at Tab C.
Effect of a New York City Default on Specific Banks
A compilation prepared by the Treasury of survey data obtained
from the FDIC, the Federal Reserve, and the Comptroller General
on the effect of a New York City default on specific banks is
attached at Tab D. In summary, a substantial number of banks
will suffer critical capital impairment. None of these are
major banks.
An additional analysis is being prepared on the impact on sav-
ings and loan institutions which is expected to reveal some
erosion of capital in these institutions.
Effects of a New York City Default on New York State's Financial
Position
A preliminary analysis of the effect of a New York City default
on New York State and New York State agencies credit, prepared
by the Treasury, is attached at Tab E. A detailed report will
be available tonight.
In summary, it appears that the State's financial position is
below average -- vulnerable but defendable. However, it appears
likely that certain components of the New York State Housing
Finance Authority will default.
Legal Procedures to Regulate the Payment of New York City's
Debts in the Event of Default
A memorandum from Rod Hills outlining legal procedures to reg-
ulate the payment of New York City's debts in the event of de-
fault is attached at Tab F.
Draft Presidential Statement
A draft Presidential statement, prepared by the Treasury, is
attached at Tab G.
Requested Meeting with Governor Carey
Governor Carey intends to meet with Chairman Burns at 4:00 p.m.
today and has requested a meeting with you subsequent to his
meeting with the Federal Reserve. There are both advantages
and disadvantages to meeting with Governor Carey.
4
Advantages:
1. Meeting with Governor Carey evidences your sympathy with the
people of New York and a desire to discuss a major financial
difficulty.
2. The meeting could result in new information or options.
Disadvantages:
1. It is likely that the meeting will be used as a platform
to indicate that the Federal Government's lack of respon-
siveness is causing New York City to default.
2. A Presidential meeting with Governor Carey involves you in
a matter that could be handled by the Secretary of the
Treasury and the Federal Reserve in accordance with your
previous directive.
It is recommended that if you decide to meet with Governor Carey
that the meeting occur after you have had an opportunity to fully
review the results of the meeting between Governor Carey and
Chairman Burns.
It is also recommended that you meet with your advisers today
to discuss the New York City situation.
Agree to meet with Governor Carey
Do not agree to meet with Governor Carey
TAB A
RARY
MAC PROPOSED FINANCIAL PACKAGE
The MAC financial package includes the following elements:
New York State commitment conditioned on securing
$750 million
$1.25 billion from other sources
The $750 million would include three parts:
(a)
$250 million in long term, open MAC bonds
(b) $250 million in short term subordinated MAC
bonds
(c)
$250 million in State loans using Mitchell-
Lama housing project properties as collateral
Mandated purchase of City paper by New York City
$500 million
Pension Fund
Mandated purchase of City paper by New York State
$250 million
Pension Fund
Real Estate Tax Advance
$150 million
State Insurance Fund Investment
$100 million
Use of New York City Sinking Funds (requires
$180 million
legislation)
Bank roll over of existing notes
$120 million
New investment by commercial banks
$250 million
Total
$2.3 billion
The financial package would carry the city until the early part
of December. However, the City would need an additional $3.7
billion of short term financing to complete the present fiscal
year ending June 30, 1976.
It is acknowledged that there would be great difficulty in
mandating the state and city pension funds in view of the likely
opposition of the State Comptroller and the trustees of the city
pension fund.
M.A.C. Statement on City's Finances
Following is the text of the document
offices of the Governor, the Controller of
released yesterday by the Municipal As-
New York State. the Mayor and the Con-
sistance Corporation summarizing past and
troiler of the City of New York." It added
present deficits of New York City and con-
that "it was presented to the Municipal
taining current projections of city revenues
Assistance Corporation today by these of-
and expenses through the fiscal year 1977-78.
ficials as a realistic statement of the city's
An introduction to the document said it
fiscal situation for use in its financing ej-
represented "the combined judgment of the
forts."
Analytical Framework
PAST DEFICIT: The listing of past deficits
from M.A.C. borrowing not dedicated to
through fiscal year 1974-75 relies on judg-
past deficits will be applied toward the
1975-76 deficit.
ments based on audits presently in progress
REVENUE ESTIMATES: The revenue esti-
by the State Controller, on findings of the
mates represent the best combined evalua-
City Controller and on estimates by the
tion and modifications of city estimates of
city and state budget offices. This cumula-
revenue growth by major category through
tive past deficit must be amortized by pres-
fiscal year 1977-78. All estimates assume
ent and future M.A.C. financing. Other
no tax increases during this period other
audits and further examination of city rec-
than real-estate taxes necessary to pay debt
ords may require modification of these
service.
figures.
EXPENDITURES FOR 1976-77 AND 1977-
DEFICIT FOR 1975-76: The deficit for
78: Welfare expenditures are assumed to
1975-76 is based on similar judgments and
remain at projected fiscal year 1975-76
estimates. It does not reflect expense items
levels. City expenditure estimates assume
in the capital budget, which will be reduced
various growth rates for different com-
according to the schedule provided in the
ponents of the budget, and were used as
M.A.C. legislation. Any balance of proceeds
working figures for this document.
-Year Projection of Income and Expenses
New York City Tax Levy
1975-76 Through 1977-78
(Millions of Dollars)
INCOME
1975-76
1976-77
1977-78
Executive budget-realestate taxes
$3,246
$
$
Less: Provision for uncollected taxes
260
Estimated real-estate tax collections
2,986
3,190
3,300
Executive budget-general-fund income
4,170
Less: Provision for uncollected income
-90
Estimated general-fund income
4,085
4,298
4,512
Less: M.A.C. debt service, administrative costs and
capital reserve fund
-391
-611
611
Total general-fund income
3,694
3,687
3,901
Total tax-levy income
6,680
6,877
7,201
Less: Provision for estimated uncollectable state/Federal
aid, and other revenue shortfall
-197
-197
-167
Total tax levy available to support city expenditures
6,483
6,680
7,034
EXPENSES ANTICIPATED BY CITY
7,209
7,422
7,835
DEFICIT
(726)
(742)
(801)
DETAIL OF BUDGET EXPENSES ANTICIPATED BY CITY
Welfare and medical assistance (excluding administration)
852
877
877
Pensions
897
956
1,039
Debt service
1,752
1,624
1,699
Miscellaneous mandated
335
345
374
Departments and Agencies (reflects wage freeze in 1975-76)
2,606
2,789
2,963
All other
767
831
883
FORD
$7,209
$7,422
$7,835
GERALD
LIBRARY
1975-76 and Prior-Year Deficits
Millions of Dollars
Real-Estate Taxes
Reserve for real-estate taxes
$260
Amount of prior year uncollected taxes to be written off that have
resulted from court tax cancellations, in-rem foreclosure proceed-
ings, tax exemptions and abatements for government-subsidized
privately owned housing
$ 502
General-Fund June Accrual
When funds come in, treat as cash for the year collected
General-Fund Shortfall
358
1974-75
1975-76
99
State Aid, Federal Aid and Other Receivables
60
1971-1972
12
1972-73
90
1973-74
256
1974-75
250
1975-76
150
New York City Stabilization Reserve Corp.
520
Deletion of Increment in General-Fund Borrowing for 1975-76
30
M.A. C. Costs and Debt Service for 1975-76
264
Accrual Payroll Conversion (12 days) for 1975-76
(Including Education)
105
10
Police, Fire and Correction Overtime for 1975-76-
Cash to Accrual
25
*Various O.T.P.S. Items for 1974-75 and 1975-76 Cash
to Accrual
95
10
June 30, 1975, Tax Deficiency Deficit (net)
100
Shortfall in Limited Profit Housing and Parking Revenues
47.
State Education Aid-To eliminate the need of the city to borrow
against state aid received after the close of the fiscal year
170
Total: $2,582
$831
Less: Savings from pay freeze
105
$2,582
$726
*In addition, $15 million of savings will be used for this purpose in 1975-76.
Unless other steps are taken by the city
lion annually would have to be achieved
or other measures are made available to
by 1977-78. Some of this would occur nat-
the city to reduce the deficits, it will be
urally in association with the work force
necessary to achieve savings equivalent to
reductions; other amounts would have to
a reduction of approximately 46,000 peo-
be cut in areas such as contracted services,
ple from the entire city payroll in fiscal
maintenance and utilities, and vender pur-
1977-78 in order to balance the budget in
chases.
that year.
The tables that follow indicate on both
In addition, savings (in other than per-
a yeary and a cumulative basis the magni-
sonal services) to the extent of $200-mil-
tude of dollar restrictions necessary.
Savings by Year
(millions of dollars)
Other than
76-77
224
80
304
Years
Personal Service
Pers. Serv.
Total
77-78
224
80
304
75-76
112
40
152
Cumulative Savings
(adjusted for inflation)
tota deficit will be funded through the
75-76
76-77
77-78
proceeds of initial M.A.C. issues and amor-
1975-76
152
163
174
tized over the life of these bonds. The re-
1976-77
304
325
maining $481-million wil have to be fund-
1977-78
304
ed and amortized through additional debt
Total
152
467
803
issues. Since the relatively short maturity
Deficit
(726)
(742)
(801)
and reserve fund requirements on M.A.C.
