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New York City, November 1975 - July 1976 (8)
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New York City, November 1975 - July 1976 (8)
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William Seidman's Economic Policy Board Subject Files
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The original documents are located in Box 79, folder "New York City, November 1975
- July 1976 (8)" 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States of America his copyrights in all of his unpublished writings in National Archives collections.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.
MEMORANDUM
NYC
SUBJECT: Structure of the Municipal Market
The municipal bond market is unique. Not only must it
supply credit to State and local government, but it must do
so at rates sufficiently attractive (vis-a-vis the terms
available to other borrowers) to provide a subsidy (in the form
of lower borrowing costs) to municipal borrowers. Accordingly,
when it is said that conditions in the municipal market are poor,
or are deteriorating, what is meant is that borrowing costs are
not sufficiently different from those in the taxable market.
Like all markets, rates in the municipal market are
sensitive to laws of supply and demand. But in the municipal
market, the supply of available credit (or, conversely, the
demand for municipal bonds) is determined not only by the
overall availability of credit, but also by the need for tax-
exemption or tax shelter.
A tax-free entity -- a pension fund or foundation, for
example -- will demand no less yield on a municipal tax-exempt
bond than on a fully taxable bond of comparable quality. But at
the other end of the spectrum, an investor subject to a
70 percent effective tax rate could receive 70 percent less yield
from a tax-exempt security and still break even. Accordingly, there
is a direct relationship between the level of Federal taxation
FORD & LIBRARY GERALD
Digitized from Box 79 of the L. William Seidman Files at the Gerald R. Ford Presidential Library
- 2 -
and the supply of credit to the municipal market.
The municipal market is populated primarily by investors
who rely on return from financial assets as an important
source of income. * To the extent those investors are
subject to a lower rate of taxation (for whatever reason)
the premium they are willing to pay for tax-exempt securities
(and thus the subsidy provided the borrower) is commensurately
reduced.
Supply of Tax-Exempt Credit
In recent years, the major institutional purchasers of
tax-exempts -- commercial banks and fire and casualty insurance
companies -- have moderated their involvement in the municipal
market. With respect to insurance companies, the explanation
is quite straightforward: underwriting losses have increased
dramatically relative to premium income, thus "sheltering" a
much larger portion of total income from Federal tax.
A more complex set of factors has been at work with
respect to the need for tax-exempt income at commercial banks:
1. Offshore operations have accounted for an increasingly
large share of income (more than 50% in the case of
Citibank and Morgan Guaranty, for example.) Taxes
paid to foreign governments on income derived from
FORD is LIBRARY GERALD
such operations may be credited against U.S. tax
liability, thus reducing the effective U.S. rate
and the consequent need for shelter.
* As such, investors can be distinguished from industrial corporation
which look primarily to capital assets, rather than financial
assets as the primary income source.
3
2. Most major U.S. banks have expanded into related
financial areas such as leasing. Such activities
provide substantial tax shelter.
3. As a consequence of general business conditions
and aggressive lending policies, loan charge-offs
have increased substantially, thus reducing taxable
income. For example, aggregate net charge-offs by the
New York Clearing House member banks grew from $42.7
million in 1969 to $419.1 million in 1974.
4. Concern with image and public relations has led
many banks to adjust their holdings to insure a
"respectable" level of taxable income and of tax
payments. Historically, many banks -- especially
smaller ones -- paid no Federal tax at all, primarily
as a result of tax-exempt income. In recent years,
more banks have decided that "a reasonable" level
of tax payments is desirable.
After commercial banks, households (i.e., individual
investors) have traditionally been the largest owners of
tax exempts. Although precise data is not available, dealers
report that the shocks of the past year (repeal of
the Port Authority Covenant, UDC, New York City) have cut
sharply into individual interest in tax-exempts.
Demand for Tax-Exempt Credit
At the same time factors have been at work to moderate
the supply of credit available to the municipal market, demand
FORD
- 4 -
for such credit has grown dramatically. In the last decade,
tax-exempt debt outstanding rose from $100 billion to $207
billion. In 1974 alone, $22.8 billion in bonds and an
additional $29 billion of short term notes came to market.
Much of this debt was issued for traditional public
purposes -- e.g. schools, water and sewer facilities, hospitals,
etc. But $2.2 billion, nearly ten percent of the total bond
volume, was used to fund pollution control facilities of
private corporations. The financial benefits of the tax-exempt
subsidy accrued not to the taxpayers, but to corporate share-
holders. And an additional $340 million of publicly issued
tax-exempt debt was in the form of industrial development bonds,
used to finance everything from warehouses to fast food outlets.
In addition to this $2.5+ billion annual volume of
publicly marketed tax-exempt debt for private purposes, it
has been estimated that at least another $4 billion (and perhaps
as much as $7 billion) per year is placed privately, normally
in the form of direct bank loans. In short, as much as 25%
of the annual demand for tax-exempt credit may be for non-public
purposes.
