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NEW YORK CITY FINANCIAL CRISIS

HEARINGS
BEFORE THE

COMMITTEE ON
BANKING, HOUSING AND URBAN AFFAIRS
UNITED STATES SENATE
NINETY-FOURTH CONGRESS
F I R S T SESSION
ON

S. 1833, S. 1862, S. 2372, S. 2514,
and S. 2523
TO F U R N I S H LOAN G U A R A N T I E S TO M U N I C I P A L I T I E S SUFF E R I N G F I N A N C I A L A D V E R S I T I E S TO ENABLE T H E M TO
A C H I E V E F I S C A L BALANCE AND FINANCIAL H E A L T H AT
MINIMUM COST AND D I S R U P T I O N TO T H E NATION

OCTOBER 9, 10, 18, AND 23, 1975

P r i n t e d for the use of the Committee on Banking,
Housing and Urban Affairs

U.S. GOVERNMENT PRINTING OFFICE
60-832




WASHINGTON : 1975

COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS
W I L L I A M P R O X M I R E , Wisconsin,
J O H N SPARKMAN, Alabama
H A R R I S O N A. W I L L I A M S , J R . , New Jersey
THOMAS J. McINTYRE, New H a m p s h i r e
ALAN CRANSTON, California
ADLAI E. STEVENSON, Illinois
J O S E P H R. B I D E N , J R . , Delaware
R O B E R T MORGAN, North Carolina




Chairman

J O H N TOWER, Texas
EDWARD W. BROOKE, Massachusetts
BOB PACKWOOD, Oregon
J E S S E H E L M S , North Carolina
J A K E GARN, U t a h

K E N N E T H A. M C L E A N , Staff Director
ANTHONY T. CLUFF, Minority Staff Director
ROBERT E. WEJNTRAI'B, Professional Staff Member
(II)

CONTENTS
Page

S.
S.
S.
S.
S.

1833
1862
2372
2514
2523

3
6
6
34
10
LIST OF WITNESSES
THURSDAY, OCTOBER 9

H e n r y M. Jackson, U.S. Senator from the State of Washington
H u b e r t H. H u m p h r e y , U.S. Senator from the State of Minnesota
William E. Simon, Secretary of the Treasury
Jacob K. Javits, U.S. Senator from t h e State of New York
Lennox L. Moak, director of finance, city of Philadelphia

13
24
37
75
89

F R I D A Y O C T O B E R 10

H u g h L. Carey, Governor of the State of New York
Simon Rif kind, Paul Weiss, Rifkind, W h a r t o n & Garrison
Felix G. R o h a t y n , Lazard Freres
Brenton W. Harries, S t a n d a r d & Poor's Corp
E d w a r d M. Kresky Wertheim & Co., Inc
Paul J. Markowski, Argus Research
Wallace O. Sellers, Merrill Lynch
William J. Solari, Donaldson Lufkin
S. G r a d y Fullerton, Harris C o u n t y auditor, Houston, Tex
Joe E. Torrence, director of finance, Metropolitan G o v e r n m e n t of Nashville
and Davidson County, Tenn
John M. Urie. director of finance, Kansas City,
J o h n Petersen, Municipal Finance Officers Association
SATURDAY, OCTOBER




348
348
348

18

Abraham D. Beame, mayor, New York City
Moon Landrieu, mayor, New Orleans
John Mulroy, county executive, Onondago County, N . Y., representing t h e
National Association of Counties
K e n n e t h Axelson, deputy mayor, New York City
Ira Millstein, attorney, New York City
David H . Rodgers, mayor, Spokane, Wash
Richard Carver, mayor, Peoria, 111
Frank Wille, chairman, Federal Deposit Insurance Corporation
James E. Smith, Comptroller of the Currency
George Mitchell, Vice Chairman, Federal Reserve Board
David Rockefeller, chairman of the board, Chase M a n h a t t a n
Elmore C. Patterson, chairman of the board, Morgan G u a r a n t y
Walter B. Wriston, chairman, First National City Bank of New York
A. W. Clausen, president, Bank of America
Morris D. Crawford, chairman of the board, Bowery Savings Bank, New
York City
R. Stewart Rauch, Jr., chairman, Philadelphia Savings F u n d Society
H a r r y WT. Albright, Jr., president, Dime Savings Bank, New York
Peter G. Peterson, chairman, Lehman Bros., Inc
Martin Mayer, author
(in)

249
249
300
302
302
302
302
336
348

440
440
440
440
440
557
558
568
568
568
640
640
640
640
640
64 0
640
706
706

NEW YORK CITY FINANCIAL CRISIS
T H U R S D A Y , OCTOBER 9, 1974
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS,

Washington, B.C.
The committee met at 9:45 a.m. in room 1202, Dirksen Senate Office
Building, Senator William Proxmire, chairman of the committee,
presiding.
Present: Senators Proxmire, Melntyre, Tower, Brooke, Packwood,
and Garn.
Also present: Senator Abraham Ribicoff.
STATEMENT OF CHAIRMAN PROXMIRE
The CHAIRMAN. The committee will come to order. Today we begin
hearings on whether to provide financial assistance to cities and other
State and local government units on the edge of bankruptcy, and if
so, how much? That/s our issue. It's not an easy one to decide. But we
have to resolve it. We can't duck it.
There's no way we can avoid deciding, and in the very near future—
6 weeks at the outside—whether to provide Federal aid to State and
local government units in trouble. New York City, the Nation's biggest
city and financial center, the world's financial center in fact, is close
to bankruptcy for us to duck the issue and hope it goes away. A promptdecision-up or down—is essential to settle the issue and clear the
air, as Chairman Burns said in a. statement before the Joint Economic Committee yesterday. The municipal bond market has suffered
seriously in the past 2 weeks because of the uncertainty. We need a
prompt decision.
We have to decide whether the Federal Government should aid New
York City or let it default. No informed observer believes the city
can continue to service its debt and pay its other creditors without
Federal help.
Let me outline very briefly the specific questions which the committee must answer. First, we have to find out what will happen in
the event of default. What are the likely consequences and costs? No
one knows—or can know—for sure. Default by New York City won't
necessarily be a calamity. Maybe the economic recovery now under
way will be unaffected. Conceivably there won't be any serious disruptions in financial markets and the ability of other local government
units to sell and service debt will not be seriously impaired. Perhaps
the Nation's banks will be virtually unscathed and continue to function smoothly in channeling credit to investors. Possibly vital city
services will not be interrupted, only waste removed from its budget,




(l)

2
and New York could even emerge from bankruptcy with a manageable
debt structure.
Maybe. Conceivably. Perhaps. Possibly. But maybe not. Maybe default wrill leave the municipal securities market in shambles for months,
even years, disrupt other financial markets, threaten the solvency of
large numbers of banks throughout the country, and depress economic
activity and employment in New York and elsewhere. Our first question in these hearings will be to make a judgment as to what will happen
if New York defaults.
Second, the committee must weigh the costs and benefits of Federal
prerlit assistance to State and local governments. The benefits of a
Federal guarantee to New York City are threefold.
First, the TT.S. Treasury itself can make money on a Federal guarantee if New York is required to issue taxable bonds as a condition for
obtaining a guarantee. By taking tax-exempt issues off the market, I
estimate the Treasury would gain $25 million a year in additional tax
revenues for every billion dollars of bonds guaranteed. Also, a guarantee fee of 1 percent would pick up an additional $10 million a year
in revenue for the Treasury for every billion dollars guaranteed.
Second, by preventing a default and the potential ripple effect on the
municipal bond market, a Federal guarantee can help hold down
interest rates on municipal bonds and prevent property tax increases
from being imposed on taxpayers all across the country which otherwise might be necessary to meet the higher cost of servicing municipal
debt,
Third, the prevention of a New York default will help obviate ripple effects in other capital markets and in our banking system. There
are some who fear that these effects could impair our economic recovery and perpetuate our present high rate of unemployment.
Aginst these benefits, we must weigh the costs. The most obvious
cost is, of course, the price of a subsequent default by New York City
in which case Uncle Sam would be left holding the bag. These risks can
be reduced if we insist that any guarantee be collateralized with future revenue sharing payments.
A second cost is the danger that a Federal guarantee might weaken
the resolve of New York City to put its own fiscal house in order.
Again, these risks can be reduced if stringent controls are imposed
by those who administer the guarantee. This means insuring with no
and's, if's, or but's that New York City be required to balance its
budget within 2 or 3 years.
A third cost is the danger that a Federal guarantee would undermine the incentive for sound management on the part of other cities
and invite similar requests for Federal assistance. Once again, these
costs can be reduced if the Federal guarantee program establishes
stringent preconditions so that future applicants will be discouraged
except in truly emergency situations. Further discussion is needed if
States are to be required to impose a tax sufficient to cover half or
perhaps all of the city's operating deficit and thus make a balanced
budget a prompt reality at a clear and painful sacrifice to the States.
The incentive for prudent management may be further reinforced if
the investors in New York City obligations are required to bear some
loss. Even a slight loss will make municipal bond investors more quality conscious in the future and thus provide cities with a strengthened




3
incentive to improve their municipal bond rating. Future investors
must understand that high yielding securities carry risks which they
and they alone must bear.
The hearings we begin today will bring these questions into focus
and enable us to decide what actions, if any, the committee should recommend that the Senate take to furnish loans, guarantees, or other
financial assistance to New York and other cities and States in financial difficulties which are beyond their capacities to cope with.
Our first witness will be Senator Jackson, of Washington. He will
be followed by Senator Javits and Senator Humphrey. Each of these
colleagues of ours has introduced legislation to resolve the crisis. Senator Bentsen has also introduced such legislation. He is unable to be
here today.
After hearing from my distinguished colleagues, we will hear from
Mr. Lennox Moak and William Simon, Secretary of the Treasury. The
witness list for tomorrow is available in the committee's office. The list
for the 18th will be made available as soon as it is ready.
[The hi lis being considered follow : ]
[S. 1833, 94th Cong., 1st sess. ]
A BILL To authorize emergency loan guarantees to units of government

Be it enacted by the Senate and House of Representatives
of America in ("ongress
assembled,
FINDINGS

AND

of the I'nited

States

PURPOSE

SECTION 1. (a) The Congress finds that—
(1) State and local governments suffer during recessionary periods from
an e x t r a o r d i n a r y combination of rising costs, deteriorating tax bases, and
tight money ;
(2) in their duty to continue to provide needed services to the public,
such units of government a r e forced to borrow increased amounts of funds
in the capital m a r k e t s ;
(3) in extreme cases this situation impairs the ability of some units of
government to enter the Nation's capital markets and to finance needed
services;
(4) the deterioration of the financial condition of State and local government reflects directly upon the economic condition of t h e country as a whole
and the t h e ability of this country to provide maximum production, employment and purchasing power ; and
(5) the existence of a loan g u a r a n t e e authority in the Federal Government
is necessary in the national interest to enable such units of government to
m a i n t a i n a sound fiscal s t r u c t u r e during temporary, recessionary periods.
(b) I t is the purpose of this Act to provide authority for emergency financial
assistance in the form of loan guarantees to aid units of government to meet
temporary and urgent, financial requirements which, if not met, might seriously
impair the ability of such governments to provide needed services to the public,
and might seriously affect the economy of t h e Nation or a region thereof.
DEFINITIONS

SEC. 2. As used in t h i s Act—
(1) The t e r m "unit of government" means the government of a municipality, township, or other unit of government below the State or county
level which is a unit of general government which has a population in excess
of one hundred t h o u s a n d (determined on the basis of t h e same principles a s
a r e used by the Bureau of the Census for general statistical purposes) ; and
(2) The term "Secretary" means the Secretary of the Treasury.
EMERGENCY LOAN GUARANTEE

AUTHORITY

SEC. 3. ( a ) In furtherance of the purpose of this Act, the Secretary is authorized upon t e r m s and conditions prescribed by him, and after consulting with the




4
chairmen a n d ranking minority members of t h e Committee on Banking, Housing
a n d Urban Affairs of the Senate and the Committee on Banking, Currency a n d
Housing of the House of Representatives to make commitments to g u a r a n t e e
a n d to g u a r a n t e e any financing institution against loss of principal or interest
on any loan to a unit of government for the purpose of assisting t h a t u n i t of
government t o meet temporary and urgent financial needs which if not met
(1) could seriously impair the ability of the unit of government to provide
services for t h e public, a n d (2) could adversely and seriously affect t h e economy
of the region surrounding the unit of government.
(b) No g u a r a n t e e of a loan shall be made under this section unless t h e Secretary finds and appropriately certifies t h a t —
(1) the loan is necessary to carry out t h e purpose of this A c t ;
(2) the loan is not otherwise available on reasonable terms and conditions
from any source, public or private ;
(3) there is reasonable assurance of repayment of the loan ;
(4) a failure to provide a g u a r a n t e e of the loan under the a u t h o r i t y of
t h i s section wTould seriously impair the ability to produce the goods and
services of the enterprise in behalf of which the g u a r a n t e e is t o be m a d e ;
and
(5) the loan to be guaranteed will 'be applied to productive purposes which
a r e necessary to the economic health and welfare of the Nation or a region
thereof.
(c) The Secretary shall require such security for guarantees a n d such agreements regarding management of the components of the unit of government to be
assisted as he may deem appropriate. At a minimum, the Secretary shall require
any unit of government receiving a g u a r a n t e e under this Act to develop a prog r a m for achieving a balanced budget financed by recurring revenues, and a
program of long-range planning sufficient to insure the expectation of balanced
budgets in the future.
(d) T h e Secretary shall consult, as necessry, with any unit of government
which h a s received a loan guaranteed under this section concerning any m a t t e r
which may bear upon the ability of the unit of government to repay t h e loan
within t h e time fixed therefor and reasonable protection to the United States.
(e) (1) The maximum obligation of the Secretary under any loan or loans
made to any one borrower within any one year which is guaranteed u n d e r this
section shall not exceed $500,000,000 unless—
(A) prior to making such guarantee the Secretary submits to t h e Congress a full and detailed rej>ort of the circumstances requiring t h e g u a r a n t e e
and t h e justification therefor in furtherance of the purposes of this A c t ; and
( B ) a period of thirty calendar days of continuous session of the Congress following t h e d a t e on which such report is submitted to the Congress
elapses, and during such period there is not passed by either t h e Senate or
the House of Representatives a resolution stating in substance t h a t t h e
Senate or t h e House of Representatives, as t h e case may be, does not approve
the proposed guarantee.
F o r the purposes of p a r a g r a p h ( B ) , in the computation of the thirty-day period
there shall be excluded the days on which either the Senate or the House of
Representatives is not in session because of adjournment of more t h a n three d a y s
to a day certain or an adjournment of the Congress sine die.
(2) The maximum obligation of the Secretary under all outstanding loans
g u a r a n t e e d under this section shall not exceed a t any time $5,000,000,000.
(f) (1) P a y m e n t s required to be made as a consequence of any g u a r a n t e e
u n d e r this section shall be made by the Secretary from the loan g u a r a n t e e fund
established p u r s u a n t to subsection ( g ) .
(2) I n the event of any default on any loan guaranteed under this section and
payment in accordance with the g u a r a n t e e is made by the Secretary, t h e Attorney
General shall t a k e such action as may be appropriate to recover the amount paid
by the Secretary, with interest, from the defaulting borrower.
(3) The Secretary shall prescribe and collect a g u a r a n t e e fee in connection
with each loan guaranteed under this Act. Sums realized from such fees shall
be deposited in the loan g u a r a n t e e fund established p u r s u a n t to subsection ( g ) .
(g) (1) There is established in the T r e a s u r y a loan g u a r a n t e e fund to be
administered by the Secretary. The fund shall be used only for t h e purpose of
the g u a r a n t e e program authorized by this section, including t h e payment of
a d m i n i s t r a t i v e expenses. All fees paid in connection with such program shall
be credited to the fund. Moneys in the fund not needed for current operations




5
may be invested in bonds or other obligations of, or guaranteed by, the United
States.
(2) T h e r e are authorized to be appropriated to the loan g u a r a n t e e fund such
amounts as may be necessary to provide requisite capital. In the event there a r e
insufficient moneys in the fund to meet obligations of the fund, the Secretary
shall transfer to the fund such sums as may be necessary to fulfill such
obligations. The Secretary may use, for the purpose of making any such
transfer, the proceeds from the sale of any securities issued u n d e r the Second
Liberty Bond Act a r e extended to include such transfers to the fund. There a r e
authorized to be appropriated to the Secretary of the T r e a s u r y such sums
as may be necessary to repay such transfers. Interest on sums so transferred
shall be paid from time to time, a t a r a t e determined by the Secretary, from fees
credited to the fund.
(h) There is created a Loan G u a r a n t e e Policy Board which shall consist
of a chairman appointed by the President, with t h e advice and consent of the
Senate, and the Chairman of the Federal Reserve Board and the Secretary of the
Treasury a s members. The Board shall establish general x>olicies (particularly
wTith respect to the national or regional economic interest involved in the granting or denial of applications for guarantees under this section and with respect
to the coordination of the functions of the Secretary under this section with
other activities and policies of the Government) which shall govern the granting
or denial of applications for guarantees under this section.
(i) Any Federal Reserve bank is authorized to act as fiscal agent of the Secret a r y in the making of contracts of g u a r a n t e e under this section and in otherwise
carrying out the purposes of this section. All funds necessary to enable any
such fiscal agent to c a r r y out any g u a r a n t e e made by it on behalf of the Secretary
shall be supplied and disbursed by or under authority from the Secretary.
No such fiscal agent shall have any responsibility or accountability except as
agent in taking any action p u r s u a n t to or under authority of the provisions of
this section. Each such fiscal agent shall be reimbursed by the Secretary for all
expenses and losses incurred by it in acting as agent on behalf of the Secretary,
including (without being limited to) the expenses of litigation.
( j ) ( l ) Except as provided in p a r a g r a p h s (2) and (3) of this subsection,
this section and all a u t h o r i t y conferred thereunder shall t e r m i n a t e upon the
expiration of one year after the date of enactment of this Act, or upon the
establishment of an Emergency Loan Guarantee Corporation p u r s u a n t to section 4,
whichever is the earlier.
(2) If, upon the expiration of one year after the date of enactment of this Act
action on the Emergency Loan Guarantee Corporation is pending before the
Congress, the a u t h o r i t y conferred under this section shall continue until
such action is completed or upon the establishment of the Corporation, whichever
is the earlier.
(3) The termination of this section and the authority conferred thereunder
shall not affect the disbursement of funds under, or the carrying out of, any
contract, guarantee, commitment, or other obligation entered into p u r s u a n t to
this section prior to such termination, or the taking of any action necessary to
preserve or protect the interests of the United States in any amounts advanced
or paid out p u r s u a n t to this section.
REPORT ; E S T A B L I S H M E N T OF EMERGENCY LOAN GUARANTEE

CORPORATION

SEC. 4. Not l a t e r t h a n one year after the d a t e of enactment of this Act, the
Secretary shall submit to the Congress a full and complete report of his operations under section 3, together with his recommendations with respect to the
need for the establishment of an Emergency Loan G u a r a n t e e Corporation to
provide for the continuation of a loan g u a r a n t e e assistance program comparable to t h a t authorized under section 3. If the Secretary recommends the establishment of such Corporation, he shall, a t t h e time of submitting such report
or a t any time thereafter but prior to the expiration of one year after the d a t e
of enactment of this Act, submit to the Congress a c h a r t e r for the organization
of such Corporation. Such c h a r t e r shall take effect, and the Emergency Loan
G u a r a n t e e Corporation shall become a body corporate with the powers stated
in such charter, upon the expiration of the first period of sixty calendar days
of continuous session of the Congress following the d a t e on which the charter
is t r a n s m i t t e d to the Congress, if between the date of t r a n s m i t t a l and the
expiration of such sixty-day period there h a s not been passed by either the
Senate or t h e House of Representatives a resolution s t a t i n g in substance that




6
it does not approve t h e proposed c h a r t e r or the establishment of t h e proposed
Corporation. F o r the purpose of the foregoing, there shall be excluded, in t h e
computation of such sixty-day period, t h e days on which either the Senate or
the House of Representatives is not in session because of a d j o u r n m e n t of more
t h a n three d a y s to a day certain or an adjournment of the Congress sine die.
PROCEDURES W I T H RESPECT TO DISAPPROVAL RESOLUTIONS

SEC. 5. The provisions of sections 910 through 913 of title 5, United States
Code, shall be applicable with respect to the procedure to be followed in t h e
Senate and House of Representatives in the exercise of their respective responsibilities under sections 3 ( e ) and 4 of this Act, except t h a t references in such
provisions to a "resolution witli respect to a reorganization p l a n " shall be deemed
for the purposes of this section to refer to a resolution of disapproval under
sections 3 ( e ) and 4.
[S. 1862, 94th Cong., 1st sess.]
A B I L L To amend the Federal Financing Bank Act of 1973 to provide funds to general
u n i t s of local government in financial distress

Be it enacted by the Senate and House of Representatives
of the United
States of America in Congress
assembled,
SECTION 1. Section 3 of the Federal Financing Bank Act of 1973 is amended
by adding a t the end thereof the following :
" ( 5 ) The term 'unit of local government' means a county, municipality,
city, town, township, or other unit of general local government.".
SEC. 2. Section 6 of the Federal Financing Bank Act of 1973 is amended by
adding at the end thereof the following :
" ( d ) In addition, t h e Bank shall purchase general obligation bonds which a r e
issued by a unit of local government if—
" ( 1 ) the m a t u r i t y of such obligations does not exceed twro y e a r s ;
" ( 2 ) the unit of local government issuing such obligations for purchase
by the Bank provides such assurances as the Secretary of Housing and
Urban Development deem necessary t h a t such unit of local government has
made a bona fide a t t e m p t without success to obtain such funds a t reasonable
terms from private sources, State sources, or general offerings to the public;
" ( 3 ) the unit of local government has submitted to t h e Secretary of
Housing and Urban Development a comprehensive plan of fiscal and budget a r y expenditures and controls to achieve a balanced budget and which will,
to the satisfaction of the Secretary, permit the full retirement of any such
obligation within two years ; and
" ( 4 ) the proceeds of any issue of obligations purchased under this subsection will not be utilized for construction or for any purpose other t h a n the
satisfaction of liabilities already incurred.
The aggregate amount of obligations purchased under this subsection may not
exceed $3,000,000,000.".
[S. 2372. 94th Cong., 1st sess.]
A B I L L To secure fair financing for local units of government

Be it enacted by the Senate and House of Representatives
of the United
States
of America in Congress assembled, T h a t this Act may be cited as t h e " F a i r
Financing for Local Government Act of 1975".
FINDINGS AND DECLARATION OF PURPOSE

SEC. 2. ( a ) T h e Congress finds t h a t —
(1) I n t e r e s t r a t e s on local government bonds have now risen to levels a t
which a significant portion of local t a x revenues is consumed servicing debt
r a t h e r t h a n in improving the delivery and quality of essential public services ;
and
(2) Capital funds must be available at reasonable r a t e s if t h e essential
services provided by local government a r e to be maintained.
(b) It is the purpose of this Act to reduce the cost of government a t t h e local
level by lowering interest rates, and to expand t h e m a r k e t for municipal securities issued by cities with balanced budget programs.




7
DEFINITIONS

SEC. 3. As used in t h i s Act—
(1) The term " S t a t e " means the several States, t h e District of Columbia,
and the Commonwealth of P u e r t o Rico.
(2) The term "unit of local government" means any public corporate body,
political subdivision, public agency or other instrumentality established
under the laws of any State with a u t h o r i t y to issue securities.
(3) The term "municipal bond" means any bond issued by a unit of local
government, or any agency or i n s t r u m e n t a l i t y of a unit of local government,
but does not include any bond issued in order to raise funds for any industrial or commercial facility for p r i v a t e use, by lease, conditional or installment sales contract, or other means of transfer, where such facility is or
will be used primarily for the mining, manufacturing, assembling, fabricating, storing, processing, or sale of articles or commodities.
(4) The term " i n s u r e r " means any insurance company, or group of companies under common ownership, or any pool or association of insurance
companies, which is authorized to engage in the insurance business under
the laws of any State.
(5) The term " S t a t e local assistance agency" means any corporation,
board, agency or other instrumentality which issues its own obligations and
uses the proceeds thereof to purchase bond issues of units of local government within t h a t State, whether or not such State guarantees the payment
of the obligations of such State local assistance agency.
T I T L E I — F A I R F I N A N C E I N S U R A N C E BOARD
E S T A B L I S H M E N T OF BOARD

SEC. 101. There is hereby established a F a i r Finance I n s u r a n c e Board (hereinafter "the B o a r d " ) . T h e Board shall have its principal offices in the District
of Columbia and shall be deemed, for purposes of venue in civil actions, to be a
resident thereof. T h e Board may establish offices in such other places a s it deems
necessary in the conduct of its business.
M E M B E R S AND P E R S O N N E L

SEC. 102. ( a ) (1) T h e Board shall consist of a Chairman and four members
appointed by the President, by and with the advice and consent of the Senate.
The Chairman and t h e members of the Board shall be persons who, as a result
of their training, experience and a t t a i n m e n t s , in academia, the labor movement,
commerce a n d / o r government, a r e exceptionally well qualified to formulate
and carry out t h e purposes of this Act. Appointments of the Chairman and members p u r s u a n t to t h i s subsection shall be made in a manner such t h a t not more
t h a n three members of the Board including the Chairman shall be members of
the same political party. The Chairman and each member shall serve for a term
of five years, except t h a t of the Chairman a n d members first appointed to the
B o a r d ; one shall serve for one year, one for two years, one for three years, one
for four years, and one for five years, to be designated by the President a t the
time of appointment.
(2) I n addition to t h e members appointed by the President, the Secretary of the
Treasury a n d t h e Secretary of Housing and Urban Development shall serve as
nonvoting members of the Board ex-officio.
(b) the Board shall meet at the call of the Chairman which shall be not less
often t h a n four times per year.
(c) E x officio members of the Board shall not be compensated for their services.
(d) Subject to such rules a s may be adopted by the Board, the Chairman may
appoint and fix the salary of such personnel a s may be necessary for the conduct
of t h e business of the Board, in accordance with the provisions of title 5, United
States Code, governing appointment in the competitive service, and chapter 51
and subchapter I I I of chapter 53 of such title relating to classification and general schedule pay rates, and to obtain the services of experts and consultants in
accordance with section 3109 of title 5, United States Code, a t rates for individuals not to exceed the per diem equivalent for GS-18.
(e) T h e members of the Board, other t h a n ex officio members, shall receive
compensation as prescribed for offices and positions a t level I I of the Executive
Schedule (5 U.S.C. 5312). The members of the Board, other t h a n ex officio members, shall not—




8
(1) have any financial interest or relationship, direct or indirect, with any
person engaged in the issuance, sale, distribution or rating of municipal
bonds;
(2) after his service on the Board has ended, represent anyone other than
the United States in connection with a matter in which the Board is a party
or has an interest and in which he participates personally and substantially for the Board; or
(3) receive any emoluments, salary, or supplementation of his Government salary, from a private source as compensation for his services to the
Board.
(g) There shall be a General Counsel to the Board who shall be appointed by
the Board and who shall receive compensation at the rate prescribed for offices
and positions at level III of the Executive Schedule (5 U.S.C. 5314).
GENERAL P O W E R S OF T H E BOARD

SEC. 103. (a) For the purpose of carrying out its functions under this Act, the
Board shall have the power—
(1) to have a seal which may be altered at pleasure and to use the same
by causing it, or a facsimile thereof, to be impressed or affixed or in any
other manner reproduced;
(2) to sue and be sued;
(3) to enter into and perform contracts, leases, cooperative agreements,
and other transactions, on such terms as the Board shall deem appropriate,
and to consent to modification thereof, without regard to sections 3648 and
3709 of the Revised Statutes, as amended (31 U.S.C 529: 71 U.S.C. 5). and
section 322 of the Act of June 30, 1932, as amended (40 U.S.C. 278a) ;
(4) to issue such rules and regulations as may be deemed necessary or
appropriate to carry out the purposes of this Act;
(5) to exercise all power specifically granted by this Act and such incidental powers as are necessary to carry out the purposes of this Act.
(b) All suits of a civil nature at common law or in equity to which the Board
shall be a party shall be deemed to arise under the laws of the United States, except that no attachment, garnishment, or other similar process shall be issued
against the Board or its property.
(c) The Board is authorized to secure directly from any executive department
or agency information, estimates, statistics, and technical assistance for the
purpose of carrying out its functions under this Act. Each such executive department, or agency shall furnish the information, estimates, statistics, and technical
assistance directly to the Board upon its request.
(d) On request of the Board, the head of any executive department or agency
may detail, with or without reimbursement, any of its personnel to assist the
Board in carrying out its functions under this section.
FINALITY

OF

CERTAIN

FINANCIAL

TRANSACTIONS

SEC. 104. Notwithstanding the provisions of any other law, any financial transaction authorized under this Act shall be final and conclusive upon all officers
of the United States.
TAXATION

SEC. 105. The Board, including its reserves, surplus, and income shall be exempt from all taxation now or hereafter imposed by the United States, or by any
State, or any subdivision thereof, except any real property acquired by the Board
shall be subject to taxation by any State or political subdivision thereof, to the
same extent, according to its value as other real property is taxed.
GOVERNMENT CORPORATION CONTROL ACT

SEC. 106. Section 101 of the Government Corporation Control Act is amended
by inserting after "Pension Benefit Guarantee Corporation" the following: "Fair
Finance Insurance Board."
TITLE II—FUNCTIONS OF THE BOARD
REINSURANCE

OF

MUNICIPAL

BONI>S

SEC. 201. The Board is authorized to offer to any insurers, subject to the conditions hereinafter set forth, reinsurance against 75 per centum of losses result-




9
ing from the failure of any unit of local government to pay all or any p a r t of
scheduled municipal bond principal a n d interest payments on insured municipal
bonds as such payments become due and payable.
SEC. 202. The Board is authorized to enter into any contract, agreement, or
other arrangement with any insurer for reinsurance coverage, p u r s u a n t to section 201 hereof, in consideration of payment to the Board by the i n s u r e r of a
premium which shall be determined by the Board, hut which shall not exceed 1
per centum of the total amount of the interest and principal a m o u n t s insured.
CONDITIONS

OF

REINSURANCE

SEC. 203. The Board shall not enter into any contract or agreement to provide
reinsurance to any insurer under this Act unless the Board shall determine t h a t
the assets of the insurer a r e sufficient to meet the obligations incurred by it under
its contract with the issuer, p u r s u a n t to s t a n d a r d s and procedures to be established by the Board of Directors.
GUARANTEE

OF

STATE

LOCAL

ASSISTANCE

BONDS

SEC. 204. The Board is authorized to offer to the State local assistance agency
of any State, subject to the conditions hereinafter set forth, a g u a r a n t e e of payment of 75 per centum of the total amount of the interest a n d principal of bonds
issued by such agency for the purpose of purchasing municipal bonds issued by a
unit of local government within such State.
SEC. 205. The Board is authorized to issue a g u a r a n t e e of the bonds of a State
local assistance agency, p u r s u a n t to section 204 hereof, in consideration of payment to the Board, of a fee which shall be determined by the Board, but which
shall not exceed 1 per centum of the total amount of the interest and principal
of said bonds.
SEC. 20<>. NO g u a r a n t e e shall be issued by the Board under this Act unless—
(a) The Board determines that the amortization provisions of the bond of the
State local assistance agency are not in excess of its debt-paying capacity.
i b) The Board determines t h a t the State local assistance agency :
(1) Prescribes and enforces s t a n d a r d s and procedures for accounting and
financial control, by local governments whose bonds a r e guaranteed,, which
are in accordance with generally accepted accounting principles;
<2) Requires t h a t local governments whose bonds are guaranteed adopt a
sound program for achieving a balanced budget financed by recurring
revenues;
(.*{> Conducts sufficient periodic audit and oversight activities to insure
the adherence to prescribed standards, procedures and principles by local
governments whose bonds a r e guaranteed.
T I T L E I I I — S P E C I A L STUDY AND ANNUAL R E P O R T S
LOCAL S E C U R I T I E S

MARKET

STUDY

SEC. 301. The Board shall conduct a study of the market for securities issued
by units of local government, and shall include as subjects of concern in such
study—
( l i The availability, and present and potential sources of funds for the
purchase of such securities ;
(2) Influences upon, and developments in, interest rates for such
securities :
(3> Suggested reforms in the financial structures and functioning, and
in present methods of financing the activities of, units of local government.
(4 ) Federal and State efforts to assist in the marketing of such securities.
S E C 302. T h e Board shall submit such local securities m a r k e t study to the
President for transmission to the Congress no later t h a n one hundred and
eighty days subsequent to the enactment of this Act.
SEC. 303. The Board shall submit to the President for transmission to the
Congress a comprehensive annual report of its activities under this Act.
T I T L E IV—ADVISORY COMMITTEES
LOCAL GOVERNMENT ADVISORY

COMMITTEES

SEC. 401. ( a ) T h e Board is authorized to establish special advisory committees which shall consult with the Board during the planning and imple-




10
mentation of its functions a n d shall provide advice and information to t h e
Board concerning all aspects of its activities.
(b) The advisory committees shall provide for the representation of t h e
following interests and such other interests as the Board may deem necessary
or d e s i r a b l e :
(1) city, county and State governments ;
(2) the labor movement; and
(3) the financial community.
(c) The advisory committees authorized by this section and such o t h e r advisory boards, committees, and councils as may be established by t h e Board
shall be subject to the provisions of the Federal Advisory Committee Act (86
Stat. 770, title 5 App. U.S.C.).
TITLE V—FAIR FINANCE INSURANCE FUND
SEC. 501. ( a ) To carry out the reinsurance and g u a r a n t e e programs authorized
by this Act, there shall be established in the Treasury of the United States a
F a i r Finance I n s u r a n c e F u n d (hereinafter "the F u n d " ) which shall be available, without fiscal year limitations :
(1) to make such payments as may, from time to time, be required u n d e r
reinsurance or g u a r a n t e e agreements entered into u n d e r this A c t ; and
(2) to pay such a d m i n i s t r a t i v e expenses as may be necessary or approp r i a t e to carry out t h e purposes of this Act.
(b) T h e F u n d shall be credited with :
(1) P r e m i u m s for reinsurance contracts and fees for g u a r a n t e e c o n t r a c t s
which may be collected under the provisions of this A c t ;
(2) Such funds as may be advanced to the Fund from appropriations in
order to maintain the Fund in an operative condition a d e q u a t e to meet its
liabilities;
(3) I n t e r e s t which may be earned on investments of the F u n d p u r s u a n t
to subsection 401(c) ;
(4) Receipts from any other source which may, from time to time, be
credited to the Fund.
(c) If, after any amounts which may have been advanced from appropriations
have been credited to the appropriations from which advanced, the B o a r d determines t h a t the moneys of the Fund are in excess of current needs, it may
request the investment by the Secretary of the Treasury of such a m o u n t s as it
deems advisable in obligations issued or guaranteed by the United States.
APPROPRIATIO N S

SEC. 502. T h e r e a r e authorized to be appropriated such sums as may be necessary to carry out the provisions of this Act. In the event there a r e insufficient
moneys in t h e Fund to meet obligations of the Board, the Secretary of the
T r e a s u r y shall transfer to the F u n d such sums as may be necessary to fulfill
such obligations. The Secretary of the T r e a s u r y may use, for t h e purpose of
making any such transfer, the proceeds from the sale of any securities issued
u n d e r the Second Liberty Bond A c t ; and the purposes for which securities
may be issued under such act a r e extended to include the purchase of any such
notes or other obligations.
[S. 2528, 94th Cong., 1st sess.]
A B I L L To amend the Emergency Loan G u a r a n t e e Act to permit the Emergency Loan
G u a r a n t e e Board to g u a r a n t e e the bonds of States and municipalities

Be it enacted by the Senate and House of Representatives
of the United
States of America in Congress assembled. T h a t ( a ) section 4 ( a ) ( 2 ) of the
Emergency Loan G u a r a n t e e Act (Public Law 92-70) is amended by inserting " ( A ) " immediately after " ( 2 ) " , by striking out the period at the end thereof
and inserting in lieu thereof " ; or' , and by adding a t the end thereof t h e following new s u b p a r a g r a p h :
" ( B ) or in the case where the borrower is a State or political subdivision
thereof, such State certifies t h a t it could not lend the political subdivision
sufficient funds or g u a r a n t e e t h a t political subdivision debt i n s t r u m e n t s
in order for t h a t political subdivision to meet its needs without jeopardizing
the financial stability of the States.".




11
(b) Section 4 ( b ) of the Emergency Loan G u a r a n t e e Act is amended by—
(1) striking out " L o a n s " and inserting in lieu thereof t h e following:
"In the case where the borrower is not a State or political subdivision
thereof, loans" ; and
(2) inserting a t the end thereof the following new sentence: "In the
case where the borrower is a State or political subdivision thereof, shall
be payable in whatever period of time the Board shall, by rule, determine
to be appropriate.".
SEC. 2. Section 5 of the Emergency Loan Guarantee Act is amended by inserting ", except in the case where the borrower is a State or political subdivision
thereof," immdiately after "shall" the first time it appears therein.
SEC. 3. Section 0 of the Emergency Loan G u a r a n t e e Act is amended by inserting "or State or political subdivision thereof" immediately after "enterprise''
each time it appears therein.
SEC. 4. Section (J of the Emergency Loan Guarantee Act is amended by inserting after the end of section (f) —
" ( g ) The Board, in g r a n t i n g a loan guarantee to a debt issue of a State or
its political subdivision—
" ( I ) shall require t h a t the debt instruments be subject to Federal taxation ;
" ( 2 ) shall require t h a t the State or agency granted a loan guarantee
give evidence that its budget will be balanced by real revenues within three
years after the g u a r a n t e e is granted and for the period of time covered by
the g u a r a n t e e ;
" ( 3 ) shall require t h a t only full faith and credit obligations shall be
eligible for the g u a r a n t e e ;
" ( 4 ) may require t h a t a member of the Board or its designee serve on
the State or local governmental agency or agencies which have the responsibility for revenue collection and expenditures ;
" ( 5 ) may require t h a t the State or local agency adopt fiscal guidelines
and rules and regulations deemed necessary to assure payment of interest
and principal on the debt instrument guaranteed by the Board.".
SEC. 5. Section 7 of the Emergency Loan Guarantee Act is amended by inserting "or State or political subdivision thereof" immediately after "enterprise"
each time it appears therein.
SEC. 6. Section 8 of the Emergency Loan Guarantee Act is amended by striking
out "$250,000,000" and inserting in lieu thereof "$50,000,000,000".
SEC. 7. Section 12 of the Emergency Loan Guarantee Act is amended by striking out " J u n e 30, 1973," and inserting in lieu thereof " J u n e 30, 1977,".
S E C 8. Section 13 of the Emergency Loan Guarantee Act is amended by striking out "December 31, 1973." and inserting in lieu thereof "December 31, 1977,".
SEC. 9. The Emergency Loan G u a r a n t e e Act is amended by adding at the end
thereof the following new section :
"DEFINITIONS

"SEC. 14. For purposes of this Act, the term—
" ( 1 ) ' S t a t e ' refers to any State of the United States or the District
of Columbia.
" ( 2 ) 'political subdivision' means a city, town, borough, county, parish,
or district created by or p u r s u a n t to the law of any State.".

STATEMENT 0E SENATOR TOWER
Senator TOWER. T have a brief statement, Mr. Chairman. Noting
our reason for meeting today is not a pleasant one, the Nation's largest
city has been brought to the brink of financial default. The second
most populous State is in severe financial straits. Other solutions having failed, Federal intervention is being sought. We are here to listen
to the problems and proposals for their resolution. We have to cut
aside the rhetoric, emotion, claims, and counterclaims to consider a
variety of factors.
This situation cannot and must not be ignored. Having examined
the causes, we must pierce the borders of cities and States to assess




12
the national impact. We must examine the proposals for relief that
have been offered. With the record established, we can determine
whether involvement of the Federal Government in this instance will
share the burden or encourage the spread of this situation beyond
current problems.
Senator BROOKE. Mr. Chairman, I have a statement. In the interest
of time, I will not read it but I ask it follow the statement you made
and the statement of Senator Tower.
[The statement follows:]

STATEMENT OF SENATOR BROOKE
Senator BROOKE. For the past 6 months, we have all watched the
financial uriraveling of the citv of New York with growing apprehension. The sheer size of New York City's debt makes its insolvency a
matter of national concern. And I suppose it was inevitable that faced
with the financial collapse of New York City, the Congress would
be called upon to decide whether Federal assistance should be
provided.
New^ York is our largest and most important city, the financial
capital of the country. I t is a major commercial center, and provides
a forum for world political discussion. Moreover, the residents of New
York make significant contributions to our culture. No American who
understands the important role New York plays in our national economy and culture can fail to wish the city well.
However, Mr. Chairman. I must state that T have grave reservations
about the wisdom of financing the debt of the city of New York
through Federal loans, guarantees, or insurance. For 200 years, our
Federal system has left to State and local governments the responsibility for financing their own activities. This tradition has worked
well for us, and if we depart from it here, I do not know when, if
ever, we shall return.
The first major public position I held in Massachusetts was the
chairmanship of the finance commission for the city of Boston, and
in that job, I learned something about municipal finance. I don't think
there can be much doubt that the city of New York has not been responsible in the management of its finances. But I also do not believe
that the issue before this committee is whether or not New York City
"deserves" assistance. Rather the question is this: If the city of New
York defaults, how much damage would that do to our national
economy ?
Our Founding Fathers established a Federal system of Government
for many good and practical reasons. F o r my part, Mr. Chairman, I
would be loath to support any bill which would ensnare the Federal
Government in the local budget making process except in the face of
a grave threat to the national welfare. However. I shall listen carefully
to the testimony at our hearings, and I shall keep an open mind on
the question of whether we should provide Federal assistance to Newr
York City.
The CHATRMAX. Senator Jackson, do you have a statement ?
Senator JACKSON. Yes.