Net
(574)
(275)
2
debt produce a debt-service schedule that
*The estimates reflect cumulative deficits
declines significantly subsequent to 1977.
through 1976-1977 totalling $3,431-million,
78, the $481-million in additional debt is-
(2,582-million.from 1974-75 and prior years,
sues can be service after 1977-73 from that
portion of the sales-tax revenues that had
$574-million from 1975-76 and $275-mil-
previously been used for M.A.C. debt serv-
lion from 1976-77) $2,950-million of the
ice.
GERALD FORD LIBRARY
FORD
GERALD
CONFIDENTIAL
POSSIBLE ACTIONS WITH RESPECT
TO DEFAULT BY NEW YORK CITY
At the request of the President, Secretary Simon has
designated Under Secretary Edwin Yeo as Chairman of the
Federal effort. He chairs a steering group consisting
of Richard Dunham, Deputy Director, Domestic Council,
Roderick Hills, Deputy Counsel to the President, Antonin
Scalia, Assistant Attorney General, and Calvin Collier,
Associate Director (Economic and Government) of the
Office of Management and Budget. Robert Gerard of
Treasury is acting as staff coordinator.
I. Financial Mechanism
Insuring a workable mechanism for controlling the
financial affairs of the City in the event of default is
perhaps the most important priority. An effective mech-
anism of this nature will in and of itself do much to
satisfy the remaining objectives.
The model for such a mechanism is the corporate
bankruptcy provisions of existing Federal law. Simply
stated, such provisions place in the hands of a Federal
judge plenary control over the financial inflows and
outflows, as well as the assets, of a debtor.
Existing municipal bankruptcy provisions of Federal
law are inadequate in that they require prior written con-
sent of 51 percent in interest of the city's security
holders to a reorganization plan before a Federal court
can obtain jurisdiction. Although certain constitutional
provisions are implicated in any revision of the municipal
bankruptcy law, it appears possible to amend the law to
eliminate the 51 percent requirement, thus assuring the
opportunity for prompt and secure Federal court jurisdiction
over the City's financial affairs.
At the same time, there is one loophole in existing
law. If default occurs and the City is sued by a security
holder, it may seek. a Federal stay of such suit by filing,
among other things, a reorganization plan and a statement
to the effect that there is a "reasonable prospect" that
the 51 percent consent requirement can ultimately be met.
Such a stay may be granted for 60 days and extended for
an additional 60 days. To effect a permanent solution,
the requisite consents would still have to be obtained.
The stay route, however, would prevent a major potential
CONFIDENTIAL
Determined to be Administrative Marking
GERALD FORD LIBRARY
Date 2/24/83 By &
2
CONFIDENTIAL
source of chaos: a number of legal actions resulting in
conflicting injunctions one payment to court
ordering note holders, not the police; another ordering
the reverse, etc.
II.
Public Order
In the event of default, the City may be financially
unable to meet payrolls. In addition, there is a possibility
that the City's mechanism for making payments may cease to
function. This poses two threats. First, in the event
payrolls are not met (for either reason) or serious uncer-
tainties as to pay develop, a general or partial strike
could occur and could involve the police and/or firemen.
Second, in the event assistance payments are not made there
could be rioting beyond the capacity of local authorities
to control.
Legally, the State has primary responsibility to deal
with such matters in the first instance. Accordingly, our
preparation must be along two lines. First, we must assess
the resources (and the mobilization time required) of the
state in this regard. Second, we must assess both our
legal authority and practical ability to act, both on
the assumption that the State will act and on the assump-
tion that it will not.
III.
Federal Payments
As suggested above, one potential source of unrest
would be an interruption in the flow of Federal payments
for welfare, medicaid and other forms of assistance. Two
issues are presented. First, what legal impediments exist
in the event the City is unable to meet its matching share
obligations. Second, how can the USG and/or the State
assure continuing flows in the event the City's payment
mechanism ceases to operate because of strikes, etc.
OMB has identified three HEW programs which con-
stitute the bulk of Federal payments potentially affected
by a default. With respect to these programs, further
work is required in determining the legal implications
(primarily as a matter of State law) of the City's possible
failure to meet matching requirements. In addition, it is
necessary to develop a mechanism to administer these pro-
grams in the event of the City's failure to do SO.
To date, very little is known about the remaining
programs. Further information will be developed to permit
a determination whether coverage of such programs is essen-
tial to the success of the plan.
CONFIDENTIAL
GERALD
LIBRARY
3
CONFIDENTIAL
IV.
Banking System
The main threat to the banking system is psychologi-
cal. A New York City default would not meaningfully im-
pair the capital of any of the major banks. The real risk
is that such potential failures, coupled with the other
uncertainties attending a default, could cause a worldwide
lack of confidence in the major U.S. institutions.
Accordingly, we must act to insure that no liquidity
problems arise and that bank failures are averted. The
FED has already announced that discount windows will be
open. The FDIC will be ready to purchase convertible
capital notes of banks threatened with large capital im-
pairments. To avoid "bail out" charges, such purchases
would involve severe penalties for bank officials respon-
sible for the imprudent levels of ownership.
V. Operation of Essential Financial Institutions
In the event of civil disorder certain financial in-
stitutions--e.g. New York Fed, Stock Exchange--may be
unable to open due to inability of employees to travel,
security concerns, etc. Such closing could impair essen-
tial financial operations of the USG and undermine
national and international confidence in our markets.
We are exploring possible contingency action
under two assumptions: (1) conditions force a closing of
one-two days; (2) a closing of longer duration. We will
have to identify the specific functions which cannot be
interrupted. Alternative means, if any, for performing
such functions must be developed.
VI. Orderly Markets
Overall order (or disorder) in the capital mar-
kets will be largely a function of our success in imple-
menting the other elements of the plan. However, there
is one area of special concern. In mid September, four
housing agencies (New York State Housing Finance Authority,
New York State Dormitory Authority, New Jersey Housing
Finance Authority, and Massachusetts Housing Finance
Authority) will need to fund out or roll over maturing
short term securities. These agencies have recently had
ficulties in raising funds in the public market for
two reasons. First, overall market uncertainty caused by
CONFIDENTIAL
4
CONFIDENTIAL
New York City's problems. Second, lack of understanding
of the underlying financial resources of the agencies.
Such understanding was less necessary as long as the
moral obligation commitment was viewed as a reliable
credit basis. In the wake of UDC, this is no longer
the case and these securities are generally being
looked at as straight revenue bonds.
Our primary concern is with New York State Housing
Finance Authority. Most of the Dormitory Authority's
September obligation has been prefunded. Massachusetts
and New Jersey have experienced substantially less
difficulty than the New York agencies and will be less
"tainted" by further adverse events.
An indepth review of. Housing Finance Authority's
underlying financial soundness is being conducted in
New York. Although hard, audited, results will not be
available in time to meet September's requirements, we
do expect to have sufficient information to determine
whether notes can be privately placed in September.
In addition, consideration should be given to the
possibility of employing Section 802 of the Housing Act
of 1974. Section 802 permits Federal guarantees of tax-
able state housing agencies obligations and provides a
one-third interest subsidy.
CONFIDENTIAL
GENALO FORD LIBRARY
b
/
TAB D
EFFECT OF A NEW YORK CITY DEFAULT
ON SPECIFIC BANKS
The attached table is based on a survey of holdings by the Comptroller
of the Currency (national banks), the Federal Reserve (state chartered
banks which are members of the Federal Reserve) and a sample of 10%
of the 8, 000 state chartered non-member banks.
Banks with significant holdings of NYC obligations have been divided for
the purposes of that survey into three categories, banks holding NYC
obligations equal to (1) 50-75% of capital; (2) 75-124% of capital; and
(3) over 125% of capital.
Banks in the last category will be severely impacted by default; banks
in the second category will be vulnerable as a result of default.
The Regulatory authorities will approach each bank on a case by case
basis. In the case of some banks, the principal owners may be able to
provide additional equity capital. For example, the Comptroller of the
Currency feels that Mr. Safra, who is the principal shareholder in the
Republic National Bank, has access to additional capital.
Banks in the final category, the severely impacted group, would be con-
tacted immediately following a default by NYC. A meeting would be
arranged at which the bank's condition would be reviewed with manage-
ment. If additional capital is needed, as perceived by the regulatory
authorities, the possibility of the Board of the bank raising capital, the
merger of the impacted bank with another bank, and the purchase by
FDIC of subordinated notes or convertible subordinated notes will be
explored. The end result should be a plan of action to deal with each
individual impacted bank.
The three regulatory authorities agreed some weeks ago that they would
not require an immediate write-off of the difference between the book
value (purchase price by the banks) and the market value of defaulted
NYC obligations. Their plans are to have a six month grace period.
This delays the technical impact of default on the solvency of impacted
banks until the expiration of the grace period and would give the regu-
latory authorities time to arrive at solutions for each impacted bank.
While very real in terms of each bank, the grace period will probably
not delay the public's awareness regarding holdings of NYC obligations
by specific banks. The securities laws will probably require that banks
disclose to the investing public their holdings of NYC debt.
FORD
LIBRARY
2
We have two principal weapons to deal with the financial impact on the
banking system of a default by NYC.
1. The Federal Reserve will be in a position to fulfill its role as
a "lender of last resort. 11 In this role they insure that liquidity needs
are met much as they did following the collapse of Penn Central.
