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Podcast

The Year NYC Went Broke

Planet Money

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  • Short-Term IOUs Masked Long-Term Risk
    • New York used short-term IOUs to move future tax revenue into the present to pay recurring expenses.
    • That practice hid cash shortfalls and created repeating rollover risk that eventually collapsed trust. Transcript: Nick Fountain And this marvel of social coordination, like so many things in our world, is made possible by money. Yeah, my family pays city income tax and property tax and sales tax. Keith Romer And because my wife is self-employed, something called the Metropolitan Commuter Transportation Mobility Tax. Nick Fountain And all of those taxes pay for the sanitation workers and the teachers and the firefighters. Those city employees mostly get paid every two weeks. But the taxes and the big chunks of money that come from the state of New York or the federal government, those come on a completely different timeline. Income taxes are due in April. A lot of property taxes are due in July and January. Keith Romer Lots of cities like Chicago, L.A., Houston, Philadelphia, San Francisco, they deal with this with a little financial magic trick. They move money from the future, when the taxes come in, to the present, when they need to pay their workers. The cities pull off this trick by selling short-term debt. Nick Fountain Little IOUs that only last for a few months. Now, New York has generally had enough cash on hand that it hasn’t had to use this short-term debt trick for a while. (Time 0:01:39)
  • A Hippie’s Wake-Up Call To City Hall
    • Steve Clifford dug through city financial records and discovered years of accounting gimmicks that produced paper revenue but not cash.
    • He concluded the city had about $3 billion in debt created by these maneuvers and warned the controller it was effectively bankrupt. Transcript: Nick Fountain Books. Steve had worked on city finances before, and he did have an MBA from Harvard. But otherwise, he says, he was not your typical city hall employee. Steve Clifford I was late to start as a hippie, but I had long hair and I wore jeans and tashiki and whatnot. Had a loft in Soho. I was taking lots of dope. Keith Romer Money was tight for the city back then. So Steve says New York made extensive use of that financial magic trick we mentioned earlier, where it took the money it was going to get in the future and transported it to the present. Yeah, the city would sell IOUs for lots of things. Nick Fountain For the real estate taxes it expected to receive, for the state and federal aid it was counting on later in the year. And banks were plenty happy to buy up all of these IOUs. Keith Romer They paid a pretty good interest rate. Lots of individual investors, big insurance companies, other banks were happy to take those IOUs off the bank’s hands. And rating agencies said New York City debt was pretty safe. Steve Clifford You could look at Park Avenue and you can say, these guys can’t go broke. I mean, you want to talk about, you know, real property? I mean, these things are worth billions. The city can’t go broke. Keith Romer Now, Steve’s small part in this whole drama had to do with what he found when he poked around in the city’s books. How would you describe the financial record keeping of New York City? Steve Clifford Well, there was no record keeping. I mean, there was a balance sheet. There was an income statement. And, you know, there were the computers whirring in the background. And, you know, what was going on was the Wizard of Oz. Keith Romer See, Steve had gotten his hands on all this different information about all the different funds and accounts and sub-budgets that had anything to do with the city’s finances. Steve Clifford And I started to, you know, just almost for the fun of it, started adding these things up. And what he discovered was a very, very big problem. What had happened was for the, at least for 10 years, there was a totally uncoordinated charade of different people devising different gimmicks that produced accounting revenue, But didn’t produce cash. Nick Fountain Steve says for about a decade, New York City made moves that appeared to balance the city’s budget, but very much did not. Steve Clifford The city would, in various places, just delay an expense, like a payment for the pension funds. It’s supposed to be paid in June 30th, but we’ll pay it in July, and then it’ll go into the next year’s budget. Give us more for this year. Nick Fountain Or the city would pretend that its estimate at the beginning of the year for how much tax it would take in was the final number that went on its balance sheet, regardless of how much money It actually took in. And in a narrow sense, all of this was legal, but these kinds of financial shenanigans didn’t exactly accord with generally accepted accounting principles. Keith Romer And if you squint just right, you can maybe even feel a kind of sympathy for the politicians who are doing this stuff. All of the things they were elected to do, to launch new government initiatives or provide the generous social services New York City was famous for back