13
STATEMENT OF HENRY M. JACKSON, U.S. SENATOR FROM THE
STATE OF WASHINGTON
The CHAIRMAN. Because there is a parallel jurisdiction with their
committee, Senators Ribicoff, Percy, and Javits will join us in part if
they wish to do so at the hearings.
Senator JACKSON. T welcome this opportunity to ask that you give
serious consideration to Senate bill 2372, a measure designed to save the
Nation's cities from collapse in our present economic turmoil. I am
pleased that Senators Humphrey, Ribicoff, Magnuson, Williams, and
Javits are cosponsoring this legislation.
This legislation will provide Federal guarantees for municipal
bonds, in much the same way that the Federal Deposit Insurance Corporation provides guarantees for bank deposits.
New York and the other cities of America are not asking for bailouts. They are asking for help in helping themselves.
This bill will benefit New York, and every other city, town, and
county in America; and any subdivisions of a State which qualify,
such as school districts, water districts, and similar entries.
It was not designed to save New York, but New York must be saved.
To show callous indifference to the fate of the Nation's largest city—
its greatest city—as the administration is doing, is beyond comprehension.
If New York City goes under, no city in the Nation is safe. If New
York City goes under the State of New York may well go under—and
no State in the Nation will be safe.
This is truly a national problem, and it demands a national solution.
Inflation and recession grip the national economy, and cannot be combated on a local level.
I find the indifference of the administration to this national crisis
shocking and irresponsible. At a time when our economy is already
fragile, this kind of indifference is especially indefensible.
Secretary Simon says it is something we shouldn't bother with.
It is beyond my comprehension in light of Dr. Burns' statement of
yesterday.
If it is based on ideology the administration should not allow itself
to be blinded to reality by rigid, outmoded ideologies.
If it is based on politics, let us realize that the situation is too serious
to allow for playing politics.
Unless the National Government acts, we face a serious disruption
of the municipal bond market.
We face a crisis of liquidity for many commercial banks.
We face a threat to the security of thousands—millions—of investors
throughout the country.
Today, there is over $207 billion in tax-exempt bonds outstanding.
Interest rates on municipal bond issues have jumped upwards recently—and not only for New York but for every government unit in the
country,
I think that is a significant point, which demonstrates it is a national
problem, and not just a NewT York problem.
The Bond Buyer Index tells the story. I n January 1974, the Index
stood at just over 5 percent. Today, 18 months later, where does it
stand? I t has gone up over 50 percent in these 18 months, and now

6 0 - 8 3 2 O - 75 - 2




14
stands at an all-time high, 7.67 percent. And every week, it continues
to jump upward to reach new record levels.
With $207 billion in municipal bonds outstanding, these incredible
increases in interest rates are costing millions of dollars now, and will
eventually cost billions. Instead of paying for policemen, firemen,
teachers, sanitation men, scarce tax dollars will be siphoned off into
paying high interest rates.
And if New York City and New York State go into default, let us be
clear on the impact. For of that $207 billion national municipal bond
market, nearly $35 billion represents bonds of New York State and
New York City.
There is hardly a major bank or insurance company in this country
whose portfolio does not contain millions of dollars in New York
State and City bonds. The banks of New York State are estimated
to hold perhaps $5 billion in these bonds. The financial institutions of
America are, taken together, estimated to hold a total of perhaps $17
billion in New York bonds.
The effects of a default by New York City and New York State on
our financial markets are therefore clear.
I can only hope that Congress will take matters into its own hands
and pass this and similar legislation to head off a municipal bond panic
throughout the country.
Senate bill 2372, the Fair Financing for Local Government Act of
1975, assures the availability of credit on reasonable terms to counties
towns and cities whose finances are in order.
The Federal Government would stand behind the obligations of
local governments, protecting investors and encouraging them to invest
in their communities.
The act would further encourage the development of new sources of
private investment capital for local obligation bonds.
The Federal Government would provide reinsurance of 75 percent
of private insurance coverage an issuer could obtain.
Further, the act would provide that when a State assists local governments in securing credit, the Federal Government would guarantee
75 percent of any State obligations.
To qualify for Federal guarantees, the State agency must itself be
in sound financial shape, and must insist on rational budget practices
and accurate accounting procedures by local governments.
Mr. Chairman, I ask that a factsheet describing S. 2372 be included
in the record following my remarks.
The CHAIRMAN. Without objection t h a t will be so done.
[The document follows:]
FAIR FINANCING FOR LOCAL GOVERNMENT ACT OF

1975

1. The three key goals a r e :
(a) To lower interest rates paid by local governments on their bonds.
(b) To enhance the marketability of local government bonds.
(e) To promote sound local government finance without direct federal
intervention in local government financial affairs.
2. The Basic Plan:
A. A Fair Finance Insurance Board would be established by the federal government. The Board would charge premiums for its services and, like the Federal
Deposit Insurance Corporation, is designated to be self-financing.
B. Re-Insurance—Insurance policies are available for some municipal bond
issues. The Board would be empowered to reinsure 75% of municipal bond
insurance issued to a city by a private insurance company.




15
C. Guarantees—The Board would also be empowered to guarantee 75% of
the bonds issued by any state agency set up to help local governments. (Such
agencies already exist in Vermont, Maine, and New York, and some local government bonds are state-guaranteed in California, New Hampshire, Michigan, and
Minnesota.)
Sound economic standards for localities would be assured in three ways:
(1) Since 25% of the value of the bonds is not insured, the state would
have an incentive to monitor city finances and avoid losses should a city
default;
(2) The Board is required by the Act, before issuing a guarantee, to determine that the state agency prescribes and enforces strict accounting standards, financial controls, and balanced budget programs ;
(3) Any state agency which failed to comply would be disqualified from
the guarantee program.
3. The Fair Finance Insurance Board.
The Board would consist of a Chairman and four members, all appointed by
the President with the advice and consent of the Senate.
The Board Chairman and members would be individuals from academia, the
labor movement, commerce, or government, who are by their experience well
qualified to carry out the purposes of this Act. They shall serve terms of five
years.
In addition, the Secretary of the Treasury and the Secretary of Housing and
Urban Development will be ex-oflicio members of the Board.
4. Local Securities Market Study.
The Board will conduct a study of the national market in local government
securities, focusing especially on :
(a) The availability, and present and potential sources of funds for the
purchase of such securities ;
(b) Influences on, and developments in, interest rates for such securities;
(e) Suggested reforms in the financial structures and functioning, and
in present methods of financing the activities of local governments;
.(d) Federal and state efforts to assist in the marketing of such securities.
5. Local Government Advisory Committees.
The Board will establish special advisory committees to consult with it and
provide it with advice and needed information. These advisory committees will
consist of representatives of:
(a) City, county, and state governments :
f ib) The labor movement:
u ) The financial community.
S e n a t o r J A C K S O N . I do not claim t o have all t h e a n s w e r s t o t h i s immensely complex problems. R u t I believe t h e F a i r F i n a n c i n g A c t is a
start.
I t allows for the needed Federal role—without undue Federal interference with local government affairs.
It helps local governments which are trying to help themselves.
I t allows for a State role—and for a contribution from private
enterprise.
It is a major new step, but it is not so earthshaking a departure that
it is impractical. All it requires is recognition that the finances of cities
and towns and counties are a national concern—and the will to act
>vhen those finances are threatened.
The F a i r Financing for Local Government Act is a practical plan
to come to the assistance of local governments being badly hurt—
by the national recession, and national inflation. I t calls for national
action.
I urge that the Committee give this bill favorable consideration.
Thank you, Mr. Chairman,
I hope we act without delay because I believe, Mr. Chairman, that
the situation is so precarious that if a default occurs before we act,
an effort to try to pick up the pieces legislatively wTill be costly. And




16
it will not be as effective as will a remedy now, through the legislative
mill, to deal with that problem.
The CHAIRMAN. Thank you very, very much, Senator Jackson. W e
appreciate your presentation.
I t is a little puzzling to the Committee to know how to proceed.
Both of your colleagues are on the floor and I know you are interested
in that, too.
Senator JACKSON. I'm cochairing a conference where we have 40
participants on energy.
The CHAIRMAN. The principal provision of your proposal is that
the Federal Government would provide insurance of 75 percent of the
value of the obligations of the city or town or State that was involved,
is that correct, sir ?
Senator JACKSON. T h a t is correct, sir.
The CHAIRMAN. The other 25 percent could be provided in the case
of New York City, for example, by New York State or by private
group of businessmen or banks or any other group ?
Senator JACKSON. That is right. As the Chair knows, some firms
have started into the insurance business as it pertains to municipal
bonds on both ends. They will provide insurance for the investor and
also insurance to municipalities or subdivisions of a State. I think
one such company, and I believe the first to pioneer it, is M G I C with
headquarters in Milwaukee. They were the first to go into this particular market area. On a limited scale obviously. But their coverage
contemplates dealing with both situations.
The CHAIRMAN. NOW, you do not require that the instrument insured
be taxable. New York has indicated they are willing to pay the premium price or the penalty of issuing a taxable security that would 'be
guaranteed. There has been objection on the part of many people to
guaranteeing a nontaxable security because it would make it superior
to any other kind of issue.
To have 75 percent faith and credit of the U.S. Government, it may
be viewed by most as equivalent to a full coverage from a practical
standpoint and it would not be taxable. There has been strong resistance
in principle by the Treasury on that.
Senator JACKSON. The Chair raises a proper question. I would make
a couple of observations. This is of the essence. Time is running out.
There is a joint jurisdictional problem with the Finance Committee
that would have to be worked out,
I would point out two things. One is that the guarantee is 75 percent
and not 100 percent, so that if it is the judgment of the committee
that these bonds should be subject to tax it may be something less than
the total tax. That is a consideration in view of the fact that the guarantee of an issue is 75 percent and not 100 percent. As the Chair knows
most of the Government guaranteed bonds, such as those of the Farmers Home Administration, Federal Land Bank, and similar institutions, issues guaranteed by the Government, are exempt from State
and local financial taxes or other taxes under existing decisions of the
court. I assume that that would be kept in mind in connection with this
particular problem.
Mr. TOWER. Mr. Chairman, I have no particular questions. I feel,
however, that I would be remiss if I didn't make a comment. I feel I
would have to take issue with my friend from the State of Washing-




17
ton, who has been my ally in many battles not relating to New York
Cit
y". . . the situation is too serious to allow for playing politics," et
cetera—This has been hung on the administration by my distinguished colleague. If that tag applies to the administration, it applies
to a number of people in this country, both Democrat and Republican,
who raise rational and, I think, legitimate and pragmatic concerns.
There is widespread feeling all over the country that New York City
has lived beyond its means, played politics too often in passing out the
"goodies" as Fortune magazine has said, and has not managed its
affairs in the responsible way that the vast majority of cities in this
country have.
There are a lot of serious questions that the American taxpayer
raises in relation to this that have to be answered. I t doesn't stem from
callous indifference on his part or shocking irresponsible attitude. I
don't think it has much to do with ideology or politics. The vast majority of people in my State, bankers in particular, are opposed to doing
anything about New York City. They are lukewarm if they do favor it.
There is legitimate concern all over the country that we may set
dangerous precedents here that would result in the same sort of thing
occurring in other cities. I t is a concern that we will create problems in
other cities, rather than solving the problems for the one city.
Senator JACKSON. I think it was callous for the Secretary of the
Treasury and the White House, in general, to have said that is a New
York problem and it will not impact elsewhere. That is a failure to
understand the way in which a bond market will react.
May I say, one of the first letters that I received in support of this
legislation came from Governor Herschler, of Wyoming. They continue to sell their bonds. What concerned me is that the administration failed to comprehend the all-pervasive impact of what happened
in New York.
The fact is that your leading banks would be insolvent if New York
defaulted, and there is a failure to recognize, I think, the rim effect of
this kind of activity.
Saying that it is a New York City problem—I insist on a tough
financial standard—but to say it is just a New York City problem begs
the question. If New York defaults and Burns now has made a completed switch in his position, and he recognizes—if New York defaults
it will be chaos.
Helmut Schmidt, who is a responsible Chancellor of Germany, came
in and pointed out that the collapse of the New York bonds would
have an international impact. There is something in economics that
always gets us in trouble when we try to project. That is the element
of confidence and psychology. No one can read the numbers and try to
determine the psychological impact on a given situation. I t is in that
context that I made my statement. I stand by it.
I think there is a callous indifference. The administration is now
coming around to recognizing that it will impact beyond the State
of New York, and it already has.
Senator TOWER. I was simply saying that the perception of New
York as having been irresponsible is pretty widely held over the
country. We need to be concerned that wTe don't encourage other
cities to engage in spending beyond what its tax base or Federal or
State aid will support. If we do we will create much larger problems.




18
Senator PACKWOOD. I'm intrigued with some of Senator Jackson's
figures; $207 billion in municipal bonds outstanding in this country,
$35 billion of which are New York State or New York City bonds.
W h a t that means is that New York State with Sy2 ° r 9 percent of the
population of this country—they have 18 percent of the outstanding
debt interests in this country. I t seems to give credence to the claim
that they have been paying their way more on a debt basis than payas-you-go basis if those figures are true.
Senator JACKSON. I don't know whether you can come to that conclusion. I'm not here to discuss what has happened in the past in New
York City. The bill I'm proposing would require real tough standards
for meeting the eligibility requirement to get insurance. New York
City and State are engaged in a lot of activities. They have a power
authority that issues municipal bonds. They have been involved, as
the Senator knows, in large housing projects. One of the biggest ones
is the one that then Governor Rockefeller sponsored in the housing
field, that had been turned down by the people in the State in a referendum, and which he pounded through the legislature. I t has since
defaulted.
That issue is over a half-billion, and w^ent into default.
Senator PACKWOOD. I'm only saying that for some reason they used
debt financing disproportionately more than their population bears
to the rest of the population in this country.
Senator JACKSON. That may be. May I point out to the Senator t h a t
for one reason or another the top banks in the Nation, and the second
largest is there, and the third largest, First National City and Chase
Manhattan—they are heavily into those bonds. I assume bankers in
New York City are prudent, especially Chase Manhattan. I would
think that they must have recognized those bonds were good.
I t is not just New York City that has this problem. There is a
serious situation in Newark, Cleveland, Buffalo, and other places.
This legislation does not assist and help those who are not prudent.
All I'm saying is that you can't isolate New York City and New
York State from the rest of the Nation. That is the line the administration was taking until yesterday when Dr. Burns came down very
strong on quick, decisive action lest it create a panic.
Senator PACKWOOD. What does your bill provide in terms of Federal Government guarantees? Once we guarantee a bond and there is
a default, how do we get our money back ?
Senator JACKSON. We set up an insurance arrangement. There is a
1 percent fee you have to pay. If it is a 6-percent bond they have to pay
1 percent. T h a t goes into the corporation and that is the means of
financing.
Senator PACKWOOD. YOU mean every municipality has to pay that
additional 1 percent?
Senator JACKSON. Those who want to participate. Yes, it is insurance. You don't insure something without paying a premium.
Senator PACKWOOD. I n other words, every city that has a good credit
rating if they want to participate, their bond will go up 1 percent in
order to participate.
Senator JACKSON. The point I would make in response to that, and
it is an obvious one, the obvious point is with government insurance
their rating would go up and interest rate would go down. The Bond




19
Index has gone in a little over a year from 5 to 7.67 percent.
What this insurance program would do is bring that interest rate
down, and the 1 percent they pay would be more than compensated
because the rates would drop more than 1 percent.
So that they would have a lower service charge, and when you have
$207 billion in bonds and when the bond interest rate goes up 1 percent, obviously the increase in cost is over $2 billion a year. For
those municipalities or municipal subdivisions of a State. That is what
we seek to do.
Senator TOWER. Would the Senator suspend ? There is a vote on the
Senate floor. I understand there will be two back-to-back votes.
Under the circumstances we will recess the hearing.
Would you be able to come back, Senator ?
Senator JACKSON. Yes, I will come back.
I thank the Chair.
(Recess.)
The CHAIRMAN. Senator Jackson, we are glad to have you back. We
apologize for the interruption.
Senator Garn %
Senator GARN. Thank you, Mr. Chairman.
Senator Jackson, I don't want you to interpret my remarks as
anyway directed at you or your bill. I feel strongly about this issue,
as you well know. Nine months ago I was mayor of a city and president-elect of the National League of Cities. Among the majority of
mayors in this country, you would find overwhelming opposition of
bailing out New York City or anyone, primarily because those of us
who ran our cities in an efficient way and balanced our budgets—well,
New York gave us trouble for years.
We were told by our employees, this is what they pay in New York,
and we ought to be paid the same. Regardless of what we ultimately
decide to do with or for them, we ought to recognize what the causes
are. And, in my opinion, and in the opinion of a lot of other mayors
around this country, it is gutless, irresponsible leadership. We have
politicians in New York City who have yielded willy-nilly to every
demend by the unions, sanitation workers—$18,000 a year for a sanitation worker, et cetera.
My salary as a full-time administrator of an entire city was $19,400.
I was once talking to four or five New York State senators. I told them
this as bluntly as I have stated it here. T was surprised when they all
agreed with me since they were all representing New York City. One
of them said it is worse. He said sanitation workers put in 4i/£ hours a
day. You have seen how dirty New York is, they don't do a good job
at it anyway. That man said that the sanitation workers union is one
of the strongest in the city. "If I said to them what I just said to you,
we wouldn't be returned to Albany."
They have yielded to the pressures. I find it difficult to think the
residents of Utah or Oregon or anywhere else should put their backing
behind a city that is financially irresponsible. There is packing of that
city payroll, they have more employees per capita, and the services are
lousy, despite those expenditures.
This is not directly related to this bill. I think it needs to be said,
and the public ou^ht to know why New York is in the state they are
in. Maybe if the Governor of New York would put a sufficient tax on




20
the residents of New York State to bail them out, and the residents
said we don't want to do it anymore, then we would get more responsible leadership in that area, and the people would realize that they
have been getting ripped off.
That is a callous statement, but as a former mayor, I have little
sympathy for the kind of irresponsible leadership that has been exhibited in New York by the mayor and councilmen for a long, long
time.
Senator JACKSON. I appreciate the Senator's statement. I am not
prepared to go into the problems of the city of New York. We are
confronted with a condition, not a theory. What do we do if New York
defaults? There is an overwhelming majority view that the impact
of such a default could be catastrophic in terms of the financial community. I t is a situation which is pervasive and impacts everywhere. I
have some letters here. I have a letter from the mayor of Tucson strongly supporting the legislation, because of the problems they are running
into. They are a financially sound community. I am talking about interest rates and the ability to sell bonds.
The Governor of Wyoming strongly supports the legislation, because
they are running into trouble. They are running into trouble in my
State in being able to even sell bonds. We have to ask ourselves what
do we do in this kind of situation ?
W h a t I am suggesting here under this proposal is that you set up
an insurance program which should not cost the Federal Government
any money. They would pay a 1-percent premium into a fund like
the F D I C . I t should be self-liquidating. I t would have the effect of
at least dealing with a problem that has seriously affected areas other
than New York City. I n fact, the municipal subdivisions of every
area of the country have been hit. The value of a bond has gone down.
The interest rates have gone up. I t is continuing and will cost literally
hundreds of millions of dollars more in the immediate period to service
the debt on these issues. The city of New York is a separate problem.
I n order to qualify for insurance on future bonds, they would have
to make very stringent—meet very stringent criteria as set out in the
bill on page 10.1 wanted to emphasize that. This is not a bailout. This
is a sound insurance program, where when a community does have a
proper rating, a Moody rating, they can be eligible, and it will in effect
reduce the costs of servicing that debt. And, second, it will stabilize
the market, so they can sell the bonds.
The city of New York's problems, the city of Newark's problems,
the city of Cleveland's, are all separate issues. W h a t I am trying to
deal with is the impact that these developments are now having on the
situation. Now, we have got the assurance, I believe—the Chair would
know, because he is on the Joint Economic Committee—when Dr.
Burns testified they have a contingency plan to save the banks in
New York by, in effect, guaranteeing the paper or seeing to it that
the paper they hold will be honored. They will bail out, in effect, the
leading banks in New York, in the event of a default. The percentage
of bonds they hold should there be a default—percentage of New
York bonds they hold—should there be a default, would render some
of these banks or virtually all of them, insolvent.
The impact of insolvency in the major banks in New York would
reverberate all over the United States and in the international market




21
as well. Chancellor Helmut Schmidt recently made that comment.
Germany has probably one of the stronger economies of Europe. When
he makes that observation, I think it has to be taken seriously.
Senator GARN. With all due respect, I would not agree with you as
to the dire consequences that may happen as a result of default. I have
a real fear on the other side of the coin.
Senator JACKSON. What do you do with the banks ?
Senator GARN. I am not convinced that the banks would fold because
of this.
Senator JACKSON. Dr. Burns said unless the Fed is prepared to
step in, they will be insolvent. I don't think it could be any stronger.
You are talking about the second and third largest banks in America.
The second largest is First National City and third largest is Chase
Manhattan.
Senator GARN. I don't always agree with Arthur Burns.
Senator JACKSON. I don't always, but he has nowr made a 180° turn.
Senator GARN. We hear about the dire consequences that wrill happen, if we do not help in New York. I think there are dire consequences
on the other side. There are a lot of other mayors around the country
who would like to be reelected. I think you can see a trend of a city
saying, "I can go ahead and promise the big pension benefits and free
this and that and if I get in trouble, the precedent has been set, because
they bailed out NewT York and they will now hail out me.*' I think
there are consequences in that direction.
Senator JACKSON. This bill is not a bailout.
Senator GARN. I understand that. T am diverting from your bill
to make some of these other comments.
The CHAIRMAN. I undei*stand Senator Packwood has not finished.
The Secretary of the Treasury has agreed to come down, but he has
an urgent appointment later.
Senator PACKWOOD. It seems. Senator Jackson, New York can be
bailed out for one of three reasons. They are more deserving of any
other city. Two, the banks will fail and w^e can't allow the banks to
fail. Three, other cities won't be able to sell municipal bonds if New
York defaults. T am not sure the last case has been made yet. I was
intrigued with the New York Times story yesterday about the American Bankers Association Convention in New York. A survey of bankers' attitudes was conducted by the Newr York Times. Questionnaires
were handed out to 2,000 banker's. The respondents represented a wTide
cross-section of the banking community, both geographically and in
size of institutions. The results were that, despite Mayor Beanie's pleas
to the banking convention, by margin of more than 2 to 1, the bankers
felt that the Federal Government should not assume a role in the New
York financial crisis. If the banks are worried as you suggest-—this
poll does not indicate that. This poll indicates that the overwhelming
bulk of the bankers in this country are not really seriously worried
about New York City defaulting on its bonds,
T have no other questions, Mr. Chairman.
Senator JACKSON. May I observe that, of course, the bulk of the
bonds are held by the New York banks. You might ask the Secretary
of the Treasury what would happen to the banks in New York if
New York defaults.




22
May I mention that my understanding is, and I may be wrong, but
the Chair, I am sure, will be pursuing this, that Mr. Wriston, who is
head of First National City, and Mr. Rockefeller, who is the head of
Chase Manhattan, have come out for help. Their banks are pretty well
loaded with these bonds.
Senator PACKWOOD. That is the reason they called for help probably.
They have a heavy portfolio of these bonds.
Senator JACKSON. Would you allow the banks to go into insolvency ?
Senator PACKWOOD. I am not sure nor am I sure of the merits of your
bill to require all municipalities to pay another percent.
Senator JACKSON. Not require.
Senator PACKWOOD. They won't be able to sell their bonds unless
they join.
Senator JACKSON. I t is voluntary.
Senator PACKWOOD. But from a practical standpoint you can't sell
your bonds unless you join.
Senator JACKSON. I t is practical. It says those municipalities that
can qualify, should not be penalized in interest rates by what happens
elsewhere. That is the thrust of it. The most important thing in economics, where the forecasters all go off the deep end—Einstein started
out life being an economist and after 18 months he quit, because he
found it too imprecise, too indefinite and too uncertain, and turned to
the study of mathematics or physics. The forecasters go off in human
behavior, the so-called element of confidence or lack of it, the psychological impact. Those are not measurable things, because human beings
are not measurable.
W h y should we penalize cities that are solvent, cities that are in a
position to demonstrate that they have a good fiscal policy? Why
should we penalize them ?
Senator PACKWOOD. YOU say they are being penalized, because of
New York City's potential default and that is the reason interest rates
are going up. I don't think that case has been proven yet.
Senator JACKSON. Mr. Chairman, I suggest you bring in people. We
have been in touch—I tried to study these things carefully—we have
been in touch with people in the financial community here, experts on
municipal bonds and the bond market. I would prefer not to testify on
that. Call for the best evidence. The best evidence is the people that
are qualified in that area. The overwhelming information that has been
coming into us is that that case has been made. The bond market is
in a state of disarray. May I suggest that one man in the private sector
who happens to be in the second oldest firm, Henry Kaufman, is probably one of the ablest economists in the country, with Solomon
Brothers. If you want to look for a scholar, if you want to look for an
outstanding businessman and investment banker, you might ask him to
testify. I think you would get a good deal of what all this means.
I am not saying bring in a wild character from Podunk, from some
college, who may have a different view, but I am talking about one of
the oldest and biggest bond houses in the country.
Senator PACKWOOD. I S that the same Kaufman who said a year ago
that if we have $70 billion in debt interest rates would rise?
Senator JACKSON. I don't know about that, but I would say Mr.
Kaufman is one of the outstanding economists in the country. I n the
area of interest rates his track record is good. If you have an economist




23
who has a perfect record, I would like to meet that one. I have never
met one who has had a perfect track record.
Senator RIBICOFF. Mr. Chairman, first my appreciation to you for
allowing me to participate in these hearings. Senator Jackson, the
comments made by our colleagues, Senator Garn and Senator Packwood, have to be taken very seriously, because they do reflect a large
segment of thinking in the United States. The points they make will
be the subject of continuous argument in committee and on the floor.
I think a couple of points should be made to take into account their
comments. First, your bill is not a New York City bill. I t is national
in scope.
Senator JACKSON. That is correct.
Senator RIBICOFF. A recent Congressional Research Service report
shows out of 140 local governments surveyed, 122 entered the current
fiscal year with a combined surplus of $340 million. They will end the
year with a $40 million deficit. This indicates that you have a national
trend that involves more than New York City. Isn't that correct?
Senator JACKSON. The Senator is correct. There are several cities
that are really on the brink, that are in deep, deep trouble.
Senator RIBICOFF. At the beginning of the week, under the chairmanship of Senator Humphrey before the Joint Economic Committee,
14 of the mayors of the largest cities of America even cities in good
financial condition testified that there was a great ripple effect
throughout the Nation, affecting their ability to finance and raise
money for bonds, and when they did their interest rates were up
between 100 and 200 percent, because of the New York situation.
Senator JACKSON. The Senator is correct. When it goes up just one
point with a $207 billion outstanding municipal portfolio, it goes up
$2 billion, just 1 percent with that kind of portfolio.
Senator RIBICOFF. Mayor Landrieu was on the Today Show this
morning and made a pertinent comment. He said New York City had
become the national service center of America, that the problems of the
entire Nation were dumped into New York. It is losing middle class
population and jobs and getting the poor, black, and the old coming
into New York City. As a consequence, the problems of the Nation
are being clumped onto the backs of New York City.
In 1971 before the Finance Committee I proposed that we nationalize
welfare. If in 1971 we had nationalized welfare, New York City and
New York State would have had a billion dollars more in revenue.
The revenue received, a billion dollars a year, would have helped prevent New York City from reaching the deficit state it is now in. We
have a problem. We have been studying this so long. Welfare is national in scope. The blacks and poor keep coming in from the South over the
last two decades into New York City. The white middle class come into
Connecticut and we are glad to have them, or New Jersey. That city
goes down as we drop the poor into NewT York.
Senator JACKSON. I have made speech after speech supporting your
position. I t makes no sense to require the States—ever since the Supreme Court rule that there can be no residence requirement in connection with eligibility for welfare—to place the burden of that task,
which is a national responsibility, on the States and the cities. In my
State, the State of Washington bears its 50 percent, but in NewT York
the city of New York bears




24
Senator RIBICOFF. Twenty-five percent.
Senator JACKSON [continuing]. Twenty-five or 30 percent of the
share that is borne by the State. I t is into NewT York City where you
have had the greatest influx.
Senator RIBICOFF. I t is even more than that, Senator Jackson. We,
in the Congress of the United States, have jiggered all Federal contributions in such a way as to help the rural areas at the expense of
the city.
The welfare payments go from the Federal Government, anywhere
from 50 percent to the States like New York and Connecticut to 83
percent to the rural cities in the United States. Then they dump their
rural poor into New York City. The revenue-sharing formulas in
this country unfortunately do not take into account sufficiently the
urban factor and welfare.
If the administration is sincere, there is much they can do to come
to the Congress and try to have a sense of equity throughout the
United States on all our revenue-sharing formulas, because the revenue-sharing formulas are so structured to make sure that cities like
New York remain poor.
Senator JACKSON. I agree with the Senator. I support his position.
Welfare is a national problem and requires a national solution. When
you have these pockets like New York City, where you have inordinate
influx of people wTho, in turn, represent an inordinate percentage of
those who go on welfare, you are inviting bankruptcy, and I know
of no other area in the United States where there has been such a
heavy influx of people coming in, who will become eligible for welfare.
The CHAIRMAN. Thank you very mudi. Senator Jackson. You have
been most helpful.
If the committee would permit, I'd like to suggest that we do
something a little different. Secretary Simon is here. Senator Humphrey is here. We have asked Secretary Simon if he would permit
Senator Humphrey to speak for 7 or 8 minutes and give his presentation and then ask the committee if they would agree to simply let
Senator Humphrey go. That's asking an awful lot, knowing Senator Humphrey, but will you come forward right now and deliver your
statement without our having a chance to question you ?
STATEMENT 0E HUBERT H. HUMPHREY, U.S. SENATOR FROM
MINNESOTA
Senator HUMPHREY. Mr. Chairman, you're going to miss a great
opportunity.
The CHAIRMAN. I'm sure we are.
Senator HUMPHREY. I think you're denying yourself the best part
of the day.
The CHAIRMAN. I'm sure we are. Go ahead.
Senator HUMPHREY. Mr. Chairman and members of the committee,
as Senator Jackson and others have said here earlier the Joint Economic Committee had hearings on this subject. I believe that the
chairman was very active in those hearings as was Senator Ribicoff
and others. I am presenting to the Senate today a bill which would
establish an Emergency Intergovernmental Assistance Board to extend
aid to hard-pressed municipalities and local governments.




25
I also present for the use of the committee a short description of
the bill.
The CHAIRMAN. And the statement will be printed in full in the
record.
Senator H U M P H R E Y . If one examines the issue before this committee
carefully, it's clear that the question before your committee is not,
"Should the Federal Government provide assistance to New York?"
but rather, "Should the Federal Government provide assistance before
or after default?" That's the issue. Let me explain to the committee
what I mean by this statement.
If the Federal Government does not assist New York City by midDecember the city will most certainly default on its obligations before
the end of the year. We have had no testimony to the contrary. However, the act of default will not eliminate the need for the city to
borrow money. The city will have to borrow approximately $1 billion
in January, February and March in anticipation of real revenues that
will be received later in the fiscal year.
Now the city will have to borrow that money or close down. So the
question is: What does default do to the capacity of the city to borrow
the billion dollars that it has to have just as surely as human beings
have to have water and air in order to live. The city will also have to
borrow to help cover the deficit this year, a borrowing which even
those who are calling for large cuts in the operating budget of the city
realize is necessary. If the city cannot obtain these funds, which is
certainly probable if the city were in default, it would simply be
unable to meet payrolls, to issue assistance checks, to provide the
public services that a people in a large metropolis need.
Clearly, the result would be disastrous. We are not just talking
about an ordinary financial operation. We are talking about literally
the life and the death of a city—its ability to provide for its people.
At this point the Federal Government would have no choice but to
intercede. I believe this committee has to consider the possibility of
open chaos in the city of New York with all the adverse consequences
that implies. The city must have a billion dollars in borrowing before
the anticipated revenues from taxes can be collected.
It is this fact of life which causes me to conclude that there's no
constructive purpose to be served by default. Federal assistance will
be necessary even subsequent to default. In fact, the need for Federal
assistance may even be greater if the effects of default are as serious
as some here have projected, and the Chairman of the Federal Reserve
Board has made it very clear that if the city defaults the Fed has
emergency plans to save the banks. I only wish that the Chairman of
the Federal Reserve Board were chairman of the city because he takes
care of his clients. His constituents, he has testified in this very room
as of yesterday, will be protected by unlimited funds for the banks.
So what you're really considering is do we take preventive action
before default or do we let default or bankruptcy run its course. Then
ask yourselves the question: Who will loan the*city a billion dollars
to operate from December until April ?
Consider those cold months in New York City; consider no police,
no firemen, consider no sanitary services; because the billion dollars
is absolutely essential to the city. I t must borrow and then can collect
the taxes that would repay the billion dollars.




26
Now after default or bankruptcy you have to ask yourselves what
rate of interest would they have to pay on the billion dollars or could
they even get it at all ? That's New York.
The subject of today's hearing is undoubtedly one, however, whose
significance extends far beyond the boundaries of New York City and
New York State. This is no bailout of New York City or New York
State any more than saving the Franklin National Bank w^as a bailout
of that bank. That was to save the banking structure of this country.
That's what that was all about. That was its justification. The Federal
Reserve Board did not save Franklin National Bank because they loved
the officers of Franklin National, who had mismanaged Franklin
National. The Secretary of the Treasury will tell you, as has the
Chairman of the Federal Reserve Board under testimony before the
Joint Economic Committee, that the Federal Reserve Board stepped
in to save Franklin National for fear that if they didn't, it would tear
apart the entire banking system. He's testified to that. It's a matter of
public record.
To be sure, the 8 million Americans that reside within the boundaries
'of this city will be most seriously affected. But even without default
they face significant cutbacks in services, freezes on employee wages,
work force reductions, and other severe hardships. I n fact, most of
those steps have already been taken. Only yesterday, Senator Proxmire, you outlined in the Joint Economic Committee the steps that had
been taken by the city of New York and the State of New York. I will
not burden the record with going through those again, but they were
many.
The issue becomes all the more serious when it is recognized that
the State of New York is now involved in the finances of the city.
I t is likely that the mere existence of the default will greatly jeopardize New York State's own ability to obtain financing in the capital
markets. That's been testified to by the Chairman of the Federal
Reserve Board and others. We must all understand that the State
will have to borrow up to $4 billion for its own purposes and functions by June 1976, a feat which would be improbable should the city
default and further increase skepticism about any security with the
name of New York on it.
NOWT the State of New York has made huge investments to temporarily ease the situation in New York City. But if New York City
defaults the entire financial structure of the government of the State
of New York is put in jeopardy—not my words, but the testimony
is here. I'm not here to testify for New York. I'm here to testify for
the country, for the banking system of this country, for the municipalities of this country, because the problems extend beyond the boundaries of any one State or city.
Interest rates in the municipal bond market have soared to usurious
levels. Yesterday the Chairman of the Federal Reserve Board said
the last 2 weeks had shown unbelievable increases in interest rates
on municipals that are tax exempt. I won't go down through the
list of them, but they are going to 10 percent. Incredible.
We had a panel of 13 mayors testify before the J E C . W h a t did
they say ? They were from all over the United States. They weren't
in here testifying for New York. They wTere testifying for themselves.
They realized very early that a policy of default would be penny




27
wise and dollar foolish. I t wasn't with any great affection or benevolence for New York City that precipitated this supportive testimony but a clear appreciation of the fact that the uncertainty caused
by New York's financial crisis wTas costing all of them millions and
millions of dollars. As Senator Jackson pointed out here a moment
ago, a 1-percent increase in municipal bond rates on the amount
of outstanding bonds would be equivalent to a $2 billion increase in
interest that has to be borne by the people of the municipalities that
are A - l credit ratings.
You poison the whole thing. I tell you, it's like putting poison in
the well from whence we all have to drink. Now once that's done,
everybody gets a little sick. There's even a real threat that a default
by New York City would seriously weaken the economic recovery
now underway. Who testified to that? Chairman Burns. Who else
testified to it ? Helmut Schmidt, the Chancellor of the Federal Republic of Germany who is considered to be one of the most able financial
experts in the Western World. The New York Times yesterday contained an article which cited quotations from several international
economic experts warning of the international repercussions of such
a default. As you said here yesterday, Mr. Chairman, it was a bank
in Austria that failed in the early 1930's that precipitated at total collapse of the financial markets. I can't even remember its name. This
is a very delicate, sensitive operation.
I'm proposing legislation which has been discussed by others.
Several members of this committee have contributed to this legislation.
It's not original. None of you necessarily wish to take the responsibility for it, but at least you have made an input as Chairman Burns
did yesterday. I am introducing legislation that would enact the Intergovernmental Emergency Assistance Act. I t provides a simple and
reasonable mechanism for averting municipal defaults and bankruptcies and the serious consequences that could ensue. I t is simple
so that it can be implemented quickly to meet the immediate crisis.
Yesterday Chairman Burns said if the Congress is to act it must
do it promptly. Chairman Burns further said that while as of yesterday he would not favor Federal legislation, he said it was his responsibility to deal with the facts and not be locked into a position. I
believe that the testimony yesterday of the Chairman of the Federal
Reserve Board indicates that he's watching the facts very carefully
and the facts are not at all encouraging.
My bill would establish an Emergency Intergovernmental Assistance Board of five members: the Secretary of the Treasury, the Secretary of Housing and Urban Development, and three members appointed by the President with the advice and consent of the Senate.
The Board will determine by majority vote the elegibility of jurisdictions that apply for assistance. Tf the Board approves an applicant
its recommendation is passed to the Secretary of the Treasury who
must then provide assistance through a guarantee of taxable State
or local government general obligation bonds.
Any city will be eligible when it fails in a bona fide attempt to obtain
private financing. The Board, made up of the five appointed by the
President, will determine whether or not a bona fide effort has been
made to obtain private financing. Local governments must apply with
the approval of the State, have failed in an attempt to obtain private




28
financing, be certified by the State that all State remedies have been
exhausted, and that further State assistance will jeopardize the credit
worthiness of the State. Through these provisions we are assured that
all reasonable non-Federal remedies have been exhausted.
The major prerequisite for assistance under my proposal is that
each State must submit to the Board for itself or for the eligible local
government a 3-year financial plan. The plan shall detail the applicant's projected revenues, expenditures, scheduled borrowings and
other information as the Board shall require. The plan, which the
State will be responsible for enforcing—mind you we hold accountable
the State—must also contain specific proposals to assure the achievement of the balanced operating budget within 2 years; (2) a specific
proposal for the retirement of the applicant's noncurrent short-term
debt; (3) specific assurances that the State will allow the eligible
government to raise whatever taxes are necessary to avert default;
in orther words, self-help—and—no expenditures or borrowing will
be permitted unless they are included in the plan.
Any State which fails to enforce the provisions of the plan would
have its entire revenue-sharing payment from the Federal Government
withheld until compliance is achieved. Now I tell you that's strong
discipline. I do not believe in a bail-out. I do not believe in a handout.
I do not want to see this become anything that will lead to more and
more municipalities coming to the Federal Treasury.
My provisions in this bill are tough. They are stringent. They are
strict. They are spartan. They require the local government to have
exhausted every means, including tightening up on its budget, including State control of its finances, including if you please a program in 2 years to put the city's obligations and revenues in balance.
All the restrictions and limitations that I think are reasonable and
feasible—These are the provisions that have been testified to by the
Chairman of the Federal Reserve Board.
I have left out only one and I'm sure the committee will want to
consider it. The Chairman said that he thought that the State ought
to have a special tax that would fund 50 percent of the operating
deficit of the city. I didn't include that because many States today
may not be able to handle that. For example, New York State itself
may have some trouble. But this is a matter for the committee to
consider.
Finally, this approach conforms very closely to testimony before
the Joint Economic Committee. While Chairman Burns did not advocate Federal assistance at this date, I remind you he did not rule
it out. But as of this time, he did suggest that any assistance program
should include the following elements: strict limitations should be
placed on eligibility to that Federal assistance is targeted only on
cities and States in dire financial distress: (2) the State should supervise the management of the city; (3) the Federal Government should
require a strict financial plan with no expenditures or borrowings
permitted that are not included in the plan; (4) a fee should be paid
to the Treasury for the right to assistance; and (5) a State tax should
be leveled to pay one-half of the annual operating deficit of the
eligible unit of government.
My proposal includes all of those provisions with the exception of
the last. However, my proposal does say that the State should give




29
the city additional taxing power over and beyond what it may ordinarily have in order to take care of as many of its needs as possible.
Now I have tried to keep within reasonable limits of time, Mr.
Chairman, but I want to conclude on this basis. We are playing here
with fire that could spread. This country has a fragile recovery. I
want to remind this committee that many banks in this country are
overloaned. I want to remind this committee that these securities of
New York City are held by some of the largest banks. I remind you
that the big banks have been in to testify that something has to be done
and the reason that they are testifying that the Federal Government
has to do something is that they know that if New York City defaults
that they may be in jeopardy. All you've got to have is two or three
of these big ones start to fall apart and the entire banking structure
of this country will be in a serious situation.
Then we'll come rushing to the Federal Reserve System. They will
open the discount window. There will be unlimited amounts of credit
whihc jeopardizes again the money markets which really throws the
economy into an uproar.
Why can't we take preventive action before bankruptcy or default
is forced upon us ? I submit to you that when top people internationally
tell us that this could jeopardize their recovery because they are tied
in so closely to us; when the Chase Manhattan Bank gives you information as to what's necessary, when the Chairman of the Federal Reserve
comes down here and tells you that a default could seriously impair our
recovery, I think that it's time to act.
Might I say that mayors and Governors and other public officials
throughout the country have been making this case as well. I understand, may I say, that our good and distinguished friend, the Senator
from Oregon, had some concern about other areas. I have a letter here
from the State Treasurer of the State of Oregon. I t was a copy of a
letter addressed to the Honorable William Simon, Secretary of the
Treasury.
The State Treasurer of Oregon is one of those who's very concerned.
He says, u A s the State Treasurer of the State of Oregon, and one of
those most closely concerned with the vagaries of the municipal bond
market, I am writing to you to express my concern about the course of
events in New York City, both past and present,"
Then he says, " I have, however, concluded that the State of Oregon
paid at lejftst one-eighth percent more because of the dislocation and
disarray of the municipal bond market. That dislocation and disarray
were, in fact, cauesd by the woes of New York City."
Then over on page 2, "the administration has considered, and apparently rejected, the concept of a guarantee which would strip away
the tax-exempt status of the bonds. I believe that this should receive
further consideration."
And he goes on to point out that something has to be done.
Now the question of what you want to do is another matter, but I
am here to testify that we will imperil our recovery, we will jeopardize
the municipal bond market, we will threaten the solvency of the banking structure of this country, and we could precipitate a major economic disaster unless something is done promptly—promptly—to
alleviate the situation which plagues New York City and the State of
New York at this time.