2. The Federal Reserve's ability to help in cases involving
insolvency is limited. Where a bank must charge off losses against
capital and the result is a sharp reduction or elimination of capital, only
the FDIC can help. Chairman Frank Wille has assured me that:
"The Board of the FDIC is determined that no insured bank
should fail as a result of NYC's default. To this end, it is
prepared to receive sympathetically, in necessitous cases
certified by the appropriate bank agency, requests for short-
term FDIC capital assistance, on a subordinated basis,
with the terms of such assistance to be negotiated on an
individual basis in order to protect the public interest and
to assume repayment to the FDIC in a timely fashion. The
FDIC Board is prepared to receive such requests for capital
assistance from banks both within and without the New York
metropolitan area. 11
This means that the FDIC would purchase convertible capital notes of
severely impacted banks. This would save many banks. In the most
extreme cases, however, this technique would not work because a bank
must have some equity left in order to function. In cases where equity
was totally wiped out, a likely alternative to liquidation would be an
assisted sale by FDIC of the destroyed bank to another bank.
LIBRARY
Banks with NYC Holdings Totalling 125% or More of Capital
Capital
NYC Holdings
%
Deak N/B
Fleischmanns, N.Y.
382,223
756,802
198
Flushing N/B
2,397,880
4,978,000
207.6
Flushing, N.Y.
Gulley National Bank
1, 264,407 2,402,374
190
Gulley Bridge, W. Va.
First National Bank of South
2,784,026
3,480,033
125
Charleston, W. Va.
First N/B
Cape Canaveral, Fla.
2,849,386 4,217,092
148
First National Bank of
Princeton-Naranja, Fla.
522,339 1,206,603
231
Banks with NYC Holdings Totalling 75-124% of Capital
Capital
NYC Holdings
%
Harbor N/B
3,017,833
3,603,293
119.4
Boston, Mass.
Columbus N/B
6,758,958
8,300,000
122.8
Providence, R. I.
Citibank (Suffolk), N.A.
3,163,180
3,780,000.
119.5
Bay Shore, N. Y.
Century N/B
6,672,842
6,072,286
91
New York City, N.Y.
Sterling N/B
49,755,220
49,257,668
99
New York City, N.Y.
First N/B of Norfolk
642,166
687,018
107
Norfolk, N. Y.
N/B of Roxbury
455,403
455,403
100
Roxbury, N. Y.
American Bk. & Tr. Co.
25,353,000
28,970,000
114.3
New York City, N. Y.
First National Bank of
St. Mary's, W. Va.
729,180
554,177
76
Boca Raton N/B
Boca Raton, Fla.
7,693,530
7,078,048
92
Flagship N/B of Westland
1,272,661
1,043,582
82
Hialeah, Fla.
American N/B
"
1,208,511
1,136,000
94
Champaign, I11.
Roodhouse N/B
520,619
505,000
97
Roodhouse, Ill.
Warren Bank
5,985,000
4,600,000
76.9
Warren, Mich.
First N/B
631,522
581,000
92
Mountain Home, Ark.
LIBRARY
2
Banks with NYC Holdings Totalling 75-124% of Capital
Capital
NYC Holdings
010
First National Bank
452,041
443,000
98
Fairfax, Minn.
Central N/B & Trust Co.
14,598,958
14,015,000
96
Des Moines, Iowa
National Bank of
Caruthersville, Missouri
844,578
701,000
83
Farmers & Merchants N/B
754,118
641,000
85
Hennessee, Okla.
San Luis Obispo N/B
1,909,821
2,139,000
112
GENALE FORD LIBRARY
Banks with NYC Holdings Totalling 50-75% of Capital
Capital
NYC Holdings
olo
National Bank of Fairhaven
1,919,532
1,076,853
56.1
Fairhaven, Mass.
Republic N/B
95,000,000
51,300,000
54
Brooklyn, N. Y.
First N/B of Dryden
1,982,193
1,129,850'
57
Dryden, N. Y.
Community N/B
7,886,797
4,653,210
59
Staten Island, N. Y.
Freedom N/B
3,102,113
1,706,162
55
New York City, N. Y.
Citibank (Mid-Hudson) N. A.
3,816,981
2,023,000
53
Woodbury, N. Y.
Industrial N/B of
2,675,202
1,417,857
53
Washington, D.C.
The Bank of St. Albans,
2,228,000
1,200,000
53.9
St. Albans, W. Va.
Citizens Bank
785,000
495,000
63.1
Smithville, Tenn.
First N/B of
1,879,377
1,165,214
62
Crestview, Fla.
First N/B
9,197,958
6,070,652
66
Hialeah, Fla.
First N/B of
i
2,747,378
1,648,427
60
Merritt Island, Fla.
Pan American Bk of Ormond
850,248
425,124
50
Beach, N.A.
Ormond Beach, Fla.
First N/B of the Upper Keys
2,397,944
1,702,540
71
Tavernier, Fla.
Metropolitan Bank
1,833,000
1,000,000
54.5
Tampa, Fla.
Banks with NYC Holdings Totalling 50-75% of Capital
Capital
NYC Holdings
%
Columbia N/B of Chicago
2,929,851
Chicago, Ill.
1,963,000
67
Elliott St. Bk.
4,098,000
2,060,000
50.3
Jacksonville, Ill.
Peoples Bank & Tr. Co.
662,000
of Sylacauga, Ala.
430,000
65.0
Hiawatha National Bank
536,842
306,000
57
Hager City, Wis.
American N/B
6,759,459
5,002,000
74
Eau Claire, Wisconsin
First N/B of
993,333
Nevada, Missouri
596,000
60
Kansas State Bank
389,000
260,000
66.8
Kansas, Ill.
Barclays Bank of New York
31,519,000
17,215,000
54.6
New York Ciry, New York
State Bank of Niantic
Niantic, Ill.
857,000
435,000
50.8
Endicott Trust Co.
Endicott, New York
9,457,000
5,230,000
55.3
GERAUD R.FOPD2 (IBRARY
TAB E
LIBRARY
GERALD
MEMORANDUM (Preliminary)
Subject: Effect of NYC Default on New York State and
New York State Agencies Credit
This memorandum sets forth our preliminary views
concerning the above question. It is based in part on
information and analysis supplied by Morgan Guaranty
Trust Co. of New York. It will be expanded to reflect
an in-depth review of the factual data which has been
initiated.
We have limited our analysis to evaluating the
consequences of impaired ability to do necessary, as
opposed to discretionary, funding. All New York State
issuers are paying more for money as a result of NYC's
problems and will pay even more if NYC defaults. The
question addressed here is whether issuers will be unable
to borrow and be forced to default as a consequence.
New York State
New York State is a fundamentally sound credit. Its
outstanding debt is $6.9 billion ($3.3 billion long term,
$3.6 billion short). Although the State's own direct debt
load (4.6% of estimated property values) is above the
state median (1.5%), it is adequately secured by sufficiently
diversified revenue sources, including personal income
taxes (39.4%), business taxes (16%), consumption and use
taxes (37.3%) and other miscellaneous receipts. The State's
credit position has been eroded through the increased
issuance of indirect obligations, or "moral obligation"
debt, currently estimated to be in excess of $6.5 billion,
including both long-term and short-term obligations.
Unlike NYC, NYS does not and has never borrowed to
finance deficits. It does use the short term credit market
to smooth out seasonal variations in cash flow. Most of
NYS' short term borrowing for its 1975-1976 fiscal year
(April 1 - March 31) has been done. It does have an $800
million note maturity on September 15 and, largely as a
result of having advanced substantial cash to NYC, must
roll over $500 million of the maturity.
We are concerned that inadequate attention has been
paid to the structure of this $500 million borrowing. In
an unsettled market -- especially if NYC defaults - - a
business as usual approach just won't work. We will be
working with the banking community to provide for the
orderly handling of this borrowing. Although there is
basis for doubt, we think in the final analysis that
the money will get raised and the State will not default.
NYS Agencies
Two important state agencies -- NYS Housing Finance
Agency (HFA) and NYS Dormitory Authority (DA) - - have note
maturities on September 15. We understand that DA will have
sufficient cash to pay off the maturing notes.
The HFA situation is more complex. There are 11
programs under HFA and each can be looked at as a
separate REIT, the borrowing of which is secured only by
revenues from that program (as well as the State "moral
obligation" which is now ignored in the market). Of the
11 programs, 5 are dormant, 2 are financially sound, but
need to refund short term debt, and 4 need to borrow but
are fundamentally unsound financially.
Of the $50+ million September 15 maturity, all but
$3 million is for one of the 2 sound programs. The
bankers are hopeful that they can finance the sound portion
this week, thus avoiding a potential collision between
default and this sound program's current needs.
Looking at October and beyond, the picture is far
more cloudy. However, our principal basis of concern
is the weakness of the programs. A default by NYC
in September would impede a solution to this problem,
but would not, in our view, be the determining factor.
OKO
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MEMORANDUM
NY
THE WHITE HOUSE
WASHINGTON
September 3, 1975
TO ECONOMIC POLICY BOARD MEMBERS
THROUGH
L. WM. SEIDMAN
FROM
ROD HILLS
RH.