then, to help people, to make The world a better place, all of that takes money. Moving some things around on the balance sheet made it possible. Nick Fountain Also, it let them add jobs and raise wages and make nice with powerful unions whose votes they were going to need in that next election. Yes, also that. Keith Romer But once you stop squinting, what you see is that all of this budgetary sleight of hand, it was funded by debt, by those IOUs the city kept selling year after year. Steve Clifford Nobody understood the cumulant effect of all these things. Absolutely no one. Nick Fountain So Steve wrote up everything he found and took it to his boss, the city controller, Jay Golden. Steve Clifford I started explaining all these gimmicks to him and said, look, we got $3 billion in debt and no way to pay it because it’s all been created by these gimmicks. Now, Jay didn’t know what to make of me because I was still this hippie guy, you know, who wore jeans to work and sandals to work. And so I go in and tell him, look, the city’s bankrupt. I mean, you know, his reaction was, that can’t be, you know. Keith Romer Steve did manage to pretty quickly convince his boss that, yes, the city was, in fact, in a rough spot. But even if the city completely swore off the budget shenanigans that had created that $3 billion deficit, it still owed billions of dollars more because of the shenanigans it had already Nick Fountain Done. And in the meantime, for the city to avoid default and keep functioning, it had to keep borrowing. When it came time to pay off one of those IOUs, kind of their only move was to issue more IOUs. (Time 0:05:40)
  • The Day No One Bought The IOUs
    • At an auction in February 1975, zero banks bid on the city’s IOUs, signaling a sudden loss of market trust.
    • Without buyers, the city only had a month or two of cash left to keep services running. Transcript: Nick Fountain That morning, the city tried to hold an auction of IOUs, where syndicates of banks would come in and put their bids into a little tin box. But that day, there were precisely zero bids. Steve Clifford The announcement on behalf of the controller is that the offer, which we had expected to receive an announce at 2 o’clock this afternoon, is now expected at 4 o’clock. Well, does this mean that you have not been able to sell them so far today? Keith Romer We will have a further announcement at 4 o’clock. Yeah. Nick Fountain That day, nobody thought it was worth lending the city any more money. A couple weeks later, the city was able to sell some new short-term debt, but that was the end of the line. And without being able to roll over its debts, New York City only had enough cash on hand to get through a month or two. (Time 0:12:01)
  • MAC: A State-Backed Proxy To Restore Trust
    • The Municipal Assistance Corporation (MAC) was created so markets could lend to a state-backed proxy rather than the distrusted city.
    • MAC’s revenue pledge (first dibs on sales tax) and state backing were meant to restore investor confidence. Transcript: Keith Romer It was created as a way for New York City to get its hands on the money it needed without anyone having to lend directly to the city itself. Like, look, we get it. Nick Fountain You don’t trust the city government to pay you back. So forget about the city government. Lend Mac the money instead and let them worry about the city. Keith Romer And Mac did have a couple of things going for it. It got first dibs on sales tax collected in the city. So it definitely had money coming in. And it was backed not by the credibility of New York City, but by the credibility of New York State. Donna Shalala It was originally set up to issue bonds to stretch out the debt of New York City to give them some time to get their house in order. I think that’s the simplest way to explain it. Nick Fountain Donna was 34 years old and the only woman on the Mac board. The rest of the board was made up of the heads of big companies, a senior partner at a powerful law firm, and this famously charming investment banker named Felix Rowden. Donna Shalala He had an instinct, not for politics, but how to pull people together to get decisions. I think I was a pain in his butt initially, but he coached me along and we became very good friends. And I learned a lot from him about leadership. Keith Romer Rohitin was really good in front of TV cameras. He had this great overbite smile, these two big bushy eyebrows, and he was just so fundamentally calm. It was almost like he was wryly amused by everything that was happening. Steve Clifford I really never knew how really fraudulent the accounting was. I mean, they did things with numbers here that they’re just absolutely unbelievable. They would estimate revenues, you know, going ahead one century and estimate their expenses as of yesterday. Nick Fountain But this is kind of a way of life. Rohden was known as a dealmaker, but his main thing was mergers and acquisitions, not getting people to buy New York City’s debt. He (Time 0:15:20)
  • Selling Bonds On A Skeptical Roadshow
    • Donna Shalala and Felix Rohatyn flew across the country trying to persuade bankers to buy MAC bonds, facing skepticism and sexism along the way.