60-832 O - 75 - 3




30
New York City is not a normal city in any way. When you've eliminated the residency requirements for welfare and you've got Eastern
Airlines flying you've got problems. You have poor people by the
thousands pouring into that city and you have people entering from
the international community by the thousands. It's imperative that the
Government of the United States have an interest in the port of entry
to the United States. I t would be incomprehensive to me that the
French would let Paris go bankrupt or in default. It's incomprehensible to me that even Britain with all of its problems would let London
be defaulted or go bankrupt. New York City is special in this country.
I am not here as a resident of New York or as a citizen. I am a
former mayor of the city of Minneapolis, and I will tell you something;
the city of Minneapolis is suffering today because of New York City's
potential default. There isn't a Senator in this body or a Member
of the House that ultimately will not feel the repercussions in his or
her State or district of a default on the part of New York City.
Now you just may talk about how much money we're going to spend,
but if New York defaults bond rates go up, taxpayers will pay.
Taxpayers pay the interest on the city bonds, taxpayers pay the
interest on State bonds, and quite honestly, all we're talking about here
is a guarantee of a loan—a loan guarantee of some kind or an insured
loan of some kind that will be under the most strict terms of repayment and of sound fiscal management,
I wTould hope that this committee would see fit to do something
about it.
The Chairman. Thank you very, very much, Senator Humphrey. I
want to thank you on behalf of all the members of the committee. I
know that some members vigorously disagree with you and some
enthusiastically agree.
I'd say just two things. One is that you have made a very constructive proposal to us, a very thoughtful proposal, one that I think helps
us greatly in proceeding; and second, in all the years I have been
sitting in hearings, this is as stirring and persuasive a presentation as
I have ever heard. Thank you very much.
Senator HUMPHREY. May I ask, Mr. Chairman, that the letter to
which I referred—because I'm sure Senator Packwood would want to
see the letter—be included in the record, as wTell as a copy of the bill,
the description of the bill, and the full body of testimony ?
The CHAIRMAN. Very good.
(Complete statement and documents follow:)
STATEMENT OF HUBERT H.

HUMPHREY, U.S.
MINNESOTA

SENATOR FROM THE STATE OF

Mr. Chairman and Distinguished Colleagues: I appreciate the opportunity to
appear before this distinguished Committee and to present my views on New York
City's financial crisis. In my testimony today, I will focus briefly on the scope of
New York's financial problems and then discuss in greater detail the legislation
that I will introduce today on the floor of the Senate.
I must confess that the subject of the Committee's deliberations is one of the
most complex that I have confronted in my many years of public service. Uncertainties abound at every turn and few have been able to sort fact from fallacy.
Even the most distinguished experts have been unable or unwilling to clearly and
substantively identify the scope and dimensions of the problem. Yet, every possible
public solution, including the "do-nothing-until-default" alternative advocated
by the Administration, carries with it great risks and undetermined liabilities.




31
In fact, if one examines this issue more carefully, it is clear that the question
before your Committee is not "Should the Federal Government provide assistance
to New York City?", but rather, "Should the Federal Government provide assistance before or after default?"
Let me explain to the Committee what I mean by this statement. If the Federal
Government does not assist New York City by mid-December, the city will most
probably default on its obligations before the end of the year. But the act of default will not eliminate the need for the city to borrow. The city will have to borrow approximately $1 billion in January, February, and March in anticipation of
real revenues that will be recevied later in the fiscal year.
In addition, the city will have to borrow to help cover the deficit this year—
a borrowing which even those who are calling for large cuts in the operating
budget of the city realize is necessary. If the city cannot obtain these funds—
which is most probably if the city were in default, it would simply be unable to
meet payrolls, to issue assistance checks and to provide services. Clearly, the
result would be chaos. At this point, the Federal Government would have no
choice but intercede.
It is this fact of life which causes me to conclude that there is no constructive
purpose to be served by default. Federal assistance will be necessary even subsequent to default. In fact, the need for Federal assistance may even be greater
if the effects of default are as serious as some have projected.
The subject of today's hearing is undoubtedly one whose significance extends
far beyond the boundaries of New York City and New York State. To be sure, the
8 million Americans who reside within the boundaries of the city will be most
directly affected. Even T
without default, they face significant cutbacks in services,
freezes on employee w ages, and work force reductions which will undoubtedly
have a severe impact on the regional economy. In fact, most of these steps have
already been taken. However, with default, even in the best of worlds, the consequences for the city would be unfathomable.
This issue becomes all the more serious when it is recognized that the State
is now involved in the finances of the city. It is likely that the mere existence of
default will greatly jeopardize the State's own ability to obtain financing in the
capital markets. We must all understand that the State will have to borrow up
to $4 billion for its own purposes and functions by June 1976, a feat which would
be improbable should the city default and further increase skepticism about any
security with the name New York on it.
But the problems extend far beyond the boundaries of the city and the state.
Interest rates in the municipal bond market have soared to usurious levels. A
few cities have even had to pay above ten percent interest on a tax exempt
security. Ironically, these cities are really just innocent victims of the uncertainty caused by the New York City situation. These cities are not fiscally irresponsible. They are not bad credit risks. They do not have huge operating
deficits. They are simply victims of a situation over which they have no control.
We had a panel of thirteen Mayors testify two weeks ago before the Joint
Economic Committee in support of Federal aid to New York City. Mayors came
from all over the country, from the central cities and the suburbs. They could
easily have said, "this is a New York problem and we don't want to get involved."
But they realized very early that such a policy would be penny wise and dollarfoolish. It wasn't any great affection or benevolence for New York City that
precipitated their supportive testimony, but a clear appreciation of the fact that
the uncertainty caused by New York's financial crisis was costing all of them
millions of dollars—not just this year but for many to come.
There is even a very real threat that a default by New York City could seriously weaken the economic recovery that is now underway. Yesterday, Chairman Arthur Burns of the Federal Reserve System testified before the Joint
Economic Committee and said, "I recognize that a default, besides being a very
serious matter for the City and State of New York could have troublesome consequences for the Nation at large." It is certainly conceivable that interest rates
will rise if the city should default, putting a crimp into many investment plans.
Moreover, lending institutions that own a large number of municipal bonds will
undoubtedly be very cautious in their extensions of credit.
We have even seen the first examples of international concern about New York
City's financial crisis. Last week, Helmut Schmidt, Chancellor of West Germany,
warned of an international "domino effect" should New York City be allowed to
default. Yesterday, the New York Times contained an article which cited quotations from several international economic experts warning of the international
repercussions of a default. To quote just one, Christopher Gruebles, a director




32
of the Union Bank of Switzerland, "We feel that it (default) would seriously
affect capital markets and might also affect the dollar."
The legislation that I am introducing today, the Intergovernmental Emergency
Assistance Act, provides a simple and reasonable mechanism for averting municipal defaults and bankruptcies and the serious consequences that would ensue.
It is simple so that it can be implemented quickly to meet the immediate crisis.
Yet, the requirements that it imposes are sufficiently stringent that only the
worst cases will apply and qualify.
The bill establishes an Emergency Intergovernmental Assistance Board composed of five members—the Secretary of the Treasury, the Secretary of Housing
and Urban Development, and three members appointed by the President with
the advice and consent of Congress. The Board will determine, by majority vote,
the eligibility of jurisdictions that apply for assistance.
If the Board approves an applicant, its recommendation is passed on to the
Secretary of the Treasury who must then provide assistance through a guarantee of a taxable state or local government general obligation bond.
Any state will be eligible when it fails in a bona fide attempt to obtain private
financing. Local governments must (a) apply with the approval of a state;
(b) have failed in an attemp to obtain private financing; and (c) be certified
by the state that all state remedies have been exhausted and that further state
assistance will jeopardize the credit-worthiness of the state. Through these
provisions we are assured that all reasonable non-Federal remedies have been
exhausted.
The major prerequisite for assistance under my proposal is that each state
must submit to the Board, for itself, or for the eligible local government, a
three-year financial plan. The plan shall detail the applicant's projected revenues, expenditures, scheduled borrowings and other information as the Board
shall require. The plan, which the State will be responsible for enforcing, must
also contain (a) specific proposals to assure the achievement of a balanced
operating budget within two years, (b) specific proposals for the retirement of
the applicant's non-current short-term debt, and (c) specific assurances that the
state will allow the eligible local government to raise whatever taxes are necessary to avert default. No expenditures or borrowing will be permitted unless
they are included in the plan. Any state which failed to enforce the provisions
of the plan would have its entire revenue sharing payment withheld until compliance is achieved.
It is these strong financial controls which make it unlikely that many governments will participate in the program. No local government will be willing to
give up the power of the purse to the state unless its very survival is at stake.
The approach that this legislation takes, conforms very closely to the approach
that Chairman Arthur Burns of the Federal Reserve System suggested in testimony before the Joint Economic Committee yesterday. While Chairman Burns did
not advocate Federal assistance at this time, he did suggest that any assistance
program should include the following elements:
(1) Strict limitations should be placed on eligibility so that Federal assistance is targeted only on cities and states in financial distress;
(2) the state should supervise the management of the city ;
(3) the Federal government should require a strict financial plan with no
expenditures or borrowings permitted that are not included in the plan;
(4) a fee should be paid to the Treasury for the right to assistance; and
(5) a state tax should be levied to pay one-half of the annual operating deficit
of the eligible unit of government.
The bill that I offer today incorporates four of these five elements. First, since
an eligible government must issue taxable, rather than tax exempt securities, it
will pay a higher interest rate for its borrowing. This higher interest rate, combined with the relinquishing of the power of the purse, will prevent all but the
hardship cases from applying. Second, the state will be responsible for approving
and enforcing all of the elements of the plan, thus taking over the management
of the city. Third, the approval of a strict financial plan is a clear prerequisite for
receiving assistance under my legislation. Fourth, the legislation that I am introducing today imposes a fee of one percent for administrative and guarantee
expenses.
The bill does not incorporate a special one-year state tax because I believe a
significant tax increase may be too difficult for the state to bear in the current
recession. However, I would not rule out this suggestion if it could somehow be
made less onerous and the economic impact thus reduced. My bill does take as




33
collateral the state's revenue sharing payment, which, in my opinion, is a
negative sanction of comparable amounts.
The advantages of the bill, however, go well beyond the requirements that
Dr. Burns mentions.
First, it is a temporary solution to a short-term problem. The bill is not a substitute for normal revenue collections. It will not affect existing activities in the tax
exempt market. Rather, it will temporarily supplement the tax exempt market in
those few cases where the market cannot meet the financial needs.
Second, the program is very carefully targeted to assist only the most financially strained states and municipalities. It requires that the state or city fail in a
bona fide attempt to obtain private financing, thus limiting the program essentially to those states and cities that have lost their line of credit completely.
Further, the interest cost of these notes will be above all but the most distressed
bids in the tax exempt market, screening out all states and cities that can obtain1
reasonable private financing. In addition, as I mentioned earlier, the city would
be giving up control of its budget.
Third, the requirement for a strict financial plan for balancing the city or
state's budget and retiring its outstanding short-term notes develops a partnership in which the city, state, and Federal governments are working together to
solve the recession-induced fiscal problems. This plan prevents the Federal government from essentially taking over the management of the city. Development of
the plan and control over finances is left to the state. On the other hand, the plan
insures that the Federal government will not be caught holding the bag of bad
debts that no one else would reasonably purchase.
Fourth, this legislation incorporates a simple mechanism that can be quickly
implemented, thus dealing with immediate crises that require immediate solutions.
Fifth, this legislation will have a very positive impact on issues in the tax
exempt market. It will significantly reduce the supply and demand pressures in thM
tax exempt market, thus improving the bids for bonds and notes of all other states
and cities. More important, however, it will temporarily remove from the tax
exempt market those bonds and notes which are creating the greatest uncertainties in the market and thus the greatest skepticism about tax exempt
securities.
Finally, the bill will actually make money for the Treasury by closing up the
tax expenditure that tax exemption normally provides to the purchasers of these
securities. The annual gain to the Treasury could be as much as $400 million.
To be honest, there would be an offsetting rise in Treasury borrowing costs since
this will would expand the supply of Federal government securities.
I feel compelled to discuss frankly and honestly the total value of the securities
that the Federal government must guarantee. The estimates of the Joint
Economic Committee staff indicate that as much as $10 billion worth of city and
state securities will have to be guaranteed to avoid a major default. This is no
doubt a large sum of money, but there is no half solution to this problem.
Anything less than this amount will merely delay default for six months, and at
that point, the Federal government will be holding the bag.
However, the Federal government's actual liability is certainly far less than
this amount. If we can judge from rthe experience of RFC loans to state and
local governments in the 1930's, w e will probably experience losses of less
than one percent. More important than this historical precedent, however, is the
fact that the city and state revenue bases are simply not going to disappear.
In fact, the gill that 1 have introduced a specifically mandates that states allow
cities to raise taxes in order to avert default. This provision protects the Federal
investment.
In the case of New York, we must take special note of the fact that the city
pays approximately $1.6 billion in debt service annually. So, even if the Federal
government did guarantee $7 to $8 billion of city bonds, we could reasonably
expect to retire this debt within a ten year period.
The legislation that I introduce today is ia reasonable and fiscally sound
proposal to deal with a problem that we simply cannot afford to ignore. There
may be other proposals that warrant the attention of the Committee—possibly
direct loans or insured loans. But, I urge all of the Members of this Committee to
give this legislation careful consideration so that we can act before it is too late.
Thank you.




34
[S. 2514, 94th Cong., 1st sess.]
A BILL To establish an Emergency Intergovernmental Assistance Board, and for other
purposes

Be it enacted by the Senate and House of Representatives of the United States
of America in Congress assembled, That this Act may be cited as the "Emergency
Intergovernmental Assistance Act of 1975".
DEFINITIONS

SEC. 2. For the purposes of this Act—
(1) "general local government" means a city, town, county, or othei
general purpose subdivision of a State;
(2) "State" means a State of the United States, the District of Columbia,
and the Commonwealth of Puerto Rico;
(3) "applicant" means any State or general local government which has
filed an application for assistance under the provisions of this Act.
ESTABLISHMENT OF BOARD

SEC. 3. (a) There is established in the executive branch of the Government,
an Emergency Intergovernmental Assistance Board (hereinafter referred to as
the "Board") which shall have succession for a period of four years from the
date of enactment of this Act. The Board shall be composed of the Secretary of
the Treasury, the Secretary of Housing and Urban Development, and three other
members who are well qualified by training and experience to execute the duties
of the Board, and who shall be appointed by the President, by and with the
advice and consent of the Senate.
(b) Members of the Board from private life shall serve for a term of four
years, and any such member apix>inted to fill a vacancy shall be appointed only
for the unexpired portion of the term. Each member of the Board from private
life shall each be entitled to receive compensation at the daily equivalent of the
annual rate of basic pay for grade GS-18 of the General Schedule for each
day (including traveltime) during which he is engaged in the actual performance of his duties as a member of the Board.
(c) While away from their homes or regular places of business in the performance of services for the Board, members of the Board shall be allowed travel
expenses, including per diem in lieu of subsistence, in the same manner as per*
sons employed intermittently in the Government service are allowed expenses
under section 5703(b) of title 5, United States Code.
FUNCTIONS

SEC. 4. It shall be the function of the Board to determine the eligibility of
and approve applicants for assistance under this Act. Such determination
shall be made by a majority vote of the Board after review of information submitted by an applicant in accordance with the standards established by section
5 of this Act. Such determination shall be made by the Board within ten days of
the receipt of an application for assistance under this Act. Notification of a determination by the Board of the eligibility of an applicant shall be promptly
transmitted to the Secretary of the Treasury.
AUTHORIZATION

SEC. 5. (a) Upon notification pursuant to section 3, the Secretary of the Treasury shall, upon terms and conditions prescribed by the Board, guarantee, or enter
into a commitment to guarantee, holders of obligations issued by the applicant
against loss of principal or interest payable on such obligations.
(b) There are authorized to be appropriated such sums as may be necessary to carry out the provisions of this Act.
STANDARDS AND CONDITIONS

SEC. 6. (a) To be eligible for assistance under this Act, an applicant must
demonstrate to the satisfaction of the Board that—
(1) it has made a bona fide attempt to obtain private financial assistance
and has failed in such attempt; and




35
(2) if the applicant is a unit of general loyal government, it h a s exhausted
all a t t e m p t s to obtain State assistance which the State can reasonably extend
without damaging its own credit posture.
(b) No g u a r a n t e e shall be made u n d e r this section unless t h e Board finds
that—
(1) the obligation g u a r a n t e e is necessary to the continued operation of the
applicant; and
(2) the guaranteed obligation will be secured by the full faith and credit
of the applicant which shall be recited and appear on the face thereof.
(c) Any obligation guaranteed by t h e Secretary shall become due and payable
in full a t any time not to exceed ten years from the date of such obligation and
shall be conditioned on t h e p a y m e n t of a fee, not in excess of 1 per centum,
to the Treasury by the recipient of t h e obligation g u a r a n t e e in an a m o u n t sufficient to create a reserve against losses or defaults a n d to cover administrative
expenses.
(d) Interest on obligations guaranteed under this Act shall not be t a x exempt.
(e) If the applicant is a State, it shall furnish to the Board and the Secretary, and if the applicant is a general local government under the jurisdiction
of such State, it shall furnish through t h a t State with the endorsement of the
Governor thereof, a plan which, subsequent to its initial submission by the
applicant, may be amended by a majority vote of the Board, detailing the applicant's projected revenues, expenditures, scheduled borrowings, debt service costs,
and such other information as the Board may require for a period of three years
after the date of anticipated assistance under this Act. Such plan shall also
contain—
(1) specific proposals designed to assure achievement of a balanced operating budget under s t a n d a r d accounting practices within two years of the
receipt of assistance under this A c t ;
(2) a specific program for retirement of the applicant's existing noncurrent short-term d e b t ; and
(3) such specific assurances as the Board may require t h a t the State
will take such legislative action as may be necessary to permit applicants
which are units of general local government to utilize such lawful revenue
devices as may be necessary to avoid default upon the general obligations
issued by such applicants.
No expenditures or borrowings shall be made by any applicant during the period
of its assistance u n d e r this Act which are not specifically contained in the plan
submitted u n d e r this subsection.
(f) If any S t a t e which is an applicant or endorser u n d e r subsection (e)
fails to take such measures as may be necessary to insure compliance with a
plan filed with the B o a r d under subsection ( e ) , and with such s t a n d a r d accounting procedures and limitations on expenditures and borrowings, as the State may
require, such State shall—
(1) have its entitlement under the State and Local Fiscal Assistance Act
of 1972, or other comparable general purpose financial assistance from the
F e d e r a l Government, as determined by the Secretary, withheld until such
time as t h e Board is satisfied t h a t such State is taking all practicable steps
to assure t h a t such obligations and undertakings as a r e set forth in the plan
required by subsection (e) of this section a r e being m e t ; or
(2) shall be assessed a civil penalty equal to such sums to which the State
was entitled under t h e State a n d Local Fiscal Assistance Act of 1972 for the
fiscal years ending J u n e 30, 1973, J u n e 30, 1974, and J u n e 30, 1975.
(g) The Secretary shall consult, as necessary, with any S t a t e or general local
government which h a s received assistance under this Act concerning any m a t t e r
which may bear upon the ability of the unit of government to repay the obligation within t h e time fixed therefor and reasonable protection to the United States.
DESCRIPTION OF B I L L

Title.—Emergency
Intergovernmental Assistance Act of 1975.
General Description.—The
bill establishes an Emergency Intergovernmental
Assistance B o a r d composed of five members—the Secretary of the Treasury, the
Secretary of H U D , and three members with outstanding private experience appointed by t h e President with the advice and consent of the Senate. The Board
will determine, by majority vote, w h e t h e r jurisdictions a r e eligible for assistance
provided u n d e r t h i s Act. The Board will have not to exceed ten days from the




36
d a t e of application in which to m a k e this decision. If the B o a r d votes in favor of
assistance, this recommendation is then passed on to the Secretary of t h e Treasury who shall provide assistance by guaranteeing a taxable bond issued by the
eligible s t a t e or local government. The Secretary h a s no discretion a s to whether
to provide assistance once the Board h a s voted favorably.
Eligible Governments.—Any
state or general purpose unit of local government
will be eligible for this assistance. In the case of a local government, t h e s t a t e
will also h a v e to p a r t i c i p a t e in the application (see Other R e q u i r e m e n t s ) . I n
order to be eligible for assistance, the s t a t e or local government m u s t h a v e failed
in a bonafide a t t e m p t to obtain private financing. I n addition, in the case of a
local government, t h e s t a t e would h a v e to show t h a t it h a d provided a s much
assistance to the local government as is feasible without jeopardizing the State's
own credit worthiness.
Eligible Securities.—Any
taxable bond guaranteed by the F e d e r a l government
would have to be backed by the full faith and credit of the issuing government.
Maturities of Guarantees.—The
g u a r a n t e e s could be offered on securities with
m a t u r i t i e s of up to ten years.
Interest Rate, Fees and Charges.—The g u a r a n t e e d taxable bonds will have
their interest r a t e set by the market, but will also require a service fee of up to one
percent.
Other requirements:
Financial plan.—As a prerequisite for the provision of
assistance under this Act, each eligible s t a t e or local government m u s t submit
to t h e B o a r d and the Secretary of the T r e a s u r y a three-year plan detailing the
applicants projected revenues, expenditures, scheduled borrowings, debt service
costs and other information t h a t the Board may require. In t h e case of a local
government, the State would be required (through the endorsement of the
Governor) to sign onto and participate in the enforcement of t h e plan. T h e plan
m u s t also contain ( a ) specific proposals to assure the achievement of a balanced
operating budget within two years of receipt of t h e initial assistance under this
Act, (b) a specific program for the retirement of the applicant's non-current
short-term debt and (c) specific assurances t h a t the State will permit t h e applying local government to use any lawful revenue raising mechanisms t h a t may
be necessary to avert default on the guaranteed obligations.
No expenditures or borrowings would be permitted t h a t were not specifically
included in the plan.
T h e Board can approve by majority vote any amendments to the plan.
Any S t a t e t h a t failed to enforce a plan t h a t it h a d endorsed would have its
revenue sharing payment (or other general purpose financial assistance) withheld until it was once again in compliance with the requirements of t h e Act.
STATE OF OREGON,
TREASURY DEPARTMENT,

Salem, September
Hon.

26,1975.

W I L L I A M SIMON,

Secretary of the Treasury,
Washington,
D.C.
DEAR SECRETARY SIMON : As the State T r e a s u r e r of the S t a t e of Oregon, and
one of those most closely concerned with t h e vagaries of the Municipal Bond
market, I am writing to you to express my concern about the course of events
i n New York City, both past and present,
I recently read an article in a local newspaper h e a d l i n e d : "Simon T h r o w s
New York to the Wolves." I was even more distressed when I read the t e x t of t h e
article which legitimatized t h a t headline.
I write because I wonder if you have fully considered the implications of a
major default by the City of New York. I hope t h a t you will bear with me, so
t h a t I can explain the viewpoint of a s t a t e official t h a t has no ties with the
politics of t h a t city.
You have been quoted as saying that the present situation h a s not h a d an
affect outside of the City of New York, and t h a t a default by the City will not
have an adverse affect but will, in fact, have a beneficial effect on the balance
of governmental units in this nation. How could t h a t be? Last May, t h e State
of Oregon sold a $125 million bond issue for the benefit of our veterans' housing
program. Those bonds were rated AAA by Moody's R a t i n g Service a n d AA by
S t a n d a r d a n d Poors'. This established housing program is, probably t h e most
successful public housing program in t h e United States. Oregonians a r e justly
proud. The bonds were sold a t 6.024%. The previous issue, of t h e same amount,
sold a t 5.190%. I do not a t t r i b u t e the financial woes of the City of New York




37
for the entire difference in those rates. Obviously, many factors go into t h a t
determination. I have, however, concluded t h a t the State of Oregon paid at
least y$% more because of t h e dislocation and d i s a r r a y of the municipal bond
market. T h a t dislocation and disarray were, in fact, caused by t h e woes of
New York City.
There a r e few of us, concerned with the municipal market, t h a t would
suggest t h a t the federal government simply bail the City out. T h e r e a r e few
who believe t h a t an outright federal g u a r a n t e e for future issues of "Big Mac"
would be a logical solution. T h e r e a r e other avenues, however, t h a t should be
considered. The Administration h a s considered, and apparently rejected, the concept of a g u a r a n t e e which would strip a w a y the t a x exempt s t a t u s of the bonds. I
believe t h a t this should receive further consideration. The one benefit of this
plan, as far a s municipalities a r e concerned, is t h a t the t a x exempt m a r k e t would
not be totally occupied by those particular issues.
Another approach might be to g u a r a n t e e those bonds only if purchased by
bond buyers who do not customarily purchase t a x exempt paper. An example
would be the various public and p r i v a t e pension funds operating on a t a x exempt
status. Approaches such as these, coupled with increased federal t a k e over of
welfare expenditures by the City, would be of assistance.
I firmly believe t h a t any such assistance must be met with supervised guarantees by the City of New York t h a t their fiscal house will be kept in order.
I believe t h a t many citizens in this nation wonder why the federal government is
willing to "save" a Penn Central Railroad, Lockheed and F r a n k l i n National.
There may be logical reasons, but they a r e most difficult to explain.
I also believe t h a t the problems unique to the City of New York must be
considered when determining the possibility of assistance. No one can deny fiscal
gimmickry on the p a r t of the managers of the City. I t is true, however, t h a t
their problems a r e magnified a s compared to other cities a n d states of this
union. The fact t h a t federal and state taxation systems remove more dollars
from New York t h a n they replace, is also worth consideration.
I realize t h a t there is a school of thought t h a t a default on the p a r t of
New York City will somehow cleanse the municipal soul and, hence, be of lasting
benefit to us all. I doubt t h a t this is so. The effect on the municipal market, short
of default, has been adverse. A default could be disastrous.
I strongly urge t h a t the expertise within the administration be marshalled
to decide how best to succeed in assisting New York City, r a t h e r t h a n simply
stating the reasons why this should not or cannot be done.
Very truly yours,
J A M E S A. REDDEN.

Senator HUMPHREY. I'm sorry that I came late here, but I'm managing a bill on the floor.
The CHAIRMAN. We understand and we appreciate that.
Senator TOWER. I know we agreed to hold questions, but I just have
to say I profoundly disagree with some of the premises on which my
distinguished colleague from Minnesota proceeded.
Senator HUMPHREY. One of my problems, Senator Tower, is these
very frank disagreements with you, for whom I hold great respect.
However, I do pray for you and you pray for me.
[Laughter.]
The CHARMAN. Secretary Simon, you're a much put upon man.
You're wonderful to come down. We realize you have an appointment.
We apologize for delaying you so long. You're very patient as well as
extraordinarily able.
STATEMENT OF WILLIAM E. SIMON, SECRETARY OF THE
TREASURY
Secretary SIMON. Mr. Chairman, I'd like to say a couple of things at
the outset before I get into my prepared statement. I have been sitting
here for a little while listening to a lot of the comments and a lot of
the questions and I'd like to comment on a couple things.




38
I'd like to start out by saying one thing. Yes, we have a serious
problem. These hearings and all of the debate that has occurred over
the summer months dramatizes the potential seriousness of the problem. There is also a very great difference of opinion on what the effects
might be, what the financial impact is, but I think that there have
been a lot of irresponsibile statements and statements t h a t show a lack
of knowledge of the subject. If I may, I'd like to comment on just
a few of those.
I did not, and to the best of my knowledge Arthur Burns did not,
testify to the fact that Franklin National Bank was bailed out. The
Federal Government and the Federal Reserve System are not in the
business of bailing out banks. I went to great pains, I thought, at the
J E C a couple weeks ago in explaining what the function of the Federal Reserve System is vis-a-vis the banks.
Let me begin by noting that Franklin National Bank went bankrupt. Its equity holders and its bond holders lost their money. But the
function of the Federal Reserve System is to protect the depositors
of the institution against a potential run. They only lend money on a
collateralized, fully secured, basis while they are arranging for the
merger which utilimately occurred. Not one depositor lost 1 penny. I
would hope that the misconception that's being put forth to the
American people—that the Federal Government is in the business of
bailing out banks—can be corrected. If indeed there were to be insolvancy problems due to the New York City situation, the banks
which had the problem would suffer the financial consequences. The
Federal position as I just explained is clear.
Now as far as someone testifying on the insolvency of New York
City banks, he's making many assumptions, most of them incorrect:
(A) assuming what the market price of a defaulted security would be,
(B) assuming that the default would be permanent and not corrected;
and (C) assuming something that the figures do not substantiate.
About 10 percent of the capital and surplus of the New York City
banks is in New York City paper. That is approximately 0.6 of 1
percent of the total assets of these banks and I think those figures
explain very dramatically what the effect would be. While it has a
financial effect, yes; insolvency, I'm sorry. We have data on all banks
in the United States and their percentage of holding on capital and
equity on total assets. We're very well aware of those that are a potential problem and we have outlined our steps in previous testimony
as to what should be done.
On aonther subject, the subject of interest rates going up, Mr. Packwood and Senator Jackson had a spirited debate on interest rates and
indeed it was pursued with Senator Humphrey, as to the impact that
this is having: The unsettling impact on the market. There's absolutely no doubt about that. That's been agreed to right from the beginning. Senator Jackson talked about my former partner, Henry
Kaufman, and I share his respect for Henry. I think he's probably
the finest economist, financial economist in the United States of America. Yesterday he came out with a study that illustrates the spread
between tax exempts and taxables. I would like to put it into the
record. What it illustrates is that the medium grade municipal yield
relationships to taxables—and this is important—have changed little
on balance. Then it goes on to explain how in some instances it*s even




39
better than it was in 1970 and 1971. This is the subsidy that our States
and municipalities get, the approximately 30 percent subsidy due to the
fact that their securities are tax exempt.
As far as the welfare share of New York City, we have a formula
under Federal lawT—our share of welfare runs from 50 to 80 percent,
based on per capita income of the State. New York State, as one of the
wealthiest, gets 50 percent Federal payments. Mississippi, as one of
the poorest, gets 80 percent, The balance, the other 50 percent, is paid
by New York State. The State determines what the city share shall
be, not the Federal Government. Our share is set by a formula and, as
I say, we should take another look at all of these programs and the
formula and if changes are needed they should be made. I have been
accused of being callous in one recent editorial in the last week, accused
me of being flippant, and I just want to assure you, Mr. Chairman,
and gentlemen, that the Secretary of the Treasury is not flippant on
this issue. He is giving you his best judgment, recognizing there are
other people in the marketplace who are going to differ. That's what
markets are all about, We have some people who think markets are
going up and others who think they are going down. The judgments
are highly subjective in nature and certainly this whole situation has
had an effect on the market. Interest rates have gone up because all interest rates in the market have gone up due to inflation and our heavy
borrowings. Certain categories of cities, cities which have fiscal problems may be impacted because we have had a flight to quality since
the Penn Central bankruptcy 4 years ago. Investors are now demanding more information, the financials, where heretofore general obligations of cities and States were never questioned. Now they want the
information to make sure that their money that they invest is indeed
going to be secure.
Now I can speak to the specifics of displacements which I will under
your questioning. From the beginning of September until right now
there Lave been 10 displacements. Seven of them sold within the next
few days at interest rates within proper limits depending on their
quality. Two others had to be cut back in size due to credit considerations.
I heard toward the end of the comments that commercial banks are*
oversaved. Loans to commercial banks proposed by commercial banks
this year have declined in excess I believe—I don't have the exact number with me—of $2 billion. The loan-to-asset ratio of our commercial
banks has been put back into shape for the last 20 years. The Federal
Reserve has been A^ery diligent in this and I would suggest the loanto-asset ratio is not out of line with historical levels.
With those few remarks, I would like if I can—I will move through
this testimony. I will urge you, if you could, Mr. Chairman and gentlemen, to please read it in its entirety and I will skip whatever I can
in the interest of brevity so we can get to some questions.
Today we move from study, investigation and evaluation into the
infinitely more demanding process of considering specific legislative
responses. And as we make this transition, it becomes all the more
important that the issues be dealt with in the serious and objective
manner they deserve. Measured tones and deliberate analysis are imperatives. I have noted that there are two risks presented by a default : the financial and the psychological. I have often expressed the




40
view that the financial risk can be mitigated. But at the same time,
I have been equally candid about our inability to measure the psychological impact, and about our concerns that dire predictions and vigorous rhetoric may compound whatever psychological risks do in fact
exist. I t is our joint responsibility to see to it that these concerns are
minimized.
The proponents of the legislation pending before this committee
believe that a major program of Federal financial assistance is warranted by the circumstances. I cannot agree. What is warranted, indeed
required, is a comprehensive program of fiscal and financial reform
in order to return New York City to the capital markets. There is a
Federal role in this process but it is not the role envisioned by the
legislation before us.
Before turning to the program of reform, let me summarize for the
committee the current situation in New York City and New York
State.
First, as a consequence of the events of the past month, the credit
of New York State and its agencies has—rightly or wrongly—become
intertwined with that of New York City. The State's bond rating has
been reduced and the rating on certain of its notes withdrawn. These
actions are not based primarily on concern with the fundamental
finances of the State. Instead, they reflect the realities of the marketplace: investors currently are unwilling to purchase New York securities in the present atmosphere.
Second, potential inadequacies in the financial structure of the New
York State Housing Finance Agency have come to light. The financial community has acted most responsibly in analyzing the finances
of this agency and in presenting a proposal to the legislature designed
to cure some of these difficulties. I believe it is important that this
proposal be acted upon promptly.
All levels of government, and the private sector as well, share the
responsibility for developing a workable program that will restore
New York City's access, and that of the State as well, to the capital
markets.
I then pretty much go through the program t h a t I outlined in an
interview last week, but let me just highlight it.
First, and foremost, New York City must adopt a credible balanced
budget plan which provides for the prompt elimination of budget
deficits.
The institutional framework is now in place, but the Emergency
Financial Control Board and the new deputy mayor must now operate
in concern, devoting all of their resources to implement the fiscal
policies necessary to return the city to the market. Substantial additional expenditure cuts are required. Operating expenses must be
eliminated from the capital budget.
Second, during the period of transition to balanced budget operations, the State should provide New York City with a temporary
source of additional revenues, to avoid the accumulation of further
deficits.
Such assistance should be provided by an emergency and temporary
1- or 2-year tax, perhaps an increase in the State sales tax. When
New York City's budget has been restored to a sound fiscal basis,
these funds can be repaid by the city over time through the State
appropriation process.




41
Third, the financial and investment community must also play
an important role.
If the city and State take the actions outlined above, if operating
and capital expenditures are drastically reduced, and if pervasive
control is exercised over the fiscal and financial affairs of local governments and agencies within the State, then it will be the financial
community's own self-interest to help provide the requisite credit
to protect investments made to date and to insure healthy markets
in the future.
I t may be that further commitments from the financial community
and from investors may not be necessary. But if they are, certain
actions may be appropriate.
Within the context of an orderly proceeding for the restructuring
of New York City's debt, holders of short term securities may, if
necessary, be asked to extend maturities for a short period—perhaps
2 to 4 years.
In addition, again only if necessary, the city's bondholders may be
asked to agree to a moratorium on payments of interest and perhaps
principal for a short period of time.
Once the threshold of budgetary control has been crossed, these
actions can provide the bridge to return New York City to the capital
markets. But any comprehensive program of reform must deal with
longer range concerns as well. We in the Federal Government have a
clear responsibility with respect to this part of the process.
As a fourth part of the program, the Federal Government must
accelerate a comprehensive review of Federal, State, and local relationships. To put it bluntly, we must determine whether the priorities, practices, and procedures of the past are consistent with the needs
of the last quarter of the 20th century.
Fifth, wre must propose structural improvements in the municipal
bond market. I than talk about the taxable bond proposal which was
submitted to the Congress in 1973 which gives the option to mayors
and governors to finance in the taxable market which in effect would
broaden the market due to the fact that they can then appeal to pension funds, and so forth. I think it's a very important piece of legislation.
I go on to explain, as I did at the outset in my remarks, the traditional average of tax exempt and taxable securities and indeed that
the traditional average exists today, illustrated, as I say, by what
I'm putting in the record by Salomon Bros, and Henry Kaufman
who was referred to earlier.
I then talk about the changing structure of the municipal market,
how supply has doubled in recent years; that demand has not kept pace
with supply.
Finally, partially in recognition of the growing participation of the
smaller investor in the State and local bond market, we believe the
time has come for a federally imposed uniform system of financial
accounting and reporting by State and local issuers which sell a substantial amount of securities in our capital markets.
Then I talk about the flight to quality, realinement, again summarizing the various steps that should be taken. This is a program
designed to attack the causes of the problem at their roots. But unlike
the legislative proposals before us today, it is far more likely to return
our greatest city—indeed all our cities—-to a totally sound fiscal basis.