Representatives of New York City and State have stated
publicly that they are preparing legislation to amend the
federal bankruptcy act that would, in their opinion, be
necessary in the event of default by New York City.
Attached is an analysis of Chapter 9 of the Federal
Bankruptcy Act and the type of changes that we believe
will be sought.
Since these changes make it easier for a municipality to
work out a "plan of composition" in the event a default
occurs, they could cast some doubt as to the value of
municipal debt generally. Conversely, because they do
make it feasible for a plan to restructure debt, it is
easier to preserve some values in municipal debt after
default occurs.
The Justice Department will be asked to testify on any
new legislative proposal for the City, and we may wish
to give some policy direction to that testimony.
It should be noted that legislation involving Chapter 9
has been pending in Congress for some time.
COPY NO.
4A
ADMINISTRATIVELY CONFIDENTIAL-EYES ONLY
MUNICIPAL FINANCIAL ADJUSTMENT PROCEEDINGS AND
SUCCESTED REVISIONS
I. Type and Scope of the Proceeding
A. The present provisions of the Bankruptcy Act
dealing with municipal debt adjustment are
found at 11 U.S.C. §§ 401-403, Bankruptcy
Act Sections 81-83 (Chapter IX).
1. Chapter IX allows the voluntary filing of
a petition by a city, town, county, water
district, school district, port authority,
or similar municipal bodies,
2. Chapter IX has been found to be constitu-
tional in that it permits only voluntary
filings where not prohibited by the State.
See United States V. Bekins, 304 U.S. 27
(1938)
B. Chapter IX should be left intact in order to
minimize the effect of a new chapter on the
finances of small municipalities or their sub-
entities; a new chapter modeled on Chapter IX
should be proposed.
1. The new chapter should be made applicable
only to cities with a population of over
1,000,000 residents. (This figure could
be adjusted upward to minimize the effect
of the proposed legislation on certain
cities.)
2. There is no constitutional impediment to
so streamlining the class of debtors affected
by the proposed legislation SO as to affect
only a very small percentage of large cities.
Hanover National Bank V. Moyes, 186 U.S. 181
at 188 (1902).
3. Subentities of a municipality that qualifies
as one of the class of debtors benefited by
the statute should be permitted to file a
petition in order to maximize the effective-
ness of a plan of composition; however, such
a filing should not be mandatory SC as to
avoid the complication of including inde-
pendently solvent districts, authorities, etc.
II. Jurisdictional Aspects of the Proceeding
A. The present Act allows no interference with the
sovereignty of the States or their political
subdivisions; a provision to this effect should
be included in any proposed revision of municipal
financial adjustment proceedings. See 11 U.S.C.
§ 403 (c) (i).
1. Constitutional considerations: Congressional
authority to legislate under Article I, Section
8, cl. 4 is restricted by the provisions of
the Tenth Amendment. A constitutional barrier
is presented should any proposed statutory
provision so interfere with State sovereignty
as to deny the State's right preserved under
the Tenth Amendment to control its own fiscal
affairs.
n. See Ashton V. Cameron County Irrigation
District, 298 U.S. 513 (1936) and United
States V. Bekins, 304 U.S. 27 (1938).
11.
Since involuntary proceedings against a
municipal corporation without State con-
sent are not contemplated, we foresee no
impediment to the proposed statutory
provision presented by the Tenth Amend-
ment.
2. State consent to proceedings undertaken pur-
suant to the proposed statutory provisions
should be explicitly provided for in the
statute.
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a. Although commantators in discussing the
present provisions of Chapter IX have
stated that where a State is silent re-
garding the availability of Chapter IX
to its municipalities, such silence im-
plies the State's consent to the avail-
ability of Chapter IX, any proposed
legislation should state that if no
State prohibition exists the municipal
instrumentality may file a petition under
its provisions,
b. It should be noted that proposed bills
now under consideration by the Congress
take this approach which dispenses with
express State permission whenever a
municipality desires to avail itself of
the relevant bankruptcy remedies avail-
able to it. (House Document 93-137,
Part II, Sept. 6, 1973 (containing the
bill later proposed by the Commission
on Bankruptcy Laws) and S. 235, 94th
Cong., 1st Sess. 1974 (proposed by a
committee of Bankruptcy Referees))
c. Cf. Municipal Assistance Corporation Act,
5 McK. N.Y. Sess. Laws 237, Chapter 168,
June 10, 1975, 198th Sess. This Act
represents the State of New York's
attempt to aid municipalities, who are
unable to sell sufficient securities to
permit them to refund their outstanding
obligations or to meet their cash re-
quirements, through a State corporation's
issuance of bonds. We have found no pro-
vision therein nor in any other law of
New York prohibiting the proceeding.
3. There is no trustee in a Chapter IX proceeding
and the municipality remains in control of its
property, revenues and expenditures, The new
chapter should propose to continue this scheme
as do the above mentioned proposed bills before
Congress regarding Chapter IX.
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GERALD
B. A provision specifically stating that the
chapter does not impair or limit laws governing
the use of Federal funds should be added.
1. The present Chapter provides that the plan
itself cannot require actions by the debtor
which are unlawful, 11 U.S.C. § 403(e) (6)
2. The present Chapter does not specifically
deal with the treatment of Federal funds
during the proceedings and this silence
should be clarified. (Note Art. 5 General
Municipal Law § 99-h (McKinney 1974 supp.)).
C. There should be no provision for trustees'
avoidance powers.
1. All other bankruptcy proceedings provide for
the avoidance of: (1) prefential transfers
within four months of bankruptcy, (2) fraud-
ulent conveyances in certain circumstances,
and (3) liens obtained within certain periods.
See 11 U.S.C. §§ 96, 107 and 110 designed to
enhance equitable distribution of the debtor's
assets.
2. Bankruptcy authorities favor the exclusion of
such remedies in municipal debt adjustment
proceedings. See the proposed bills cited
supra; 5 Collier or Bankruptcy % 81.27
a.
Such avoidance powers may constitute in-
terference with the governmental and
fiscal affairs of the debtor in contra-
vention of the Tenth Amendment, discussed
supra.
b. Such powers would complicate the pro-
ceedings.
c. Since there are usually provisions pre-
venting a judgment creditor from obtaining
a judgment lien against a municipality,
some of the avoidance powers are unneces-
sary. Cf. 7B McKinney's Consolidated Laws
of New York Ann. CPLR 5203(a)5.
FORD
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GERALD
LIBRARY
D. The duration of the bankruptcy court's juris-
diction should be clarified.
1. The present Act contains no provision on this
point.
2. Commentators have suggested retention of
jurisdiction until the court is satisfied
that the plan is successfully in operation,
See e.g., George H. Hempel, "An Evaluation
of Municipal Bankruptcy Laws and Procedures",
Journal of Finance Vol. XXVIII No. 5 P. 1339,
December 1973,
E. The binding effect of the proceedings on creditors
should be clarified,
1. The present Act provides that all creditors,
whether secured or unsecured, and whether or
not their claims are filed or allowed, are
bound by the provisions of the confirmed plan
(11 U.S.C. 403(f)). Therefore, they cannot
challenge the plan outside the proceedings.
2. As in present Chapter X proceedings, this
provision should be clarified to apply to un-
scheduled creditors without notice of the
proceedings. See 11 U.S.C. § 624 (1).
3. Present Chapter IX provides for a discharge
of all debts dealt with in the plan and
there is no exception for unscheduled
creditors without notice, as is the case in
straight bankruptcy and Chapter XI pro-
coedings.
4. Provision for the discharge of unscheduled
debts, together with a provision providing
for a totally binding plan, has proved con-
stitutional in the Chapter X context. See
6A Collier, supra 1 11.18.
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GERALD
F. The new chapter should provide for an automatic
stay upon the filing of all suits against the
debtor and all proceedings to enforce liens.
1. The present Chapter allows the bankruptcy
court discretion in granting such a stay.
The Chapter also allows the filing of 2
petition seeking a stay by a municipality
which is attempting to enter Chapter IX but
which has not completed all requirements for
filing a petition to enter Chapter IX. 11
U.S.C. 403 (c).
2. The stay would be granted without hearing and
those seeking relief from the stay must pro-
ceed affirmatively in the bankruptcy court.
a. Such a provision avoids delay and
is necessary where the debtor has
no power to avoid liens already
obtained,
b. The New Bankruptcy Rules provide for
such a stay, as do the above mentioned
bills now before Congress.
III. Operation of the Proceeding
A. The requirements of a petition initiating the
proceeding should be modified.
1. The present Chapter requires the debtor to
file a petition alleging insolvency and the
petition must be accompanied by a plan of
composition that has been accepted by credi-
tors owning 51 percent of the outstanding debt
of the municipality. A list of all known
creditors must also be attached.
2. The 51 percent requirement is not constitutionally
mandated. See Hanover National Bank v. Moyses,
supra; Campbell V. Alleghany Corp. 75 F.2d 947,
954-955 (4th Cir. 1935), cert. denied 296 U.S.
581.
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BERALO FORD LIBRABY
3. Several commentators have suggested re-
ducing the 51 percent requirement and both
proposed bills eliminate it entirely. The
total elimination of the prior acceptance
requirement is desirable.
a. The petition would merely state that
the city is unable to meet its debts
as they matured, S. 235 § 9-202.
b. A list of creditors could be filed with
the petition or at a time the court
directs. See S. 235 § 9-301.
c. Rather than requiring creditors to
answer the petition, as in 11 U.S.C.