Impact of Inflation
To this point, we have identified the following sources
of disturbance: stagnant supply of tax-exempt credit caused by
(1) less institutional need for tax-exempt income, and (2) uncertaint
as to the soundness of tax-exempt credits; sharply increased
GERALD FORD LIBRARY
DE 5 -
demand for tax-exempt credit, in large part attributable to
the use of such credit for non-public purposes. To complete
the survey, we must look at the impact of inflation on both
the supply and demand sides.
Inflation's impact on the supply side is quite complex.
On the one hand, since inflation causes an increase in
taxable income while real income remains constant, it can be
said to increase the need for tax shelter. More importantly,
however, inflation reduces the amount of funds available for
investment and increases the price of what is available:
-- Under our progressive tax system, inflation drives
taxpayers into higher brackets without increasing
real wealth; a greater proportion of after tax income
must be spent rather than saved to maintain a level
standard of living.
-- Inflation and its now inevitable handmaiden -- the
expectation of future inflation -- makes savers less
willing to invest funds for extended periods and causes
them to demand higher returns for what is invested.
On the demand side, inflation drives up the component and
overall costs of the projects which must be financed. The result
is a greater demand for tax-exempt credit without an increase
in the benefits provided.
Overall Market Impact
All of these phenomena have contributed in varying degrees
to the current condition of the market. As of September 1,
GERALD
- 6 -
the Bond Buyer 20-bond index stood at 7.18%, within a few
basis points of its historical high. Although it is difficult
to calculate with precision the level of subsidy such rates
provide, it is clear that the subsidy is well below the 35 - 40%
traditionally thought to be provided by the tax-exemption.
Potential Additional Complications
Two additional difficulties exist on the horizon. First
is tax reform. Should corporate tax reform result in an overall
lowering of the tax burden for financial corporations, the contri-
bution of this sector will be further eroded. In addition,
modifications of the minimum tax rules could lessen individual
investor commitments to the market.
Of more immediate concern is securities regulation. The
1975 Securities Act Amendments brought municipal dealers under
Federal regulation for the first time. While such a move was
long overdue and sound as a matter of policy, it will impose
new costs on the market, costs which must ultimately be borne
by the issuers.
Moreover, the New York City situation has focused attention
on the need for better information about individual municipal
credits. While the new 1975 law expressly forbids the United
States Government from requiring issuers to disclose anything,
it equally expressly authorizes imposing such a disclosure burden
on underwriters and dealers. In addition, a recent lawsuit raises
the question whether an underwriter or dealer can be held
GERALD
LIBRARY
- 7 -
liable under the anti-fraud provisions of the securities law
(e.g. Rule 10b-5) for failure to inquire behind the
Official Statement into the issuers true financial condition.
Clearly, more (and more accurate) disclosure is a
desirable -- indeed necessary -- objective. But if corporate
disclosure rules are superimposed overnight on the municipal
market (as could occur as a consequence of the above-mentioned
lawsuit) no prudent firm would be willing to deal in either the
new issue or secondary market. It would take at least 6 months
to a year for most tax-exempt issuers to bring their financial
information up to corporate market standards.
Potential Financial Policy Options for the U.S. Government
A. Reduction in Demand for Tax-Exempt Credits
1. Eliminate tax-exemption for pollution ontrol,
industrial development financing.
2. Finance Urban Renewal Projects (guaranteed by
HUD) through the Federal Financing Bank.
B. Increase in Supply of Credit
1. Establish Federal Municipal Bond Bank to purchase
state and local debt.
2. Direct Federal financing of state and local
capital projects.
3. Measures to increase effective tax rate of financial
institutions.
4. Exempt municipal bond income from minimum tax
provisions.
GERALD
LIBRARY
- 8 -
C. Provide Direct Subsidy
1.
Provide 33 1/3% interest subsidy on taxable
debt issued by state and local government.
CHECK DD VIBRARY
I. What bankruptcy bill in present form will achieve.
1. Prevent all city funds from being tied up by set-
offs and lawsuits.
2. Enable orderly plan to be developed for partial pay-
ment of creditors over long term.
3. Enable some new borrowing, secured on priority basis
by future tax revenues.
II. What bankruptcy bill in present form will not achieve.
1. Enable non-disruption of all city services.
New borrowing will not be sufficient to cover all
current expenses, since future tax revenues at current
level of spending will not do SO. If non-disruption of
all city services is desired, financial assistance will
be necessary.
2. Assure sound management of city's finances.
Under the proposed bankruptcy law, city management
will not (and cannot constitutionally) be placed in a
Federal trustee, but will remain with elected officials.