42
I then talk about the proposals that are before us today—guarantees, insurance, and so forth, as well as the Federal financing bank, as
well as Senator Humphrey's suggestion of the national domestic development bank which I testified to Congress about I think 8 or 9
years ago in the urban development bank proposal. None of these
proposals are really radically different from those proposals.
I then talk about objections, expansion of Federal credit and driving up borrowing costs, and the discipline of the market would be lost.
I note that there is no difference between a guarantee and an insurance
program.
Unfortunately, the private insurance companies, the largest of the
twTo that are in the business, the maximum insurance that it will provide is $20 million per issuing. That means if we do three-quarters, the
total size of the issue of the Federal Government would be asked to
guarantee would be $80 million and this certainly would not assist
anyone. So the reinsurance scheme is not applicable to the problems of
today.
I then go on to talk about the other bills and our objections to the
serious implications of the capital markets and restraints, and so forth.
Then I talk about the municipal bond market. Some think, incorrectly, that this market is distinct. I t is not. It's an integral part of
our capital market structure as a wrhole. The same things are happening in our capital markets as a whole, as I said at the outset. Things
we warned about a year ago are happening in all markets, including
the municipal bond market—higher rates, snorter maturities, crowding
out of many additional marginal credits. Yield differentials between
the stronger and the weaker credits, are at record highs. Recently the
spread between A and Baa industrial bonds has been as high as 200
basis points; double the 1974 figures and four times greater than the
1971-73 average. Additional Federal credit in the market could cause
these spreads to widen further. And if guaranteed bonds retained the
tax-exempt feature, the impact on unguaranteed municipal issuers
would be especially direct and could be severe.
These are the concerns of the Nation expressed in the Joint Economic Committee 2 weeks ago, but we think they misplaced the blame.
Yes, I remember one mayor saying that his borrowing cost compared
to 1973 has gone up by x. Well, so has everybody else's, and that's the
problem with inflation. Any program of Federal assistance wrould
further exacerbate these problems.
Then we talk about the Federal Government and w^hat its function
would be in managing State and local decisionmaking and what the
State and local decisionmaking might be if we wrere to adopt one of
these programs. While some have suggested the interposition of State
control, I seriously doubt whether it would provide a viable alternative. There would be little reason for a State agency not to yield to the
same pressures as a local government in the absence of discipline from
the market or some other source.
We would have to create a new bureaucracy, and let there be no mistake, this would not be temporary and it would involve a labor
bureaucracy.
On the guarantee side, as you have heard me say before, if we guaranteed tax exempts we would be creating a security even better than the
Federal Government's. Those municipalities which did not wish to subject themselves to the criteria of the Secretary of the Treasury, which




48
would be his responsibility, would be forced to pay higher interest
rates.
I then talk about the guaranteed bond and the penalty, the impact
of default. We have talked today and concentrated on a variety of
approaches in the financial situation in New York City and New York
State, I believe the approach 1 have suggested is desirable and workable. I cannot support the approaches in the legislation before this
committee.
To complete the analysis, however, it's necessary to discuss the consequences if none of the approaches is adopted. My views on the impact
of a potential default haven't changed materially. I have always believed that a default would be highly undesirable, indeed awful. I have
always believed that a default could and should be avoided by any
appropriate means. But putting aside the rhetoric, putting aside the
politics and putting aside for a moment the absolute desirability of
avoiding a default, I cannot conclude that the default would devastate
our financial markets or our economy.
At the same time, I have often underscored the importance of the
psychological factors and our inability to predict the psychological
impact with any certainty. We have been carefully monitoring the
marketplace daily and we have noted the developing psychological
impact of the marketplace. Restraint is of the utmost importance. I
must point out that dire predictions of pending doom could well become self-fulfilling.
My views on the overall question of the impact of default are fully
expressed in my testimony before the Joint Economic Committee and
I do not need to repeat them in detail here. I do want to concentrate
and expand upon one particular concern: the impact of a potential
default on the ability of other State and local governments to raise
necessary funds in the municipal market.
Earlier in my testimony I noted that municipal governments are
facing the same pressures as all other borrowers : a diminishing supply
of capital at higher and higher rates caused primarily by inflation and
the growing Federal usurpation of the supply of credit in this country. I also mentioned that within the municipal market itself there
are structural problems which need to be addressed as State and local
capital requirements grow faster than the demand for tax-exempt
securities. I have also noted that all investors are increasingly sensitive
to quality consideration and are demanding more and more evidence
of financial soundness.
Perhaps the most important factor in today's market is uncertainty,
a psychological factor which markets do not tolerate well. A number
of intermediaries and investors are, we understand, refusing to commit
funds to the marl et—thus impairing the borrowing ability of many
State and local governments—until the New York City situation is
resolved. New York City's difficulties have been the major factor in
the uncertainty and have intensified investor concern with quality.
But New York's financial crisis did not create the other problems besetting the market, and an end to that crisis will not make them go
away.
When T testified before the Joint Economic Committee and Senator
Humphrey, T didn't realize at that time that he had been the mayor
of Minneapolis. Minneapolis is a fine AAA city. Minneapolis sold on
September 8 or 9 at 5.53 interest cost. Cities like Minneapolis, those
who have run their financial and fiscal affairs properly, benefit from a




44
flight to quality. I t is the borrower at the lower end of the spectrum
that suffers, just as they do in the corporate market and in other markets.
So I don't believe that a default would precipitate a series of defaults by other cities throughout the country. No other city has had a
cumulative deficit like New York City's and thus none must borrow
simply to meet operating needs from year to year. To the extent other
cities must borrow within a fiscal year to deal with seasonal cash flow
variations, I cannot conclude that a default will materially impair
their ability to do so. I n short, either other cities have the money to
pay their debts or they do not. Those which do should be able to obtain
credit.
I n asking ourselves what the impact of a default would be, we must
also ask the correlary question of what would be the impact of various
mechanisms to avoid default. If, for example, New York City were
able to avoid default by implementation of the plan discussed at the
beginning of my testimony, I believe that the result would be a renewed sense of faith in the ability of the State and local government
sector and our financial institutions to deal with even the most severe
problems in a responsible manner.
If, on the other hand, default were to be avoided by a Federal assistance program, the reaction could be more complex. Clearly, there
would be no basis for concluding that avoidance of default meant that
State and local governments were able to carry out their financial obligations. Just the contrary would be true. Meanwhile, there would be
far more incentive for State and local governments to embark on more
spending programs, irrespecsive of whether resources were available
to finance them. The discipline built into the present system would be
lost entirely.
What the Federal Government would do for New York, all would
believe, it would necessarily do for any other jurisdiction which became unable to meet its obligations.
This committee faces some difficult choices. The risks of a default,
in the final analysis, are unknown and unknowable. My own judgment is that such risks should be manageable. Moreover, as I have
indicated in my testimony today, the proposals pending before the
committee present a series of concerns which outweigh the risks as
I perceive them.
Mr. Chairman, I would like to conclude my remarks today with
some purely personal observations. I t has been nearly 7 months to
the day that the city's bankers reached the conclusion that a market
no longer existed for the securities of the city. For this entire period,
the citizens of the greatest city in the world—its financial, industrial,
and cultural hub—have lived from crisis to crisis. As one with deep
personal and professional ties to New York City, I have great compassion for the plight of the citizens of New York and I share their
determination to achieve a prompt and proper end to the crisis.
Over this period much in the way of laudable progress has been
made. An "untouchable" expenditure increase for fiscal year 1975-76
was pared somewhat. The inexorable growth in the municipal payroll
has been pared to some degree. The cumbersome overlay of bureaucratic structures has been partially reorganized and financial professionals are now playing an increasingly important role in the affairs
of the city.
If this degree of progress has been made, one may legitimately ask,




45
why hasn't the market reopened to the city ? I am afraid the answer
lies in timing. Each of these steps, while laudable in and of itself,
invariably came too late.
It is difficult to state precisely what actions would have reopened
the market at any given point in time. But it must be clear to all that
what would have reopened the market in April would no longer do
the job in J u n e ; and what would have been adequate in June was
insufficient in August. In short, throughout these long and enervating
months, events and demands consistently outdistanced actions.
Another important point emerges from this troublesome history.
There can be no doubt that Federal financial involvement at any
point along the way would have stopped the reform process dead in
its tracks. We need only look at what occurred when MAC was created in early June. For 6 weeks, virtually nothing in the way of reforms was accomplished. In late June, the need to obtain legislative
approval of the city's budget caused a brief flurry of activity—announcements of layoffs, hospital and firehouse closings. But as the
garbage piled up over the Fourth of July weekend, most layoffs were
rescinded, and the closing orders have been largely ignored.
It was not until it became clear that MAC would be unable to borrow in August that the process of reform began anew. Each new
deadline was faced with more strident demands for Federal assistance. And, after such assistance was again refused, the city and the
State managed to take another hesitant, painful step in the right
direction.
At the end of August, after* nearly fi months of crisis, the first meaningful data regarding the city's finances was released. While subsequent events have revealed that even such data was inaccurate and inadequate, at least a benchmark with which to measure the accomplishments of the past and the challenges of the future had been established.
Again I ask the inevitable question: would such actions have taken
place if Federal assistance had been promised or provided ?
Much has been done, but much more needs to be done: A credible
plan for the prompt elimination of the budget deficit must be implemented—I then go through a list of what needs to be done.
If these things are done, and the market does not reopen, is default
the only solution? In recent weeks and again today, I have expressed
the view that the financial risks presented by a default can be mitigated, and, objectively speaking, the impact need only be temporary
and managebale. At the same time. I have been equally candid about
our inability to measure the psychological impact. We have continued
to make market assessments on an ongoing basis and we remain deeply
concerned that dire predictions and vigorous rhetoric may compound
whatever psychological risks do in fact exist.
The time has come, ladies and gentlemen, to concentrate all of our
efforts to restoring our greatest city to fiscal integrity. I have said
many times that fiscal integrity is easy to lose and hard to recover. As
we proceed through this difficult period in our history, I can only hope
that the travails of New York City will have some impact on our
attitudes as to the proper role of government in our society. What New
York City has learned in the past 7 months is a valuable lesson for us
all. As we proceed with legislative consideration of the city's financial
crisis, let us not ignore this important message.
The CIIAIRMAX. Thank you very, very much, Mr. Secretary, for an
extraordinarily able and thoughtful presentation.
[Complete statement follows:]
60-832 O - 75 - 4




46
FOR RELEASE ON DELIVERY
STATEMENT OF THE HONORABLE WILLIAM E. SIMON
SECRETARY OF THE TREASURY
BEFORE THE SENATE COMMITTEE ON
BANKING, HOUSING AND URBAN AFFAIRS
THURSDAY, OCTOBER 9 AT 9:30 A.M. EDT
NEW YORK CITY'S FINANCIAL SITUATION
Mr. Chairman and Members of this Distinguished Committee:
Today marks an important juncture in Congressional
consideration of the financial situation in New York City.
Today we move from study, investigation and evaluation into
the infinitely more demanding process of considering specific
legislative responses. And as we make this transition, it
becomes all the more important that the issues be dealt with
in the serious and objective manner they deserve. Measured
tones and deliberate analysis are imperatives. I have noted
that there are two risks presented by a default: the
financial and the psychological. I have often expressed the
view that the financial risk can be mitigated. But at the
same time, I have been equally candid about our inability to
measure the psychological impact, and about our concerns that
dire predicitions and vigorous rhetoric may compound whateverpsychological risks do in fact exist. It is our joint responsibility to see to it that these concerns are minimized.
The proponents of the Legislation pending before this
Committee believe that a major program of Federal financial
assistance is warranted by the circumstances. I cannot agree.
What is warranted, indeed required, is a comprehensive program
of fiscal and financial reform in order to return New York City
to the capital markets. There is a Federal role in this process,
but. it is not. the role envisioned by the legislation before us.
Before turning to the program of reform, let me summarize
for the Committee the current situation in New York City and
New York State.
WS-40S




47
First, as a consequence of the events of the past month,
the credit of New York State and its agencies has--rightly or
wrongly-- become intertwined with that of New York City. The
State's bond rating has been reduced and the rating on certain
of its notes withdrawn. These actions are not based primarily
on concern with the fundamental finances of the State. Instead,
they reflect the realities of the marketplace:
investors
currently are unwilling to purchase New York securities in the
present atmosphere.
Second, potential inadequacies in the financial structure
of the New York State Housing Finance Agency have come to
light. The financial community has acted most responsibly in
analyzing the finances of this Agency and in presenting a proposal to the legislature designed to cure some of these difficulties. 1 believe it is important that this proposal be acted
upon promptly.

?Hilding a Bridge to the Capital Markets
All levels of government, and the private sector as well,
share the responsibility for developing a workable program
that will restore New York City's access, and that of the
State as well, to the capital markets. What must be done is
to build a solid bridge, span by span, over which New York City
can return to the private capital markets. In my view, such a
program should involve the following elements.
First, and foremost, New York City
must adopt a credible balanced budget
plan which provides for the prompt
elimination of budget deficits.
The institutional framework is now in place, but the Emergency
Financial Control Board and the new Deputy Mayor must now
operate in concert, devoting all of their resources to implement
the fiscal policies necessary to return the City to the market.
Substantial additional expenditure cuts are required. Operating
expenses must be eliminated from the capital budget. Employee
benefit programs must be reviewed. And capital spending must be
brought under control. These measures must be accompanied by a
continued re-aligament of the City's management to insure that
the tough decisions which have to be made will continue to be
made. Until investors arc convinced that New York City's management is in control of the City's financial future, there can be
no mark et.




-48
Second, during the period of transition
to balanced budget operations, the
state should provide New York City with
a temporary source of additional revenues,
to avoid the accumulation of further
deficits.
Such assistance should be provided by an emergency and temporary
one or two year tax, perhaps an increase in the state sales tax.
When New York City's budget has been restored to a sound fiscal
basis, these funds can be repaid by the City over time through
the state appropriation process.
Third, the financial and investment
community must also play an important
role.
Irrespective of what conclusions one may reach about the
potential impact of a larger financial crisis on our markets
and financial institutions, there is no question that it is
in the best interests of all concerned to avoid a potential
problem. If the City and State take the actions outlined above,
if operating and capital expenditures are drastically reduced,
and if pervasive control is exercised over the fiscal and
financial affairs of local governments and agencies within the
State, then it will be in tho financial community's own selfinterest to help provide the requisite credit to protect
investments made to date and to insure healthy markets in the
future.
'
'
It may be that further commitments from the financial
community and from investors may not be necessary. But if they
are, certain actions may be appropriate.
Within the context of an orderly proceeding for the
restructing of New York City's debt, holders of short term
securities may, if necessary, be asked to extend maturities for
a short period--perhaps 2 to 4 years.
In addition, again only if necessary, the City's bondholders
may be asked to agree to a moratorium on payments of interest and
perhaps principal for a short period of time.
Once the threshold of budgetary control has been crossed,
these actions can provide the bridge to return New York City
to the capital markets. But any comprehensive program of reform
must deal with longer range concerns as well. I e in the Federal
V
Government have a clear responsibility with respect: to this part
of the process.




49
As a four_th part of the program, the
Federa~r—Government must accelerate a
comprehensive review of Federal, state
and local relationships. To put it
bluntly, we must determine whether the
priorities, practices and procedures
of the past are consistent with the
needs of the last quarter of the
twentieth century.
Specifically, in the area of assistance to the disadvantaged,
we should review once again our administrative machinery and make
whatever changes are necessary to provide state and local governments the full benefits they are entitled to under existing law.
But a comprehensive response requires more action as well.
If we determine that large cities and populous states are
unfairly disadvantaged under existing formulae or programs, we
should consider corrective legislation, if necessary, to remedy
whatever imbalances exist.
I have often said that assisting the poor is a legitimate,
indeed a fundamental, responsibility of a compassionate democratic
society. But if we allow our assistance programs to lose the
support of the majority of our citizens, our ability to provide
assistance may be seriously impaired.
Fifth, we must propose structural
improvements in the municipal bond
market.
In proposing these changes, we will not have lost sight of the
fact that even in these unsettled times the municipal market has
served state and local government well.
During August alone, for example, four states and 225
municipalities raised nearly $2.6 billion in long term debt. And
contrary to widely held opinion, such funds were raised at a cost
not disproportionate to historical levels.
Traditionally, yields on tax-exempt securities have been,
on the average, 50 percent lower than taxable yields. Yield
spreads will vary according to quality, maturity, call protection, monetary conditions and similar factors. Moreover,
yields will also vary within rating catergories. For example,
largely because of the substantial volume of debt outstanding,
yields on New York City securities were significant higher than
yields on comparably rated securities of other issuers. It is
noteworthy that in September, the spread between prime




50
municipals and comparable quality utility issuers was
squarely on the 30 percent figure: That is 6.9 percent for
municipals versus 9.9 percent for utilities.
While the market lias performed well, improvements can be
made. In recent years an inbalance between supply and demand
has developed. Tax-exempt borrowing is at unprecedented levels:
$40 billion of bond and notes in the first eight months of this
year alone. But the growth in demand--especially from institutionshas not kept pace. Casualty companies, always large buyers, have
had their need for tax-exempt income reduced. And commercial
banks, traditionally the largest purchasers of tax-exempts, have
cut back their participation substantially, reflecting other
sources of tax shelter such as loan losses, leasing activities,
and foreign tax credits. In 1969, commercial banks were net
purchasers of municipals in an amount equal to 97 percent of
new issue volume. For the first six months of this year, their
net purchases dropped to 12 percent of new issue volume.
In addition, also as a consequence of these specialized
sources of demand, yields in the tax-exempt market tend to rise
disproportionally during periods of tight money as banks are
forced to commit their limited credit resources to their
commerical customers.
Accordingly, to broaden the market, and to effect a
reduction in the volume of tax-exempt debt, State and local
government should be afforded the option of issuing debt on a
taxable basis, with an appropriate interest subsidy from the
Federal Government. Also, tax-exempt debt now issued for nongovernmental purposes --pollution control and industrial development bonds--should be issued on a fully taxable basis, again
with appropriate interest subsidies. According to our calculations,
these changes should result in a substantial benefit to state and
local government in the form of a broader market for their
securities, which could result in lower borrowing costs, at little,
if any, expense to the Federal Treasury.
Lastly, partically in recognition of
the growing participation of the smaller
investor in the state and local bond
market, we believe the time lias come for
a Federally imposed uniform system of
financial accounting and reporting by
state and local issuers which sell a
substantial amount of securities in our
capital markets.




51
Precipitated by major financial reversals such as the
Penn
Central bankruptcy, there has been a marked increase in the
tendency of investors to restrict themselves to higher grade
instruments--a "flight to quality" to use the terminology of
the market. We must satisfy this legitimate interest of the
investing public in detailed, accurate and comparable data
by requiring complete and accurate disclosure. This system
of disclosure has helped make our corporate markets the
finest in the world. The time has come to broaden it to the
municipal market as well.
In my view, it is these steps which Congress and the
nation must focus upon in dealing with New York City's financial
crisis:
a sound fiscal policy administered by
a realigned management, and including
a credible balanced budget;
a temporary increase in state assistance
through a state tax;
an orderly mechanism for debt restructing, with the financial community and
investors participating in the bridge
back to the capital markets;
a complete study on Federal, State and
local relationships in the area of
assistance to the disadvantaged;
a broader market for municipal securities;
and
a uniform
state and

financial disclosure system for
local government.

This is a program designed to attack the causes of the
problem at tlicir roots. But unlike the legislative proposals
before us today, it is far more likely to return our greatest
city--indeed all our cities--to a totally sound fiscal basis.

The

L c g i s la t i yy?__ P r o p o_syyl s

T h r e e o f t h e p r o p o s a l s b e f o r e us t o d a y - - S . 1 S 5 3 , S . 2 5 7 2
a n d S e n a t o r P r o x m i r e ' s s u g g e s t i o n of a t a x a b l e u n s u b s i d i z e d
b o n d w i t h a p e n a l t y premiurn - - i n v o 1 v e g u a r a n t e e s or i n s u r a n c e




52
of municipal debt. We are also considering Senator Bentsen's
approach in S. 1862: Federal Financing Bank purchases of
State and local debt. Finally, while not specifically on
today's agenda, I shall also discuss Senator Humprhcy's
suggestion of a National Domestic Development Bank, embodied
in S. 1475.
Generally speaking, my concerns with proposals for Federal
financial assistance are twofold:
First, any such assistance would involve expansion of
Federal credit, driving up Federal borrowing costs, the borrowing
of all other issuers and crowding out certain marginal borrowers.
Second, the discipline of the market would be lost. No
longer would spending be constrained by the desire to avoid higher
borrowing costs or the loss of credit. Only pervasive Federal
fiscal and financial control of local government, in violation of
federalism, could provide the constraint.
Guarantees or Insurance
There is absolutely no difference between a guarantee program and insurance program. Either would involve a commitment
by the Federal Government to meet debt service requirements in
the event the issuer is unable or unwilling to make such payments
out of its own revenue sources. And once provided, a guarantee
could not be withdrawn if, for example, the issuer failed to
meet the fiscal conditions of the program. The government's
obligation under a guarantee program would be to the investor,
not the issuer.
S. 2372 proposes that the Federal Government re-insure 75
percent of the risk underwritten by private insurers of
municipal bonds. This proposal would be of no value to New York
or any other city of even moderate size. The private insurance
sector has been unwilling to commit substantial resources to
this form of insurance and consequently the risk ceiling of the
larger of the two private insurers is only $20 million per
issuer. Given that maximum risk level, even with Federal reinsurance only $80 million of the securities of any issuer could
benefit from the program.
Loans
S. 1S62 and S. 1473 wouLd in effect provide for Federal
loans to State and local government. S. 1862 would use the
existing mechanism of the Federal Financing Bank of purchase
municipal securities. Since the purchases would be without
recourse, there would be no means of enforcing compliance with




53
guidelines regarding fiscal restraint. I would also note that
the $3 billion purchase authority would be inadequate even to
deal with New York City's needs alone.
S. 14 7 3 would create a new bureaucracy-- a National Domestic
Development Bank--to allocate credit to State and local governments. Federal bureaucrats, located not only in Washington but
scattered throughout the country, would be given the final word
on whether a particular local need was worthy of financing.
Guarantees, insurance, loans, development banks--each of
these proposals has serious implications for the condition of
our capital markets, would eliminate market restraints on
spending at the State and local level, and could threaten the
traditionaly autonomy of these levels of government over their
fiscal and financial affairs.

Impact on Capi tal i 1 arke_t
v
Too often, when we concern ourselves with the problems of
the municipa] bond market we tend to forget that this market is
not entirely distinct, but is instead an integral part of our
capital market structure as a whole. And the same things that are
happening in our capital markets as a whole, the same things we
warned about almost a year ago, arc happening in the municipal
market. Higher rates, shorter maturities, crowding out of sound,
but marginal credits:
these are the concerns the nation's mayors
brought to the President and to the Joint Economic Committee two
weeks ago. But they misplaced the blame. The blame primarily lies
not with Xew Vork City, but with inflation, caused by massive
continuing federal deficits and the substantial new federal borrowing
r equ i r ed t o finance t hem.
Any program of Federal assistance would further exacerbate
these problems. Any expansion of Federal credit--including a
federally guaranteed municipal bond--would further strain our
overburdened capital markets. Federal borrowing costs would rise
and, since our borrowing establishes a benchmark in the marketplace, trie borrowing costs of all other issuers would rise as well.
Many additional marginal credits- -housing, small business, consumers-would be crowded out of" the markets. Yield differentials between
the stronger and the ueaker credits, are at record highs: recently
the spread between A and Baa Industrial bonds has been as high as
200 basi< points; double the 1974 figures and four times greater
t h a n t h e 1 9" 1 - 7 3 a v e r a g e . A a d i t i o n a 1 I7 e d e r a 1 c r e d i t in t h e m a r k e t
c o u l d cau.~o t h e s e s p r e a d s to w i d e n f u r t h e r . And if g u a r a n t e e d
b o n d s r e t a i n e d t h e t a x - e x e m p t f e a t u r e , the impact on u n g u a r a n t e e d
municipal
i s s u e r s u o u l d be e s p e c i a l l y d i r e c t and c o u l d be s e v e r e -




54
Fiscal Restraint
Of even more concern is the potential effect of these
programs on fiscal and financial decision-making at the
State and local level. Like all borrowers, a State or local
government's access to credit depends upon its ability to
persuade potential lenders that its financial affairs are
such that the lender can reasonably expect to be repaid.
A Federal guarantee would have the effect of removing this
element of concern on the part of the lender and thus have
the corresponding effect of removing the market imposed
restraints on the borrower.
The only effective substitute for the restraints of the
marketplace would be direct Federal control. While some
have suggested the interposition of State control, I seriously
doubt whether it would provide a viable alternative. There
would be little reason for a State agency not to yield to the
same pressures as a local government in the absence of
discipline from the market or some other source.
Federal control of fiscal and financial affairs at the
local level presents grave practical and philosophical difficulties. This is not a dispute between liberals and conservatives, but rather simply a question of the right of citizens
to be governed by their duly elected local leaders rather
than by Federal bureaucrats.
We would have to create a new bureaucracy, simply to
concoct and enforce the guidelines as to local priorities we
here in Washington would be imposing on the Governments of
the nation. We would be confronted with the sorry spectacle
of duly-elected local officials lining up outside my door,
attempting to persuade me that they were carrying out their
responsibilities in a satisfactory fashion. We would, in
short, be contravening constitutionally - imposed principles
of Federalism; principles which lie at the heart of the
structure of government in this nation.
Thousands, perhaps tens of thousands, of governments
would resist this intrusion into local affairs. And they
would be absolutely right. But in the final analysis,




55
theirs would be a Hobson's Choice: Submit to Federal control
or pay the price of independence in the bond markets.
None of us can assess with any degree of precision the
contribution the division of governmental authority called
for by the Constitution has made to the quality of life in
this country. But I doubt our society would be as heterogenuous, as tolerant of diversity, as responsive to local
needs if all basic decisions were made here in Washington.
Comparison with Existing Programs
It is such considerations which plainly distinguish the
pending bills from programs such as FDIC or FHA insurance.
It is altogether appropriate to require that all of the
nation's banks be subject to the same operating standards
and be subject to consistent and detailed Federal supervision
and regulation. It is equally appropriate that a citizen
seeking the assistance of the Federal government in obtaining
a mortgage disclose fully his financial situation and open
the property he desires to purchase to extensive Federal
scrutiny.
Imposing uniform standards on State and local governments is plainly an entirely different matter. Each political
subdivision in this nation has unique needs. And each is
led by a person selected for the job by an electorate which
believed that such a person could best translate the needs of
the community into effective governmental decisions. Yet any
program of financial assistance would require bureaucrats in
Washington to supervise these decisions and reverse them if
necessary, irrespective of the wishes of the local electorate.
It is one thing to supervise a corporate management, or to
reject the views of boards of directors or stock-holders.
Under our democratic system, it is quite another to supervise
and control the affairs of local governments.
In short, State and local government have a special
status in our Federal system. The proposals for Federal
financial assistance now pending before this Committee
would, of necessity, require that such special status be
ended.




56
Guaranteed Bond with Penalty
As an alternative approach, the Chairman has suggested
guaranteeing municipal debt, but imposing an extremely high
interest rate penalty. First, as with any guarantee program,
the adverse impact on the capital markets I outlined above
would be fully present. Second, any conceivable penalty
rate -- 3, 4, even 5 percent -- would represent a small
increase in the burden on the borrower, relative to the
value of obtaining access to credit. When an issuer is
faced with the possibility of losing access to credit, it
is likely to cut its expenditures, but when the prospect is
only higher borrowing costs, the incentives for restraint
are far weaker.
Impact of Default
I have concentrated today on a variety of approaches to
the financial situation in New York City and New York State.
I believe the approach I have suggested is desirable and
workable. I cannot support the approaches in the legislation
before this Committee. To complete the analysis, however,
it is necessary to discuss the consequences if none of the
approaches is adopted.
My views on the impact of a potential default have not
changed materially. I have always believed that a default
would be highly undesirable; "awful" may be the best description. I have always believed that a default could and should
be avoided by any appropriate means. But putting aside for
a moment the absolute desirability of avoiding default, I
cannot conclude that a default would devastate our financial
markets or our economy.
At the same time, I have often underscored the importance
of psychological factors and our inability to predict psychological reactions with any certainty. We have been carefully
monitoring the marketplace daily and have noted the developing
psychological impact. Restraint is of utmost importance;
I must point out that dire predictions of impending doom could
well become self-fulfilling.




57
My views on the overall question of the impact of
default are fully expressed in my testimony before the
Joint Economic Committee and I do not need to repeat them
in detail here. I do want to concentrate and expand upon
one particular concern: the impact of a potential default
on the ability of other State and local governments to
raise necessary funds in the municipal market.
Earlier in my testimony, I noted that municipal governments are facing the same pressures as all other borrowers:
a diminishing supply of capital at higher and higher rates
caused primarily by inflation and the growing Federal
usurpation of the supply of credit in this country. I also
mentioned that within the municipal market itself there are
structural problems which need to be addressed as State and
local capital requirements grow faster than the demand for
tax-exempt securities. I have also noted that all investors
are increasingly sensitive to quality considerations and are
demanding more and more evidence of financial soundness.
Perhaps the most important factor in today's market
is uncertainty, a psychological factor which markets do not
tolerate well. A number of intermediaries and investors
are, we understand, refusing to commit funds to the market
--thus impairing the borrowing ability of many State and
local governments -~ until the New York City situation is
resolved. New York City's difficulties have been the major
factor in the uncertainty and have intensified investor
concern, with quality. But New York's financial crisis did
not create the other problems besetting the market, and an
end to that crisis will not make them go away.
Markets have a tendency to discount future events and
a potential New York City default has been discounted to a
significant degree in the form of higher overall yields and
shifts in quality preferences. If default actually occurs,
a possible further shift in quality preferences could
influence the ability of credits which are perceived to be
weak to raise funds in the capital markets. By contrast,
the stronger credits may well benefit as investors' preferences
shift even further in the direction of the higher grade issues.
I do not believe a default would precipitate a series of
defaults by other cities through the country. No other city




58
has had a cumulative deficit like New York City's and thus
none must borrow simply to meet operating needs from year
to year. To the extent other cities must borrow within a
fiscal year to deal with seasonal cash flow variations, I
cannot conclude that a default will materially impair
their ability to do so. In short, either other cities
have the money to pay their debts or they do not. Those
which do should be able to obtain credit.
In asking ourselves what the impact of a default would
be, we must also ask the correlary question of what would be
the impact of various mechanisms to avoid default. If, for
example, New York City were able to avoid default by implementation of the plan discussed at the beginning of my
testimony, I believe that the result would be a renewed
sense of faith in the ability of the State and local government sector and our financial institutions to deal with even
the most severe problems in a responsible manner.
If, on the other hand, default were to be avoided by a
Federal assistance program, the reaction could be more
complex. Clearly, there would be no basis for concluding
that avoidance of default meant that State and local governments were able to carry out their financial obligations,
Just the contrary would be true. Meanwhile, there would be
far more incentive for State and local governments to embark
on more spending programs, irrespective of whether resources
were available to finance them. The discipline built into
the present system would be lost entirely.
And even if the assistance program were limited to New
York City, its impact would be felt throughout the country.
Issuers and investors would come to believe that every
municipal security -- or certainly those of major borrowers -in effect carried the moral obligation of the United States,
even without a guarantee in advance. What the Federal government would do for New York, all would believe, it would
necessarily do for any other jurisdiction which became unable
to meet its obligations.
But perceptive investors would recognize the fundamental
change in our system of finance and would see the risks
presented. The inflationary expectations generated by the




59
actual and potential expansion of the Federal credit
involved would serve to accelerate some of the adverse
trends we have seen in the markets over the recent past.
Investors would become even more wary of long term
commitments and would demand even higher yields on the
commitments which are made. The ability of all sectors
of the economy to finance investments in our future growth
could be further impaired.
This committee faces some difficult choices. The
risks of a default, in the final analysis, are unknown and
unknowable. My own judgment is that such risks should be
manageable. Moreover, as I have indicated in my testimony
today, the proposals pending before the Committee presents
a series of concerns which outweigh the risks as I perceive
them. I would urge the Committee to concentrate its
resources and its influence on approaches to the problem
which will restore confidence in the fiscal and political
integrity of the State and local governmental sector.
Mr. Chairman, I would like to conclude my remarks today
with some purely personal observations. It has been nearly
seven months to the day that the City's bankers reached the
conclusion that a market no longer existed for the securities
of the City. For this entire period, the citizens of the
greatest city in the world -- its financial, industrial and
cultural hub -- have lived from crisis to crisis. As one
with deep personal and professional ties to New York City,
I have great compassion for the plight of the citizens of
New York and I share their determination to achieve a prompt
and proper end to the crisis.
Over this period much in the way of laudable progress
has been made. An "untouchable" expenditure increase for
fiscal year 1975-76 was pared somewhat. The inexorable
growth in the municipal payroll has been pared to some
degree. The cumbersome overlay of bureaucratic structures
has been partially reorganized and financial professionals
are now playing an increasingly important role in the
affairs of the City.
If this degree of progress has been made, one may
legitimately ask, why hasn't the market reopened to the City?




60
I am afraid the answer lies in timing. Each of these steps,
while laudable in and of itself, invariably came too late.
It is difficult to state precisely what actions would
have reopened the market at any given point in time. But
it must be clear to all that what would have reopened the
market in April would no longer do the job in June. And
what would have been adequate in June was insufficient in
August. In short, throughout these long and enervating
months, events and demands consistently outdistanced actions.
Another important point emerges from this troublesome
history. There can be no doubt that Federal financial
involvement at any point along the way would have stopped
the reform process dead in its tracks. We need only look
at what occurred when MAC was created in early June. For
six weeks, virtually nothing in the way of reforms was
accomplished. In late June, the need to obtain legislative
approval of the City's budget caused a brief flurry of
activity -- announcements of lay-offs, hospital and fire
house closings. But as the garbage piled up over the
Fourth of July weekend, most lay-offs were rescinded; and
the closing orders have been largely ignored.
It was not until it became clear that MAC would be
unable to borrow in August that the process of reform began
anew. Each new deadline was faced with more strident demands
for Federal assistance. And, after such assistance was again
refused, the City and the State managed to take another
hesitant, painful step in the right direction.
At the end of August, after nearly six months of crisis,
the first meaningful data regarding the city's finances was
released. While subsequent events have revealed that even
such data was inaccurate and inadequate, at least a benchmark
with which to measure the accomplishments of the past and the
challenges of the future had been established. Again I ask
the inevitable question: would such actions have taken place
if Federal assistance had been promised or provided?
Much has been done, but much more needs to be done:
-- A credible plan for the prompt elimination of the
budget deficit must be implemented;




61
-- in that regard, the State must act to provide a
temporary supplement to the City's existing
revenue base;
•-- ineligibles must be removed from the City's public
assistance roils;
-- capital expenditures must: be reduced severly and
operating expenses must be fully eliminated from
the capital budget;
-- the city's accounts must be fully conformed to
acceptable accounting principles;
-- reform of the City's management structure must be
completed;
-- if necessary, steps must be taken to restructure
the City's short term debt.
If these things are done, and the market does not reopen,
is default the only solution? In recent weeks and again today,
I have expressed the view that the financial risks presented
by a default can be mitigated, and, objectively speaking,
the impact need only be temporary and manageable. At the same
time, I have been equally candid about our inability to measure
the psychological impact. We have continued to make market
assessments on an ongoing basis and we remain deeply concerned
that dire predictions and vigorous rhetoric may compound whatever psychological risks do in fact exist.
The tinse has come, ladies and gentlemen, to concentrate
all of our efforts to restoring our greatest city to fiscal
integrity. I have said many times that fiscal integrity is
easy to lose and hard to recover. As we proceed through this
difficult period in our history, I can only hope that the
travails of New York City will have some impact on our attitudes as EO cne proper role of government in our society.
What New York City has learned in the past seven months is a
valuable lesson for us all. As we proceed with legislative
consideration of the City's financial crisis, let us not
ignore this important message.

60-832

O - 75 - 5




62
The CHAIRMAN. Mr. Secretary, you indicated when you appeared
before the Joint Economic Committee a couple weeks ago that it was
within the power of New York City to avoid default. Do you still
share that view ? Do you still have that same opinion ?
Secretary SIMON. I believe I said the city and the State, Mr. Chairman. This must be a combined effort.
The CHAIRMAN. I stand corrected. Do you still share that opinion,
that the city and State together could avoid default ?
Secretary SIMON. There again, we have gone on in this crisis for,
as I said in my testimony, 7 months and New York City is still being
denied access to the market. The uncertainty has also created a problem with New York State in its financing. Nobody can say with certainty that indeed it could be avoided if they did all of these following
actions and if everyone—the bankers in New York City and New York
State got together and devised plans.
My plan I'm sure could be added to and subtracted from and a
credible plan put into place that could avoid default, but nobody is
going to know, Mr. Chairman, until something happens and nothing
has happened.
The CHAIRMAN. Well, a number of things have happened, as you
pointed out on page 14, not enough in your view. You think more can
happen, further reform. The question, however, is a tough, almost
arithmetic question. As I understand it, New York has a rollover in
the next 6 months that is obligations coming due w^hich they have to
refinance of $2.8 billion. They have an operating deficit in the next
6 months of about $800 million. They have capital needs in the next
6 months of $1.5 billion.
Now I can understand that they could drastically cut those capital
expenditures, although I'm sure there are some capital expenditures
that may be absolutely essential; but that could certainly be sharply
reduced; but how in the world is the city and this State, which has
already jeopardized its credit severely and is having trouble selling
its agency obligations—how can they come up with $3.5 to $4 billion
under these circumstances? I t just seems to me that any reforms that
might be suggested would be wholly unrealistic. Is that wrong?
Secretary SIMON. Well, Mr. Chairman, it seems to me that—let's
concentrate on New York State for a second—recognizing New York
City is the largest and indeed the most important city probably, not
only in New York State but many believe in the United States, I must
admit from my parochial point of view I happen to think it's extremely important.
Senator TOWER. Next to Dallas and Houston.
Secretary SIMON. We could debate that point, But the point is,
what's throwing a cloud over New York City is the recognition on
the part of the investors that New York City must do all this financing. Until a credible financial plan is put forward so the investors
say, "All right. They have a plan here and they know what they're
going to do"
The CHAIRMAN. Mr. Secretary, look what's already been done. The
State has already created an agency that has taken virtual control
of New York's fiscal ope rat ions.
Secretary SIMON. They have shuffled the debt around, as Arthur
Burns said yesterday. They have transferred debt from the city to the
State and--




63
The CHAIRMAN. But as I look at the list that you have, a shopping
list beginning at the bottom of page 15 and continuing through the
top of page 16, it's hard for me to see $3.5 billion or $2.5 billion or
$2 billion or $1 billion. The only element that would seem to raise
substantial funds, the only elements, are capital expenditures being
reduced, and ineligibles being removed from the city's public assistance rolls, and I think you would agree that's not nearly enough
cushion there to do the job.
Secretary SIMON. There's one other step Mr. Chairman, the possibility of New York State imposing a temporary tax increase for
whatever period of time it takes for the New York City budget to
get back in balance. You knowT, you get to the fundamental question
we ask ourselves: Has New York State and New York City done
enough so that the Federal Government must consider action? Have
they done enough? And I'm suggesting no.
The CHAIRMAN. Well, I think you may be right and I think almost
everybody here, including Senator Javits, would agree that something
more can be done. However, I'm just wondering how we can be reasonable about this.
Yesterday the Chairman of the Federal Reserve Board suggested
that the New York State impose a tax over a year that would cover
half of the operating deficit or about $500 million. Now in order to
do what you propose here it seems to me they would have to impose
a tax that wTithin the next 6 months would bring in $3 or $4 billion
which would be a tax of maybe 70 percent of their revenue during
that 6-month period.
Secretary SIMON. You're talking about the total.
The CHAIRMAN. YOU suggested the tax.

Secretary SIMON. Yes, and what I'm suggesting is they have an
operating deficit as we understand it in the area of $800 million—a
billion someone said, but these numbers have not been presented to
the public yet. That is the estimate we have in the Treasury Department.
Now let's say that New York City puts forth a budget running
through fiscal 1977 or fiscal 1978, and at the end of fiscal 1978 it shows
a surplus; that they have begun to take the operating expenditures
out of the capital budget and move them back to the operating budget;
that they have implemented the tough cutback programs, whether
it's tuition on the city universities or tolls on the bridges or whatever
steps that New York City deems is proper at this point—a combination of all these, and admittedly they are tough actions, yes. New
York State provides a temporary tax mechanism, perhaps through
the sales tax—but I'm sure there are other methods—1, 2, or 3 years
until the end of this program. Then, in my judgment, it is reasonable
to expect that investors knowing exactly what the full story is, that
there are financials, that the Emergency Control Board is going to
run the aifairs of New York City and insure that this program is
carried out to the nth degree
The CHAIRMAN. Then you expect the investors might react that way,
but in view of what the investors have gone through over the last year,
and particularly the last few months and especially the last 2 weeks,
investors might very well not do this, and every expert that we have
heard has indicated they think investors would not come up with the
necessary funds.




64
Now supposing we can get this same reaction, this commitment by
the State, commitment by the city, this firm assurance and write it into
law, then the Federal guarantee would do the job. Then we would be
able to provide the funds. Then you would get the discipline because
the discipline could be enforced by the instrument that you provide,
by the guarantee. In other words, the guarantee stops if they don't
proceed to balance the budget, if they engage in any expenditures that
aren't agreed upon.
Secretary SIMON. I think we're talking now, Mr. Chairman, about
hypothesis because the actions haven't been taken—all the actions that
could have been taken. Every action that's been taken—again, it's
painful and difficult—they have been done begrudgingly because
there's still the belief up there, I believe, that the Federal Government
is going to do exactly
The CHAIRMAN. I think they have to take more action and certainly
whether I feel that way or not, from a realistic standpoint, New Yorkers realize the only way they're going to get Federal assistance is to
take these painful actions and commit themselves to it and keep doing
it; but my argument with you is that the immediate situation of requiring $3.5 billion or $4 billion, no matter what drastic action they
take in borrowings over the next 6 months puts them in a position
which will make it impossible for them to avoid default unless they
get Federal assistance.
Now let me ask you this. If New York City defaults—we have just
heard from Senator Humphrey and you heard his full statement. He
said that the effects on New York would be absolutely catastrophic.
You don't believe they would be. But in any event, it seems to me that
they could be very, very serious indeed once they default. Then it
would seem to me that tlie prospects of their being able to raise capital
would enormously decrease and then Senator Humphrey's position—
and I think it's a position that makes some sense—then the Federal
Government would have to come in under very difficult circumstances.
All municipalities in the country would suffer and at that point w^e
have to move in with assistance.
Secretary SIMON. YOU know, you bring up a fundamental point
about who gets paid first in this eventuality. Do the bondholders? Do
the noteholders get paid interest on principal first, or are essential
services allowed to continue? New York City, contrary to public
belief, has had a greater revenue increase than most major cities in
the United States each year. The problem is their expenditures have
been double what their revenues have been. Their assessed valuations
have continued to go up. New York City revenues in our analysis are
nearly adequate—let's forget the bondholders and noteholders—to
insure that essential services would be maintained in the event of a
default. If need be, as I say, the restructuring that I outlined in my
testimony for a brief period of time—3-, 6-, 9-month notes could
be
The CHAIRMAN. Mr. Secretary, how can you tell how brief a period
of time that's likely to be ?
Secretary SIMON. There again, a credible program to put the budget
back into balanceThe CHAIRMAN. But the catastrophic effect of this city having defaulted is something, it would seem to me, to chill investors for a long




65

time to come. Tf I were bead of a bank I would be verv reluctant about
buying: obligations of the citv that had gone into default and still
faced these enormous difficulties, and certainly T would be very wary
as an individual of investing in the bonds of the city under those
circumstances, even with the high rate of interest.
Secretary SIMON. It would pav a penalty rate of interest.
The CHAIRMAN. Having defaulted?
Secretary SIMON. Tt always has.
The CHAIRMAN. Well, it would have to pay an extraordinary rate
if it had gone through default. My point is, can we have it both ways?
Maybe we can. Can we provide assistance to New York and still secure
the discipline which you verv properly call for and all of us recognize
that New York must provide? They must cut the spending that
they're- going through. They must impose additional taxes. They must
make a commitment io balance their budget. They must agree to perTVJH +iH> State to manage their operations and the Federal Government
to h,nvp a veto over any action that might endanger our guarantee.
But T just wonder, under these circumstances, if it should not be
the objective of the administration and the committee and the Congress
to try to achieve an end which will get this reform and would also
avoid the default that can very seriously affect the cities in every one
of our States.
Secretary SIMON. AS T said, Mr. Chairman, there is nothing that I
would rather see than a default be avoided. T tried to tell my friends
back in New York 7 or 8 months ago when they first came down that
the Federal Government would take an adamant stand on New York
State and New York City taking the tough steps that have to be
taken. Sadly, lots of these things have not been done. The small steps
have been take]). Much more needs to be done and we are not going
to know the answer to your question until those steps indeed are taken.
The CHAIRMAN. Senator Tower?
Senator TOWER. Mr. Secretary, for the record, has the administration changed or deviated from its original position on the assistance
to New York?
Secretary SIMON. NO. sir.

Senator TOWER. There is 7io slippage toward perhaps getting
involved?
Secretary SIMON. Mr. Tower, T don't know how my remarks last
weekend which I repeated in my testimony this morning as to what
steps New York' City and New York State could take to avoid this
problem, could be interpreted as a change in position. We have been
accused of saying, "Well, we won't give assistance but there's nothing
that can be done.'" So T thought it would be useful to describe one
thing that could be done or a series of things that could be done, and
Fin sure as T said before there could be others.
Senator TOWER. T was sure of that position, but T thought it should
be stated for the record.
T understand that many States and cities have had no difficulties in
borrowing' as a result of the New York City crisis. Certainly, the financial affairs of my State and its cities are in good shape. Their bonds
are rated high. Tt would appear that the ability to borrow without difficulty reflects the flight to quality that you have referred to. T think
this is an example that a flight to quality is underway.