403(b), creditors opposed should
affirmatively challenge the petition.
See S. 233 § 9-203.
B. The present provisions classifying creditors
should be retained.
1. Chapter IX now provides for the modification
or alteration of the rights of creditors
generally; secured, unsecured, municipal
bondholders, and holders of bonds to be paid
out of special assessments, revenues, taxes,
etc., 11 U.S.C. § 403.
2. There is no constitutional impediment to
the alteration of the debts of bondholders.
5 Collier, supra, § 81.09, note 9. Further-
more, Chapter X has been consistently upheld
even though vested rights are affected and
even secured creditors may be subordinated.
6 Collier, supra, rj 0.01 and 13.26; Matter
of Prima Co., 88 F.2d 785 (7th Cir. 1937).
C. The requirements for confirmation of the plan
should be revised.
1. Presently, Chapter IX requires that credi-
tors owning two-thirds of the claims in a
class whose claims have been filed and
allowed and affected by the plan must con-
sent to the plan.
FORD
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GERALD
LIBRARY
2. There is no constitutional reason for
the two-thirds requirement. S. 235,
§ 9-307 (c) suggests majority approval
only.
3. A revision requiring only majority approval
would contribute to the likelihood of accep-
tance and eliminate some delay.
4. Chapter IX provides for separate classes of
creditors; those entitled to priority (for
example, the United States Government),
unsecured creditors generally, and secured
creditors.
a. Secured creditors are not in one class
but in separate classes, defined accord-
ing to the property upon which they have
liens. 5 Collier, supra, I 81.15. For
example, bondholders with liens on
specific revenue would constitute
separate classes, defined according
to the particular bond issue involved.
This coincides with general State law.
See e.g., N.Y. General Municipal Law
Art. 14-C § 407. (McKinneys 1974).
b. If any class of creditors affected by the
plan in a material way did not accept the
plan, Chapter IX requires that they be
paid in full or that their liens be pro-
tected. 11 U.S.C. § 403(d).
In order to accelerate confirmation of
the plan, a time limit for acceptance
should be established, Hempel, supra,
suggests 90 days.
D. Presently, Chapter IX proceedings are handled by
the District Court Judge rather than by the bank-
ruptcy judge, as in Chapter X. There appears to
be reason to revise this.
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FORD is LIBRARY 0ERALD
IV. Miscellaneous
Any disruptive effects of the proposed chapter might
be reduced by the inclusion therein of a specific pro-
vision for the limited duration of such proceedings.
FORD
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GERALD
LIBRARY
OF
THE
THE 1789 TREASURY
THE SECRETARY OF THE TREASURY
WASHINGTON
SEP
X
1975
MEMORANDUM FOR THE PRESIDENT
Subject: New York City
The attached paper reviews options for Federal financial
intervention in the NYC crisis. This crisis originated in an
inability of the political mechanism in NYC to reconcile
expenditures with available revenues. For years, the gaps
have been financed through the issuance of short term debt,
but investors will now no longer finance these gaps. A
stagnant tax base resulting from NYC's structural economic
problems intensifies the problems, by foreclosing substantial
new revenue sources. And entrenched political interests inhibit
actions to reduce expenditures substantially.
Governor Carey and other interests -- e.g. banks, city
labor unions, representatives of welfare and other social
services interests -- have dealt with the issue of default
adroitly, at least in a political sense. Drawing on wide-
spread apprehension as a result of the crunch of '74 and
the financial impact of the recession, they have coupled
NYC's default with the integrity of the banking system, the
ability of municipalities and states to raise money in the
future and the continuance of the present upswing in economic
activity.
They have designed a "financial plan" which mandates use
of state and city employee pension fund money and the purchase
of Big MAC obligations by the State. This "plan" has a dual
trigger mechanism. The approximately $2.0 billion raised
under "the plan" would carry the City through the end of
November. By that time the reconciliation process mentioned
above would have had to progress sufficiently so as to enable
the City to reenter the public markets to finance $3.7 billion
in additional funds to carry it through the first half of
calendar '76. Second, Big MAC will, under the plan, have to
be able to tap the bond market for $750 million to repay the
State by the end of its fiscal year (3/31/76).
FORD
- 2 -
If the reconciliation process is not well underway by
the end of November, NYC will default and this event creates
the risk of, but will not necessarily result in, a default
by the State and its agencies as well.
A solution pressed upon us is Federal involvement,
through a direct loan, a partial guarantee of City or
Big MAC securities or a full guarantee. A guarantee or
direct assistance would eliminate the threat of default.
Unfortunately, it is inconceivable that a guarantee could
be limited to NYC or Big MAC securities. First, it would
be unfair to exempt NYC from the painful process of reconciling
income with outgo. Second, it would be difficult to pass
legislation limited only to NYC. There are other municipalities
where the pain of reconciliation is just as extreme as that
felt by NYC, but where the totals involved are not nearly
so dramatic.
If this assumption is correct, a guarantee for NYC would
only begin the process of guarantees and/or direct loans for
state and local governments. As this developed, the incentive
for other municipalities to endure the stress of reconciling
income with outgo would be reduced. Structural deficits in
countless municipalities would be the end result of this
process. A substantial increase in Federally-guaranteed
debt of states and municipalities would be the end result.
And why not a guarantee for Atlanta's badly needed rapid
transit system or Detroit's partially completed major hospital.
This in turn would crowd out those sectors of our economy
that do not enjoy a guarantee; for example, much of the housing
sector, individuals and corporations. In turn, these groups
would bring to bear strong pressures to obtain guarantees for
themselves.
The economic aspects of structural municipal deficits
financed through the issuance of guaranteed securities would
parallel to a significant degree the impact of large direct
deficits by the Federal Government. Strong additional pressure
would be brought on the Federal Reserve to provide reserves to
facilitate the financing of those deficits and to reduce the
incidence of crowding out.
If the Federal Government attempted to control local
finances to protect it from exposure under guarantees, it
would become enmeshed in the local politics of thousands of
political subdivisions. Direct Federal aid, a guarantee or
a partial guarantee might avoid default. But it also would
begin the Federalization of state and local affairs.
LIBRARY
William E. Simon
SEP 8 1975
DECISION MEMORANDUM
SUBJECT: Financial Assistance for New York City
This memorandum has been prepared in light of the
pending action by the New York State Legislature to provide
funds for New York City -- primarily through State borrowing
and through purchases of City and/or MAC debt by public
employee pension funds. The Legislation poses a risk to
the State's credit and increases the likelihood that the
State (and various State agencies) would be severely
impacted in the event New York City defaults.
These concerns have led to more strident demands that
the USG indicate a willingness to provide financial assist-
ance to New York City to avoid a default in December. This
memorandum sets forth the options available (with appropriate
legislation) at the Federal level.
This memorandum is in two parts. Part I sets forth
the options for a new program of direct Federal financial
assistance to New York City. Part II explores the
possibility of using existing Federal resources to ameliorate
the problems.
Part I: Direct Financial Assistance
Background
The analysis contained herein is premised upon the
following assumptions:
1. The State Legislature will enact the Governor's
legislative package, providing sufficient funds (approximately
$2 billion) to carry the City through December 1.
2. Implementation of the package will exhaust the
cash flow resources of the State, its pension funds and
the banking system in New York State with respect to
additional financial assistance to New York City.
3. New York City will not be able to borrow in the
public market by December 1.
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As a practical matter, enactment of the Legislation
will impose two market access requirements:
-- the City will be required to borrow $3.7 billion in
net new cash between December 1 and June 30, 1976,
the end of its fiscal year;
-- Big MAC will be required to borrow $750 million by
March 31, 1976 (the end of the State's fiscal year)
to refund the State TAN issue.
Forms of Assistance - General
There are two basic options:
1. A Federal guarantee of securities issued by
the City, the State or MAC; or
2. A direct Federal grant or loan to the City,
the State or MAC.
Either basic option will require legislation. As
discussed more fully in the treatment of options, an important
consideration is the breadth of any assistance program.
Since, as a practical matter, any proposal involves a
Federal allocation of credit, it is essential that constraints
closely approximating free market constraints be imposed.
If constraints on the amount of and eligibility for
assistance are not imposed, any assistance program will be
abused by borrowers attempting to use such assistance as
their primary source of financing.
Before evaluating specific forms of assistance, the
threshold question of whether to provide any form of Federal
financial assistance is presented.
Pros
-- Would avert a default by the City and/or the
State.
-- Would eliminate the risk of a major financial
collapse precipitated by a City and/or State
default.
-- Would show Administration concern for urban
problems.
-- Would protect banks from losses, thus reducing
the risk of a series of insolvencies leading to
a loss of confidence in the banking system.
- 3 -
Cons
- - Would eliminate requirement for limiting
expenditures to level of revenues at State
and local government level.
-- Would increase USG borrowing costs by increasing
USG demand for credit.
-- Would increase the borrowing costs of all other
borrowers, and could close the credit market to
certain marginal borrowers.
-- Would conflict with Administration policy against
new spending.
-- Would set a bad precedent by opening the door to
any borrower (or class of borrowers) in financial
difficulties who can claim potential impact on
financial system.