    • They struggled to sell bonds because investors distrusted the city’s governance and finances. Transcript: Donna Shalala We had to peddle the bonds, the MAC bonds, all over the country. And so we all got on airplanes. Keith Romer You personally, you were like flying around the country? With David Rockefeller. As in one of the Rockefellers. At the time, David Rockefeller was the head of Chase Manhattan Bank. Donna Shalala We landed in Dallas, private plane, went to the Dallas Athletic Club to meet with the bankers, the great Texas bankers. And when we pulled up, one of his staff members came and said, Donna can’t go in the front door because they don’t allow women in the front door. And he said, so we’ll take her around and she can go in the back door and meet with you. And David Rockefeller turned to me and he said, Donna, he said, I’ve never gone in a back door in my life. He said, follow me. And he walked me right through the front door of the Dallas Athletic Club. Keith Romer Were you able to convince any Dallas bankers to purchase Mac? Donna Shalala No, someone stood up and said, why should we invest in a place in which the mayor doesn’t know how many employees he has? David Rockefeller couldn’t answer that question. So I don’t think we sold many bonds that day. And (Time 0:18:05)
  • Garbage In The Streets
    • Budget cuts led to massive labor unrest, including a sanitation workers’ strike that left garbage piling up.
    • Streets filled with trash and fires, making the crisis visible and urgent to all New Yorkers. Transcript: Keith Romer Mayor Beam announced a series of spending cuts. The city would pull back on social services and eliminate jobs. The very large and very powerful city workers unions were understandably not real happy with the mayor’s plans. Speaker 5 The sounds of people striking and protesting layoffs. In New York, a large group of laid-off policemen and their supporters gathered in protest near City Hall. Nick Fountain At airports and hotels, members of the police union handed out brochures to tourists titled, Welcome to Fear City. The brochures warned how dangerous the city would be when police were laid off and offered tips for how to survive a visit. Don’t take the subway. Stay off the streets after 6 p.m. Do not walk anywhere. Keith Romer In early July, in 90 degree heat, sanitation workers staged an unofficial but very comprehensive strike. No garbage has been picked up in the city since the weekend. Steve Clifford The refuse piles up at the rate of 28,000 tons a day. A woman from Manhattan thought the layoffs could have been avoided. I think it’s a terrible, terrible thing. I think Beam and all his other people should take $2,000 off their salary. How do you feel about having 5,000 less cops on the street and 28,000 tons of garbage on the sidewalk? Terrible. I’m frightened stiff. I was afraid to ride the trains before I walked the streets. You could be sure I’d locked in the house. Keith Romer For Donna, the sanitation workers’ strike was sort of the worst thing that could have happened. Donna Shalala It was a disaster. Right in the middle of what we were trying to do. We had garbage all over the streets. (Time 0:19:30)
  • Shared Pain As A Stabilizing Strategy
    • Felix Rohatyn brokered a ‘shared pain’ grand bargain where unions, property owners, and others provided upfront cash or bought bonds.