Bankruptcy court can exercise minimal control over city
management by jawboning and by refusing to permit priority
borrowing except for certain purposes. But basic manage-
ment of city finances will remain in same old crowd.
There will be no additional incentive to establish sound
fiscal basis so long as bankruptcy proceeding continues
and enough financial assistance to meet current needs is
received.
If assured reform of city finances is desired, one
of the following methods must be considered:
A. As condition of commencement of bankruptcy pro-
ceeding, require filing of a good faith plan which will
not only provide for partial payment of creditors but will
also establish fiscal affairs of the city on a fiscally
sound basis within a reasonable period of time implementa-
tion of the latter to be commenced as soon as petition is
filed, and petition to be dismissed if compliance is not
continued.
Advantages
1. Eliminates need of Federal Government drawing
up or approving plans for fiscal retrenchment beforehand--
decisions will have to be made by city and approved by
district judge.
2. Provides automatic sanction for failure to live
up to plan, without substantial possibility of political
interference.
Disadvantages
1. Cannot be certain what the judge will consider
a sound fiscal plan.
-2-
LIBRARY
2. Sanction for failure to comply with plan is
massive namely, dismissal of bankruptcy suit enabling all
creditors to set off their claims or seek other judicial
remedies at once.
B. Condition the granting of any Federal aid upon
immediate establishment and implementation of sound fiscal
plan.
Advantages
1. If properly structured, could enable continuous
Federal surveillance of implementation of reforms.
2. Enables measured response- withholding of greater
or lesser amounts of funds.
Disadvantages
1. Does not remove the matter from the political
arena President is blamed for cutting off funds and caus-
ing 5,000 policemen and brain surgeons to be fired.
2. May not be a credible sanction, since political
resistance to cut-off would be substantial.
C. Do not condition Federal assistance at all, but
make it very clear that it is a one-shot subsidy not to
be repeated. City would then presumably be forced to set
its house in order.
Advantages
1. Removes Federal Government from political decisions
concerning what city services must be cut back.
-3- -
LIBRARY
2. Is the solution least destructive of the prin-
ciples of federalism.
Disadvantages
1. The Federal warning that "this is the last time"
may not be credible and the city may simply place itself
in the position of having to be rescued again.
2. May be difficult to obtain legislation from the
Congress without strings.
LIBRARY
-4- -
Tab B
It is proposed that the New York State legislature pass
any of the following tax packages and direct that the revenues
are to be applied to finance special new MAC notes to be issued
on December 1, and thereafter as required.
Net Cash Requirements
million dollars
1
N.Y. City
N.Y. State
Total
(incl. HFA)
Dec. 75 - June 76
$ 699
$1,811
$2,510
July 76 - June 77
390
50
440
July 77 - June 78
-434
-
-434
Total
$ 655
$1,860
$2,515
1
Includes deferral of all payments on principal of notes
and bonds and cancelling half of all scheduled interest
payments.
LIBRARY
Option 1
Cash Need $2,960 million
Option A:
10% Income Tax Surcharge (2 years)
$ 764
4 cent gas tax (3 years)
696
1 cent sales tax (3 years)
1,515
$ 2,975
Option B:
5% Surcharge (2 years)
$ 382
6 cent Gas Tax (3 years)
1,044
1 cent Sales Tax (3 years)
1,515
$ 2,941
Option C:
5% Surcharge (2 years)
382
4 cent Gas Tax (3 years)
696
2 cent Sales Tax first year,
1 cent 2nd and 3rd year
2,020
$ 3,098
Surplus of $597 million available for refunds year 3.
LIBRARY
Option 2
$250 Million Mitchell-Lama Purchase
Cash Need $2710 million
Option
A:
7% Surcharge 2 years
532
4 cent gas tax 3 years
696
1 cent sales tax 3 years
1515
2743
Option
B:
4% Surcharge 2 years
304
5 cent gas tax 3 years
870
1 cent sales tax 3 years
1515
2689
Option C: 9% Surcharge 2 years
684
6 cent gas tax 3 years
1044
1 cent sales tax 2 years
1010
2738
LIBRARY
Option 3
$250 million M-L Purchase
$200 million GNMA Purchase HFA Mortgages
$250 million Guarantee HFA Bonds
Cash Need 2490
Option A:
8% Surcharge (2 yrs)
$608
5 cent gas (3yrs)
70
1 cent sales (2 yrs)
1010
$2488
Option B:
4% Surcharge (2 yrs. )
$304
4 cent gas (3 yrs.)
696
1 cent sales (3 yrs. )
1515
$2515
Option C:
9% Surcharge (3 yrs. )
$1026
4 cents gas (2 yrs. )
464
1 cent sales (2 yrs.)