I. Guarantees
A guarantee would involve an agreement by the USG to
pay the debt service on a loan (evidenced by a note or
bond) if the underlying borrower failed to pay. Within
the guarantee concept, there are numerous sub-options.
A guarantee can be full (an agreement to pay all unpaid
debt service) or partial (an agreement to pay a
specified percentage of unpaid debt service). A Federal
guarantee program could be made available (1) to all
municipal debt; (2) to a specified annual dollar amount
outstanding; or (3) to a single issue of New York debt
to finance New York City's $3.7 billion shortfall.
Evaluation of Options
1. General Guarantee Concept
Pros
-- Makes N.Y. Securities marketable
-- Requires no immediate USG cash outlay
-- May be more palatable to Congress than
cash outlays.
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Cons
-- Requires extensive supervision if USG's
contingent financial interests are to be
protected.
-- Expansion of Federal credit drives up
USG borrowing costs.
- - Could reduce or deny market access to
borrowers (crowding out).
-- Eliminates incentives for fiscal restraint;
i.e., balancing of revenues and expendi-
tures.
2. Full vs. Partial
Full Guarantee
Pros
-- Easier to administer
- - More certain to insure a market for the
bonds.
-- Lowest borrowing cost for issuer.
Cons
-- More USG contingent exposure
-- More adverse impact on other borrowers.
Partial Guarantee
Pros
-- - Less USG contingent exposure.
-- Less adverse impact on other borrowers.
Cons
- - More difficult to administer.
-- - May not create a market for the bonds.
- - - Higher borrowing cost to issuer.
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3. Scope of Program
All Municipal Debt
Pros
-- Most fair.
-- Provides greatest amount of assistance
nationwide.
-- - Easy to administer, no allocation or
eligibility decisions.
-- No prejudice to municipalities which
need to borrow.
Cons
- - Greatest USG exposure.
-- - Largest adverse impact on USG borrowing
costs, borrowing costs of other issuers.
-- Broadest elimination of incentives for
fiscal restraint.
-- - If Federal supervision is involved, would
require large bureaucracy.
Specified Annual Dollar Limit
Pros
-- Limits USG exposure.
-- Limits impact on capital markets.
-- Limits outlays for Federal supervision.
Cons
- Difficult to administer.
-- Severe problems of allocation.
-- Depending on allocation mechanism, may
not satisfy New York City's requirements.
-- Severe prejudice (competitive disadvantage)
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to tax-exempt borrowers which do not
obtain guarantee.
" 6 -
One-Shot Guarantee of Special NYC Issue
Pros
-- Least USG exposure.
-- Least impact on markets, other borrowers.
-- Easiest to administer.
Cons
- - Unfair to all other borrowers.
-- Rewards NYC for its fiscal irresponsi-
bility.
-- May be difficult to obtain Congressional
support.
II. Insurance and Re-insurance
Insurance of new issues of municipal bonds cannot
be distinguished -- in form or in substance -- from a
guarantee. Re-insurance cannot be distinguished --
insofar as the USG is concerned - - from a partial
guarantee. Insurance and guarantees involve the
identical legal commitment from the insurer or
guarantor: an irrevocable agreement effective on
the date of issue to make debt service payments if
the issuer fails to make such payments. Unlike
traditional casualty insurance, once the commitment
is made, the insurer never has the opportunity to
reevaluate the risk or adjust the premium. A11 he
can do is retain the right to participate in the
issuer's affairs (compare the rights the USG reserved
under the Lockheed guarantee program).
Under reinsurance, a private entity would be
responsible for writing the policy and would bear a
portion of the risk. The theory is that the private
entity would take on the supervisory role, and
would have a financial incentive to supervise
vigorously, thus avoiding the problem of excess
Federal involvement. However, the resources the
private insurance sector is willing to commit to
these risks are so limited (maximum exposure of
$8-15 million principal per issue), that with respect
to issuers of any size, the Federal share of insurance
would have to be close to 100%. In these cases, the
market problems outlined above would continue to be
present. And, in light of the fact that the option
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of withdrawing the insurance is permanently fore-
closed at the outset, it is doubtful whether any
private insurance company could exercise a degree
of effective control over the affairs of a
New York, Los Angeles, or Chicago.
Pros and Cons
Because insurance and re-insurance are identical
to a full guarantee and a partial guarantee, those
pros and cons are fully applicable.
III. Direct Loan or Purchase of Securities
This form of assistance has two distinguishing
features. First, it involves an immediate cash
outlay by the USG. Second, the City (or other
borrower) would not be forced to go into the market
itself - - accordingly, the USG would have to borrow
in the open market to make the loan.
Apart from these features, the considerations
-- and sub-options -- regarding the direct loan
approach are virtually identical to those involved
with respect to guarantees. The pros and cons of
various programmatic features - - e.g. purchase all
debt, purchase dollar limit, purchase NYC alone --
are the same.
One different sub-option can be identified.
To create incentives for fiscal reform (and
restored public market access) the USG could make
loans available on a matching basis; i.e., for
every $5 the City raises in the public market, the
USG will provide $1. Recognizing the importance of
self-reliance, most existing USG assistance to
State and local government is in matching form.
Matching Loans
Pros
-- Preserves incentives for fiscal restraint.
-- Requires less funding from USG, reducing
adverse market impact.
Cons
-- If City is unable to restore market
confidence, will not be adequate to
prevent default.
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Direct Loan vs. Guarantee
The similarities notwithstanding, there are
certain advantages and disadvantages to a direct
loan program which stem from the above-described
distinguishing features.
Advantages of Direct Loan
-- Does not directly affect the municipal
market; indeed, by eliminating a
portion of demand from the market, may
cause a short term improvement in market
conditions for other borrowers.
-- Direct cash payment insures City will
receive funds.
Disadvantages
-- Requirement of actual USG borrowing (as
opposed to intangible expansion of USG
credit) may have more severe and
immediate effect on USG borrowing cost,
borrowing costs of other borrowers.
- - Direct cash outlay would directly
increase USG budget deficit, further
lessening USG flexibility regarding
fiscal policy.
IV.
Three Year Advance of City's Share of Welfare
It has been claimed that the City's welfare
burden is a national concern: the poor and dis-
advantaged, as well as illegal aliens, gravitate to
NYC. Accordingly, it has been suggested that we seek
legislation authorizing an advance to the City in an
amount equal to the City's share of welfare costs for
three years: approximately $2.7 billion. In return,
the USG would receive a 10 year City bond, bearing
interest at Treasury bond rates. In addition,
beginning three years from now, the City would establish
a sinking fund to repay the bond when due.
Pros
-- Would provide a substantial portion of
the City's cash needs.
IBRARY
-- Would not disrupt municipal bond market.
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Cons
-- Would be difficult politically to
confine to NYC.
-- Would require substantial borrowing by
USG, driving up USG borrowing costs
and affecting other borrowers.
-- Could be viewed as a concession of
broader Federal responsibility in the
welfare area, tying our hands with
respect to upcoming welfare reform
proposals.
Part II: Use of Existing Resources
I.
Federal Reserve
Two avenues of assistance are available through the
Federal Reserve. First, the Federal Reserve Banks are
authorized to supply liquidity to the banking system by
accepting for discount financial assets held by the bank.
Discounting is in effect a secured loan to the bank, but
it is important to note that the bank remains liable to
the Fed for the full 'amount of loan. Accordingly, if a
bank were to discount NYC Securities with the Fed, the
bank would still bear the risk of loss. Dr. Burns has
announced that the "discount window" will be available
to banks impacted by the New York crisis.
The discount window is not a source of direct
assistance to New York City. However, the Federal Reserve
banks are empowered to make direct loans -- secured or
unsecured -- to any borrower "in exigent circumstances.
Direct Fed Loan
Pros
-- Would provide NYC with the necessary cash.
-- Would not require legislation.
-- Would eliminate the risk of a major
financial collapse precipitated by a City
and/or State default.
-- Would show Federal concern for urban problems.
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Cons
- - Would set a bad precedent by opening this
avenue of assistance (which has never been
used in comparable circumstance) to borrowers
who can claim broad impact on financial
system.
-- Would place Fed in the role of the City's
bankers and could lead to pressure for
further loans to protect initial loan.
II.
GNMA Program
GNMA has the general legal authority to purchase
mortgages of all types. It must, however, obtain
periodic authority from Congress for actual blocks of
purchases. It has recently used up a $5 billion block;
legislation is now pending (and expected to pass soon)
giving GNMA an additional block. The City owns $700
million in mortgages on existing low and moderate income
properties ("Mitchell-Lama" projects) which would
qualify for GNMA purchase.
Pros
-- Provides a substantial Federal commitment.
-- - - Would not disrupt municipal market or
disadvantage other borrowers in that market.
Cons
-- - Would be inconsistent with Congressional
purpose to use GNMA to generate new housing
starts.
-- Would impede recovery in housing sector.
-- Would establish dangerous precedent: many
state and local agencies own mortgages they
have been unable to fund through long term
debt.
III.
Change Method of Medicaid Reimbursement
By shifting Medicaid hospital payments from a
reimbursement to an advance basis, we could provide
$75 million. To make the shift, the State would also
have to change its method, requiring a $37.5 million
outlay by the State.