66
I have been noting some interesting figures, that seems to indicate
rather severe discrepancies between fiscal practices in different cities.
These are 1971 figures, and I don't have a complete update, but in 1971
the per capita outstanding debt of New York City was $1,288 compared
to the next highest city, Philadelphia, $572, less than half that amount.
New York's spending was at the rate of $1,207 per capita compared to
the next highest city, this time being Seattle, of $446, almost three
times more. The 1971 expenditures of New York City were greater
than the combined expenditures of the next 24 largest cities comprising
23 million people, compared to 8 million people in New York.
That would indicate to me that some rather severe discrepancies exist
between New York and other major cities.
Looking at other figures, Fortune magazine says that New York
City has 51 employees for every 1,000 inhabitants. Most other large
cities the ratio is 35 per 1,000. The current spending per capita is at
$1,224 compared to the average for all other cities in the country of
$295.
Of course, T think we all know that New York is in the grip of the
trade unions. We know that wages are inordinately high there and
they are ordinarily dictated by the trade unions without regard to demand for productivity or the burden on the city or anything like that.
One thing that I would like for you to comment on, Mr. Secretary, is
it possible to show that the proliferation of matching programs by the
Federal Government through categorical grants and the like have
tended to encourage or provide an incentive for some cities to engage
in programs and spending beyond the ability of their tax base to support it ?
Secretary SIMON. Yes. I don't have an analysis with me on that
subject.
Senator TOWER. I n other words, I wonder if we're not part of the
problem here.
Secretary SIMON. Well, of course, it does, and wThere there are matching programs they obviously want to take advantage of the Federal
money that's available and they have to put their percentage up—25 to
50 percent of the money if they wish to build day care centers, as one
example. So, sure, that adds to the problem.
Senator TOWTER. D O you think that perhaps default on the part of
New York City, perhaps a worsening of the problem, would ultimately
force reform on the part of New York City so that it could act responsibly? Could it perhaps serve as an object lesson to other cities in the
United States?
Secretary SIMON. I think that everything that's occurred thus far
has already served adequate warning on other cities in the United
States. Indeed I find no evidence of other cities or States which have
this kind of a problem. I don't know of any other city that borrows in
the marketplace to make up a deficit. Most short-term borrowing on the
part of States and some larger municipalities comes in anticipation of
taxes and is repaid when the taxes are collected. Nobody has had a
cumulative deficit like New York City and nobody has got the unique
problems that some people brought up here this morning like New
York City. There are also the longer range problems that we have to
look at—some of our formulas for Federal assistance and all the rest
of our aid to our cities—is it up to date ? Is it in the 20th century ? But




07
T think the events thus far have served adequate warning on people
to put their houses in order. What T fear. Senator Tower, is that if the
Federal Government steps in at this point to guarantee or insure, does
this remove that very strict and necessary discipline of the marketplace
for many other cities in this country ? Does it precipitate, regardless
of what the punitive costs we might put on the borrowings, the demand
for more Federal funds and more fiscal laxity than now exists?
Senator TOWER. There seems to be an awareness in the market that
New York City is unique.
Secretary SIMON. Yes.

Senator TOWER. Of course, heavy pressure is being brought to bear
on the Congress to establish legislatively some form of Federal assistance for New York City and it may very wTell come to pass. I
haven't been convinced that we should cfo it myself, but my primary
concern is the impact of New York's plight on the rest of the country and I think we have to view it in the national context.
Secretary SIMON. I agree with that.
Senator TOWER. If we so view it, and if we initiate some sort of
assistance through legislative means, in your view what would be
proper form for such assistance to take ?
Secretary SIMON. Well, let me say at the outset that my judgment
as Secretary of the Treasury as to what the proper form would be in
no way implies that the President of the United States
Senator TOWER. I understand that you would not necessarily support such a proposal, but what I'm asking for now is what would be
the best way to go about it if indeed political pressures are brought
to bear on us or we find that the impact on the country is adverse;
then what would be the best way for us to proceed under those circumstances?
Secretary SIMON. Mr. Tower, if the Congress in its wisdom determines that the Federal financial assistance is essential in this effort,
I would urge that it not create a new bureaucracy, an KFC type
bureaucracy that always grows and cannot be gotten rid of to interpose itself into every facet of local affairs.
I would urge that Congress limit itself completely only to such
measures, perhaps as Senator Proxmire has recommended, a narrow
and restrictive program that would be administered by the Secretary
of the Treasury.
I would further urge that any program prohibit assistance until
the Secretary is satisfied beyond every reasonable doubt that the
recipient is inexorably on the road to fiscal integrity and I would
finally urge again, as Senator Proxmire has, that the financial terms
of assistance be made so punitive, the overall experience be made so
painful, that no city; no political subdivision would ever be tempted
to go down the same road.
Senator TOWER. Thank you, Mr. Secretary.
The CHAIRMAN. Senator Mclntyre ?
Senator MCTNTYRE. Mr. Secretary, are you in effect saying to this
committee that in your hard opinion that in the interest of good, constructive reform of the finances of New York City that the city ought
to either swim or sink and you don't feel it will sink?
Secretary SIMON. I'm not saying that exactly because, again, the
psychological impact, as I said, Senator Mclntyre, is unknowable by
anyone.




68
Senator MCINTYRE. We don't want to take a chance on that.
Secretary SIMON. We can give a judgment. What I'm suggesting
is that all of the steps and others that I didn't outline or different
steps that would have a similar result, have not been tried and need
to be tried before your question can be answered.
Senator MCINTYRE. Let me ask you in terms of self-help, are there
not State constitutional limitations on the city or State's ability to
borrow in the short term, related to assured sources of revenue? Are
they not up against a constitutional barrier ?
Secretary SIMON. New York State could not without a referendum
guarantee New York City debt, if that, is your question. However, I
believe
Senator MCINTYRE. I S there any legal barrier? One of your suggestions is to start taxing properly and to get enough income to pay
their debts or
Secretary SIMON. I believe that a special tax could be passed by
the legislature to build this bridge that I talked about before with a
repayment provision that I said out of future New York State appropriations which would provide the necessary capital.
Senator MCINTYRE. Assuming some Federal relief is agreed upon,
it seems to me there are at least two basic considerations. Do we not
need to separate the problems of the State of New York and the
problems of New York City and treat them somewhat differently?
And how do we rationally do this, Mr. Secretary ?
Secretary SIMON. Yes; that's true. New York City has to take the
proper steps that one day it can indeed walk alone again and walk
back to the capital market, but in the interim, you say, "All right,
until New York City can do all these tough things, because that's
going to take a little while to do, is it the State's responsibility to
do everything that it can first, or should the Federal Government
just step in first?" That is the question we're asking, Senator.
Senator MCINTYRE. YOU heard Senator Humphrey. Do you believe
that New York City is a peculiar city, a different city from any other
city in this country ?
Secretary SIMON. Yes. I would say that in a great many ways it is,
due to the fact that it is the port of entry of so many people and it
has so many peculiar characteristics; but again, some of its problems
as far as its welfare programs are brought upon by themselves. I have
a friend of mine—an acquaintance, who works in Newark, N.J., and
has a very good job and he lives in New York City. I said, "My goodness, that's an unusual thing. Why don't you live in the suburbs?"
He said, "Well, my wife was a government employee, and by living
in New York City, she can collect large welfare payments, and so
we're living over there instead."
Well, I suggest that all of these encouraging factors—the welfare
program that's obviously rewarding—I will not repeat here for the
record what I said to this chap, but you can imagine, Senator, but
I would imagine that's sroing on quite a bit.
Senator MCINTYRE. D O you agree with the Senator from Utah that
says that New York's condition is probably due to the political ineptness of their leaders of the past 10 or 20 years ?
Secretary SIMON. The last thing I'm going to do is point fingers
at what went on before. I'm going to have a hard enough time going




m
back to work in that city as it is, Senator Mclntyre, without commenting on what the problem was to start with. I do wish to return.
We all know their problem. They spent a lot more money than they
received for a long period of time, and finally the ultimate arbitrator
said, "No more; the marketplace, and the disciplines of the marketplace, have been imposed. Then you ask the question, should New York
State help them or should the Federal Government step in, and that
is the problem Congress has to consider.
Senator MCIXTYRE. But nevertheless, it's been pointed out here
that the problems of New York are not uncommon to them, that they
are spreading throughout the country as we get into this business.
Secretary SIMON. Isn't that funny? I don't subscribe to that, and
for the record. Senator Mclntyre, I would like to put in not only
Hubert Humphrey's city of Minneapolis but also it seems like about
35 or 40 States and municipalities, big and little—Philadelphias and
Detroits and all the rest of them—A's and AAA's, and show their
net interest cost and what they paid and what the proportion was,
and whenever it was out of proportion there was a good reason for
its being out of proportion. It's having an unsettling effect, I agree
with that, and it's going to have a further unsettling effect as long
as the uncertainty remains, but it's not been demonstrated that these
problems affect the other cities, no.
Senator MCIXTYRE. Would you say the same for the small towns and
small cities throughout this great country? Are they having their
troubles in the same type or way that New York City is ?
Secretary SIMOX. The small, well-run towns usually don't have tho
demands that the larger, medium sized and small medium sized do,
and they are ordinarily and continue to be financed bv the local banking systems because their name has never been nationally known. They
don't have the liquidity that investors demand to enter the major
marketplace, so they get financed bv their local banking system.
Senator MCIXTYRE. So they are OK, as far as you know ?
Secretary SIMOX. Yes.

Senator MCTXTYRE. By and large, the small towns and cities of
America are in good shape?
Secretary SIMOX. We have no evidence to the contrary, although
I'm sure. Senator McTntyre, that some do exist. There are exceptions
to that statement.
Senator" MCIXTYRE. One final question, Mr. Chairman.
I t would seem that if the Federal relief is justified, it ought to be
sufficient to restore confidence to the market without going any farther
than a minimum temporary solution requires, yet this is a very iffy
proposition because we never- know how much that will take.
Now, Mr. Secretary, where do we draw the line so as not to jump way
beyond where we ought to go if we do decide to bring some measure of
relief to New York City?
Secretary SIMOX. Well, I think I'd stand to my answer to Senator
Tower, if Congress in its wisdom, and so forth, decided that some
relief must be provided that program that I just outlined, with the
very stringent criteria very similar to what the chairman has recommended
Senator MCIXTYRE. Should it come after default in order that those
bondholders lose their dough, or should it come before default?




70
Secretary SIMON. It's not a matter of bondholders losing their
dough. You're more concerned with the impact—psychologic impact
as far as our financial system and all of the other considerations that
we have discussed, because it's been the experience and it was the experience back in the 1930's when cities did default that the bondholders were repaid. I t was a moratorium on the interest payments. Some
debt was rescheduled, but eventually the Michigans and others who
defaulted at that time, the bondholders were paid. So they would be
again. I t would be a postponement of their payment.
Senator MCTNTYRE. I n your opinion, Mr. Secretary, would the
chairman's plan restore market confidence?
Secretary SIMON. Nobody can say with absolute certainty whether
the plan that I outlined or the one the chairman has, which I'm not
totally familiar with, would restore confidence, but the question is,
it hasn't been tried and let's put a tough program in place and put
that budget forward where people are going to say, "Yes, sir. They
are going to be there 2 years from now. They are going to have a
balanced budget. They are going to have x tens of thousands excess.
They are going to change their accounting procedures. New York
State is going to help in the interim by doing this, the financial community of New York State." I'm not talking about the New York City
banks. I'm talking about the Lincoln Rochesters and Securities Long
Island, as well as the savings institutions, will assist in providing this
bridge once the fiscal and financial credibility is restored; yes, Senator.
Senator MCTNTYRE. Thank you.
The CHAIRMAN. Senator Brooke.
Senator BROOKE. Thank you, Mr. Chairman.
And thank you, Mr. Secretary, for a very able and I think a very
persuasive presentation.
I would be loathe personally to support anv bill which would ensnare the Federal Government in the local budgetmaking process except in the face of a grave threat to the national welfare. Senator
Proxmire in questioning you asked what impact a default by New
York City would have on New York. But I want to know what the
impact would be on the Nation and on its economv. Could you give us
some thinking as to what the impact would be on the national economy
if New York defaulted?
Secretary SIMON. Well, in our judgment, Senator Brooke, it would
not have—again, we are dealing with the financial side, not the psychological aspects of what would happen as far as individuals in
the fear that has been created in some quarters as a result of the vigorousness of the debate up to date and many of the statements that have
been made that I talked about off the cuff in my opening comments.
I t shows a lack of understanding of the marketplace of people who
don't become experts in this subject. But if the essential services—
we're making this assumption that the essential services of New York
City are indeed maintained—there need be no disruption to the United
States economv unless, of course, they were disrupted and the bondholders were paid out of the revenues. This has to be done in a very
delicate way. I t has to be handled in a scheduled way, yes, but it's our
analysis that there would be insignificant impact as far as our economy is concerned. As far as the market consequences, Senator Brooke,
I have talked about that here today and on other occasions at great
length.




71
One can mitigate through the F D I C , through the Federal Reserve's
role in providing secured liquidity to the commercial banks who may
have overextended themselves as far as city paper is concerned, and
that's not the major banks. That portion can be mitigated.
Again, what the psychological effect would be, no one can judge.
We can just make judgments based on experiences in the past.
Senator BROOK?:. NOW, we're already beginning to hear from mayors
of other cities who anticipate that they at some time may be in positions similar to that in which New York City finds itself. Do you know
how many cities in this country now are close to the financial condition in which New York City finds itself?
Secretary SIMON. According to our analysis, none, Senator Brooke.
We know of no city that borrows short term—and this is the important
thing to understand—short term to finance a cumulative deficit as
New York City has done. As these short term notes continue to be due,
they have to pay them off, and in order to pay them off they have to do
what we call rollover in the marketplace and if their credit rating has
been impaired and their credit standing has been impaired as a result of a cumulative effect of borrowing like this, the market, as this
one did, closes.
Now, T know of no other city that does this. The rest of the cities
that finance short do so in anticipation mostly of tax receipts and
then repay.
Senator BROOKE. D O you think that we are being subjected to a sort
of scare tactic, that the country is being alarmed that if New York
City goes into default then other cities are going to follow suit, and
that our Nation's economy is going to suffer as a result ?
Secretary STMON. Well, again, T heard the mayors talk about the
very high interest rates that they are paying and the fear when they
are paying higher interest rates that the next step is not being able
to borrow at all. The point is that everybody is paying higher interest
rates. The prime corporations today have to pay 10 percent, rates that
are more illustrative of a terminal stage of a boom than they are of a
commencement of an economic recovery. Certainly municipalities are
going to be paying higher than they did a couple years ago and this
is occurring, but as I put in the record, these various cities, f rom Ector
County, Tex., to you name it, all over the country are represented in
the list of those who have financed over the last 4 months. It illustrates that cities big and small have been able to finance, some with
distortions, because we take some A-rated securities in the municipal
market. New York City has always traded substantially higher than
other A-rated securities in the market, paid a higher interest rate,
as a result of two factors. One, its veritable demand on the marketplace, 40 percent on short term notes, and the fear on the part of investors that they weren't running their business properly. These factors narrowed the number of investors that bought New York City's.
So you're going to have wide variations depending on how the investor perceives a municipality to be running its affairs. This is something that's really prettv brandnew and it started in the Penn Central, as T said, the flight to quality. Ten or fifteen years ago, nobody
ever thought that the ad valorem general obligation tax of any general
obligation security in this country could ever be questioned. Nobody
got the proper financials. Nobody needed them. They were bought
with the confidence that the taxing power of this municipality or State




72
backed the securities. This has put that whole notion under very
severe question, to put it mildly, and now the investors are demanding
to see more financial information about the State and municipalities.
That's why we put in the mandatory reporting requirement. We think
that's essential for States and municipalities to continue to finance at
reasonable interest rates.
Senator BROOKE. Without oversimplification, it seems to me that
we're talking about investor confidence. That's what we're trying to
achieve.
Secretary SIMON. Yes, sir.

Senator BROOKE. That's what New York needs, is investor confidence. Senator Proximire said that he felt in questioning you he indicated that if New York City did default, it would be difficult, if not
impossible, to get investor confidence; the city couldn't come back.
What's your opinion ?
Secretary SIMON. Well, if I did imply that, Senator Brooke, I did
not certainly intend to imply that.
Senator BROOKE. Not that you did. I think the Senator questioned
you about that.
Secretary SIMON. Because again, this concerns the psychological impact. Is confidence going to be restored if New York City does all these
things, if they restructure and they do everything we have discussed
here this morning? Nobody knows with any certainty what the answer
to that question is.
Senator BROOKE. But you don't have any fear of that ?
Secretary SIMON. Well, certainly I am concerned about that. I'd be
foolish if I were not. Of course, I am. My point is that what I have
been asking, indeed imploring, for a long period of time is the right
steps be taken. The President has asked Arthur Burns and I to monitor
closely over these past 7 months the New York City situation and keep
him posted on the events in the marketplace, most especially the psychology of the market, what the impact on the marketplace has been,
and as each week and month has dragged by, certainly what could
have been done in June wasn't acceptable in July and et cetera, right
out to where we are now. So more is going to have to be done today
than certainly would have had to have been done 3 or 4 months ago. I'm
saying let's do what has to be done instead of just talking about it.
Senator BROOKE. One of the bills I think calls for 75 percent guarantee. Do you think that even with a 75 percent guarantee that the
city of New York would be able to get investors for the remaining
25 percent?
Secretary SIMON. N O , and, of course, the private insurance companies wouldn't pick up the slack for a couple of reasons. The first reason being you don't get fire insurance when your house is on fire, and
the second reason is that they have a limit—the largest of the insurers
has a limit of $20 million per issuing and so that effectively would
take care of any aid to New York City in particular.
I t would have to be, whether it's a guarantee or an insurance or
whatever the proposal is you're talking about—if there is to be involvement, you're talking about full Federal Government involvement,
not partial.
Senator BROOKE. Thank you.
The CHAIRMAN. Senator Garn ?




73
Senator GARN. Thank you, Mr. Chairman.
Mr. Secretary, I think Senator Mclntyre's question is answered by
the facts. I don't think you need to say you agree or disagree with my
statement about the fiscally irresponsible leadership in New York
City over a long period of time. Statistics read by Senator Tower I
think show that. It's staggering. It's almost unbelievable that one city
could spend more than the next 24 put together and most of the mayors
of this country would agree with that statement and a long time before
this came up.
And I do think, in answer to another question, I do think we are
seeing a propaganda battle that overstates the effect on the rest of
this Nation. Madison Avenue or whoever is doing it is doing a fantastic job of convincing the whole country that we are going to go
down the river if New York defaults on their bonds. I think it's being
greatly overplayed to put pressure on the Congress to come up with
some kind of bailout program.
We have also had testimony here today and constantly heard that
New York City isn't responsible for all these problems—the interest
rates going up. Wouldn't it be fair to assume that the $75 billion budget
deficit passed by the Congress of the United States cumulative $550
billion debt might have something to do with the economy of this
country, that New York City isn't doing it all by itself?
Secretary SIMON. That, plus the extraordinary inflation that we still
have; but most importantly, and I want to reemphasize this because
when it's put in the record the spread between taxable and tax exempt
issues, while there have been abberations between various quality
ranges, the spread can be generally said to be stable for tax exempt
financing.
Senator (TARN. I think we're seeing something perpetrated on us
that can be a self-fulfilling prophecy. You mentioned inflation. When
I was mayor, the number one cause of their financial problems is inflation. That's the only problem I had in balancing my budget when
I was a mayor, the constant pressure of inflation, the cost of power
going up by 0 or 10 times, the wage increases that ought to be considered in this factor, too. We can't say all the other sins are going
to be spread on the other cities because of what happens in New York
Citv. We are all suffering because of inflation. That's the number one
budget problem in cities of this country.
Just to illustrate some of those cities—and I wonder how long I
would have stayed mayor of Salt Lake City—to talk about 51 employees i>er 1,000 or 35. That's a big city, but you take the medium
sized cities. Salt Lake City is about the 50th largest city in the country. We managed to have a very clean city that most people talked
about and say. "My, it's clean and well kept, good police protection
and so on." We had 13 employees per 1,000.
If you want to start multiplying this out, with no welfare included
at all. just looking at personnel cuts, to do what New York City was
doing and come up with that number of employees and pay the kind
of wages and fringe benefits and all of those things, pensions—I
would have had to instantly increase the budget by 900 percent and T
wonder if the citizens of Salt Lake City would have- liked a 000 percent
increase in their expenditures in their city and the attendant tax
increase that would have to go with it when they are already the highest taxed resident of the State of Utah.




74
I don't think we can ignore the causes of this problem and the fiscal
irresponsibility that has gone on in New York City. I'm not sure the
Feds are the ones to bail them out. As tough a shape as New York is
in, I wrould suggest that maybe the fiscal irresponsibility of the Congress of the United States and the condition this country is in—I wish
I could get some of my colleagues as stirred up about the fiscal condition of this country as they are of New York City. I would suggest,
and maybe wonder if you would agree, the only difference between the
financial problems of New York City and the U.S. Government are
that we can print money and maybe that would be a simple solution
to give NeAv York a printing press and then they could go on building
up the debt and they wouldn't default.
Secretary SIMON. I'd rather take ours away, Senator.
Senator GARN. I would agree wTith you completely, but I don't think
we can separate the problems of New York City and the economic difficulties of this country and the unwillingness of public officials, whether
it be in New York City or in the Congress, of not having the word
"no" in their vocabulary. I t seems to be forgotten.
As long as I'm on another tear, I might as well be blunt about it and
say that I'm disappointed that some of my mayor friends, some who
are sitting in the audience right here, are defending the kind of fiscal
irresponsibility of New York City, but I guess the National Conference of Mayors is not any different than the American Bar Association or the Chamber of Commerce or national unions. They are selfprotection societies and you wouldn't expect them to come in and testify and say, "No; I think New York City is irresponsible. We can't
defend them." They always have to come in and give the testimony
that you would expect from all the other groups. You never hear a doctor say an ill word of another doctor or an attorney of another attorney, and you're going to get the same thing from the leaders of the
cities in this country.
Secretary SIMON. You'll never hear me say an ill word about my
friends back in the investment banking business and you will be hearing from them and you have heard from them already. I respect their
professionalism and I have talked enough about the uncertainties involved, but this notion that's developed over the last 15 or 20 years in
the United States that every time anybody gets in trouble the Federal
Government is the one who ought to aid and solve all the problems and
just put money in it. Senator Proxmire, you have made some good
statements on the floor of the Senate about that, about what the free
enterprise system is about and two sides of that question—success and
failure. If you remove the failure from it, wre have destroyed our system. I suggest that before some of these people come down here and
ask for Federal assistance that they think a little about the long-term
trend of this country. I'm greatly concerned and I realize that I'm
very unpopular as I sit here to say things like that, but I feel compelled to say them.
Senator GARN. I have nothing else, Mr. Chairman.
The CHAIRMAN. Senator Javits, you can question or testify. You
have been so patient.
Senator JAVITS. I'd rather testify.
The CHAIRMAN. All right. Secretary Simon, thank you very, very
much. You have been most responsive and helpful in your testimony.




75
STATEMENT OF JACOB K. JAVITS, U.S. SENATOR FROM THE STATE
OF NEW YORK
Senator JAVITS. I realize the time is late with respect to lunch and
I shall try to confine my statement to a very few minutes and then be
open to questions.
Mr. Chairman, I ask unanimous consent that my total statement
will be made a part of the record.
The CHAIRMAN. Without objection, tlhe entire statement will be
incorporated in full in the record.
Senator JAVITS. I will take just 10 minutes. I think I had better go
ahead because time has just caught up with me as it has with you.
But I will take 5 minutes and that will leave a few minutes for
questions.
Mr. Chairman, I am not going to try to add to the bills which are
before you, because you have got enough bills before you to write a
good bill; I have no doubt about that. The only thing that my bill does
that the others don't do is to include a title respecting an insurance
facility, like the Securities Investor Protection Corp. for brokerage
houses, which will insure holders of municipal securities up to $50,000.
Now whatever you may do about New York, I think that is a very
sound idea that you ought to dig into, because it will encourage the
breaking up of large holdings of municipal securities and get some
of them into the hands of the rank and file of citizens.
None of these insurance schemes cost the Government any money
and, as a matter of fact, they make money. So I would definitely consider that pa icular proposition. I included the provision among the
things that 1 urge because I was very interested in self-help in the
city of New York, having New oYrkers buy New York bonds themselves, and that was the reason for this particular provision.
Now there is no question about the fact that there's been great waste
in New York and many, many very serious defaults in leadership,
but the city has not been without character, either. It's suffered a subway strike. It suffered a sanitationmaivs strike which already resulted
in the city being a very grave health hazard in order to try to resist
the excess demands responsible. I t is by no means just a rug to be
walked over.
But the situation, Mr. Chairman, in New York is unique. I t just
happens that we have been the receptacle for a tremendous demographic migration in the United States with hundreds of thousands
of rural poor from the South who moved to New York in the course
of the civil rights revolution, and hundreds of thousands who came
from Puerto Rico seeking: economic opportunity because Puerto Rico is
very much a p a r t ' >f the United States.
The result has l.een an enormous welfare undertaking of some $600
million a year paid directly by the city from its own tax base. Most
cities don't suffer from welfare costs at all, but we do because of the
arrangements between the State and the city. And a 12-percent-plus
unemployment rate makes New York practicallv a disaster area in that
regard. In addition New York has roughly a million as a target population for biligual education, which is a very, very expensive way to
educate, and which we have some help from the Federal Government,
but not remotely enough.
Then the deep problems of enormous sections of the city being




76
poor and unable to pay its way make necessary the humanitarian
effort to render hospital services and educational services which could
carry that enormous mass of people.
Now it's also been said, I think rather unfairly, that the city has
not been doing anything in the last 7 months since it got into this
terrible jam. That is not true, and I'd like to tick off for you what
it's done.
A freeze has been placed on the wages of municipal employees and
a hiring freeze instituted. Subway and bus fares have been raised from
35 to 50 cents—very tough in a time like this, very hard on the people—
and bridge tolls from 50 cents to 75 cents in those bridges which are
tolls; 31.211 city employees have been laid off since the beginning of the
year and I ask unanimous consent to introduce into the record the
official release on that subject which has just come out as recently as
yesterday.
The CHAIRMAN. Without objection.
[The information follows :1
REVENUE OR BORROWING REQUIREMENTS, JANUARY TO JUNE 1976, TO MEET NON-DEBT-SERVICE REQUIREMENTS
[Dollars in millions]

Debt
service

1

(2)

(3)

(4)

$486.9
1,038.9
490.3
639.9
164.5
331.1
367.4

June 1976

Revenues

(1)
December 1975.
January 1976...
February 1976..
March 1976
April 1976
May 1976

Other
expenditures

Additional revenue
or borrowing
needed to meet
non-debt-service
requirements

$978.9
1,078.4
982.2
1,134.0
1,075.2
890.6
975.7

$586. 4
$392. 5]
754.3
[324.1
867.5
801.6 {114. 7 •1,194.1
771.2
1362. 8
1,090.6
( !(15.4)
1,143.1 830.9 h (252.5)
1,538.7
l» (563.0

)

Items in parentheses reflect excess of revenues over "other expenditures. "

Source: Office of Comptroller: Cash Forecast of Sept. 22,1975.
N E W S FROM T H E O F F I C E OF MANAGEMENT AND BUDGET

[Wednesday, August 10, 1975]
Melvin X. Lechner, Director of the Office of Management and Budget, today
said t h a t payroll runs for September, 1975, show a s h a r p decrease of 9,408 full
time employees from the previous month of August. This latest in a series of
monthly reports on full time employees in New York City government lowers to
263,311 the total number on the payroll as of September 30, 1975—a decrease of
31,211 since December 31, 1974 or 10.5%
The most dramatic decreases during September were achieved by the B o a r d
of Education which showed 7,209 fewer x>eople on the payroll t h a n in the previous
month-—a result of the application of t h e economies directed by Mayor Beame.
There was a further decrease in Mayoral agencies from the previous month of
709. The Board of Higher Education reduced its payroll by 819, while H e a l t h
and Hospitals Corporation achieved a reduction of 493 persons.
An analysis of payroll computer runs of full time employees for the period
ending September 30, 1975, shows the following results :

Dec. 31,1974 Aug. 31,1975 Sept. 30,1975
Citywide
Mayoral
Nonmayoral.




294,522
133,094
161,428

272,719
117,275
155,444

263,311
116,566
146,745

August to
September
decrease

December to
September
decrease

9,408
709
8,699

31,211
16,528
14,683

77
The payroll runs from which this information was developed cover only full
time employees on the City payroll. They exclude CETA, EEA and W R E P
employees.
Included a r e the Off Track Betting Corporation, t h e H e a l t h and Hospitals
Corporation, the Board of Education and the Board of Higher Education and
only those employees in the Transit Authority and Cultural Institutions whose
salaries a r e paid by the City.
Excluded a r e the Triborough Bridge and Tunnel Authority, the Housing Authority and t h e T r a n s i t Authority and Cultural Institutions except as otherwise
noted.

Senator JAVITS. T continue with the cost of self-help efforts. In excess of $2 million has been raised in the capital markets with the aid
of the State agency, "Big MAC," a very very risky, but very patriotic
effort on the part of the State of New York. There has been a rather
complete shakeup in the financial management of the city, with outstanding businessmen like the president of the Metropolitan Life Insurance Co., Richard Shinn, and the president of the New York Telephone Co., Mr. Ellinghouse, having a direct relation to how the city
runs its fiscal affairs.
Then what few people fail to take into account is that over $300
million in area taxes has been advanced the city of New York by local
taxpayers who are patriotic about what happens to the city.
Finally, and we have heard a lot about the quality of the so-called
free tuition in the City University, the fact is that the City University's budget has been cut $32 million, about equal to what paid tuition
would be, and they have simply had to cut down and restrict their
services rather than to go to a tuition plan, which would bar from the
City University an enormous number of young people who merit
higher education and who simply cannot pay the tab on any basis,
even with the supplements and help of Federal and State Governments.
New York happens to have a very, very serious incubus of its own
problem of poverty. And that is very tragic.
Now I will go right away, Mr. Chairman, to this proposition of
whether we can make it or not until investor confidence is revived. I t
seems to me that this is strictly wishful thinking on the part of the
administration. Because they don't want to do anything about this
matter, that is what they start with. I think they are wrong, but that is
where they start, and they have invented the doctrine of instant confidence. There is going to be no instant confidence. Mr. Chairman.
I t takes months and years to rebuild investor confidence, and NCAV
York's situation has become so bad that it has a shortfall in the
next 4 months of over $300 million, even if it stopped paying its debt
service. Also, because of the timing of tax receipts, it's got to borrow
$1,194 million from December to the end of March, even though it
will have a net surplus of $83,000 for the months April-Mav-June,
1976.
So who is kidding whom? The fact is that services will stop. The
fact is that you will have chaos and anarchy in Neiw York, and you
may touch off a depression in this country. It took one bank to touch
off the depression of 1932, the Credit Austalt in Austria. One bank,
and here we face the failure of the most important and largest city
in this country—in the world. Mr. President, we are asked to run that
risk on the word of the Secretary of the Treasury, who say, "Forget
it; it won't be a risk; investors' confidence will return." What are we

60-832

O - 7o - 6




78

going to do if he is wrong? Nothing. We will do just nothing if he is
wrong. He will probably continue to be Secretary of the Treasury,
but the world will shudder and that is the risk we are being asked to
run, for what ?
Now the Secretary's main argument is teach New York a lesson,
and that is the main argument of many others around here, teach
New York a lesson. Well, whom are you teaching a lesson to? Eight
million people who have consistently paid three and four and more
times the Federal taxes to Washington than any other comparable
unit pays in this country, for us to spend on farms and dams and
many other projects upon which the United States lives; and the idea
is being advanced that you are going to punish them and that, therefore, their reform is carried out in all this legislation. However, I
would point out to the committee that every one of these bills calls
for the most spartan position on the part of New York, including
my own.
Now the answer, therefore, is this: Do you want to take the risk of
New York going bust with chaos and the rest of the country and the
world possibly being shaken?—T think they will be and very seriously—in order to punish New York, or do you want to punish them
without running all those risks? You are going to punish them either
way. You are going to punish them when you pass these bills. You
are going to punish if you just stay your hand and do nothing.
I definitely believe—and T don't say this as any partisan New
Yorker, but really as an objective U.S. Senator—that my State will
take a heavy burden in this, under any circumstances, and I say that it
is absolutely out of the question to run the risk we are being asked to
run when the same discipline, the same spartan regime, the same things
that you will do if you do nothing and run the risk, you will do if you
pass the bill and don't run the risk.
The CHAIRMAN. Senator Javits, thank you very much for an extremely powerful and moving statement.
Senator JAVITS. I will come back if you want me to. I will happily
submit to questions, if you want me to come back this afternoon.
The CHAIRMAN. If you'd like to come back about 2 o'clock, that wrill
be fine.
[The complete statement follows:]




79
rniiM Tin; iirrnx nr •

Senator Jacob K. Javits
New York
FOR IMMEDIATE RELEASE:
Thursday, 9 October 1975

CONTACT: Peter Teeley
202: 224-8352
144: 10/9/75

TESTIMONY BY. U.S. SENATOR JACOB K. JAVITS
BEFORE THE SENATE BANKING COMMITTEE HEARING
ON LEGISLATION TO AID NEW YORK CITY
October 9, 1975

WASHINGTON -- "Mr. Chairman, I am pleased to appear before your
Committee in support of legislation which I have introduced to establish
a Federal Loan Guarantee facility for ailing local governments. In so
doing, I would like to commend the Chairman for calling these hearings,
and my colleagues who are appearing this morning with their own legislation. While the New York City issue was initially looked on as a
local problem, and perhaps understandably so, it is clear by now that
by any standard the New York City financial crisis is a national problem
deserving of a national response.
My bill (S. 1833), together with its amendments, offers what I
believe to be *~he best Federal resnonse. Title 1 of my bill sets up an
emergency loan guarantee facility similar in makeup to the loan guarantee
operation we had for Lockheed. A Loan Guarantee Policy Board sets up
general policies for the guarantee, and the day-to-day operations of the
facility are managed by the Secretary of the Treasury. The maximum
amount of any one guarantee which the Secretary can make in any one year
is $500 million under my bill, unless the Secretary submits a full and
detailed report to Congress and neither House passes a resolution of
disapproval within 30 days. The maximum total of all outstanding loans
guaranteed under my bill could not exceed $5 billion.
The loan guarantee facility is protected with several safeguards.
For example, the Secretary would have to find that t i loan is necessary
le
to enable the local unit of government to re-enter the capital markets;
that funds are not otherwise available on reasonable terms and conditions
from any source; that there is a reasonable insurance repayment and that
failure to nrovide the guarantee would seriously impair the ability of
the local government to nroduce ^oods and services.
The guarantee would apply both to local governments (i.e. all
governments below the state level) and to so-called "eligible corporations". I believe it essential to extend any Federal guarantee
assistance to the obligations of municipal assistance-type corporations.
One of my amendments, therefore, extends the loan guarantee facility to
"eligible corporations", which are defined as any instrumentality formed
under state law which has the authority to go into the market and use
the proceeds of its borrowing to purchase debt obligations of local
governments. To protect the loan guarantee facility from abuse, only
such corporations as possess certain, rather far-reaching powers can be
certified by the Secretary of the Treasury as eligible corporations.




80
For example5 the majority of the members of the board of directors of
such a corporation trust be appointed by the Governor of the state, the
Corporation must have wide audit and subpoena powers over the unit of
local government,and it must be given authority to request and enforce
financial management programs and to enforce limits on aggregate debt
of the local government.
Title II of my bill sets up an insurance facility, again with
the Secretary of the Treasury as administrator, which would hold
individuals harmless for the first $50,000 of loss from investment in
tax exempt securities. One of the major purposes of this Title would
be to encourage smaller investors to place funds in the tax exempt
market, thus opening this rather constricted market to a hitherto
untapped source. There is no reason, with New York and many other
municipalities across the country paying in excess of 8 per cent,
tax exempt, that the smaller investors should not be encouraged to
buy up some of this paper.
A brief recapitulation of New York's chronology is helpful in
understanding the present difficulties. Simply stated, New York City's
current fiscal crisis Is the end result of enormous borrowing by
the City over the last ten years in order to meet the ever increasing
needs of City residents. To put the matter in perspective, the
following statistics are useful:
* New York City Mayor Robert F. Wagner's budget was $3.8 billion
in 1965;
* Mayor John Lindsay's budget was $8.5 billion in 1972;
* Mayor Abraham D. Beame's budget is $12.3 billion today.
* The annual cost to the City of debt service has gone from
$644 million in 1959 to $1.8 billion today.
If I accomplish nothing else today, perhaps I can dispel the
notion - advanced in some quarters - that New York City's problems are
entirely attributable to its wicked ways" or that they are a purely
local issue.
I am the first to admit that there has been waste - on occasion
extensive - and even accounting practices which amount to fiscal
gimmickry, and I am also the first to agree that elimination of such
abuses should be a prerequisite to Federal aid. But these evils are
not the major cause of the crisis confronting New York City today.
Rather, New York City's problems are primarily the result of attempting
to cope with the enormous social problems of the day compounded by
the recession and inflation which the U.S. has been experiencing.
These problems include welfare, unemployment and skyrocketing costs of
decent housing, education, medical care and senior citizen care. They
are the very same kinds of problems which confront every city that
attempts to grapple with human needs in our increasingly urbanized
society; but in the case of New York City they are most pronounced
because New York City has been forced to undertake a broader range of
responsibilities than most other cities, including:




81
1) A $1 billion welfare tab picked up by the City to
assist needy persons, many of whom migrated to New
New York City from Southern states and Puerto Rico;
2) A 12 per cent . unemployment rate;
+
3) A bilingual education program with over a million target
population and,
4) Hospital and university services offered free of charge
in order to enable people to break out of the poverty
cycle.
And all this has occurred during a time when the City's tax base
has been shrinking, as industry and the middle class have moved to
the suburbs. Also, we in New York met with a reduced tax base from
the vast demographic movement of people to New York and the North and
^ct ;> hundreds of thousands from the South in connection with the civil
- ., revolution, of the 50!s and 60' s, and the relation of Puerto
.
.
v
i '• co the United States.
•>
'
'
The New York City crisis emerged last Fall (1974) when Comptroller
Harrison Goldin began to challenge publicly Mayor Beame1s projected
budget deficit (Goldin said the deficit was $650 million; Beame said it
was $430 million). This dispute was symptomatic of underlying economic
disease. Soon thereafter (December 1974) the major New York City banks
advised Mayor Beame that the market for City obligations was drying up
(there is presently outstanding roughly $13 billion in City notes and
bonds) and this news was followed by the suspension in the Spring of
1975 of Standard and Poor;s"A" rating on City debt obligations.
In h/ndsight, it seems that we failed to heed these relatively early
«c -"Ping plg.ial , arc to take immediate setps necessary to restore "investor
v,
confidence1'. This w^s not the fault of any individual but the collective
f"ult or everyone including elected officials, organized labor, private
industry, the media and even the public
Lut events - par^ici "ai y the City's need to raise cash to meet debt
maturiti^N • o/ertook i i - ^ ce-^nlao^cy dLnd the following unprecedented
austerit- <ea8ure- ver^ n ^cpe-te^ by the Mavor and/or the State Legislituc>° in zlc-e
cocvtrit
o^ w" ' cr^ariz* 1 labor and the financial communit .
:; i : cize was placed on the wages of municipal employees and a
i
:i . _ freeze was instituted,
^ ,
c) Subway and bus fares were raised from 35c to 500 and bridge tolls
"'oi ^0c to 75£,
>rii
c) .'1,211 City employees have been laid off since the beginning of
tiie year, and tens of. thousands of additional net layoffs are in
the offing.
d) In enc^js
of ?: -iliion was raised in the capital markets with
f \G -ielp of uh£ State-created Municipal Assistance Corporation
\'l. \^ Mfic") , f. ,ch 'Ugh many people fail to perceive the fact,
big MAC bonds are TAOJ: City obligations.




82
TN v
ta<.
ai
Ttl
L^<
e) ~iyi~s

i
\

j

*• '--

vite
I is
f) Tn-----and
Tenpc \-*

g) Over $'

comprised of stock transfer
-<~/or go into City coffers but
" ~^ligations. Big MAC's cur^n ( xtremely able man from
- spading investment houses.
v;ement systems and expende Mayor's Management Adi^,"ng leader from the pric r the Metropolitan Life

"." ~"~ fiscal prospects and
a" over of courts and prisons
-~f ' . p > undertaken by the
,>r
,,T
's Commission is headed by
-~tice Owen McGivern.
: have been paid to the
voluntary basis and in ad-

van: •

h) So- r.
tier-

•^rrtTrjc-nt of Commerce) and f u n c ; ; r ct ^ n c i e s have been combined

i n rr i
i) Thr
$32
During t*"''
action.
Advices
the State, and ' V
its own credit - v •
*
In addit
crisis, an imp^ri
Buckley and jo; or
Comptroller Lev;'
Congressional Dei
Elliott, Editor-i
represents a broa
to taking whateve
financial situst5
quality of life r
are proud of the:
for New York City
serve as a rallyi
get through these
In September
program of austerit
for funds. The mar
with New York City'
islature created th
it the enormous task s O.L
all City money into
contracts, 4) compel
stripped of all fisc
City's deficit over 3 ye
of the New York Tele
State Comptroller Le vitt
V. Casey and David I Ma
private sector.