1010
$2500
Option D:
9% Surcharge (3 yrs. )
$1026
1 cent sales (3 yrs. )
1515
$2531
LIGRARY
Option 4
No default
Cash Needs $5,813 million
11% Surcharge (3 years)
$ 1,254
6 cent Gas (3 years)
1,044
3% Sales (1st year)
1,515
2% Sales (2nd and 3rd years)
2,020
$ 5,833
LIBRARY
MEETING ON NEW YORK CITY AND NEW YORK STATE
FINANCIAL SITUATIONS
Unless some form of outside financial assistance is forth-
coming, it is the consensus of your advisers that New York
City will go into default, most likely during the first
two weeks of December. The only possible way New York
City could avoid default would require Federal assistance
or substantially increased taxation by the State of New
York or the use of the City and State pension funds.
1. Should the Administration propose actions to prevent
a New York City default?
A number of bills which would provide Federal financial
assistance in the form of direct loans or guarantees are
currently under consideration in both the House and Senate.
Option A: Recommend measures to prevent default without
the use of Federal funds. Such measures would
include an increase in the State sales tax, an
income surtax, or the obligation of New York
State and/or New York City pension funds.
Option B:
Support congressional proposals to provide Fed-
eral loans and/or guarantees, with stringent
control provisions imposed by the Federal Gov-
ernment.
Option C:
Propose no measures which would prevent a New
York City default.
2. What actions are required in the event of a New York City
default?
A. Legal - Department of Justice proposed amendment to
the Federal Bankruptcy Act.
Ask Congress to enact an amendment to the Federal
Bankruptcy Act which would add a new chapter pro-
viding for the adjustment of the debts of major muni-
cipalities. (Tab A)
The proposed amendment would prevent, in the event of
a New York City default, all City funds from being
FORD is LIBRARY GERALD
tied up through litigation and require that an orderly
plan be developed for partial payment of creditors
and an operational plan for the City. However, under
Constitutional limitations, the operation of the City
and its operating expenditures must remain under the
QUESTION: Under your proposal, how would New York City
get the funds to meet essential services?
ANSWER:
According to New York City's figures, the City's
cash needs for operations and capital projects
(not including any payments of principal and
interest on outstanding debt) will exceed
revenues by approximately $700 million during the
period December 1, 1975 - June 30, 1976. There
are at least three ways this gap could be made
up.
First, New York State could impose a tempo-
rary and emergency tax -- perhaps a package
involving the income, gasoline and sales taxes --
to generate the necessary cash.
Second, the assets of the pension funds
could be used to collateralize borrowing by
MAC or the City. State and City pensions hold
well in excess of $10 billion of unencumbered
assets which would be used for this purpose.
Third, in the context of an orderly debt
restructuring proceeding, the court could
authorize the City to issue certificates of
indebtedness, to be payable, on a prior claim
basis, out of revenues in years after the budget
balancing process is complete.
BACK-
GROUND:
There are really two problems: the net cash
flow shortfall referred to in the answer and
the so-called seasonal problem. The remaining
seven months of the fiscal year can be broken
down into two periods: December-March in which
the City runs a $1.3 billion cash deficit (net
of debt service) and April-June in which it
runs a $600 million surplus. On a direct
revenue anticipation basis, the City should be
able to borrow $600 million during December-
March, but it needs one of the mechanisms
described in the answer to borrow the remainder.
Heald Gerald L. Parsky
Assistant Secretary of
Treasury
NEW YORK CITY CASH FLOW NEEDS
(dollars in millions)
Fiscal Year
Fiscal Year
1976-1977
1977-1978
July
1218
1079
August
480
410
September
(148)
(138)
October
505
94
November
146
70
December
566
392
January
116
56
February
72
(14)
March
270
387
April
(475)
(587)
May
(308)
(335)
June
(823)
(907)
Total
1619 ¹/
5072/
1/ Excludes $164 million financed from debt service payments
to pension funds.
2/ Excludes $274 million financed from debt service payments
to pension funds.
LIBRARY STRUED
Insert before existing language of section 811 (a) and add
at. the end thereof the following subsection (b) :
(b) (1) Upon application of petitioner the Secretary
of the Treasury may guarantee, in whole or in part, payments
of principal, of interest, or both on certificates of
indebtedness issued pursuant to this section for the purpose
of providing funds for the maintenance of essential services.
(2) The provision of such guarantees shall be on such
terms and conditions as may be established by the Secretary
of the Treasury in his sole discretion.
(3) Any decision, rule or other determination by the
Secretary of the Treasury pursuant to the authority conferred
under this section shall not be subject to judicial review by
any means.
(4) The aggregate amount of guarantees outstanding at
any time under this section shall not exceed /$3,000,000,000/;
the aggregate amount of guarantees outstanding with respect
to any petitioner and any affiliate of such petitioner shall
not exceed /$1,500,000,000/."