    • The deal combined civic self-interest with public-spirited arguments to mobilize resources quickly. Transcript: Donna Shalala It was his effort to get the unions and the real estate industry and the businesses all to share the pain, as he would say it. And the only way he could do that was to make sure that they understood the implications of bankruptcy. Here are the advantages to you. And guess what the disadvantages are? Nick Fountain And slowly but surely, Rohiton helped broker these pretty astounding seemseeming deals. Like, some of the city’s biggest property owners agreed to pay hundreds of millions of dollars in real estate taxes months before those taxes were due. Keith Romer After months of haggling, the city employees’ unions signed up to take billions of dollars from their own pension funds and use that to purchase the bonds that Mac was having such a hard Donna Shalala Time selling on the open market. Everybody was concerned about their own jobs, whether they were in the private or public sector. Keith Romer It sounds almost like the commonality of purpose that comes in a war or something, where if this goes down, we’re all going down with it. Donna Shalala Well, that was exactly the feeling. Why would the real estate guys have paid their taxes in advance? Out of loyalty to New York City, yes. But at the deeper sense, they and Felix understood that this great city, on its knees, that the country couldn’t survive without New York. Keith Romer I mean, there is also in that story, as I understand it, they also got a discount, right? Nick Fountain Absolutely. But we got the cash. And Donna says that same Big Apple mix of public spiritedness and naked self-interest kind of drove all of these deals. Donna Shalala Well, it’s transactional. It’s a New York transaction. (Time 0:26:01)
  • State Takes Fiscal Control To Force Discipline
    • The state traded back some fiscal control by creating an Emergency Financial Control Board to enforce real budgets.
    • This reduced ‘home rule’ but ensured disciplined budgeting and prevented future gimmicks. Transcript: Keith Romer The second part of the plan went like this. In exchange for funding a $2 billion aid package to the city, the state legislature forced the city’s elected officials to give up a lot of their power over their own budget. New York City politicians would no longer be able to just fund every exciting new initiative or genuinely important social service by fiddling with a balance sheet. Nick Fountain A presumably more responsible but less democratic entity was created to watch over the city budget, the Emergency Financial Control Board. The control board got the final say over basically every last financial move the city made and made sure that the city was making the deep cuts it had to to actually balance its budget. Donna Shalala The state essentially took away home rule from the city for the financial part of (Time 0:28:10)
  • Ford’s ‘Drop Dead’ And The Federal Turnaround
    • Despite President Ford’s initial refusal to bail out the city, political pressures and risks led the federal government to provide over $2 billion in short-term loans.
    • The federal involvement signaled that New York would not be allowed to fail and helped stabilize markets temporarily. Transcript: Nick Fountain Mayor Abe Beam traveled to Washington, D.C. To plead his city’s case. Donna Shalala What we want is the use of the federal government’s credit through guarantees on our securities until we are able to reenter the credit markets on our own. Nick Fountain In other words, Beam was asking the federal government to bail out New York City. But the president, Gerald Ford, was not having it. Steve Clifford Responsibility for New York City’s financial problems is being left on the front doorstep of the federal government, unwanted and abandoned by its real parents. Keith Romer In a speech at the National Press Club, Ford made all the usual arguments you hear made against any bailout. Why should taxpayers make investors whole on a bad bet they made? What kind of example would bailing out New York give to other cities who might be tempted to cut corners with their budgets? Steve Clifford I am prepared to veto any bill that has as its purpose a federal bailout of New York City to prevent a default. Nick Fountain I am fundamentally opposed to this so-called solution. The next day, the New York Daily News busted out a headline for the ages. Ford to city. Keith Romer Drop dead. Do you remember seeing that that headline? Of course. Donna Shalala I had it for a long time framed. Keith Romer But despite what Ford said in his speech, the federal government and Gerald Ford in particular were caught in the same incentive trap as everybody else. The country couldn’t afford to have New York City actually descend into bankruptcy. And Ford had a presidential election coming up, and New York had a lot of electoral votes. Nick Fountain So in December of 1975, the United States itself was finally pulled into Felix Rohitin’s grand bargain. The government ponied up more than $2 billion in short-term loans to New York City. (Time 0:29:30)