'"i" by an additional
lition would raise.
r->d continues to take decisive
^ \-;e been made to the City by
on The line to the extent that
:
c.r ardized.
- 'd in response to the deepening
>t_cn "ormed by me with Senator
by Governor Carey, Mayor Beame,
y, Chairman of the New York
f "hich is chaired by Osborn
\n ^orrA
of NEWSWEEK Magazine,
1
interests and is committed
"pie to improve the Cit\7fs
- tc . n in tain some decent:
•c hirdship. New Yorkers
'•".and the Citizens Committee
lat pride. It has begun to
rf v-,^, Yorkers who want to heln

lis f sr it became apparent that, despite this
* i'\ ' ; ? unable to return to the capital market
-,C - . s
•: c io: up. MAC securities had become tainted
••
)lrvs
To resolve this, the New York State Leg-?^HC.y Financial Control Board (EFCB) and assigned
':..) controlling the City's budget, 2) funneling
yzi.e.l account j 3) approving all City spending and
tb-2 City to revamp its budget by October 15th,
Lrriic" s , and 5) developing a plan to wipe out: the
rrs. The Board is headed by William Ellinghaus
: Company and consists also of Governor Care)',
, City Comptroller Goldin, Mayor Beame and Albert
-golis, the latter two having come over from the

83
Along with the creation of the EFCB, the Legislature devised a
plan to raise $2.3 billion to tide the City over through December. Components of this fiscal plan include:
-- $750 million in New York State funds;
-- $725 million in pension fund monies (of retired State and City
workers);
-- $800 million from private financial sources.
The complex plan, remarkable in scope, received an initial setback on
September 29th when the State's highest court - the Court of Appeals ruled that the Legislature could not compel the State Comptroller to invest pension fund monies. This setback was overcome, however, when Comptroller Levitt voluntarily agreed to purchase State full faith and credit
obligations (not MAC bonds) and the State agreed to use the proceeds to
purchase MAC obligations. (Attorney General Lefkowitz and MAC have appealed the Court of Appeals decision and re-argument is scheduled for
October 14th.)

i

»
"he • - r e hi chc' 1 ,
f ~ourh u n t i l t-1
r

T ^rlievn rho stage has been set to carry
i this calenJar year.
,o

d v ~a a U -*VPH*"S were unfolding, it was
4
t
l
sca1 woec- facing New York City could
L - - c ^-y^ e ^i-p j-y York City. Whether
* I
p<
"in^d
to : i«
1
-1
K 'o-V^
uncial center as well, as
' i e >w ~c
'
> 5 h«a ^-' r p o np mefoDO'.s, or because New York City
n
t£t
^-"c ~ - *-' 'r«<~ n r e <~ { ^ i / <
n orr mall our economic lives are
:o ir t
_
rent - i * fo
1' * i « s rmso^s - we cannot escape the facts
i»e
r
'•t Ne
•a f*
*~ lity's problems ar a d -t uur problems; and that the solu>
f e n o - M se r nblems is f h^ r ' c
~dlity u* all of us.
DCs ^

rrg

* "c a TOT e^e^
'dito d o
4

f - - Stat^ in its efi > J t o rer ue the City has exposed itself
u*k
" to f <
iiT'ia cpg^r LT< the .or ns o" ii^^cr interest rates for borr
7
" ^ i
- OT C*-J w o^ - t crc
"
.
rating , Sihdarly, as early as last
, tv o F -/ctroit wi "o^^d ^o O P V r' e :-ther extraordinary Inr
">^t
s o f S p>/ on a t w ;)rn Lss e. 'hlv one underwriting group
_
~n~
" " j c ' ic on *-'p,~ -_]su', and th<> ^r m g New York City crisis
c
^ ~.L < d a- a ma", ^ caust "or ^•?e* d'aat
^ d o in May, bond special4
" "'^e
c
J- 'jv?^ t,
_"/id VTJS almost at a standstill in
r
i
> t<, i r '
- i ; a i v * *.. iorn<3' i^ -aises $22 billion an.:
7
-" _ r • b ate n d loca ^ovo* rent' r^r1 )le; at Igast d g k t cities be,
*
s aes e* Yor < faced the t'.eat ot n«-v5ng t^ i r credit ratings suspended
*
^ :aus " r -h f e w pi-obler^,
A * • : ^ L a : dele in the "vALL d R ~ d JOURNAL quotes municipal bond
•";
L;_K^..L- O m.: r!ifecL" that investors have held back substant \ai 1 y ' " o
.rm
a d kir s ;>" tax exempt obligations dcauso of the New York dtuatlon^
:
The ardc e repeatedly points our t ^>t ' h ImoaoL is natdndd.-^ an^- not
"e
:tc d.^ui, Citrcs such as d , Louis and Cleveland are already -paying
;$har in.i':."".: rates as a d : * ; L ,:.Mult of .;^: Y-^rk Ciry.. Cleveland
,. - ^
,-<uay4rs in fact, are estimated ?o be in the red . n ad-: Iti -,nal $4riG,000
;
r
b^-'^us^ o - increased inte:.. est cii.rrges direct" y attributable r o the New
s
r
-f.'k crisis. An('s as recently as Tuesday o this week j ; wa: roport^ci
tiiai: OL fi-L-ials of foreign countries (Includirig West Germany. France and
K . . I n - c . e quite fearful of tbe Impact of a New York f'jty clefa fit in
/ - - a c ; .r
their ov;; capital markets. We cannot forget that the ;.: ' • dc-iiession was
!
touched eff by on^. bank failure - the Credit Austalt in Austria.




84
"Spilling over" is not really accurate to describe t : « reverberal•
tions of New York City1s difficulties in other markets. What is really
happening is that New York City is experiencing the first shock wave of
a financial catastrophe which, regrettably, is characteristic of our
increasingly urbanized society during these times of inflation and
recession.
One estimate of this increased cost of this catastrophe, applied
to the amount of interest costs which state and local governments pay
in interest on this debt, indicates that American taxpayers will be
paying between two and three billion dollars per year in extra interest
costs because of the uncertainty in the tax exempt markets.
The Federal issue j .1 also clearly apparent, in terms of the
health of the securities and financial, markets generally. Sone of the
eri ics o aid to the city, for example, have pointed out that the ratio
o c "V? t j exempt to taxa1,;e '.ecuiitios yields - a typical measure of
-.
financial market stabilit
has remained at its traditional level of
approximately 70 pei cent during the entire time that the New York City
:
crisis has been brew'nt
iai.,e,"crr 1 munt impress upon my colleagues
that: that situation ear cl^.nrcc very dramatically re recent v %eks „ as
was ijipiiod by Pn~, $urin'. In ais testimo.ty before the Joint: Economic
Coiami'.tee yesterday. The : at\o as of the ; e ; week in September was in
e-t
±.xcr:::>r. ef 30 per "L-m. ^^...ninj* that .eunicire;l.: ties isstxiug SJ^'V-^S£SB£^.
seciritLes now must pay almost the sa^e -rite as prime rated corporations.
Incidently, I have been informed that the cities and states used for the
purposes o r compiling the municipal bond irK'ex do not include New York;
what the ratio shews, '~hc.eefore„ is :-.hat othev cities and States are so
affected by the New Yore situation as to influence substantially the
interest ratos tle.y pay*
What we in Congress fa.:e, therefore, is a set of competing risks.
If ••?' act, t? run the possible risk that other units of government will
.e
start lining jp at the Treasury Tor Federal assistance. 1 would not
want this to happen, and 1 earnestly hope that such safeguard;- are viritten into any legislation as to -revent such an event from happening. We
also run the risk, as Fedora" Reserve Chairman Arthur B u m s pointed out
yesterday, of putting some strain on our financial markets with the
creation of a new series of Federally guaranteed debt. My answer to that
problem is that the provision of essential municipal services is a very,
very high priority, aveu compared with competing priorities in our
f inr ac ia 1 market s .
On the otbe bind, the risks </ face by inaction are in my mind
-e
far greater. We already have some in el cation of what is around the
ccmar: spiraling interest rates for States and municipalities across
tee country, a virtually complete investor disaffection with all kinds
of tax exempt obligations, the closing of the credit markets to many
deserving State and local borrowers, the shutting down of government
construction projects all acrosr the country., the injection of chaos —
however temporary -- to our financial markets, and a serious aborting of
.
our fragile economic recovery. "his is a risk not worth taking compared
to doing what is needed to avert it.




85
The CHAIRMAN. The committee will stand in recess until 2 o'clock
this afternoon.
[Whereupon, at 12 :55 p.m., the hearing was recessed, to reconvene
at 2 p.m. this same day.]




A FTERXOOX

SESSION

The CIIAIKMAX. The committee will come to order.
Senator Javits, you and I had to leave for another vote on the floor.
Your testimony was consequently interrupted.
Senator JAVITS. Mr. Chairman, I have completed my testimony-inchief. I simply wanted to insert a figure by way of the correction of a
figure I gave.
I understand that the city of New York is the source for $16,600
million in Federal taxes every year. The testimony is here replete with
references to the fact that it receives one-eighth of its budget by various
Federal payments, transfers, et cetera, $3.5 billion in round figures.
I shall submit, if the4 Chair will allow me, a comparison from other
major cities and other major States if I may do that.
The CHAIRMAN. Y ? S , indeed. We would be glad to have that.
Senator JAVITS. 1 have faced here before the wrath of my own constituents when I voted measures that benefited very little in Federal
taxes. I had no compunction whatsoever with that. The same can be
said of many other Senators, I am sure.
I only raise that issue because we have not complained. In fact, we
have cooperated in many, many other things which were necessary to
save other parts of this Nation.
Now, our time has come.
I would like to restate, because I was quite impassioned, Mr. Chairman, but I feel this is the real issue : the real issue is that the Secretary
of the Treasury or President and others say strip New York to the
bone, adopt a spartan regime, expiate the sins of the past by bringing
the budget to balance in 3 years and the investors will come back to
you.
I call that the doctrine of instant confidence.
On the other hand, people like myself say impose as spartan a
regime on New York City as any fair person would consider reasonable
and require the State to support the city—which, legally speaking,
is a creature of the State—to the maximum extent that will not simply
seriously impair its own credit standing and its own financial situation; and then give it an opportunity by meeting those conditions
to put itself back in shape so that investor confidence hopefully may
return.
If it does not, we doirt want the city to run the risk of going bankrupt and touching off a real depression in this country and perhaps the
world.
They both come to the same thing.
On the one hand we are proposing measures to eliminate the risk of
the earthquake effect which I personally think will occur.
On the other hand, we are taking that risk.
I see no honorable reason in policy why Ave should do nothing simply on the word of a few people, high in Government, even who are
admittedly expert in finance, who say it won't happen.
(86)




87

I produce for the chairman the evidence of Chairman Burns himself whom both of us heard in this very seat say only yesterday, that he
was shaken by the events of the last 2 weeks.
We are men of great experience, Mr. Chairman, around here.
We are often very surprised at how speedily events overtake opinions.
Perhaps as good an example of that as any is what happened in South
Vietnam within a space of a few weeks.
So I say it is not necessary to take the risk, to teach New York a
lesson. New York will be taught a lesson no matter what you do, no
matter which of these bills you pass.
That is a lot more secure way to teach New York a lesson if that is
the objective—T think it is analogous to punishing 8 million people
because of the alleged sins of their rulers—but be that as you may. if
you want to do that you can do it as effectively without running a risk
to the whole country and to the whole system.
The instant confidence theory won't work because even courts in the
absence of evidence will say there are some things of which a court
will take judicial notice.
That is the common experience of men.
If you throw a ball up m the air, it will come down.
It is the common experience of men that you can't restore enough
confidence that if you default on your debt service you can raise $1
billion by the end of March.
So, Mr. Chairman, and 1 think Hubert Humphrey was present in
saying let's spend as much as necessary to avoid the city from shattering, so that we don't have to spend more to pick up the pieces.
The Chairman. Senator davits, I think all of us in the Senate,
whether we agree with you, as many do or disagree, as a number do,
recognize that you are a man of extraordinary intelligence. You are
as intelligent a man and knowledgeable a man as has served in the
Senate in my experience here.
You have served in the Senate for 19 years representing the State
of New York.
You served before that as attorney general of the State of New
York. You served before that as a Congressman from a district in the
city of New York.
With that background, you know as much about what the Federal
Government can and cannot do and should and should not do and
what the city or State of New York can do as anybody alive.
With that in mind, can you tell us what would happen in your
judgment if the city did not get Federal assistance, if it had defaulted
and was not able to meet this tremendous demand for refinancing for
meeting its capital budget and its operating budget ?
Would it under those circumstances be necessary at that point for
the Federal Government to assist, and, if not, how would New York
City and the State solve their problems?
Senator JAVTTS. Mr. Chairman, you are very kind to me. T deeply
appreciate it.
T cannot look into a crystal ball. T can only join my prayers with
yours and that of every other American that no such thing as could
happen does happen.
But I must tell you that at least one of the results in my judgment
would be a very drastic fall in securities markets.




88

I don't see how that could be avoided if we let our biggest city go
bust. I t indicates the United States has lost something itself in terms
of its determination to hold together as a nation.
Second, I believe that it would be a very long time winning back
people to municipal securities even though we expedited the pressure.
Third, you have the terrible complications of a default. On the
ground of common prudence I support regulating our bankruptcy
statute to bring up to date.
But I doubt such a new bankruptcy statute would be in place before
the event of a possible New York City default.
And I don't believe that the present bankruptcy statute would help
at all.
I don't think the city, even if it wanted to, could qualify.
Then you would have as an immediate aftermath in my judgment
a multiplicity of suits in New York asserting liens, et cetera. Courts
would be flooded. The comptroller could not see his way clear to make
any payments except under the auspices of a court to pay policemen,
firemen, and sanitation workers.
You could have a general strike. It is already being threatened on
the ground that the current crisis is being used to break down the whole
area of collective bargaining between the cities and its employees.
You would cause a material erosion of the New York tax base by a
further exodus—it has ah'eady cost us almost half a million jobs in
the last decade.
The wreckage I have described is enough.
If you put a stop on relief checks, what do you think will happen
in the Bedford-Stuyvesant and ITarlems and Brownsvilles and South
Bronxes of New York?
Even if I am completely wrong and these things are not going to
happen, why run the risk ?
What is beinjr asked of the Federal Government ? To lend its credit
for a, rollover for what Secretary Simon defines as an absolutely safe
situation.
He says even the present bond holders will get their money. I t would
take 2 to 4 years. What is that to the Federal Government ?
With all the remedies that would be im^olved, yours, mine and Senator Humphrey's, this thing would be No. 1 credit if there is anything left to be No. 1 credit for.
This is the issue. That is the essential argument.
The CHAIRMAN. SO it is likely—nothing, of course, is certain. But
it is likely if the Federal Govei'nment provides a guarantee that there
would be no cost to the Federal Government. There would be no additional cost to other municipalities from higher interest and therefore higher taxes.
On the other hand, if New York does default, the Federal Government would in all likelihood on the basis of the disaster situation you
described, would have to step in at that point with massive appropriations, substantial spending, and with an adverse effect on many, many
municipalities or affecting all municipalities across the country.
Senator JAVTTS. My answer is resoundingly, yes. When you compare the risk, if New York can come back that fast, why run the
risk?




89
That is what Secretary Simon says. But if he looked at the city's
cash flow he would have to admit no matter what you did you would
not restore investor confidence by December 1.
That is a month and a half away.
The CHAIRMAN. Finally, Senator Javits, it is, I think, the problem really is trying to persuade the administration to see just exactly
what you have said now and also trying somehow to work out the kind
of a situation that Senator Tower and Secretary Simon developed at
the very end of their questioning.
Senator Tower said what kind of a situation should we as a Congress be looking at if we relied on the advice of the Treasury to put
together something.
lie won't support it now.
Maybe like other people, he may change.
Pie said something so punitive that no other city would ever apply
again.
Senator JAVITS. That is Draconian. You don't even punish criminals
that way.
The CHAIRMAN. Nevertheless, it seems to me I got a feeling from
him for the first time that the administration was 'beginning possibly
to think about something they had dismissed without any consideration before.
Senator JAVITS. Mr. Chairman, may I make a suggestion?
The CHAIRMAN. Yes.
Senator JAVITS. YOU were

kind enough to say such nice things about
me that T am emboldened to do it.
T think the most important thing Arthur Burns said yesterday was
that in the last 2 weeks he began to worry. That is in essence what
he said.
T think if this committee should on the basis of these hearings go
ahead and begin to mark up a bill, by the time that bill is ready for
the floor, which would be about a minimum of 21/? weeks, and gets to
the floor, which would be a minimum of 3 weeks, taking us to the
middle of November, I think Mr. Burns and Mr. Simon and everybody else*, will be worried enough to talk business.
But if we wait and ponder, we will be too late.
The CHAIRMAN. Senator Javits, thank you very much. That is excellent advice.
We will try to mark up the bill as soon as we can.
Senator JAVITS. Thank you.
The CHAIRMAN. Our final witness is Mr. Lennox L. Moak, director
of finance, city of Philadelphia.
STATEMENT OF LENNOX L. MOAK, DIRECTOR OF FINANCE, CITY
OF PHILADELPHIA, PA.
The CHAIRMAN. We are glad to have you here. Mr. Moak.
Mi*. MOAK. Thank you very much.
I wish to address my remarks today to both a short-term problem
and a much longer term problem. As a director of finance of a large
city, we are indeed suffering at this time in the municipal market.
The results of many pressures upon that market and that those pressures have brought us to the verge of no market, For example, on




90
July 22 of this year, I offered a $60 million general obligation bond
issue in Philadelphia for which I would normally receive three
bids. I received only one bid because of the basic market conditions.
I n September with an A rating, a very high grade water and sewer
bond, much above its actual rating and its quality, we paid 8.99 percent interest.
The following day I opened negotiations with the syndicate concerning our next need for cash of $75 million of anticipation notes.
I n each case when I talked to a member of that syndicate, I encountered a great skepticism as to whether or not it could be done at
all.
This is a city which when the books were closed for last June 30
would show a bona fide cash balance of several millions of dollars in
its consolidated operating fund statement.
I t is a city which has operated for 4 years with no tax increase and
actually a small tax decrease. This is the antithesis of some people's
concepts of irresponsible operation of a municipal government. I t
is, however, a city which needs cash in the course of a year in substantial amounts. We need long-term cash to carry forward a $200
million to $300 million capital program. We need short-term cash
for about 10 months in the year in anticipation of taxes received in
the last 2 months, and we need $7 million to pay interest on money
that we have earned from the State and Federal Government which
has not been paid to us in cash. We must depend on the capital market
continuously to provide both short-term and long-term financing.
Increasingly, it seems that the confidence in municipal bonds has
disappeared. My analysis of this indicates that this is due to several
factors. The first is there is no universal accepted accounting procedure
for State and local governments so that one does not know when he
reads an accounting statement precisely what it really means.
Second, there are no broadly accepted set of opinions for disclosure
of information concerning financial conditions, and in many cases,
especially general obligations bond issues are sold with no disclosure
whatever to potential purchasers. This is not true in the case of
revenue bond issuers. Yet, even there, it depends on the combined
interests of the parties concerned in the transaction.
Third, there is a growing concern over the importance and reliability of ratings of tax to municipal securities. The securities I'm
attempting to negotiate at the moment have the highest rating for
Moody's, and yet I am having considerable difficulty because the
market, allowing with discounting for New York and other places,
has discounted the quality of the rating assigned.
Fourth, the market is inundated with unnecessary amounts of securities unrelated to the basic operations of State and local government. We have huge amounts of industrial development debt. Tremendous amounts of pollution control debt which has been authorized
and some of it issued. We have community facility bonds which benefit hospitals, nursing homes, institutions of higher learning, and the
like. If we wish to support, and I think they could and should be
supported more efficiently through direct tax credits or appropriations, rather than by use of tax exempt bonds, notes, and mortgages.
This list goes on through numerous ether types of facilities. I t
seems to me that the basic market, especially in the East, has reached




91

a point where if we are to restore it, we must take a number of comprehensive actions which are industrywide although they would be
invoked largely on a voluntary basis.
Congress has recently established the Municipal Securities Rulemaking Board within the Securities and Exchange Commission. I have
the pleasure of serving as a member of that Board. I believe that the
concepts which were considered by the Congress—and in part at my
own suggestion modified—in the course of adoption of that measure
should be reexamined. I t is time for the establishment of municipal
securities commission for oversight of muncipal bonds in the United
States. The commission would establish standards for disclosure, for
accounting, recommended improved standards for rating of bonds and
administer programs which are authorized by the Congress for its
administration.
I think the legislation which the Congress should now consider should
limit the use of tax-free bonds and the taxable option bonds, if authorized, to conventional State and local functions. We cannot support
everything that everyone wants to support through a so-called municipal bond. The Bond Buyer, says that in the first 9 months of this year
we sold $22 billion or $23 billion of long-term muncipal bonds, plus an
accounted amount of short-term paper—sold either as notes or direct
loans to the banks.
The market cannot absorb this much paper on any reasonable basis.
We have to take some forthright steps to reduce the demands on the
market.
Third, I think Congress should establish the taxable option municipal bond with a substantial interest payment by the Federal Government preferably with the direct passthrough mechanism to the investor
in order that we can get maximum benefits from them. I personally
have some doubts as to whether that particular option, if used as an
option, would do much to improve the market. However, for certain
sectors of the market, it could constitute an important element of relief.
The fourth step which T propose is that the Congress establish a
municipal bond insurance and guarantee program and that this program would be optional. It would be limited to debt for conventional
government operations and the amount of debt to be guaranteed or
insured or both should be limited in something like $100 per capita
in a city which was performing all of the local governmental functions such as New York or as in the case of Philadelphia, $100 per
capita to be divided between the city and the school district. This
limit, if set low enough, would provide a guaranteed base for important
conventional governmental activities, and would help to dissaude some
of the unwise use of such a guarantee that involved no such limit. The
prerequisites to qualification for the insurance and guarantee program
would be to comply with the accounting standards adopted by the
commission, to comply with disclosure standards, to provide assurance
that the debtor government will provide revenues sufficient to meet the
debt service. Moreover, the issuei* should deposit with the commission
an amount equal to the maximum annual debt service requirement on
oustanding guarantee debt.
This is a device used in the case of revenue debt in municipal bonds
today and helps improve the quality of those bonds. The issuei* would
have to agree to accept assessments made by the commission from time




92
to time to reimburse us for any losses which may be incurred. In that
connection, it may be necessary to impose some limitation on the
amount of such assessments in order to encourage those State and local
government that have great responsibility to accept the provisions
of this section. In other words, they might think they had to pay too
high a premium in due course.
All of this would be applicable only to new debt or new capital programs. Outstanding municipal debt would be administered in its conventional manner except in a case I outlined briefly below. Additional
debt for conventional functions beyond that guarantee would still be
issued by State and local governments without such guarantee or
insurance on either a tax-free or a taxable bond option basis.
Additional debt for municipal enterprises and facilities should be
stricken from the list of tax-free and taxable option financing in order
to hold down the market to a level that can absorb the debt most
important to most citizens in State and local government.
There is a need to provide for important reentry of the commercial
banks who have largely withdrawn from the municipal market in
order to have support.
I n connection with the Xew York emergency, I urge that future
conversation concerning this matter differentiate carefully between
potential bankruptcy and potential default. Potential bankruptcy
arises from the fact that a man's financial affairs or corporation's
financial affairs are in such a difficult position that they need a basi^
reorganization. I t may be they need the protection from the law for
a period of time from harassment in order to accomplish a rational
reorganization.
Potential technical default confronts every issuer at any time he
has a temporary shortage of cash and has an obligation due that is
affected. The city of Philadelphia has a debt service payment due in
January of each year. We have an adverse cash flow the first 8 months
of our fiscal year. We may have healthy receipts in the last 4 months.
If we have no way of anticipating receipts of the final 4 months in
meeting the debt service in January, we are a potential defaultee.
We can like practically any State or local government in the United
States, with the exception of those who carry huge surpluses, be
put in a position of a potential defaultee. We should differentiate
between this kind of situation and one that involves long-term problems.
In order to meet the problems of these two, especially the problems
of potential bankruptcy, it is my suggestion that the proposed Municipal Service Commission promptly be created and it be authorized to
undertake a pattern of insurance for refunding notes in ?> years to
meet the debt service of State and local government in 1975, 1976,
and 1977. The plan should provide for reorganization during that
period so that the government affected can have its financial affairs put
back in a suitable condition.
One thing which, despite the conversations I have heard here today
and in many other places about New York, that has not been brought
out clearly, I believe, is that much of Xew York's problem is the
nature of the debt planning, rather than the amount of the debt.
Probably 40 percent of Xew York's debt at any given time is due
within 24 months. Xo other government except the U.S. Government,




93
and I don't think even it is ever* in that posture. This is a tremendous
percentage of its total outstanding debt being of short-term character.
It has continued to place New York in a bad situation. If that were
replaced by long-term debt, it could dispel the lack of confidence in
the investors and would improve the situation in New York.
The remaining details of my proposal are in the memorandum I
have presented to you. I will not burden you with recitation of those
at this time.
Thank you very much.
[The complete statement follows:]
IMPROVING T H E M U N I C I P A L BOND MARKET : T H E PRESENT

SITUATION

(Substance of r e m a r k s of Lennox L. Moak 1 to the Senate Committee on Banking
and Currency on October 9,1975)
In many respects, the municipal bond m a r k e t is on the verge of disappearance
for many jurisdictions. Even where it is operative, exhorbitant interest costs
a r e required of issuers of medium and good grade bonds if they a r e to have any
access to the market. These recent experiences of the City of Philadelphia
suffice:
(1) On July 22, in a sale of $G0 million general obligation bonds of the City of
Philadelphia, we received a single bid. Instead of three syndicates bidding vigorously against each other, as has been the custom in Philadelphia, all of the bidders
were obliged to pool their resources in order to .be able to handle a medium-sized,
good grade general obligation bond.
(2) On September 29, the City sold $50 million of very high grade w a t e r and
sewer bonds of the City of Philadelphia at an 8.99 percent interest cost.
(3) On September 30, we m a d e careful inquiry of a number of the leaders in
the municipal bond field concerning the conditions under which Philadelphia could
obtain a $75 million bond anticipation loan. In each case we encountered skepticism a s to whether it could be done at all.
REASONS FOR VIRTUAL DISAPPEARANCE OF MARKET

The reasons for t h e v i r t u a l disappearance of the municipal m a r k e t a r e immediately tied to the New York situation ; however, the fundamental causes go
far beyond New York. I t is to the l a t t e r conditions t h a t I wish to direct your
attention today :
(1) There arc no universally-accepted
and universally-applied
systems of
accounting and reporting for local and state governments.—There
are three accepted ways of reporting revenues of these governments and also three ways of
reporting expenditures : Cash ; Full A c c r u a l ; and P a r t i a l Accrual.
This makes for nine distinctive ways in which a balance sheet and statement
of financial condition can be developed.
Moreover, where municipal enterprises are involved, depreciation may or may
not be used. This raises the number of alternatives to as many as 15 different
ways in which the same basic facts can be reported—with 15 different answers as
to w h a t constitutes the financial condition of the enterprise.
(2) There arc no broadly accepted principles relating to what
constitutes
reasonable disclosure of information.—In
the issuance of general obligation bonds,
it is customary t h a t no official statement be issued.
1
[This is a personal statement of Mr. Moak and does not necessarily reflect the views
of the City of Philadelphia or any other organization with which he is associated.]
Mr. Moak is Director of Finance of the City of Philadelphia and Senior Lecturer in Public
Finance. Fels I n s t i t u t e . University of Pennsylvania. He is Vice-President of the Municipal
Finance Officers Association of the United States and Canada. Mr. Moak is a u t h o r of six
volumes on different aspects of local government finance covering such areas as debt
administration, sales tax enforcement, budgeting, capital programming and capital
budgeting, and most recently a comprehensive volume entitled Concepts and Practices
in
Local Government
Finance. Most of his professional work has been in research in s t a t e
and local government. P r i o r to locating in Philadelphia in 1949, he served for 11 years in
Louisiana, where he was on occasion Budget Officer for the S t a t e of Louisiana, Personnel
Director for the City of New Orleans, and Lecturer in Government, Tulane University of
Louisiana. He is a native of Mississippi and spent his vouth and secured his education in
Texas.

60-832 O - 75 - 7




94
In the issuance of revenue bonds, the contents of the official s t a t e m e n t depend
largely upon the combined judgment of the issuing officer, the bond counsel, t h e
consulting engineer, and, in negotiated deals, the head of the syndicate. B u t inasmuch a s the actors vary from one bond issue to another, so do t h e contents
of the official statements.
Even when the original disclosure is adequate, there a r e no requirements
for an effective flow of continuing information during the life of the bond issue.
Nor is there any uniform system for its organization and circulation. Nor is t h e r e
any central point from which existing information can be secured.
(3) There is a growing concern over the importance
and reliability
of the
ratings attached to municipal
securities.—I
am not u n d e r t a k i n g to open up
the basic subject of the m a t t e r of ratings and the m a n n e r in which they may be
improved; however, any catalogue of the ills in the municipal bond m a r k e t m u s t
not be ostrich in character.
T h e r e h a s to be a recognition of the importance of ratings and research
into ways in which the systems may be improved.
(4) The market is inundated with unnecessary
amounts of securities
unrelated to basic operations of state and local governments.—There
a r e m a n y kinds
of tax-exempt a n d tax-preference paper in t h e m a r k e t which should not be there.
P r i m a r y in this list a r e :
(a) I n d u s t r i a l development debt—whether in t h e form of i n d u s t r i a l aid
bonds, tax-exempt mortgages, or general development schemes of s t a t e a n d
local governments.
(b) Pollution control bonds.
(c) Community facility bonds for the benefit of nonprofit corporations,
e.g., hospitals, n u r s i n g homes, and institutions of higher learning.
(d) Housing bonds and redevelopment bonds in a wide variety of types.
(e) Commercial operations, e.g., office buildings, p a r k i n g facilities, a n d
stadia.
This debt is largely for the purpose of providing a subsidy to these different
kinds of economic or social activities. The use of t h e municipal bond m a r k e t as
a means of providing such subsidy is both inappropriate and inefficient.
CORRECTIVE ACTIONS NEEDED TO R E E S T A B L I S H AND M A I N T A I N A M U N I C I P A L

MARKET

I n my opinion t h e Congress should enact a comprehensive plan which would
include t h e following elements :
/ . Establish a Municipal Securities
Commission
The functions of the Commission would include :
A. General research in respect to and improvement of t h e municipal bond
market.
B. Establishment of well-defined alternative systems of accounting which
would be acceptable for application by s t a t e and local governments.
C. Establishment of s t a n d a r d s for disclosure incident to the creation and
servicing of debt of s t a t e and local governments.
D. Development of recommended improved s t a n d a r d s for use of those who
r a t e municipal bonds but, with the u n d e r s t a n d i n g t h a t the r a t i n g agencies
a r e not legally obliged to adopt such s t a n d a r d s . T h e Commission would have
no control in respect to r a t i n g agencies.
E. Administration of programs authorized by the Congress in support of
t h e municipal bond m a r k e t .
F . Absorption of any functions being exercised by o t h e r federal agencies
t h a t may be more appropriately placed with t h e Commission.
I t is recommended t h a t in t h e performance of functions " B " and "C", t h e Commission utilize the device of self-regulatory boards of the type t h a t h a v e functioned effectively in connection with the Securities and E x c h a n g e Commission.
27. Limit the Use of Tax-Free and Taxable-Option
Municipal Bonds to Conventional State and Local
Functions
T h e wide use of municipal bonds in the various ancillary a r e a s ( e n u m e r a t e d
under No. 4 on P a g e 4) h a s contributed to the collapse of t h e municipal m a r k e t .
Congress should immediately w i t h d r a w the availability of tax-exempt securities
for these purposes in t h e future. I t should not extend proposed taxable-option
bonds for these purposes.
Where the Congress believes t h a t financial assistance is required for these
areas, such assistance should be provided through either ( a ) t a x credits, or (b)
appropriations, or some combination of t h e two.




95
III. Establish a Taxable-Option Municipal Bond
The advantages a n d the disadvantages of the "taxable-option" municipal bond
have now been discussed for a sufficient period to enable a basic u n d e r s t a n d i n g
of this proposal.
I t is recommended t h a t Congress establish such a taxable-option municipal
bond on a basis of free choice of use by s t a t e and local governments.
For t h i s taxable-option bond to perform satisfactorily, it is believed t h a t the
federal subsidy r a t e should be a t least 40 percent.
The taxable-option bond would provide for significant improvement in t h e
net costs of borrowing to many jurisdictions with good actual credit positions
but which have been discriminated against unfairly in the marketplace through
u n w a r r a n t e d identity with the problems of New York.
However, the taxable-option bond does not provide a basis for broad improvement in t h e bond market. However, if administered in a m a n n e r t h a t assures a
pass through of federal dollars to the investor, it could provide a modest support
to the m a r k e t circumstances.
IV. Establish a Federal Municipal Bond Insurance and Guarantee
Program
In my view, we cannot reestablish a m a r k e t a t reasonable costs to s t a t e and
local governments short of providing a basic new set of conditions under which a
large portion of municipal debt will be issued in the future.
After a very careful study of the m a t t e r for many years and intensified study
during recent months, I am now of the opinion t h a t the only way is to provide
for a system of insurance and guarantees, on an optional basis, for those s t a t e and
local governments which wish to take advantage of the system of insurance and
guarantees outlined below.
The proposed Municipal Securities Commission would be responsible for the
development and implementation of a system of insurance for bonds of state and
local governments which accept this option in the issuance of t h a t portion of their
new debt which falls within the limits of the program.
The system of insurance and guarantees should be limited to :
(a) Debt for conventional governmental operations of s t a t e and local governments, including w a t e r and sewer systems but excluding other kinds of
enterprise and ancillary operational debt.
(b) The amount of the debt to be insured or g u a r a n t e e d would be limited
to an amount determined through per capita and other techniques but would
generally be limited to about $100 per capita for each of the next three years.
Within the three-year period, the Municipal Securities Commission and the
Congress would determine the ground rules to apply to debt issued after
J a n u a r y 1, 1979.
Prerequisites for Qualification for Insu ranee /Guarantee
Program
To qualify for inclusion in the insurance and g u a r a n t e e program, the issuing
s t a t e or local government would be obliged to do the following :
1. Comply with the accounting s t a n d a r d s adopted by the Commission from
time to time.
2. Comply with the s t a n d a r d s for disclosure at the time of issuance and
during t h e period t h a t insured and guaranteed debt is outstanding.
3. Provide assurance satisfactory to the Commission t h a t the s t a t e or local
government will provide revenues sufficient to meet the debt service on the
debt a t all times.
4. Deposit with the Commission an amount equal to t h e maximum a n n u a l
debt service requirements on the outstanding guaranteed debt. 2
5. Agree to accept assessments which may be made by the Commission from
time to time in order to reimburse t h e Commission for any losses it h a s
incurred as a result of default of obligation of a state or local government
which is insured and guaranteed by the Commission.
6. Provide an equitable share of the operating expenses of t h e Commission.
The Commission would be authorized to insure all debt accepted by it and to
pledge the full faith and credit of the United States as a further g u a r a n t e e to such
debt. It is intended t h a t the g u a r a n t e e will be solely for the purposes of increasing the acceptability of the debt in the marketplace and t h a t the United States
would never in fact be called upon to make good on the guarantee.
2
Upon m a t u r i t y of all the debt in an issue, the deposit and interest accumulated thereupon would be returned to the issuer.




%
The insured and guaranteed debt could be issued either as non-taxable debt
or as taxable-option debt at the option of the issuer.
The effect of adoption of this proposal would bring down the rates of interest
payable by those governments that accept the provisions of the Act. It would
tend to standardize the risks and would thereby tend to provide only a narrow
range of very high quality municipal debt.
Outstanding Municipal Debt
It is intended that the Commission should be primarily concerned with newissue debt. However, as outlined in a subsequent section of this presentation,
the Commission would have important interim powers in relation to the reorganization of outstanding debt for state or local governments confronted with
bankruptcy or default in its debt payments.
In all other respects it is intended that state and local governments work out
their own problems in relation to their outstanding debt.
In this manner, the Congress and the federal government would be providing
a vehicle by which orderly processes of capital program execution on a reasonable basis could go forward in all state and local governments.
Additional Municipal Debt for Conventional Functions
Beyond the insured and guaranteed municipal debt, state and local governments would be free to continue to issue their tax-free debt or their taxable-option
debt to provide moneys in substitution for or as a supplement to the insured and
guaranteed debt for conventional state and local government functions.
Additional Municipal Debt for Enterprise and Ancillary Functions
Except for completion of projects in the pipe-line, state and local governments would not in the future have the option of either tax-free or taxableoption debt in the financing or enterprises and ancillary purposes of the type
that have been outlined on Page 4 of this proposal.
To the extent that state and local governments which to continue the operation of these functions or assistance in financing of these functions, they would
be obliged to issue taxable debt in the name of the state or local government^
or to provide subsidies to these functions within the requirements of state
constitutional and statutory limits.
One final point. It is essential that the commercial banks be brought back
to the municipal market and that they be encouraged to participate in it in a
more orderly fashion than has characterized their participation during the past
decade. This action is necessary ; however, the means by which it can be accomplished is a topic for discussion at another time and after greater exploration of the options.
T H E PRESENT NEW

YORK

EMERGENCY

In the discussion of the long-term program in the foreging portion of this
presentation, I have urged that state and local governments should be responsible for management of their own debt under the new system. This is, I believe,
an essential element of any long-term survival of a federal system.
However, we are confronted with an emergency of major dimensions in the
case of New York City. In order fully to understand theT differences between
New York and other cities (and perhaps some states) w hich could easily be
severely affected by a New York failure, it is essential that we have a clearheaded distinction between two situations :
(1) Potential Bankruptcy.—When a corporation's financial affairs are in such
a difficult condition that a thorough reorganization of these affairs is a prerequisite to its continuance as a viable organization and when such reorganization can be effected only under the protective wing of superior legal process that
allows time and freedom from harassment, we must recognize that one is confronted with a de facto temporary bankruptcy.
This is the situation of New York City at this time.
(2) Potential Default.—A default consists of an impending temporary inability
to meet obligations as they fall due. This can occur to corporations which are
in basically sound financial condition but which are temporarily unable to secure
orderly access to capital markets for external reasons that have little relationship to basic internal financial strength.
There has been an almost universal failure of those who have spoken on the
current situation to make this distinction and to apply it properly to the financial
affairs of local and state governments outside New York City.




97
There is a relationship between the potential bankruptcy of New York and
the potential defaults elsewhere. However, it is a causitive r e l a t i o n s h i p ; it is
not an organic relationship.
Temporary default by a large number of cities (and perhaps some states)
can be triggered by a temporary bankruptcy in the case of the City of New
York. These can, in my opinion, be avoided only if appropriate and timely means
a r e applied to t h e New York situation in a vigorous manner now.
If a wholesale default occurs in New York City, the capital m a r k e t s will become so disorganized t h a t many other jurisdictions will not have orderly access
to capital absolutely required for the ordinary management of their financial
affairs. This lack of access can put these jurisdictions into temporary default.
Such temporary defaults by a few jurisdictions can spread quickly to the point
t h a t almost no one h a s access to an organized capital market.
We cannot countenance this kind of catastrophe !
Not only the capital m a r k e t s for state and local governments would be affected.
The malaise would spread far beyond those precincts.
If we a r e to avoid this catastrophe, how can it be best done? My program is :
(1) Immediately create the proposed Municipal Securities Commission.
(2) Authorize a p a t t e r n of issuance of insured refunding notes with a life
of up to three years to meet the debt srevice on any debt of a s t a t e or local
government falling due within the remainder of 1975 or during 1976 and 1977.
(3) Provide t h a t the affairs of the governments which t a k e a d v a n t a g e of this
insured program be placed under the most rigorous supervision of the proposed
Municipal Securities Commission. Where local governments are involved, the
Commission could t a k e advantage of state supervisory services, which would
be an integral and required portion of the program.
Plans for the reorganization of the debt of each government taking advantage
of the insured notes would be developed under guidelines established by the
Commission. Legislation would be enacted which would enable the Commission
to order such plans into effect and such orders would have the same force of law
as the orders of a court in commercial bankruptcy proceedings.
(4) Provide the Commission with authority for insurance in an amount roughly
equal to 125 percent of the total debt service requirements of the City of New
York for the period November 1, 1975. to December 31, 1977. This should be
sufficient to take care of New York City and such other governments as decide
to take advantage of the emergency program.
I strongly advise t h a t no emergency program be enacted without simultaneously
enacting a program for a long-term reorganization of the municipal securities
m a r k e t along the lines hereinabove outlined. To do so is to delay the essential
reorganization of t h a t m a r k e t in order t h a t it can function effectively.

The CHAIRMAN. Thank you very, very much, Mr. Moak, for coming.
This is most impressive. Your background, as I understand it, you are
not only the Director of Finance for the city of Philadelphia, but you
are lecturer on public finance at the University of Pennsylvania, and
you are vice president of the Mutual Municipal Finance Officers Association of the United States and Canada.
On page 12, when you discuss the New York situation, you say
temporary default by a large number of cities and perhaps some
States can be triggered by a temporary bankruptcy in the case of the
city of Xew York. These can, in my opinion, be avoided only if appropriate and timely means are applied to the New York situation in a
vigorous manner now. By that, T take it that you mean that we have
to provide some kind of assistance, loan, guarantee, something of the
kind within the next very few weeks; is that correct?
Mr. MOAK. That is my belief. T know of a number of cities who are
confronted with a tax pattern, revenue pattern similar to the one I have
described for Philadelphia. Tf we cannot raise funds we—like the
other places—will find that despite our basically sound position, we are
out of business.
The CHAIRMAN. That is the kind of information this committee
lacked this morning. A number of members indicated that New York




98
was sui generis. You point out it is unusual. I t is the only city with
the short-term problem. In spite of that other cities may be sound, but
there are many cities that would have to go into default, too, because
of the paralysis in the municipal bond market and the lack of confidence and the fact that banks and other investors would be unwilling
to invest in the municipal bond market.
Mr. MOAK. That is my belief and my knowledge from a number of
large cities in the Nation.
The CHAIRMAN. This is reminiscent—I'm not old enough to remember it as well as others and neither are you—of the run on the banks in
the 1930's when, as I understand, banks that were sound would have
depositors come in and insist on being repaid. Of course, even a sound
bank could be put into a position of default under those circumstances
very quickly. I t required Federal action in that case to restore confidence, that's right.
Mr. MOAK. That is true. I happen to remember standing by observing one run on a bank in Port Arthur, Tex., in 1933, where money was
carried out the front door of one bank to anoaher bank down the street.
Both banks survived and still survive today. But I have a recollection
of seeing the panic associated with that action.
The CHAIRMAN. Your next paragraph is fascinating. You say:
If a wholesale default occurs in New York City, the capital markets will
become so disorganized that many other jurisdictions will not have orderly
access to capital absolutely required for the ordinary management of their
financial affairs. This lack of access can put these jurisdictions into temporary
default. Such temporary defaults by a few jurisdictions can spread quickly to the
point that almost no one has access to an organized capital market.