- 11 -
Pros
-- - Provides some cash assistance.
-- - Since most Federal assistance is on an
advance rather than reimbursement basis,
would not represent a basic policy change.
Cons
-- Shift nationwide, involving $500 million,
would involve a substantial one time cost
to the USG
-- Benefit to City small in relation to overall
need.
-- State matching requirement could burden
State.
IV.
Advance Revenue Sharing
The third quarter revenue sharing payment ($64
million to the City, $57 million to the State) is
scheduled to be made in the first week of October. The
fourth quarter payment (in the same amounts) is payable
in the first week of January. These payments can
legally be made any time in the relevant quarter.
Pros
-- Provides some financial assistance.
Cons
- - - Would not provide new cash: NYC's problem
is no longer so much one of timing of cash
flow, as of total amount.
- - Would have to be provided nationwide imposing
substantial cost on USG.
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OF
DEPARTMENT THE TREASURY
THE
THE SECRETARY OF THE TREASURY
WASHINGTON 20220
1789
September 16, 1975
Dear Mr. Chairman:
I am writing in response to your letter of
September 5, 1975, requesting an analysis of the
potential impact of an inability by New York City
to meet its obligations as they mature. It is clearly
appropriate that we fully evaluate the potential
consequences of such an event and the methods
available for dealing with them.
As you know, I shall be testifying before your
Committee on the 24th of September on many of the
questions that you have raised, and in that testimony
I plan to cover these issues in full detail. In the
meantime, in order to be responsive to your needs as
well as those of your colleagues, I would like to
offer brief comments on each of the points that you
have mentioned.
Financial Markets
As I have said many times in commenting upon
the possible impact of a default by New York City
upon our financial system, we are dealing in the realm
of personal judgments; absolute certainty is simply
not possible. Based upon past experience, however,
I have great faith in the resiliency of our financial
markets and, subject to the willingness of most
market professionals to view the situation objectively,
I believe those markets are capable of handling a
default with no more than moderate and relatively
short-lived disruption. I must add that to some extent,
the possibility of a New York City default has already
been discounted in the marketplace. Although a variety
of complex factors have contributed to the current
high levels of tax-exempt yields, one element is the
expectation of a New York City default. Accordingly,
if default were to occur, we would expect only a
moderate degree of further adjustment.
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Other Issuers of Tax-Exempts
New York City's well publicized difficulties have
clearly resulted in more intensive scrutiny of the
underlying soundness of all tax-exempt credits, a
healthy development in our view. We would expect the
levels of care employed in analyzing potential tax-
exempt investments to rise even further in the event of
a default, in effect rewarding issuers whose financial
affairs are entirely in order. We do not believe,
however, that any other issuer will default as a direct
consequence of a default by New York City.
Banking System
As the Committee is aware, the Treasury Department
along with the bank regulatory agencies has reviewed
the exposure of the banking system in the event of a
default by New York City. Based upon that review, we
have concluded that a default would not cause solvency
problems for any major bank. We have identified
certain smaller banks which may face material capital
reductions as a result of a default. These few banks
are being carefully watched by the appropriate regulatory
agencies, which will take the necessary steps to insure
that no innocent parties are adversely affected by the
impact of a New York City default on certain banks.
Overall Economic Outlook
As a result of widespread publicity, the nation
is fully aware of the financial situation in New York
City and is particularly sensitive to the unique
aspects of the situation: specifically, the city's
massive deficit spending. Given these levels of
awareness, we do not believe a default would undermine
fundamental confidence in our economy or cause financial
institutions to adopt unnecessarily restrictive credit
policies.
Indeed, just the contrary may be true. If the
Federal government were to act to prevent default --
by guaranteeing New York City or MAC debt, for example
-- there is a serious risk that the capital and the
credit markets would react adversely. The expansion of
the Federal credit involved would have a measurable
impact on borrowing costs throughout the capital markets,
and would exacerbate the market access problems of
marginal issuers. And any attempt to compensate through
a relaxation of monetary policy would fuel expectations
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of future inflation, strengthening investor reluctance
to commit funds for the long term.
In recent weeks, many prominent figures, including
a number of leaders of the financial community, have
predicted that a default could place an intolerable
degree of strain upon our financial system, and
possibly upon the whole of our society. As I indicated
earlier, absolute certainty with regard to the possible
repercussions of a default is simply not possible.
Nonetheless, there would appear to be little objective
evidence to support such conclusions. Indeed, I am
deeply concerned about some of these statements because
I believe they increase the element of risk to our
financial system. Accordingly, as we work together
in seeking the best possible outcomes to this matter,
it is essential that all parties concerned excercise
restraint and sound judgment with due regard to the
importance of the issues at stake.
Until we meet on the 24th, my staff stands
ready to continue working with the Members and staff
of the Joint Economic Committee in exchanging factual
and other information.
Sincerely yours,
Belfor William E. Stmon
The Honorable
Hubert H. Humphrey
Chairman
Joint Economic Committee
Washington, D. C.
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or
THE
9-17
NYC
the THE DI
THE UNDER SECRETARY OF THE TREASURY
WASHINGTON, D.C. 20220
1789
MEMORANDUM FOR THE HONORABLE L. WILLIAM SEIDMAN
Assistant to the President for
Economic Affairs
FROM:
Edwin H. Yeo III
Under Secretary for Monetary Affairs
SUBJECT:
Response to Humphrey letter regarding impact
of default by New York City
As we discussed, I am attaching the most recent
draft of the above response. I would appreciate your
views on the draft, as well as your views on the
question whether we should attempt to avoid sending
any response at this time, instead reserving our
comments until Bill testifies on the 24th.
Attachment
GREATS FORD TERART
THE SECRETARY OF THE TREASURY
WASHINGTON 20220
Dear Mr. Chairman:
I am writing in response to your letter of September 5,
1975, requesting an analysis of the potential impact of
an inability by New York City to meet its obligations as
they mature. It is clearly appropriate that we fully
evaluate the potential consequences of such an event and
the methods available for dealing with them.
Any financial reversal has two aspects: a tangible
and objective aspect on the one hand and a psychological
aspect on the other. It would be inadequate to limit the
analysis to only one of these aspects. And confusing the
two would further cloud our evaluation of the impact of
default. Indeed, I sense that such confusion is in large
part responsible for some of the more extreme predictions
which have dominated this dialogue in recent weeks.
There are three relevant terms and concepts. There
is "insolvency" which, simply stated, means that a person
or a city has current obligations which exceed its avail-
able funds. "Default" is a technical legal term describing
a debtor's refusal or inability to pay a creditor who has
demanded payment. "Bankruptcy" simply describes a legal
proceeding - - provided for in the Constitution -- under
which an insolvent person in default turns over to a court
the job of deciding how his financial resources will be
apportioned among creditors.
At this point, it is important to draw a distinction
between the options available in the event of a corporate
default and those available with respect to a municipal
default. If a corporation defaults and is subsequently
brought under the jurisdiction of a Federal bankruptcy
court, one option - - albeit often not the most desirable
one is liquidation: the sale of assets to satisfy
the claims of creditors and the subsequent disappearance
of the corporation as a continuing entity. Both common
sense and Constitutional principles preclude such an
option with respect to municipal defaults.
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In this respect, a default by a state or local govern-
ment is closely analogous to a default by an individual
person. In either case, if a bankruptcy proceeding ensures,
resources essential to the maintenance of life in the one
case and essential services in the other, are protected
from the demands of creditors. It is important to re-emphasize
this point: if New York City defaulted, it would continue to
exist and to operate. The City will not, as recently implied
by statements from heretofore responsible quarters, fall
into a chasm which will magically open along Park Avenue,
or be drawn into a massive whirlpool in New York harbor.
In short, it is essential not to confuse the legal
and idiomatic meanings of the term bankruptcy. In common
parlance, we may use bankruptcy to define a condition devoid
of substance or resources. By that definition, New York
has not been and is not now bankrupt. And a default in
the future will not change this. If it does default,
however, and wishes to deal with its creditors in an orderly
way, a proceeding under the Federal bankruptcy laws may be
the most appropriate solution.
If the City defaulted on an obligation to redeem
maturing debt for cash, one immediate question is whether
the City could continue to provide essential services:
police and fire protection, sanitation, mass transit. water
and
prodiction
in
this
regard
is
dependent upon the willingness of the City's employees to
act in the public interest. If such is the case, it is my
view that such services will continue to be available
after a default.
There may be creditors of the City who, in an attempt
to perfect their claims, will seek judicial assistance in
preventing the payment of public employee salaries. This
risk only underscores further the importance of providing a
mechanism under which the claims of all legitimate creditors
can be dealt with in a single proceeding. Accordingly, we
have developed amendments designed to cure the inadequacies
of existing Chapter 9 of the Federal Bankruptcy Act, and
we expect shortly to submit them to Congress for prompt,
and hopefully favorable, consideration.
But it is nevertheless fair to ask what the impact
would be if the City were unable -- for whatever reason - -
to provide such services in the event of default. As
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prudence dictates, the Office of Management and Budget
and the Domestic Council have looked closely at this
question. Based upon that evaluation, we have concluded
that State and Federal resources are adequate to insure
that all assistance programs will continue to operate and
that essential services will be provided.