What you are saying is if the default occurs in New York City on a
wholesale basis, first you will have a few other cities that will not be
able to borrow money and will be put in a position of not meeting their
obligations after default. When that happens it is likely to spread so
even the soundest city with the top rating and highest quality is in a
position of very serious jeopardy and may well default also.
Mr. MOAK. This is brought on by the structure of a particular market
that we are now in. Historically the municipal bond market depended
on commercial banks for about half of the total new market offerings,
upon the casualty insurance company for one-sixth and the remainer
of the market for one-third to 40 percent. The commercial banks have
largely withdrawn in the last 12 months for a variety of reasons. The
casualty insurance companies have been obliged to withdraw because
the adverse cash flows in that industry. This leaves us with the household sector. The household sector is composed largely in the municipal
field of two groups. One supersophisticated in the form of the
municipal bond funds. Numerically the greatest is the ordinary
investor who has recently come into the municipal bond field. He
is the man who can get scared the fastest as soon as one of his bonds
defaults. He won't want any more and his friend won't want any more
municipal bonds.
This is the kind of market that is most susceptible to the panic that
you mention in the run on the banks.
The OHAIRMAX. That is very helpful. No witness has given us that
information. This is most effective. You have a different solution here.
Your overall program seems to me to be sound and thoughtful.




90
Obviously it would take some time to put that in effect. You say
meanwhile in the case of New York, you could have to create at least
a skeleton of the Municipal Securities Commission as your propose.
Then you say authorize a pattern of issuance of insured refunding
notes with a life of up to 3 years.
Now that approach goes beyond what you said in the body which
would have limited this stringently to $100 per capita which would be
$800 million for New York, far less than their requirement.
Mr. MOAK. I'm trying to distinguish between new issue debt and
old debt that we have to reorganize.
The CHAIRMAN. That helps me. On old debt—you don't provide
the tight discipline which other witnesses have suggested. That is
that the city would show it has a good prospect of balancing its budget,
show it has made a very strong effort, show that the State is behind
it and all this. Do you regard that as unnecessary?
Mr. MOAK. I have participated in two modest rescues on a beach in
my life. You don't stop in the midst of an emergency to make a lot of
inquiries and ^et a lot of assurances. I don't have time to stop in
the middle of this to make inquiries and get assurances. If we are
going to keep this market open, you have indicated the crucial time
which is now until Christmas. If we don't act before Christmas, it is
my opinion that New York City will have defaulted and, having
defaulted, the market will gradually close, if not close almost immediately. I t has been almost closed 2 or 3 separate days in the course of
the last few months.
The CHAIRMAN. That is a gloomy analysis for this reason: Whether
we agree or disagree with you, we have to convince the administration to get a bill passed. We will not get a bill out of this committee
unless we get consensus of the Republicans and Democrats. As you
know, there is a strong feeling in the country that we should not assist
New York. I t is reflected particularly in the Congress. One price that
New York people seem willing to pay is that they are willing to
submit to these inquiries. They are willing to submit to whatever
discipline may be required because they are desperate.
Mr. MOAK. Excuse me, sir. Perhaps you have not had opportunity to
look at paragraph 3, that the insurance programs would be placed
under the most rigorous supervision of this commission and where
local governments are concerned, the commission could take advantage.
The CHAIRMAN. What it does not do is require any eligibility factor.
You would permit a city to come in no matter what their setup was
at the time, providing they agree to the discipline of the commission.
Mr. MOAK. Quite frankly, such knowledge as I have—and it is not
complete—of the city of New York, no set of standards we would
sit down and write as good abstract standards, could be met by the
city of New York. Therefore, I don't see any point in going through
the mental exercise
The CHAIRMAN. I mean some of the things they have already done:
reduce their spending, increase taxes, and so forth, so they reduce
their deficit.
Mr. MOAK. I understand. My guess is you put what concerns the
city of New York through the ringer. I was invited to New York
and invited to be the chief of staff for the emergency board upon which
the Governor and mayor sit. Therefore, I am not totally ignorant. I n




100
my opinion, it wrould be very difficult for tests to be impartially
administered that the city could pass.
The CHAIRMAN. Now, if New York—T want to be sure I understand
everything you are saying. No. 1, you say that if Ave do not act, that
it seems clear that New York will default before Christmas or after
Christmas shortly?
Mr. MOAK. In my belief.

The CHAIRMAN. If New York defaults, then you are saying there
wTill be other defaults and they will rapidly spread and we may have
a situation in which no city is able to get financing?
Mr. MOAK. I don't want to go that strong. If my statement says no
city, I have overstated my position. I'm trying to say the market
would be vastly affected so many large jurisdictions would be out of
the market totally.
The CHAIRMAN. When you say temporary defaults by few jurisdictions can spread quickly enough so that no one would have access to
an orderly capital market.
Mr. MOAK. I don't think you will have an orderly capital market.
I t is not that everybody will default. In orderly capital market when
I go to a market, I expect three bids. When I get one bid, I don't have
an orderly capital market. I have a disorganized market where all
bidders have come together and handed me one bid, take it or leave
it. That is not orderly capital market. I t is not to say there is no
market. There is still a market but it is a very strange one and it is
one which I, as an issuer, have to take or leave.
The CHAIRMAN. I'm glad we clarified that. You are saying that if
New York defaults there will be other cities defaulting and most
cities will be in a position that they won't be able to get bids from
competing groups to sell their obligation. They will have to place it
on the basis of having the buyer virtually dictate the terms.
Mr. MOAK. That is exactly what Ave have been confronted with
already. We had to go to negotiated bids which Ave didn't want to
because the other choice A T s take a single bid.
Aa
The CHAIRMAN. Secretary Simon indicated he thinks the air would
rapidly clear once the situation is settled and the market has discounted the default by New York already. HOAV long do you think
the disorganization would last absent the kind of measure you proposed here?
Mr. MOAK. T stated that New York, on Sunday in speaking to the
financial writers, that Ave would do very well 6 months after default,
but during that 6-month period Ave would haATe varying degrees of
chaos. I think 6 months after the major default the market would have
reorganized itself to a considerable degree, so that many people AAT1IO
were temporarily out of the market would be in the market. During
the interim period
The CHAIRMAN. What do you base that judgment on? It seems that
if New York defaults and bondholders go through the loss, that the
municipal market would be scarred for years to come.
Mr. MOAK. I think it will be scarred for years; don't misunderstand.
My judgment is within 6 months Ave Avill have a market. We may be
paying a huge additional premium in order to have a market, but I
think we will haA^e a market just as we have some kind of market
today.




101

The C nAIRMAN. Could you give us some notion or dimensions of
the additional interest rate that might be a result of that kind of an
experience ?
Mr. MOAK. I t is very difficult because we are now at the feather edge
of a totally speculative market as far as municipals are concerned. If
you consider a 10-percent municipal rate as equivalent to 20- or 22percent taxable rate, anybody paying that 20 to 22 percent is in a
speculative market. If you pay him 10 at tax-free rate, you are on the
edge of a speculative market. Once you get into the speculative market, the ball jumps up and down like a yo-yo. It is no longer something
you plot on a graph. It is like Big Mac bonds today jump around. Any
bond in serious trouble jumps around.
I would say the figure would be in the range of 20 to 25, 30 percent
above wrhat we are now paying.
Mr. CHAIRMAN. In dollars, the municipal borrowings in this country
are 200
Mr. MOAK. $25 billion per year. A new cost has to be associated with
that rather than the $200 billion mentioned here today.
The CHAIRMAN. What would be the cost of this? $25 billion times
2 percent. Would you say it would be $500 million cost?
Mr. MOAK. I would say we are talking about around $1 billion per
annum; $1 billion per annum issue of additional cost.
The CHAIRMAN. Average bond is 10 or 15 years. The cost would be—
runout cost would be $10 billion.
Mr. MOAK. Over the life of the issue.
The CHAIRMAN. That has to be paid by property taxpayers all over
the country.
Mr. MOAK. All kinds of State and local taxes. I t is not all property
taxpayers.
The CHAIRMAN. Not all property, but that is the one we are most
sensitive to in my State.
Mr. MOAK. That would be the major source.
The CHAIRMAN. Thank you, Mr. Moak, very, very much. Yours was
most helpful testimony. You have given us a lot of information we
didn't have. I will call this to the attention of other members of the
committee. I'm sure they will be greatly influenced by it. It is extremely
interesting.
Mr. MOAK. Thank you very much.
The CHAIRMAN. The committee will stand in recess until 10 o'clock
tomorrow morning, to reconvene in this room.
[Whereupon, at 3 :10 p.m., the hearing was recessed, to reconvene at
10 a.m. Friday, Ocotber 10,1975.]
[Material received for the record follows:]
STATEMENT OF W.

M.

E L L I N G H A U S , PRESIDENT, N E W YORK

TELEPHONE

My name is William Ellinghaus, president of New York Telephone, and member of the New York City Emergency Financial Control Board . . . and I'd like
to t h a n k this committee for inviting me to give my assessment of New York City's
financial crisis.
I t ' s my view t h a t New York City desperately needs the help now of the Federal government because I doubt we're going to be able to make it on our own
much longer. Despite our best efforts to put our City's finances in order . . .
despite the financial assistance of the State of New York . . . the stringent reforms and reductions we a r e making in New York City's expenditures . . . the
layoffs and the service reductions . . . the help from businesses which have pre-




102
paid taxes when they are still in the throes of a deep local economic depression . . . despite all this and more, we seem to be racing faster and faster toward
default because the investor is afraid. Afraid now, not only of MAC securities,
but of the entire national municipal securities market itself.
Default would do damage to more than New York City. The specter of default
by itself is one of the most unsettling ingredients in our economy today. The real
thing will be much worse. And that will be too bad because default can be averted.
The action the City, the State and the Emergency Financial Control Board have
been taking can put the City on a sound fiscal footing again. But to do it we
must get out from under this cloud of default, which is creating so much uncertainty not only in the country but abroad. It is not for lack of trying ourselves that
I appear here.
Back in April 1975, when the financial market became closed to New York City,
Governor Carey and the New York State Legislature came to the City's assistance
by creating the Municipal Assistance Corporation. MAC was given statutory
power to borrow three billion dollars on behalf of New York City . . . with the
purpose of enabling the City to meet its financial obligations until September,
and then the City would be able to enter the money market on its own. When
the MAC Board was formed, Mayor Beame asked me to serve as one of its directors, and subsequently I was asked by Governor Carey to serve as the Board's
Chairman.
In July MAC put together a one-billion dollar bond issue. While that offering
was successfully sold, we on the MAC Board were disappointed that there weren't
more subscriptions to the issue and that it had very little acceptance outside
New York City.
As we assembled a financial package for August, our difficulties increased. The
buyer resistance we'd seen the financial community exhibit in July now had
spread through other investment channels. MAC bonds, which are secured by
tax revenues and which are not bonds of the city, were still considered by investors to be no different than New York City paper. Still, the August financial
package was successfully sold, thanks to the cooperation of the banks in New
York and organized municipal and State labor unions in the State.
By the end of August, however, the MAC Board got a clear signal from the
underwriters that sale of a third billion dollars was impossible. There simply
was no market for New York City or MAC securities in the amounts required to
meet the city's immediate cash requirements. Accordingly, on August 25, the MAC
Board advised the Governor that it could not raise the third billion dollars of
its statutory mandate. We advised the Governor that the city of New York would
be in default in September unless the Governor and the State intervened.
The Governor, as a result, convened a special legislative session the first
week of September. The outcome of that session was passage of the Emergency
Financial Control Act of the City of New York, which called for the setting up
of the Emergency Financial Control Board. Governor Carey appointed me a member of that board, and I resigned as chairman and director of MAC.
The board's powers are spelled out unequivocally under the law.
The board, in conjunction with the city, is mandated to develop a financial
plan for each of 3 fiscal years between now and June 30, 1978, when the city's
expense budget must be in balance . . . and in conformance with the uniform
system of accounts for municipalities.
The city's plan must provide for payment of its debt service, as well as for
programs mandated by State and Federal law.
And the city in fiscal 1976 and 1977 must make substantial progress toward
balancing the budget.
If those requirements aren't met, or if the city doesn't submit a plan approved
by the board by October 20, 1975, then the board is required to formulate a
plan of its own for the city that would go into effect October 30.




103
The board also can scrutinize any city operation and see t h a t the city invokes
w h a t the board recommends to increase efficiency and improve services.
And, under the Control Act, city officials are subject to criminal and administrative penalities if they fail to carry out the board's directives.
Meanwhile, the city of New York has been acting.
It froze the wages of employees covered by collective bargaining agreements.
I t put a freeze on the salaries of management and executive personnel.
I t put a halt to all new capital construction projects.
I t has cut the City University's budget by 32 million dollars.
T r a n s i t fares were increased.
City governmental jobs, since December 1974, have been reduced by a total
of 31.211, through layoffs, retirements and attrition.
And the city h a s appointed a respected financial expert from business, who
is working without salary, to serve as deputy mayor of finances.
In addition, there's also been help and cooiieration from the municipal unions,
which have invested in MAC bonds. Large companies, as I noted earlier, have
prepaid taxes amounting to some $330 million to ease the city's cash squeeze.
The banks, despite large holdings in New York City obligations, have continued
to help us find alternatives t h a t would prevent the city from defaulting.
And finally there's been the support of the State of New York. Governor Carey,
the legislature, the State's labor unions. Controller A r t h u r Levitt—all have
been working to rescue the city.
The State lias agreed to furnish some $750 million And now the State's own
credit, which until recently h a d the highest rating, h a s begun to suffer.
New York State is finding it more expensive and harder to borrow in order
to fund essential projects. The State of New York lias done about all it can
to help the city.
W h a t this chronology of crisis a d d s up to is t h i s : We have tried to go it alone.
When we saw t h a t the investor wanted more evidence that we were serious about
living within the limits of our own resources, we created the mechanism to
control expenditures and bring about improvements in governmental efficiency
and productivity. And then we started cutting municipal services. But the money
market remains closed.
Were the financial m a r k e t open to MAC, we in New York City and the State
would not be here asking your help. Because we now have the managerial and
budgetary controls to put the city's finances on a sound footing by 1978. But
MAC hasn't been able to borrow the rest of the needed funds under i t s mandate . . . and the city will not be able to go into the monev market on its own in
1976.
We're making the sacrifices, all of us—the city worker, the subway rider, the
banks, the taxpayers, the people of the State of New York. W e can't go it alone.
The city's cash requirements must be met—and they won't be if the financial
market stays shut to MAC and New York City. And t h a t is why default looms.
Not because we're not doing w h a t ' s expected of us. The investment community, as
I read it, believes we're serious about living within our means. But nonetheless,
investors are afraid because default seems inevitable unless the Federal Government comes to the city's assistance. And, it seems to me, t h a t fear of default
could very well create default. It's as though we're back in the 1930's when it
took Federal insurance to convince depositors t h a t the money in their bank accounts was safe. I think it's going to take something like t h a t to restore confidence
in the municipal m a r k e t today.
Default is a national and international concern.
Default by New York City would have colossal reverberations. Tt's time, I
believe, for the Congress to act.




104

RESEARCH INSTRUMENT COMPANY, INC.
1975 0 r ' ! •

:

i I2:6§£STEWART AVENUE, GARDEN CITY, N. Y. 11530 - (516) 248-1001
October

Senator Wm. Proxmier
Senate Banking Committee
United States Senate
Washington, D. C. 20510
Reference:
Dear Senator Proxmier:

7,

1975

New York City Financing

I am writing the following so that it can be introduced into the
official record and would appreciate its circulation to the other
Members of the Committee.
The City of New York, everyone recognizes, is fiscally irresponsible.
On top of it, we are seeing a game of Brinkmanship. We see the
City administration not taking positive action immediately to stop
the waste. The City is, by no means, bankrupt! If Chicago had a
population similar to New York, based on their present number of
employees, they would require about 100,000 employees to do what
New York City requires 330,000 employees. It has been variously
estimated that there are about 100,000 City employees who could be
dispensed with without disturbing the basic, essential services.
These 100,000 represent, primarily, political appointees who, of
course, the present administration would not like to have to dispense
with. Many practices that the City has followed has created,
essentially, the highest paid City employees anywhere in the country
plus the hidden, mountainous pension system. It has become the
example for all other communities to follow as far as wage levels
are concerned.
To cite one example of the Cityfs administrators1 "do nothing"
attitude, for several years sanitation workers established their
pension on the basis of the final overtime in the last years worked.
The administrators arranged that those men who were going to retire
had plenty of overtime so much so that when they retired most had
sufficient income in their last years to give them 100% pensions.
This was an out-and-out conspiracy to defraud the City. To the best
of my knowledge and belief, the City has made no effort to set aside
these pensions, which were obtained fraudulently, by the conspiracy
of their fellow supervisors. Is this a City that should be helped?
New York City can spend more money if they are allowed to. Little
things, such as the Day Nursery Program, cost $6,000.00 a year per
child. This is far more than the economic benefit of the earnings




105
of the working mothers. Very few of the women, who can have gainful
employment, can earn an amount equal to the cost of their children
to the City. This is especially true where more than one child is
involved. It is variously estimated that this program, alone, costs
the order of $200,000,000.00.
There are a few philosophical questions that must be answered. With
all the monumental waste should New York City be helped or must
the help come only after the waste is eliminated? Almost every
Federal help program is politically contraverted when it is
administered in New York City. The Brooke Amendment became a
direct $150,000,000.00 windfall to the recipients of welfare. We
must rethink some of the social philosophies behind that which goes
on in New York City. In New York City, the raising of illegitimate
children is rewarded; the assumption being made that I, as a tax
payer, must pay for the other fellow's bastard. Under the welfare
system in New York, families have $300.00 a month apartments, can
operate an automobile and, even, have a color TV set.
The exodus of jobs from New York City is, partially, because in
the low end jobs, you cannot find workers. Why work when theCity
provides all?
Enough about waste and philosophy - let us look at the market place
for bonds. The problem in New York City is no different than the
problem of anyone else trying to raise money in the present market
place. Most utilities are, presently, strapped for funds in spite
of huge rises in utility charges. There is insufficient money,
for example, in the market place to finance the nuclear plants. Bond
issues cannot be put out except with huge rates. An investor would
be a fool to put his money into that which does not provide a high
yield while inflation is what it is. Even good, old Uncle Sam is
finding it has to pay 8.47c for intermediate term borrowings.
Part of the problem is that the United States is not generating
sufficient new capital to finance the programs that already exist
and, simultaneously, destroying the old capital; and when they
decide not to print new dollars there just aren't enough bucks to
go around.
Our great country has disintegrated into a country of political
pressure groups and the politicians, unfortunately, do not have
sufficient rectal fortitude to put the Nation ahead of the pressure
groups who have helped elect them. The problems of the United
States have been foretold as far back as the early 30's.




106
Many of the policies of the Government are, intrinsically, destroying
the work ethic. It does not even pay to go to college any more.
We see the spectacle of Mayor Aliotto yielding to bombing and firemen becoming arsonists and vandal pressmen destroying the 1st Amendment and the Bill of Rights. Only a restoration of self control
and a National interest can save the day. It is up to Congress to
offer some kind of leadership which they are shunning.
The problem of New York is to demonstrate, now, that with the huge
tax base that they are milking they can not only pay for all essential services; they must also squeeze the water out of the various
jobs; such as Sanitation, 3 to 4 times the cost of removal of waste
as in the private sector; $15,000.00 a year change-clerks in the
subway system; 1/4 million dollar pension benefits; public housing
at $50,000.00 per apartment. This clamor for aid from the Federal
Government should be put in proper perspective. New York City must
be saved from its politicians and administrators but the dilemma is,
how can a Democratic Congress do this to a Democratic City with
100,000 political appointees.

Very truly yours,
RESEARCH INSTRUMENT COMPANY, INC.

Milton Stoll, President
MS:ml




107
Written Statement of James A. Lebenthal, Executive Vice President, Lebenthal & Co., Inc.
Consequences of New York City Default on Individual Bond Owner
Nobody claims to know who the owners of New York City's bonds are, and that is
just one of the enormous difficulties in visualizing in human terms the consequences
of default by the second largest borrower in our capital society.
The Municipal Bond firm of which I am Executive Vice President,
Lebenthal & Co., Inc. with offices located at 1 State Street Plaza, New York, NY
10004, may be in a unique position to supply some hard statistics on the ownership
of New York City bonds.
Since 1925, Lebenthal & Company has been specializing in Municipal Bonds, catering almost exclusively to the individual investor.
An analysis of the business records of our firm leads me to the estimate that
no less than 160,000 small individual investors own the major portion of New York
City's outstanding long term bonds. New York City has a total of $7,350,610,000
bonds outstanding. I would place the combined ownings of these 160,000 households
at approximately $4,895,000,000, two thirds of the debt outstanding*.
But because the tax free coupon interest from municipal bonds need not be
reported and the Treasury Department has no record of municipal bond ownership...
because the federal reserve figures are preoccupied with bank ownership and it
is only through a process of elimination that we have any governmental figures at all
on ownership by households of $62.3 of the $207 billion state and local debt
outstanding...and because of the natural reticence of people to speak openly
about their money,-the impression could exist that Municipal Bonds are the private
preserve of banks and a few Park Avenue millionaires.
That is not the picture I am now going to present or that is supported by the
more than 300 letters Lebenthal & Co., Inc. has received in reply to a request for
bondholders on our mailing list to come forward, write and be identified, a small
sample of which are appended hereto.
The typical owner of New York City bonds is on in years.
The bonds represent the family's savings, accumulated over a lifetime.
Payment is usually made by check drawn on savings accounts. The bonds are
savings.
The average transaction is $10,000. The average portfolio is less than $35,000.
The typical New York City bond customer at Lebenthal files a joint return on
approximately $25,000 a year, which is the 36% federal income tax bracket and a combined tax bracket in New York State of 45%. One did not have to be a tycoon to benefit
meaningfully from the extraordinary tax-free yields that New York City issues have
produced over the past five years. At the 80% tax-free to taxable yield ratio that

*This analysis of the ownership of New York City debt by individuals is limited to
funded debt, bonds only, of which Lebenthal & Co., Inc. had been a major underwriter,
and marketer. Not having been an underwriter of the city's notes, the company
has played a negligible role in the marketing of notes and does not possess the
expertise to analyze individual ownership.




108
has prevailed in the 21 issues that have ccme out during those years, the tax-free
takehome pay from the New York City municipal bond would produce the following yield
advantages for t h i s many households in the U.S. over the after tax return from
taxable a l t e r n a t i v e s :
25% advantage for 2,370,000 households in 36% or higher federal bracket
34%
38%
45%
54%
62%

"
"
"
"
"

"
"
"
"
"

1,520,000
1,070,000
790,000
620,000
510,000

ii o n a
II

ii

ii

n

n

A on

II

II

II

II

n 40a

••

••

it

>•

.. 45% ..
,. 5Q% .,

The typical investor, buys any Municipal Bond to hold to maturity. Not to trade.
Not to make money off market moves. But for income to live on, to provide for retimement or a fund for the future such as children's college education.
These excerpts from the letter appended hereto express the frugal nature of
the typical individual municipal bond investor:
"My wife and I live in an old clapboard house in a rural town of 1,000
inhabitants in upstate New York. We both work, and we both drive Volkswagens.
Our thermostat is set at 65 during the hours we are at home and awake, and 60 all
other times. We burn wood when we want to be warmer...Our steaks are chuck, and
infrequent. We have chosen our style of life, and I think we live well.
I am not a bank, and I am hardly a millionaire. The New York City bonds
I own represent a considerable portion of my savings. I purchased the bonds
because they provided an excellent tax-free return, and like others I thought
them secure."
William M. Burstein, RD 2, Petersburg NY 10138
"I, too, am one who put his own savings plus the savings of those who
trusted my judgement into Municipal Bonds of N.Y.C. I understood the security
of NYC Bonds was second to that of the U.S. Goverment. I never dreamed a city
so great, so vital to the economy of the U.S. could or would be let to default."
Robert J. Forrest, 378 Red Maple Drive, Wantagh, NY
"I am about to reach the age of 70 and was preparing my hard earned
money as a house painter for a safe income. I own City and State Bonds which I
considered a very safe investment, and as I understand now should N.Y.City default
the bank will be protected, but I believe my money was earned much harder than
the banks. I slaved all these years to earn this money to have a little protection
for my old age." Mr. Max Hochberg, 23 Hickory Hill Dr., Dobbs Ferry, NY 10522
"My husband has a job that does not afford him a pension. He started
buying municipal bonds in 1968, spacing the maturity dates so that we would
always have some money coming in to live on.
There was no gamble involved when we purchased bonds. If we wanted to
gamble, we'd have invested in the stock market." Phyllis Jacobs, 15-16 Prospect
Ave., Fairlawn, NJ. 07410
"I thought I was making a conservative & sound investment when I took funds
from my savings account to buy NYC bonds. My thoughts were to plan for my
retirement five years hence." Irving Karess, 12 Baker Hill Road, Great Neck,
NY 11023




109
"...I bought these bonds with the full faith of the city behind them.
I did not seek great financial gains in the stock market or business investments.
All I wanted was security and the ability to sleep well at night knowing that
at a later time in life, I would have no financial worries..."
Daniel Klein, M.D.
3689 Bedford Avenue,
Brooklyn, NY 11229
"We are in the middle seventies and for security reasons at this stage in
our lives we liquidated much of our investment in common stocks and transferred
it to safe and sound municipal and state bonds..."
Ben Levin
545 Central Ave.,
Cedarhurst, NY 11516
"All my life I've worked. I've worked for Klein's Dept. in the great
depression for $2.00 on a Saturday. I've worked in factories. When I married,
after I had my children my husband took sick and I worked for eighteen years...
Every dime I saved went into New York City savings Bonds, now I am told that
these Bonds are going to be worthless. I am heartsick. I have nothing to
look forward to living any-longer...."
Mary Millstein
35 P. Seacoast Terrace
Brooklyn, NY 11235
"My wife and I are conservative Midwesterners who grew up in middle and
lower middle class homes in southwestern Ohio. We both experienced the
Depression in the 1930s in this area; and accordingly we feel a strong need to
be financially secure as we approach retirement age. We have no inherited
wealth, but only the savings from our earnings
"...we decided to place a substantial part of our savings in "safe"
investments in Municipal Bands backed by the full faith and credit of state
and local governments...
"Perhaps we would be no worse off if we, like Government, had been
profligate spenders who lived beyond our means..."
Louis E. Schmidt
5504 Galbraith Apt. 49
Cincinnati, Ohio 45236
"...I keep trying to explain to my wife that I wasn't speculating..."
Robert J. Sperber
140 Lockwood Avenue
New Rochelle, NY 10801
"...we are not business people (and not rich)—both of us are middle income
municipal teachers who live a modest life in the City...and denied ourselves
many things in an effort to achieve some modest financial security..."
Mr. Dennis Sandman
1917 East 8 Street,
Brooklyn, NY 11223
"...At the moment these dividends are paying my food bills."
Barnard Searle
106-D Finderne Ave.,
Grandview Gardens
Sommerville, NJ 08876

60-832

O - 75 - 8




110
"...Municipal bonds are 'legal investments' for all public bodies, banking
and insurance companies. Thus, I view them in the same light as Federal Treasury
Notes, Savings Bonds etc. They are obligations of one of the branches of our
'Government.'
"...And, the fact is that the only thing that makes U.S. Treasury Notes
any more solid than New York City notes (considering the fantastic nation debt)
is the ability of the Federal Government to issue paper money."
Keith H. Steinkraus
Professor Microbiology
Cornell University
681 Castle Street,
Geneva, NY 14456
"...My wife is afraid all our savings will go down the drain if Nev? York
City defaults...
"I would like you to know the money I invested in these Municipal Bonds
was hard earned money that had been saved from a salary..."
John M. Tagliani
18 Hillcrest Road,
Tenafly, NJ 07670
"When we retired, we took the cash savings we had in our retirement funds
and placed them in New York City and State Bonds...
"We were impressed with the fact that the whole credit and credibility of
the community, city, state and nation supported the probity and security of
our loan."
Dr. Abraham Tauber
441-16 North Broadway,
Yonkers, NY 10701
"I just can't believe it. We were
safest places. And we thought that one
cities and towns of this great nation.
which we lost a great deal when we were




always taught to put our money in the
of the safest placed would be the
Certainly as safe as the banks in
much younger."
Sally B. Wyner
15 Bound Brook Road,
Newton, Mass 02161

Ill
160,000 Estimate Based on Lebenthal & Co., I n c . ' s Sales of 5% of City's Bonds
To 12,000 Individuals
The conclusion that no l e s s than 160,000 such individuals own New York
City's long term debt has been arrived a t by a physical count of certain of our
business records and extrapolations made therefrom. Let me explain.
Since 1966 we have maintained copies of confirmations of sale to individuals
filed by the date the bond sold matures. By counting the par value of New York
City bonds sold to individuals maturing in three representative years and comparing
the sum against the total city debt maturing those years, we have determined our
share of the market.
Of the $718,763,240 in bonds the city has maturing in fiscal 1978 (July 1,
1977-June 30, 1978), Lebenthal & Co., Inc. has placed $33,418,000 or 4.65% of the
1978 maturity with individuals.
Of $733,779,240 maturing in fiscal 1980, Lebenthal & Co., Inc. has placed
$35,420,000 or 4.8% with individuals.
Of $210,311,240 maturing in fiscal 1985, Lebenthal & Co., Inc. has placed
$17,874,000 or 8.5% with individuals.
The longer the year of maturity, the greater the percentage of bonds maturing
in that year Lebenthal & Co., Inc. appears to have sold. But giving proper weight
to the fact that 49.6% of the c i t y ' s long term debt matures within 5 years, and 77.5%
within ten years, I calculate that we have placed with individuals an average of
approximately 5 of the bonds New York City has maturing in a l l years. The grand
%
t o t a l of the c i t y ' s outstanding bonded debt i s $7,350,610,000 principal value.
Five percent of that amount sold by Lebenthal to individuals comes to approximately
$367,500,000. Because the individual usually buys to hold to
maturity—less than 5 of our customers s e l l their bonds back to us before
%
maturity—it may be presumed that most of the bonds we have sold are s t i l l
reposed in the customer's safety deposit box.
W know the number of bonds and the percent of the c i t y ' s long term debt
e
we have sold.
W know the number of individuals to whom we have sold New York City bonds.
e
Again a physical count made by each salesperson of customers, has determined that
we have sold New York City bonds to no l e s s than 12,000 individuals in the past
nine years.
The next step is to project 12,000, the ownership figure which we know to
represent 5 or l/20th of the c i t y ' s outstanding bonds into a total individual
%
ownership figure. And here, because I cannot speak for other firms in the
Municipal Bond Industry, I must f a l l back on "soft" s t a t i s t i c s .
Lebenthals Co., Inc. numbers 13 active salespersons, myself included.
Our sales staff has never been more numerous than 16. If 13-16 salespersons
in the Municipal Bond establishment account for the placement of New York City
bonds in the hands of 12,000 individuals, t h i s Committee may project for i t s e l f
the t o t a l number of individuals to whom the r e s t of our industry may have sold
New York City bonds.




112
As a starting point, if one hypothesized that New York City bonds were owned
by none other than individuals, then 20 times 12,000 or 240,000 is the maximum
number of of individuals owning the bonds. Obviously this number would have to
be reduced by the percentage of the city's bonds owned by banks and other nonhousehold owners.
It is my opinion that non-household ownership accounts for one third of the
city's outstanding bonded debt.
The other two thirds in my opinion are owned by individuals.
In other words, 66% of the city's grand total of $7,350,610,000 outstanding
bonds or $4,895,000,000 principal value, are owned by 160,000 (66% of 240,000)
individuals.
I feel that any error in these computations is biased towards conservatism.
We have produced statistics (appended hereto as Exhibits C and D) which show
a market potential among individuals much greater than 160,000 households.
As we have already indicated, and the Exhibits spell out in detail, the market
for a tax-free bond expands and contracts in relationship to size of yield and
the attractiveness of the tax free yield in relationship to yields of other
investments that are taxable.
In 10 of the 21 issues of New York City bonds floated between Feb. 15, 1970
and the last issue dated Feb. 15, 1975, the 10 year maturity has produced an 80%
tax-free to taxable yield ratio when compared to Aa-utilities available in the
market at the same time. At an 80% yield ratio, we have already shown that
2,370,000 households in the 36% federal tax bracket are 25% better off in a
tax free bond than with the after tax yield of a taxable bond.

The Human Consequence of Default
But one need not expand on the figure of 160,000 people to make the point.
A default by New York City would be a human disaster whose consequences cannot
be confined to the pine-panelled walls of the banking establishment. To people
who have put their life savings into the full faith and credit general obligation
bonds of an issuer, there is no difference between the loss of those savings and
ruin by flood, dust, locusts, or a mortgage foerclosed on a homestead.
These letters from New York City bondholders speak for themselves:
"My investments in NYC municipals as I believe your records will indicate
amount to $17,169.92...
If I were to lose all this investment, it would be a terrible situation
for me and family..." Anthony Cozza, 410 East 17th Street, Brooklyn, NY 11226
"We kept these moneys as a reserve to avoid going to an old age home.
We don't want to impose upon the government for aid in our remaining years.
If the city should default it will be chaotic for us." Samuel L. Goldstein,
32 Court, Brooklyn, NY 11201
"...If the city goes into default we are wiped out..."
8511 Coventry Road, Brooklyn, NY 11236




Reda F. Lindenbaum,

113
"I cannot state too strongly the trauma which would result to me and
my family if the city of New York defaults.
The money invested in good faith and feeling secure behind the promise
of full faith and credit has become almost a nightmare of disbelief..."
Phillip E. Marquis, 15 West 72d Street, New York, NY 10023
"Will you please—please save my Municipal Bond Money. I am over seventy
years of age. I have worked very hard all my life—(fifty years)—before
I went on social security.
I have lived very frugal. So in my old age I would not go on welfare.
I will die before I will apply for that.
As a teenager in the last depression—1931—my hard working parents lost
their home, right here in Jamaica.
Not being skilled—can you imagine the hours and years I worked (and supported
an aged father) to save $10,000, which we placed in bonds." Margaret S. Marshall,
8911-153rd Street, Jamaica, NY 11432
"My life savings of $25,000 are invested in tax free U.D.C. and New York
City bonds...
If I lose that I shall be forced to sell my home and go on public welfare...
It is no wonder that the suicide rate among the elderly is increasing sharply..."
Curtis M. Marx, 311 Broadway, Newburg, NY 12550
"All my income except my social security and musicians union pension of
$24.00 per month come from the city I love, namely N.Y.C. municipal bonds.
I am frightened at the prospect of this city defaulting..." Charles Magnante,
19 Taconic Road, Ossining, NY 10562
"...This is my life savings Mr. President and without this income of $3700.00
a year I will be living from hand to mouth after a 45 year struggle..."
Harry C. Olson, 2152 Houghton Avenue, NYC 10473
"...I am an unemployed widow who is sending a child to college and I
felt secure in investing in New York City. Now I just count the days until
my bonds mature and pray that every day I will get my money..."
Helen Resnick, 164-32 76 Road, Flushing, NY 11366
"...If there should be default, what can the aged count on? The banks
will be taken care of by being able to borrow on their City Bonds from the
Federal. Do the senior citizens have the same recourse?..."
Mrs. Claire Stern, 488 Ocean Parkway, Brooklyn, NY 11218
"I have $60,000 in New York City bonds, a major portion of my estate.
I am 61 years of age. Have had surgery, radiation & am now taking chemo
therapoy for lung cancer. I have not been able to work for 1 year & the
future is quite bleak. My medical expenses are enormous. Loss from the
bonds would be a disaster." S. A. Waldman, O.D., 105 Fillmore St., Denver,
Colo 80206.
"I am writing on behalf of my father-in-law. He is 89 years old,
practically blind and living in a retirement hotel.
A substantial portion of his income which he needs to pay his living
expenses is derived from about $50,000 of NYC Municipal Bonds.
If this source of income should be cut off, he would probably have
to apply for some form of welfare assistance. Since he resides in New York
City, this would only add to the City's burdens..." David S. Walker,
54-25 253 Street, Little Neck, NY 11362.




114
Loss of Confidence—A Fire That Leaps the Road
I
arrive
is not
nation

offer whatever further information from our records will help this committee
at a state of mind to avoid the personal tragedies these people fear. And this
to diminish the economic consequences of a New York City default to the
as a whole.

One year ago, according to the Bond Buyer publication's 20-Bond Index, the
average tax-free Municipal Bond was yielding 6.52%. The index this week is 7.48%.
96/100 of one percent higher, when most other interest rates throughout the economy
are lower than they were one year ago. Nothing other than the New York City
financial crisis accounts for municipal rates going one way while all other rates
in the land go the other. Loss of confidence is a fire that leaps the road, and
the mere prospect of default by New York City imperils the Municipal Bond as a viable
low cost instrument for building our schools, digging our sewers, and paving our roads.
By crude scratchpad arithmetic, one full percentage point applied to $22.7 billion,
which is the volume of Municipal Bonds that were issued last year, results in
$1.8 billion in just extra interest charges alone over the 8 year life of the average
municipal issue. But I will leave to economists the business of quantifying the true
price our municipalities will have to pay 1) if New York City defaults, and 2) if in a
default, the courts should take anything less than the merciless attitude of Simon
Legree in upholding the rights of the bondholder.
Although the banks still own the major portion of the $207 billion outstanding
long and short term state and local debt, it is to the households of America that
every State, every country, every parish, every city, town, village, school district,
sewer authority and irrigation district must turn for the financing of those new
public works which are not erected by the federal government itself. (According
to The Bank of New York's Money Market Comments of June 16 and September 22, 1975
individuals accounted for 56.9-58% of the net acquisitions of new municipal offerings
in 1974, 95.2% in the first quarter of 1975, and 45% in the second quarter.)
The common sense words of the individual investor himself must be heeded:
"...people believed in the legal obligation of city and state to repay
the principal and pay the interest on those bonds; they believed in the advice
of politicians and brokers that general faith and credit of city and state stood
behind the obligations.
To be told now that this was not the 'real world' is incredible. Default
would mark a decline in confidence and trust that would extend to all financial
markets." Walter Guzzardi, Jr., 57 Park Ave., Bronxville, NY 10708
"...Never for sure back to municipals..."
Florida, NY 10921

Edith R. Keller, Glenmere Avenue,

"...Certainly people in our situation will think more than twice about
putting more funds into any other municipal offering..." Mr. and Mrs. R. Merrett,
195 Beresford Rd., Rochester, NY 14610
"...If the City of New York is allowed to default, because of Federal
Government inaction, the financial loss would be staggering. But the real
loss would be a loss of confidence. What incentive would any investor have
to buy the bonds of any other municipality?..." Irving Kreindler,
2074 Cropsey Ave., Brooklyn, NY 11214




115
"...I hope that the Federal Govenrment and the State Government will
join hands and devise a plan whereby confidence will be restored in the
integrity and fiscal responsibility of New York City and our other great
cities which will be next in line if New York City collapses. Without
confidence in the long range liquidity of our municipalities, banks, investment
companies, insurance companies and the millions of small investors like
myself will be unwilling to provide the funds needed for future development
and improvement of our cities, large and small...
...if we let the New York City economy collapse, it will have extremely
serious repercussions throughout our economy. Municipal Bonds will suffer
first through unavailability of buyers and excessive interest rates. Other
large cities will have to default also through inability to turn over their
indebtedness as bond issues become due. But most important, faith in the
integrity of municipal government, State Government and the Federal
Goverment will suffer a serious blow." Keith H. Steinkraus, Professor
Microbiology, Cornell University, 681 Castle St., Geneva, NY 14456

Executive Vice President
October 13, 1975

Letters and Exhibits Appended.
Exhibit
Exhibit
Exhibit
Exhibit

A--Letters from owners NYC bonds
B--Outstanding New York City Bond Debt by Maturity
C--Tax Free Versus Taxable Yields
D--Statistics on The Municipal Bond Market




STATISTICS ON THE MUNICIPAL BOND MARKET
(Number of Taxpaying Households in U.S. Benefitting From Tax Free Municipal Bonds by the Size of the Benefit Received.)
(Based on 1971 Internal Revenue Service Data Updated to Reflect Impact of Inflation on Incomes)
The investor in tax-free bonds accepts a lower yield than might be obtainable at the moment from comparable
quality investments—historically 70% less. But he hopes to gain more in federal and state income tax savings
than in the interest foregone. When for reasons of, say, adverse municipal market conditions municipal
rates are high in relationship to other investments which are taxable (higher than 70% ratio of tax free to
taxable), two things happen. One, for existing investors in any given tax bracket, the Municipal Bond produces
a commensurately bigger advantage over the net return after taxes from the taxable alternative. Two, market
for Municipal Bonds expands by extending the benefit of tax exempt bonds to individuals in tax brackets who
might never before have given Municipal Bonds a passing thought.
YIELD RELATIONSHIP OF TAX FREE MUNICIPAL TO TAXABLE INVESTM'T
(Tax Exempt as Percent of Taxable Yield)*
GROSS
INCOME

TAXABLE
INCOME

FEDERAL
TAX
BRACKET

NUMBER OF
HOUSEHOLDS
IN BRACKET

ACCUMULATIVE
NUMBER OF
HOUSEHOLDS IN
BRACKET OR
HIGHER

66%

68%

70%

72%

75%

80%

85%

88%

90%

ADVANTAGE OF MUNICIPAL BOND OVER AFTER TAX NET TAXABLE BOND
(Expressed as the Percent by which Investor is "Better Off"
in Municipal)
N.A.

N.A.

2

8

»

0

6

13

17

20

0

4

10

18

22

25

10

17

25

29

32

12

17

25

32

37

40

18

22

31

39

44

47

20

24

29

37

46

51

55

27

30

36

45

54

60

63

30

34

38

44

53

63

69

73

36

40

44

50

60

70

76

80

14,690,000

30,680,000

N.A.

N.A.