I do want to reiterate that we have absolutely no
reason to believe that these plans will ever need to be
implemented. But we would not have fulfilled our responsi-
bilities to the people of New York and the nation at large
had we not been prepared for all eventualities.
Financial Impact
Let me now address the most important part of your
inquiry: the impact of a default on our financial system.
As I have said many times, we are dealing entirely in the
realm of judgments; absolute certainty is simply not
possible. My own judgment is based upon an analysis of the
factual circumstances and upon my own professional experience
of more than twenty years in the investment banking business.
I have great faith in the resilience of our financial markets
and, subject to the willingness of most market professionals
to view the situation objectively. I believe these markets
handling
=
default
with
nc
Chan
medicall,
and relatively short-lived, disruption.
These views are based in part on the following considera-
tions. First, there is evidence that the markets - - and
particularly the municipal market - - have to some degree
already discounted the possibility of a New York City default.
I view such discounting as an indication of the markets'
ability to attempt to cope in advance with an unknown
event. At the same time I recognize that other professionals
would draw the opposite conclusion, finding in such market
behavior the seeds of more serious disruptions if default
were to occur. Second, there is no reason to believe that
either market participants or the public at large will
misunderstand the causes of a potential New York City
default. Given the widespread publicity of New York's
problems and the causes thereof, I believe there is little
risk that such a default would be viewed as indicative of
a pervasive economic malaise. Moreover, any default which
might occur could possibly be confined to a limited number
of New York City note maturities. The City probably has
GERALE TORO LEVERY
- 4 -
adequate financial resources to meet its debt service
obligations on its first lien bonds. Finally, any
default should be followed by prompt efforts - - probably
under the supervision of a Federal judge -- to restructure
the short term debt, insuring that holders of defaulted
obligations receive full value in the shortest possible
time.
We reach similar conclusions regarding the potential
impact on our banking system. As the Committee is aware,
we, in conjunction with the Comprtroller of the Currency,
the Federal Reserve Board and the FDIC, have taken a close
look at the holdings of New York City securities in our
banking system. We have found that no major bank would be
threatened in the event of a New York City default.
Moreover, less than 50 of the 14,000 banks in this country
own New York City securities in amounts which would
threaten solvency in the event of a default and a
subsequent writedown of these securities.
With respect to these few banks, all of which have
been identified by the regulatory agencies and are being
closely watched, various mechanisms are available to
insure that none will fail:
1. Where possible, bank directors will be required
to contribute additional capital.
2. Certain banks may be sold to, or merged with,
other banks or bank holding companies.
3. As a last resort, the FDIC may provide capital in
the form of convertible subordinated debt, at the
same time imposing appropriate sanctions on the
bank officials directly and indirectly responsi-
ble for the bank's exposure.
Conclusions with respect to the impact on other tax-
exempt credits, particularly those in New York State, are
somewhat more complex. A variety of factors -- e.g., the
unsettled condition of the market, structural inadequacies
in the market, inflation and the anticipation of future
inflation - - have all combined to cause a notable shift in
the quality and liquidity preferences of tax-exempt
investors in the past twelve months. All credits are
being increasingly scrutinized for evidence of underlying
quality. It would be reasonable to expect this phenomenom
LIBRARY
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to accelerate in the event of default by a major, widely-held,
issuer. But any governmental unit which conducts its
financial affairs in a prudent manner should have access to
the markets, such scrutiny notwithstanding.
We have taken a particularly careful look at the credits
within New York State to determine whether any credit
would be unable to withstand an increased level of scrutiny.
With respect to the great majority of credits - - including
that of the State itself -- we believe there is little risk
that a default by New York City would directly precipitate
other defaults, given appropriate public policies. We are
concerned that certain programs of the New York State
Housing Finance Agency may have inadequate revenue sources
and may be forced to rely on the State's moral obligation
pledge to meet its obligations. At the same time, it is
important to note that the difficulties of New York City
did not cause the problems which the housing agency faces;
the difficulties merely served as a catalyst in inducing
investors to review the fundamentals of all tax-exempt
credits. Similarly, a solution to New York City's
problems -- from whatever source - - is unlikely to result
in return to an attitude of laxity with respect to investor
evaluation of tax-exempt credits.
Our objective conclusions notwithstanding, there is
an element of risk which warrants mention. As efficient
as our financial system may be, it is vulnerable on one
front: prophecies of doom, however unsound, occasionally
turn out to be self-fulfilling. And when such prophecies
come from within the system itself, the risk is even
greater.
In recent weeks, many prominent figures, including a
number of leaders of the financial community, have
predicted that a default could place an intolerable degree
of strain on our financial system, indeed our society.
While, as I indicated earlier, absolute certainty is
simply not possible when predicting the unknown, there
would appear to be little support for such conclusions in
the facts as we understand them. I am deeply concerned
about these statements because I believe they introduce
an element of risk to our financial system which would not
otherwise be present. As we inquire further into the
GERALD
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potential impact of a New York City default, it is essential
that all parties concerned be sensitive to the possibility
that the evaluation process, if abused as it recently has
been, may itself be responsible for precipitating serious
adverse consequences.
Mr. Chairman, in this letter I have attempted to set
forth Treasury's objective conclusions concerning the potential
impact of a default by New York City. Based on those con-
clusions, we cannot agree that Federal financial assistance - -
given the burdens it would impose on the capital markets
and the economy and the unwise and constitutionally suspect
reordering of Federal, state and local relationships which
would result -- is warranted in these circumstances. At the
same time, I must re-emphasize that if men who are perceived
to be experts in this field continue to predict a national
disaster with little, if any, support in the facts, a
default could have national consequences, objective considera-
tions notwithstanding.
I look forward to exploring these matters with you in
greater detail on the 24th.
Sincerely yours,
William E. Simon
The Honorable
Hubert H. Humphrey
Chairman
Joint Economic Committee
Washington, D.C.
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HUBERT H. HUMPHREY, MINN., CHAIRMAN
WRIGHT PATMAN. TEX., VICE CHAIRMAN
JOH'S SPAREMAN, ALA.
RICHARD BOLLING. MO.
WILLIAM PROXMIRE. WIS.
HENRY S. RCUSS, WIS.
NEWMAN RIBICOFF, CONN.
WILLIAM S. MOORHEAD, PA.
LLOYD M. BENTSEN. JR., TEX.
LEE H. HAMILTON, IND.
EDWARD M. KENNEDY, MASS.
GILLIS W. LONG, LA.
JACOB K. JAVITS. N.Y.
Congress of the United States
CLARENCE J. BROWN. OHIO
CHARLES H. PERCY, ILL.
GARRY BROWN, MICH.
ROBERT TAFT. JR., OHIO
MARGARET M. HECKLER, MASS.
PAUL J. FANNIN, ARIZ.
JOINT ECONOMIC COMMITTEE
JOHN H. ROUSSELOT, CALIF.
(CREATED PURSUANT TO SEC. 5(a) OF PUBLIC LAW 304, 79TH CONGRESS)
JOHN R. STARK,
EXECUTIVE DIRECTOR
WASHINGTON, D.C. 20510
September 5, 1975
The Honorable William E. Simon
1836
Secretary
Department of the Treasury
Washington, D.C. 20220
Dear Mr. Secretary:
As Chairman of the Joint Economic Committee I have become
increasingly concerned that New York City's deepening
financial crisis will have profound adverse implications
for other major cities and quite possibly for other major
sectors of our economy. However, I have seen no significant
and thorough analysis assessing the full economic impact
of a default either to allay my suspicions or to confirm
my fears.
In response to this gap in information, I have asked the
staff of the Trint Economic Committee to examine in greater
detail the economic implications OI a default by New YORK
City and also to review the efficacy of various proposals to
lessen the adverse economic impact. As part of this effort
the Committee and its staff will discuss these important
issues with experts around the country.
In order to provide the Congress with an accurate and
complete description of this problem, it is essential
that the Committee receive the Administration's assessment
of the economic impact of a New York City default and any
analysis of this situation that has been prepared by the
Department of Treasury staff. Specifically we would like
you to assess, in as analytical terms as possible - the
impact of a full or "partial" default on the market for
tax exempt securities issued by other municipalities,
particularly large cities; the impact of a full or partial
default on the market for tax exempt securities issued by
states, particularly New York State; the impact of a full
or partial default on bank liquidity and the financial
stability of the banking system; the impact of a full or
partial default on the strength of economic recovery,
focussing particularly on the economic impact of declines
in investor confidence and on caution by lending in-
stitutions; and the impact of a full or DO tial default
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The Honorable William E. Simon
Page Two
September 5, 1975
on other money markets, particularly the corporate bond
market, and on the stock market.
It would also be helpful if you could supply the Committee
with any contingency plans that the Administration is
prepared to undertake to either ameliorate the possibility
of default or to minimize the economic impact of default.
If specific actions have been rejected, either to prevent
default or to minimize its impact, it would be helpful if
you could provide an explanation for the rejection.
Since the financial situation of New York City is becoming
more serious by the day, the Committee would appreciate as
prompt a response as is possible. I hope that you will be
able to provide us with your assessment of this situation
by Friday September 12.
1 greatly appreciate your efforts in responding to the
Committee's request.
Sincerely,
Hubert H. Humphrey
Chairman
Joint Economic Committee
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