25%

7,630,000

15,990,000

28%

4,180,000

8,360,000

»
»

»
»

$20M-24M

32%

1,810,000

4,180,000

"
»
»

0

2

5

$31.9M-36.8M

$24M-28M

36%

850,000

2,370,000

3

6

9

$36.8M-41.6M

$28M-32M

39%

450,000

1,520,000

8

11

14

$41.6M-46.4M

$32M-36M

42%

280,000

1,070,000

13

17

$46.4M-51.2M

$36M-40M

45%

170,000

790,000

20

23

$51.2M-56.0M

$40M-44M

48%

110,000

620,000

26

$56.0M-65.7M
AND OVER

$44M-52M

50%

510,000

510,000

32

$8M-12M

22%

$17.5M-22.3M

$12M-16M

$22.3M-27.1M

$16M-20M

$27.1M-31.9M

$12.7M-17.5M




N.A.

12

Lebenthal & Co. Inc.
Prepared October 13, 1975

15

o>

117

SUMMARY OF NEW YORK CITY BOND PRINCIPAL OUTSTANDING
Based on C o m p r t o l l e r ' s 1973-74 Report and updated by Lebenthal & C o . , Inc. to reflect
a d d i t i o n a l d e b t i n c u r r e d by t h r e e i u s s e s s i n c e d a t e of R e p o r t .
By Year
Maturing During
F i s c a l Year endi
June 3 0 :

As Reported by
NYC Comptroller
'73-'74 Report

1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

927,535,870
844,512,240
598,783,240
427,998,240
688,299,240
440,178,240
255,319,240
225,860,240
205,924,240
191,631,240
179,622,240
199,555,600
191,219,600
171,661,600
153,319,600
115,985,600
114,775,100
79,105,100
74,970,100
71,255,100
68,412,600
74,947,600
59,727,600
54,261,600
50,201,600
46,586,000
39,146,000
33,256,000
26,901,000
21,551,000
21,801,000
22,136,000
22,471,000
22,876,000
23,261,000
23,256,000
21,316,000
35,038,500

(—
8/1/74
62,550
62,550
36,550
36,550
11,050
11,050
11,050
10,150
10,150
6,250
6,250
6,250
6,250
6,250
2,100
2,100
2,100
2,100
2,100
2,100
2,100
2,100
2,100
2,100
2,100
2,100
2,100
2,100
2,100
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
2,500

—Updating Data
10/15/74

)
Total

2/15/75

79,020
79,020
60,720
60,720
13,720
13,720
13,720
12,720
12,720
9,720
9,720 .
9,720
9,720
9,720
4,320
4,320
4,320
4,320
4,320
4,320
4,320
4,320
4,320
4,320
3,920
3,920
3,920
3,920
3,920
1,720
1,720
1,720
1,720
1,720
1,720
1,720
1,720
1,340

22,710
22,710
20,710
20,710
2,710
2,710
2,710
2,710
2,710
2,710
2,710
2,710
2,710
2,710
1,510
1,510
1,510
1,510
1,510
1,510
1,510
1,510
1,510
1,510
1,310
1,310
1,310
1,310
1,310

580
580
580
580
580
580
580
1,210

1,069,105,870
1,008,792,240
718,763,240
545,978,240
733,779,240
467,658,240
282,799,240
251,440,240
231,504,240
210,311,240
198,302,240
218,235,600
209,889,600
190,346,200
159,449,600
125,115,600
123,905,100
88,235,100
84,100,100
80,385,100
77,542,600
84,077,600
68,857,600
63,391,600
58,931,600
53,916,000
46,476,000
40,586,000
34,231,000
25,581,000
25,101,000
25,436,000
25,771,000
26,176,000
26,561,000
26,556,000
24,616,000
43,088,500

TOTAL
LESS MATURED 7/1-10/1/75

LESS NOVEMBER, 1975 DEBT

Less already matured

7,350,610,170
81,804,000

LONG TERM DEBT OUTSTANDING AS OF 12/1/75

Maturing 1976-80

7,774,803,170
424,193,000

7,268,806,170

4,076,418,830
424,193,000

Outstanding 1976-80

3,652,225,830 equals 49.6% of debt maturing in f i r s t 5 years

Maturing

5,695,939,030 equals 77.5% of debt maturing in f i r s t 10 years

1976-85

Prepared by Lebental & Co., Inc.
10/13/75




TAXFREE YIELDS COMPARED TO TAXABLE ALTERNATIVES
REOFFERING YIELDS BY MATURITY OF ALL NEW ISSUE NEW YORK CITY BONDS DATED 2 / 1 5 / 7 0 TO 2 / 1 5 / 7 5
DATED DATE
OF ISSUE

PAR VALUE
OF ISSUE

1

1/2

5

1/2

YEARS TO MATURITY
10 1/2
15

1/2

20

1/2

Aa UTILITIES
CURRENT CPN

10 YR CPN

20 Y
R

GOVERMENTS

AGENCY

75.1
76.2
69.4
72.7

7.86
7.13
8.13
7.50

100+
95
100+
100+

89.8
88.4
92.7

69.1
70.8
77.0
70.7

5.96
6.11
6.12
6.36

7.00
7.12
7.15
7.15

95
95
98
91

87.2
84.0
83.4

7.30
7.56
8.48
8.02

6.33
6.65
7.22
6.67

7.20
7.36
8.03
7.57

80
84
85
62

72.4
73.8
72.0
68.3
67.9
67.9
67.0
64.6
62.9

8.17
8.26
10.15
10.10

6.93
6.88
7.70
7.53

7.81
7.87
8.85
8.74

66
78
97
93

7.50
6.89
7.56
7.35

7.35
7.00
7.80
NR

5.39
5.21
6.19
5.48

6.00
6.00
6.00

4.86
3.64
5.18
4.60

7.79
7.35
8.03
7.75

6.37
5.48
6.40
5.97

6.60
6.65
6.50
6.00

6.70
6.80
6.70
6.05

5.23
5.54
5.44
5.16

6.00
6.00
6.00
6.00

3.65
3.64
3.96
4.54

7.22
7.50
7.55
7.55

5.25
5.25
5.85
5.00

5.45
5.60
5.95
5.40

5.50
5.75
6.00
6.10

4.96
5.07
5.48
5.05

6.00
6.00
6.75
7.50

4.90
6.10
8.30
7.25

5.00
5.85
7.30
7.00

5.15
6.00
7.35
7.25

5.60
6.10
7.35
7.50

5.75
6.20
7.40
7.60

5.26
5.75
6.70
6.48

7.50
7.50
7.50
7.50

7.42
7.52
9.74
7.82

7.00

7.20

7.30

7.50

6.27

7.75

7.10
6.70
6.75
7.00

7.35
7.25
6.90
7.25

7.40
7.20
7.00
7.40

4/01/71
• 7/01/71
^10/15/71

253,110,000
357,100,000
334,860,000

3.75
6.00
4.50

5.75
7.00
6.25

6.50
7.45
6.85

7.25
6.75
7.65
NR

1/01/72
5/01/72
7/15/72
9/15/72

376,800,000
255,220,000
267,200,000
303,950,000

4.00
4.00
4.25
4.00

5.75
5.75
5.90
5.50

6.30
6.30
6.30
5.95

1/01/73
5/01/73
8/01/73
11/01/73

293,980,000
285,360,000
331,075,000
369,970,000

3.50
4.25
5.50
4.40

4.85
5.05
5.75
4.70

2/01/74
3/01/74
8/01/74
10/15/74

349,143,000
436,620,000
324,900,000
475,580,000

4.50
5.50
7.00
6.50

2/15/75

141,440,000

6.50

TO TAXABLE YIELD RATIOS
a % of t a x a b l e y i e l d )
YR NYC
BB-20 BOND INDEX
UTILITY
TO
Aa UTILITY

81.7
78.6
74.6

8.69
8.52
9.04
8.73

6.75
6.00
6.50
6.20

SELECTED TAXFREE
(Tax e x a n p t a s
4YC TO
10 1/2
5 1/2 YR I
TO Aa
MAX BANK I IATES
100+
100+
100+
100

7.88
6.40
6.36
6.28

6.00
4.90
5.25
4.85




)-DAY
-BILLS

6.00
6.00
6.00
6.00

$176,860,000
165,445,000
170,180,000
233,780,000

\

SAVINGS
& LOAN

6.53
6.50
6.28
6.35

2/15/70
4/01/70
7/01/70
9/15/70

,
,

BOND BUYER 20
BOND INDEX
AT DATE
OF SALE

63.0
72.6
72.4
71.7

64.3
69.6
66.0
64.1

00

119

Lebenthaifc&xJnc
C^STATXrTKGTPlA«£A.*CWYO«A.»»r

"Ssl

1000* - TEUI>*«<>»£212*Z5-*iiS

tKVCSTQ*

October 27, 1975

Senator Milliasi Presaixe,
Chairaaa

Senate Oaait&e on Banking, Breading and t&hsa Affairs
5241 Dirfcaen Senate Office Biag.,
l^ashirsjtQJi^ DC
D&ar Senator prcxaaxe;
X hasten to supply toe ^llj»±og <&t» to eerrecrt ifee isgres&iiati tn&fc seerf t-sisi
co the Caaeittee that Sew ?oric City bcods are printed in $10,000 denc^inattims
and, tbexeztace, are not cwced fay m a l l indivi^a&l in^estocs.
Sew ?orx City bends, as opposed t o the
wbich tiere $10,000}, have been printed
of 3/1/62. Prior thereto tney cane in
are « t i l l outstanding and owoad by oer

Botes {tbe s t i l l e s t agngeinatioti of
in $5,000 deiKRinaticfss since the tssoe
$1,000 deradnaticcsu SSany $134 piecea
enstcwers.

C?er tae weekend, we coasted t h i s first's 3,696 sales to iisdiisd^toLs s i s e s
1965 of c i t y bonds aataring in j u s t fiscal 1977 (J&X? 1 , lS76-3tsa* 38, 1977)
Bireaibdown ' o f these t r a n s ^ S o n s by par ?alne of traasactioa'2$ a§ Allows?

SIS

214
1802
33

$1£H
$11-131
$l£-2£»
S21-2S*

ssa
178
133
124
-si

$31-4131

uism
$51-731
$75-1008
S101M *

31
41
IB
10
8

60S of s±s» above sales *ere in aaoaets of $5,Q0O par ^sliae or Xes^j
6#% ware noder $10,O0d.
84% *ere of S1Q,GQ0 per ¥aloe c r less«
*




120
These 3$96 separate traosacticos represent $35,504^000 par mlrse of s a l s a ,
%feich i s 3.6% of tbe c i t y ' s $1,008,732,000 t o t a l beaded debt s a t s r i s g in
f i s c a l 1377.
Sbe hy^tifcttical average transaction, ofctai-raed by dividiisg $35304*003 i a
bcods sold by 3,696 transactions, i s $9,714* Us actaality, our 3se«3ian s a i a ,
as t h i s ataay sbows, i s l e s s than $5,000.
fcefoetrrisal s G3-, l a c , has catered toz 50 years ts» the sassXlec investor.
Gae aigat l e n t to giw» tbat fact cecsideraticatt in pcsjjectiag oar bcsid
sales pattern fear 3*6% of tbe market iato a larger" pictsare for tlse r e s t o€
the iadostry. I vaald sasoect other f i z a s do larger per tracsactisSR bG»5n&ss,
fcct I s y s e l f *oald be bard pressed to speak for tJsee,, or attaspt to qoastiry
their s a l e s by a similar analysis.




121
•jEJffjfJfW

COMMUNITY HOUSING IMPROVEMENT PROGRAM, INC.
575 WEST END AVENUE / NEW YORK N Y. 10024 I 212-

799-9348

October 23, 1975
IMPORTANT MESSAGE TO CONGRESS REGARDING NEW YORK'S FISCAL CRISIS
Dear Congressman:
During your deliberations about coming to the aid of New York City in
its moment of dire fiscal crisis, we would urge you to consider the
devastating impact rent controls have on the city's tax base. It is
not enough to cut costs in New York by reducing services, welfare and
capital expenditures, etc., in order to match expenses with income.
The income must be reviewed with respect to insuring that the dollars
expected are the dollars collected.
0

NYC real estate taxes:
written off prior years (MAC)1
est. uncollectible 1975-76 (MAC)

$502,000,000
1

CHIP estimated uncollectible 1975-76:
% Number of apartment houses in tax
arrears (HDA)2 June 30, 1974

6260,000,000
$400,000,000

28,946

Real estate taxes for the fiscal year 1975-76 were projected at
$3,246,000,000. This amount has now been reduced $260,000,000 by
agreement of the Governor, State Comptroller, Mayor and City Controller.
However, the $260,000,000 figure is too low. We believe actual uncollected taxes will amount to more than $400,000,000 due to the
crushing impact rent controls and stabilization impose on New York
City's private housing sector.
Rent controls are the main reason owners have been unable to pay real
estate taxes. (28,946 apartment buildings were in default on the
payment of real estate taxes on June 30, 1974.) Rent controls have
caused the deterioration and abandonment of more than 300,000 apartment units in the last decade.
"Municipal Assistance Corporation
•Housing & Development Administration

Representing 2500 Owners of 375,000 Apartments




122
Annually,
exceeding
purposes,
more than

owners are abandoning buildings having assessed values
$100 million, an amount rising each year. For borrowing
New York City values these same abandoned buildings at
$200 million based on "equalized assessed" value.

Part of the many billions of dollars of debt strangling our city and
state include Urban Development Corp. and Housing Finance Agency
bonds and notes for housing construction to replace abandoned housing
at $45,000 plus per apartment unit. All of this new housing is
further subsidized by federal, state and city funds.
In a decision by Judge Bernard Klieger in the housing part of the
Civil Court of the City of New York (copy enclosed), the Judge
determined, "While cities without rent control may be suffering
abandonments, it is clear however that in cities with rent control,
housing units are being pushed over the brink and abandoned because
of rent control." Further: "A rent gap approximating $750 million
has led to a deterioration in housing units, and enforced total
abandonment of valuable property on an unprecedented scale. ...The
City of New York is out some $600 million in defaulted real estate
taxes at a moment in its financial situation when every dollar is
needed." And, "The testimony and exhibits at the trial established
without contradiction or dissent that the administration of these
laws has resulted in wholesale deprivation of property without due
process of law, as well as denial of equal protection."
New York City is hiding not only the spreading bankruptcy of its
private rental housing, but also its causes. We urge Congress to
insist on all of the facts regarding the destruction of our city's
real estate tax base resulting from rent controls before extending
aid or guarantees.
We believe you will come to the same conclusion we have--New York
City's fiscal crisis can not be dealt with effectively without
restoring its real estate tax base. This can not be accomplished
unless rent controls and stabilization are phased out now.
Sincerely yours,

^^^r

William A. Moses
Chairman of the Board
WAM:wrs
Enc.




123

TIME
THE NATION
CITIES/COVER STORY

HOW TO SHE
NEW YORK
END RENT CONTROL
New York's housing has deteriorated alarmingly. More than 30,000 apartments are being abandoned each year.
One major reason is the city's archaic
rent-control law, which has been on the
books since World War II. Because
landlords in many instances cannot
raise rents enough to cover costs, they
simply walk away from unprofitable
buildings, leaving them in the hands of
the city, which can scarcely afford to rehabilitate them or even maintain them.
With fuel costs high and climbing, abandonments are bound to accelerate. Real
estate tax delinquencies are also ominously rising; they reached $220 million
in fiscal 1975.
Rent control must be phased out.
That process could be combined with a
modest building program to encourage
home ownership in the city. Though
more than a thousand acres of largely
abandoned areas in The Bronx and
Brooklyn are next to slums, they are potentially desirable because they are conveniently located. The city could clear
them and erect row houses to be sold to
middle-class buyers. Says I.D. Robbins.
a builder and former president of the
City Club, a civic watchdog group
There is a tremendous capital investment left over from the time these neighborhoods thrived. All that is missing is
people."

Excerpt from TIME Magazine, October 20, 1975




124

BARRON'S
NATIONAL BUSINESS AND FINANCIAL W E E K L Y ^ ^ ^ ^ © 1975 DOW JONES & CO., INC.
OCTOBER 27, 1975

Rotten Boroughs

New York City has been undermined by rent control.
Three decades of "emergency" curbs cost nearly $1 billion in uncollectible real estate taxes, devastate much of
Manhattan, Brooklyn, the Bronx. Civil Court judge condemns system as unworkable, unconstitutional. Gotham
literally must put house in order.
—Editorial Commentary

New York City Has Been Undermined by Rent Control
DORFMAN
Magazine isn't exactly must
DAN around here, aside, New York
reading
but we subscribe
wholeheartedly to last week's issue.
Under the catchy title, "Who's to
Blame for the Fix We're In", the author ticked off the "Twenty Critical
Decisions That Broke New York
City," ranging from enactment on
June 22, 1944, of the G.I. Bill of
Rights, which "opened the floodgates
. . . to the exodus of two million middle-income people to the suburbs," to
the default on February 25, 1975, of
the New York State Urban Development Corp. In between, there was
more than one villain of the piece:
then-Governor Thomas E. Dewey; former Mayor Robert E. Wagner, who,
on March 31, 1958, issued Executive
Order Number 49, which granted city
employes "the right to join a union of
their choice and to bargain collectively"; Republican turncoat John V.
Lindsay, who, on January 12, 1966,
settled a city-wide transit strike at
prohibitive cost, and, on March 18,
1969, "announced his candidacy for
re-election."
Even Nelson Rockefeller, who has
somehow bamboozled most of the
press into forgetting his ruinous 15year tenure in Albany, takes his
lumps. March 28, 1960: "Governor
Rockefeller signs a bill increasing by
5% the state's contribution to state
employes' pensions"; April 18, 1960:
"Governor Rockefeller signs a bill creating the State Housing Finance
Agency"; June 18, 1971: "Rockefeller
signs an amendment to the Local Finance Law," which, in effect, gave
Gotham's free-and-easy politicos a
blank check.




Compiling Critical Decisions, of
course, is a game any number can
play. With respect to the decline and
fall of New York, we can think of several that didn't make the aforesaid
list. September 1, 1932: Mayor James
J. Walker resigns from office, thereby
temporarily removing Tammany's little tin box from the local scene and replacing it with the insatiable demands
of social engineers and reformers. November 7, 1933: FioreUo H. LaGuardia wins the mayoralty by a landslide,
thus enshrining the five-cent subway
fare, sealing the doom of the Brooklyn-Manhattan Transit Co. (BMT) and
Interborough Rapid Transit Co. (IRT),
and ushering in an era of public affluence and private squalor. November
1, 1943: four months after the rest of
the country, federal rent control goes
into effect in New York City. May 1,
1950: New York State takes over the
administration of rent control from the
federal government. May 1, 1962:
New York City takes over the administration of rent control from New
York State.
Apart from Barron's, which for
over a decade has repeatedly attacked
this peculiar form of urban blight, and
The Wall Street Journal (which lately
has taken up the cudgels), few have
cared to point a finger at rent control.
The captains and the kings of high finance have trouped to Washington
and departed, without so much as a
passing glance at the subject. On Capitol Hill, where the lawmakers, as is
their wont, again seem eager to legislate in haste and repent at leisure,

Representatives and Senators alike1
unanimously have chosen to ignore the
issue. Yet as our own chronology of
Critical Decisions suggests, it cannot
escape its share of blame for New
York's financial plight. On the contrary, thanks to rent control, the city
currently is losing—either by forfeiture or failure to collect—real estate
tax revenues put at hundreds of millions of dollars per year. All told, what
Gotham has lost from this source is
fast approaching the billion dollar
mark.
But the damage cannot be properly
assessed in dollars-and-cents alone.
As even the hapless officials responsible now reluctantly concede, rent control is costing the City of New York,
through abandonment and ultimate destruction, upwards of 30,000 dwelling
units annually. That's enough (so our
colleague, James Grant, recently calculated—Barron's, April 21, 1975) to
house at two to a room the population
of Sioux Falls, S.D., or a good many
other places the residents of which are
now being asked to succor (or be
suckered by) the misgoverned metropolis.
Like the quantity of shelter, the
quality of life in the big town inevitably has suffered, too. Mobility and
freedom to choose where one wishes
to live have dwindled almost to the
vanishing point. By setting tenant
against landlord and lavishing unearned benefits on a privileged minority of subsidized squatters, rent control perennially fans the flames of social hatred and class warfare in a city
once known as the nation's meltingpot. After three decades and more of

125
an alleged "emergency," which furnished the shaky legal foundation for
rent control, New York City is in deep
financial crisis. One way or another,
quite literally and finally, it must put
its house in order.
"Disorderly" doesn't begin to describe the chaos wrought by rent control since it was imposed as a wartime
expedient in 1943. While promptly
abandoned by the rest of the U.S.
shortly after World War II, the
"emergency" measure remained alive
and well in what somebody once described as the "most unrepresentative
city in the country." Over the years,
as noted, its care and handling, growing more cumbersome and restrictive
every step of the way, shifted from
federal to state to local authorities.
First applied only to pre-war apartments, controls (rechristened "stabilization") eventually engulfed postwar
buildings too, thereby bringing new
residential construction in the five boroughs almost to a halt. Rules and regulations proliferated. As the landlord
told Barron's, in one apartment house
in the Bronx, "there are rent-controlled tenants, rent-stabilized tenants,
tenants who were decontrolled by virtue of vacancy decontrol (since rescinded) and tenants who were recontrolled or restabilized by virtue of the
Emergency Tenant Protection Act of
1974." Confusion has compounded to
the point where a justice of the Civil
Court of the City of New York recently decreed rent control—notably
in its current version, known as Maximum Base Rents — unconstitutional,
not because it violates property rights
per se, but because it has grown impossible to administer with even a pretense of equity.
Maximum Base Rents may be
shrouded in red tape, but their effects
are painfully clear. Under such stric-

tures, landlords, after protracted delay, are lucky to win a rent increase of
7.5%-8.5% annually. In striking contrast, taxes and labor are rising at well
over 10% per year, while in the past
» 18 months, the price of fuel oil, a ponderable part of total operating costs,
has soared by 200%. Small wonder
that more and more buildings are
being run at a loss, while tax delinquency, once largely confined to one
or two rotten boroughs, has spread far
and wide. According to the Municipal
Assistance Corp., newly organized
state agency which is trying more or
less successfully to fight City Hall,
$502 million in real estate taxes from
prior years must be written off. In the
current fiscal year alone, MAC estimates that another $260 million will
not be forthcoming, a staggering sum
which the Community Housing Improvement Corp., a landlord group
which knows the grim score, views as
too low by half.
Deterioration—in the trend of tax
delinquencies cited above, and in the
condition of the housing stock—is
shocking. Half a decade or so ago,
Barron's observed: "Vast stretches of
real estate in at least three of the five
boroughs have decayed beyond the
point of no return. Ancient tenements
and (until recently) quite habitable
buildings alike stand empty, boarded
up and stripped, vandalized and
blackened by fire. Some no longer
stand at all except as piles of broken
brick and rubble. Whole blocks of
Brooklyn and the Bronx have been
compared (by expert witnesses) to the
bombed-out ruins of London and Berlin." Last spring, in preparation for
weighing the case against rent control,
Civil Court Judge Bernard Kfieger
toured the blighted areas. After an
hour or two, he called a halt, saying:

"I don't want to see any more. I'm so
depressed." Since January 1, precisely 2,6% dwelling units, only a
handful privately financed, have been
started in New York City, down over
50% from the like 1974 span. Physically as well as financially, Gotham is
visibly crumbling.

* **

The moral devastation is worst of
all. In the name of social justice, landlords—including some of moderate
means—have been forced to subsidize
well-to-do or wealthy tenants who,
thanks to rent control, have turned
large apartments into part-time piedsa~terre. For those seeking a place to
live—this helps to explain why so few
want to move to New York—freedom
of choice is limited; in the covert traffic in rent-controlled flats (as must
happen where goods or services are
priced below market), discrimination,
religious and racial, flourishes. For
more than a generation, local politicians and so-called civic leaders alike
have cravenly perpetuated the evil.
Now the rest of the country is being
asked to pay for the city's mistakes. If
a bargain is struck, an end to rent
control should be a key element of
the quid pro quo.
—Robert M. Bleiberg

BARRON'S
October 27. 1975

60-832

O - 75 - 9




126
The First Condition
We think Senator Proxmire'g
Senate Banking Committee is making a mistake in envisioning a federal guarantee of New York City
securities. But the committee will
plunge beyond a mistake and into
sheer folly if it guarantees the notes
without securing the tax base that
must pay them off. This means requiring the city to repeal its rent
control laws.
We continue to believe that the
best step for the city is voluntary
bankruptcy, and that if it is unwilling to take that step the federal governm#nt ought to step aside and let
the courts handle the problem.
Mayor Beame talks of needing a billion dollars by March even if all
debt service is suspended; this is
chiefly the result of seasonal patterns in the payment of state and
federal monies that could perhaps be
corrected. In fact, the same projections show that through the remaining nine months of the fiscal year, a
suspension of debt service and an 8%
cut in other city spending would balance income and outgo.
These numbers are not significantly different from those the
Proxmire legislation contemplates.
The most important difference is
that if the city goes through bankruptcy and is forced to live without
credit, the cuts actually will be
made. If it receives a federal guarantee, Mayor Beame will come
limping back to Senator Proxmire
next year for new and bigger guarantees.
We might remind the committee
what a guarantee means. It means
that if the city is unable to pay off
the note, the federal government
must do so. The legislation would in
effect set up a new uncontrollable
federal expenditure of $6 billion.
Since the committee hopes that the
expenditure will not be necessary, it
recognizes that it must attach stringent conditions concerning the expenditure side of the city's budget.
But so far it has not recognized that
the same scrutiny must be applied
to the revenue side.
The revenue side is at least as
scary as the expense side. Earlier
this year three disinterested civic
associations—the Citizens Housing
and Planning Council, the Citizens
Budget Commission and the Citizens Union — issued an unprecedented joint statement warning of
"the virtual collapse of the housing
inventory of New York City and a
massive erosion in the property tax
base which would have a devastating impact on the city's revenueraising abilities."
"Collapse . . . massive erosion . . . devastating," the words
describe the recent effects of rent
control, which has clung on in varying forms in New York though it
was abolished soon after World War




II in the parts of the nation now
asked to guarantee the city's debt.
There is no better example of the
habit of preposterous cant at the
root of New York's problems than
the rhetoric about "greedy landlords," which obscures the huge
importance of the real estate industry to the city's tax base and credit
standing.
The real estate tax remains the
most vital single revenue source in
New York. Some 31% of the city's
assessed valuation and a somewhat
smaller part of revenues come from
apartment properties. The value of
these properties, and thus their contribution to assessed valuation and
their tax-paying abilities, depends
principally on their rental income.
The rent control and rent stabilization laws reduce this income, and
thus reduce the city's tax base, revenues, and ability to redeem securities.
This chronic problem erupted
into a full-fledged crisis with the increase in fuel costs, and other inflationary pressures, and with the reimposition of rent stabilization on
apartments previously exempted
from the older rent control law. The
apartment owners have not been
allowed to pass along the full increases in fuel costs in higher rents.
The typical apartment is now operating at a loss. If in order to make
a basic point we may be allowed an
exaggeration ignoring such complexities as tax losses: This means the
value of the property is zero, and
the assessed valuation of the city
ought to be written down by something approaching 31%.
A de facto write-down is rapidly
making itself felt. About 25% of the
apartment buildings ^ r e already in
arrears on their real estate taxes.
About 90 of the city's 125 subsidized
Mitchell-Lama projects for middle
income residents are in various
stages of default on their mortgages. A rent strike at the huge Coop City development, backed by
many members of the city government, is the principal reason the
State Housing Finance Agency is in
financial jeopardy. The outright
abandonment of apartments runs at
about 40,000 housing units a year, or
the equivalent of the entire housing I
stock in many smaller cities now
asked to guarantee New York's
debt.
Unless rent control is repealed, i
this hemorrhage will not only continue but accelerate. The city is devouring its own tax base just at the
moment it is asking the rest of the
nation to co-sign notes that base is
supposed to pay off. Making the end
of rent control the very first condition of any federal action is not a
matter of ideology, but a matter of
simple prudence.

127
THE NEW YORK TIMES, SATURDAY, OCTOBER 25, 1915

§toe#etorjj<>rk Sinter




Founded in 1851
ADOLPH S. OCHS, Publisher 1896-1935
ARTHUR HAYS SULZBERGER, Publisher 1985-1961
ORVIL E. DRYFOOS, Publisher 1961-1963

Housing New York
Does this city want more housing? Does it want to
maintain and upgrade the housing it already hJas^and at
the same time promote a cycle of renewal, ret>Idcinfeeconomically weak structures?
Bit by bit over the past thirty years city policies have
inhibited such a cycle, which is essential to municipal
health. Rent controls, for example, may have performed
an essential protective function for hundreds of thousands
of families, but they have also inhibited renewal. So have
tough relocation procedures. So have the restraints on
conversion of buildings to cooperatives or condominiums.
A heartless overnight reversal of policies deeply inscribed in the city's way of life is obviously impossible,
but there must be a gradual turn toward realism to.
stimulate housing investment.
As a first step, it may be necessary to take administration of the control system out of the hands of political
officials and vest it in some counterpart of the Public
Service Commission, which regulates utility rates. In the
last disastrous eight years of housing administration, city
government has shown itself incapable of managing the
burden of so vast and diverse a housing supply.
Beyond that, a way must be found to phase out controlled rents without unduly penalizing fixed-income
elderly people who cannot afford the real cost of their
housing or others unable to find decent housing at supportable rents. The new so-called Section 8 Federal rent
subsidies should be useful in this respect.
Without question, the fuel-cost crisis has brought the
situation to a head. There must be long-term incentives
to maintain sound housing despite the corrosive effects
of leaping operating and financing costs. The city's tax
base itself depends on it.

128

.reprinted from BARRON'S

National Business and Financial Weekly Issue of April 21, 1975
Weekly

I

Disaster Area
Rent Control Has Helped Turn Gotham Into One
BY JAMES GRANT

fiscal plight of
T aHE(and which dramaNew York City,
serialized
of uncertain
length
may or may not have
a happy ending), has gained national
notoriety in recent weeks. Early this
month, Standard & Poor's Corp. suspended the city's credit rating. Only
the timely arrival of state aid—some
$400 million which Albany itself had to
borrow—saved Gotham from an imminent, and perhaps disastrous, trip to
the credit market. Late last week, City
Hall proposed a 1975-76 budget of $13
billion, including a projected deficit of
abcyt $880 million.
One aspect of the continuing financial crisis, however, has been largely
ignored: the steady decline of New
York's pre-war apartment buildings.
Abandonment of old but still sound
structures (to illustrate, the Brooklyn
apartment _house shown below) is
sharply on the rise. Tax arrearages are
mounting. Many pre-war buildings happen to be rent-controlled, a s;a:e of affairs which, landlords say, makes it impossible to keep them in good repair.
Apocalypse Ahead?
"Is N.Y. Housing Doomed?", asks
the Real Estate Weekly on its April 3
front page. Doomed? One senses hyperbole; apocalypse, after all, is an idea
perhaps too much in vogue. Yet the
same question is posed, on the same
front page, by none other than Roger
Starr, New York City's Housing and
Development Administrator. "What is
our potential for housing 'disaster'?"
Starr asks. "Why can one suggest that
our housing stock may be reaching a
point of no return?" Tax arrearages,
abandonment and mortgage defaults
worsen apace, he writes.
Starr places most of the blame on
the soaring price of fuel. He warns that
more deterioration looms unless the
City Council passes along part of the
higher oil costs to tenants—landlords to
date have borne virtually the whole
burden.
Fuel, indeed, has risen by 200% in
the past 18 months; the cost of labor is
up 40% in three years. Taxes alone are
expected to increase 10% next year.

Yet rents—controlled in some instances, since 1943; successively "stabilized," "decontrolled," and "restabilized" in the years since 1969—have
lagged behind. Estimates vary as to
just how far.
The gap, without doubt, is widest in
rent-controlled buildings, those apartments—about 700,000 remain—built
before 1947. Though in one way or another virtually all city apartments are
"controlled," the older stock is regulated most severely. Landlords and the
city agree that rent-controlled tenants
do not pay enough to maintain their
own buildings. Citing a seven-year-old
study by the Rand Corp., owners claim
that the shortfall amounts to $750 million a year—in effect, a tax on the
bricks and mortar of older, rent-controlled apartment houses. The city declines to guess.
Most eloquent evidence that something is wrong is the spreading blight of
abandonment. Last year, Starr has testified, landlords and tenants walked
away from 36,000 apartments, enough
to house the population (at two to a
unit) of Sioux Falls, S.D. Starr bases
his appraisal on a running count of vacant buildings kept by the Fire Department. Other estimates, pointing up the
dearth of hard information, range from
15,000 to 50,000 units.
Last Exit to Brooklyn

Whatever the numbers, the spectacle of abandonment is haunting: in the
Brownsville area of Brooklyn, block
after block of vacant apartment houses,
s•-"•';pped of everything salable, stand
rot'ing; 16-ip.ch v.ulis and hardwood
floors, ornamental plaster-work and
brcken glass—deser.zd. To build an
apartment in New York today costs
abcu'. $50,000; restoration of an existing
unit, depending on its condition, can
vary from $15,000 to $30,000.
Las', mor.'h, Judge Bernard Klieger
of the Brooklyn Civil Court agreed to
view abandonment and decay firsthand in connection with an unusual
trial. The inspection was to have included the Bronx and Manhattan as
well as Brooklyn, but in Brownsville,

three hours after he began, the judge
threw up his hands. "I'm so depressed," he said. "I don't want to see
anything more." He likened the destruction to Aachen, Germany, in the
closing months of World War II.
The trial began in December, when
the Housing and Development Administration took a landlord's organization
to court to block a symbolic, one-day
boiler shutdown. The landlords, about
1,000 strong, had planned the action to
protest municipal regulations of fuel
pricing. It followed similar "Boiler
Conservation Days" last fall.
Restraining Order
The city sought (and won) a temporary restraining order against the owners on December 5. However, Community Housing Improvement Program
(CHIP), the landlords' group, filed a
countersuit for $750 million, a sum
which, if awarded, would cause the
most sudden austerity wave in the history of municipal finance. (Such an
award is considered unlikely.)
The countersuit called for something more immediate—a wholesale,
and possibly impolitic, review of the
city's housing policies. Indeed, by the
last day of the hearings, Roy Conn—he
of Army v. McCarthy, and Fifth Avenue Coach Lines v. New York—asked
that the judge rule rent control unconstitutional, a breach of the guarantee
that private property not be taken for
public use without fair and adequate
compensation.
HDA protested that the court
lacked jurisdiction in a matter so
sweeping. The setting was indeed improbable—a civil court judge ir. Brooklyn hearing arguments on the legal
theory cf rent administration. But
Judge Klieger's jurisdiction was upheld
in the" State Supreme Court and the
trial went forward. The hearings, which
lasted six days, were concluded on
March 19.
Judge Kliegwr only now is receiving
final briefs; his decision is weeks away.
Already apparent, however, is the toll
that property abandonment and falling
real-estate income have taken on the

• DOW JONES REPRINT SERVICE • P.O. BOX 300 • PRINCETON. NEW JERSEY 0 8 5 4 0 •
Reprinted from The Wall Street Journal • £ Dow Jones & Company, Inc. 1975 • Wall Street Journal Subscription Information 800-628-4040.




129
city's finances. Cumulative tax arrears
reached $648.5 million on January 31,
up from $522.3 million on the same date
in 1974 and $494.3 million on January
31, 1973.
Tax Arrearages
Last year's increase in tax arrearages (that is, the increase between February 1, 1974 and January 1,1975), plus
the 1974 cancellation of real estate
taxes, totaled $226.4 million. Arrearages plus cancellations in 1973 came to
$101.1 million, lower by half. (A cancelled tax is one that the city has either
remitted or given up on.)
Most property owners, of course,
pay their taxes; a fine of 1% a month is
levied on uncollected balances and
three year's non-payment is grounds
for foreclosure. The city expects all but
6% of the $2.8% billion it has budgeted
for real-estate taxes this year (about a
quarter of New York revenues) to be
collected by June 30.
That is the bright side. Less appealing are these facts: a 6% delinquency
rate, up from 5.59% a year ago, would
be the worst in at least 40 years; nonpayment by apartment houses, which
provide 31% of the city's real-estate tax
income, is running substantially higher.
On June 30 last year, 21.8% of New
York apartment house parcels had
slipped into arrears, vs. 11.5% of all
real-estate parcels. (Not all parcels, of
course, are taxed equally.) "Among the
older, walk-up stock," Starr writes,
"tax delinquencies went as high as
33% in Manhattan—and even the




newer elevator buildings polled double-digit arrears in the Bronx (16%) and
Manhattan and Brooklyn (11% for
both)."
The city loses in ether ways. Not
only are delinquencies mounting, but
alio rent control reduces the taxes that
r.-iight otherwise have been paid in a
free market. Whatever the "rent gap"
may be in controlled buildings—$500
million, $750 million or $1 billion annually—New York loses some of it in
taxes. Property taxes, of course, are
not tied directly to rents, but a property's assessed value to a great degree reflects the income which it produces. If
a "gross rent multiplier" of three is applied to $750 million, for example, the
"assessed value" comes to $2.25 billion. At the present tax rate, the realestate levy on such a sum amounts to
$165 million. Though the numbers are
rough, the theory is sound: less income
means lower real-estate taxes. If rents
are depressed by law, so are taxes.
Bad Light
Obviously, none of this casts the
city's tax anticipation notes in a flattering light. (On April 8, there were $1.1
billion in notes outstanding, issued
against future real-estate levies, but
backed by the city's general revenues.)
A building, though abandoned or in arrears, is normally carried on the city
tax rolls until foreclosure. There arises
the question of how much revenue the
city may prudently anticipate. The answer, simply, is that no one knows; the

numbers — on abandonment,
disinvestment, the "rent gap"
—do not exist. Without question, though, the outlook for
apartment houses in New York
City is bad and getting worse.
Certainly, things could be
better for Marian Catrina,
owner of a five-story walk-up
on 35-45 Arden Street in upper
Manhattan. Over the past 12
months, he says, he has paid
$16,168.13 in real estate taxes.
In that time, according to his
figures, expenses have outstripped income by more than
$10,000. Some 40% of the families in his building, Catrina
adds, are behind in their rent.
Of his 69 apartments, 39 are
rent controlled—that is, based
on rents that prevailed in 1943.
(With allowable increases
since 1943 and barring tenant
turnover, a rent-controlled
apartment that rented for $60 a
month 32 years ago would fetch
about $114 today.) Catrina estimates that his maintenance
costs—taxes, oil, wages—
come to $40 a room, $10 more
than rents in controlled units.
Monthly income for the other
30 apartments totals about $45
a room, he . says—enough to
cover maintenance, but not to
finance major improvements.
Minor Violations
Bruno De La Rosa, the su-

130
perintendent, says that the
Caught in the Tunnel
building has improved in the
"The building is violationyear under Catrina's ownership—ceilings have been fixed, free, it's been upgraded for air
there is new paint in the halls pollution," he says "Sixtyand the courtyard will soon be five of the 82 apartments are
repaved. Still, the property has rent-controlled. All but one
been cited for minor building- apartment is rented." Sirulnik
code violations and there is says he is feeding the building
need for an overhaul: the wir- fresh capital every month, and
ing should be replaced, while that out-of-pocket expenses
the plumbing, Catrina says, "is have totaled $20,000 since July
1973. Fuel costs have more
a mess."
than doubled—from $7,357 in
De La Rosa shows a visitor the fiscal year ended July 31,
a vacant apartment, Number 1973, to $19,997 for the 12
2H. Red wallpaper, recently months ended July 1974. There
torn from the walls, lies wad- have been increases in taxes
ded on the floor. The medicine and salaries and maintenance.
chest is gone, taken by the for- Rents have risen as well in that
mer tenant who also is said to last year—from $112,029 to an
owe two months rent. (Tenants indicated $121,034 at present
have stolen toilet seats, electri- —but not enough to keep pace.
cal fixtures and refrigerators,
"We'll wind up basically in
Catrina says.) There is a
sticker on the inside of apart- the same situation as last
year." Sirulnik says. "I feel
ment 2H; it reads "Have a
the only way to go is to see the
Nice Day."
first mortgagee—to seek susCatrina's building is located pension of amortization payin Inwood, a few blocks from ments on the first mortgage. If
The Cloisters. The neighbor- the bank doesn't go along we'll
hood is poor, largely black and give them the first mortgage. If
Hispanic, but it is not a slum. there were a light at the end of
"It's a fairly decent place," the tunnel, things would be difsays an officer at the 34th Pre- ferent. But the tunnel's
cinct; "there aren't too many blocked up with cinder block
incidents."
and I don't want to be caught
Catrina, who emigrated inside. I don't want to throw
from Romania six years ago, is good monev after bad."
frightened and frustrated.
Equity Has Disappeared
Though he put down $30,000
for the apartment house—his
Ditmas owns 4,200 apartonly such holding in New York ments in New York and sub—he says he may turn the title stantial commercial properties
back to the bank and walk outside the city. The Hinkley
away. The mortgage is for Place apartments, built in
$312,000. "I do the work here, 1929, have made money reguthe plumbing.
**<c says.
larly since the family acquired
"Still the people <trt hating them in 1950. In 1972, Sirulnik
you, blaming you
I'm fed guesses, the building might
up."
have sold for $500,000. "Now,
In another part ot ujwn, an- I doubt I could get what the
other landlord reciter nis woes. mortgage is worth—$260,000."
The building is 2-24 HinkJey His equiiy—$240,000—has disPlace, a six-story^ seemingly appeared. How long will he
prosperous brick elevator hold on? That depends on what
apartment house \r> residential happens in Albany and City
Brooklyn. The landlord is Hall, Sirulnik says.
According to Sirulnik, his
Sandy Sirulnik, president of
Ditmas Management Corp. Si- family has never walked away
rulnik, whose family has from a building. Aaron Ziegelowned New York real estate man cannot make the same
for three generations, stands on claim, and last month he sat in
the sidewalk in front of the Judge Klieger's courtroom to
building, answering news- explain why. Over the past 12
men's questions. The occasion months, Ziegelman testified,
is Judge Klieger's tour of city he "abandoned" 15 apartment
housing, and Sirulruk is ex- bui'dings—gave up the properplaining the mechanics ot los- ties at distress prices or allowed mortgagees to foreclose.
ing money.




He told the court he is losing
money on 67 of his remaining
70 buildings, all of them in
solid, middle-class neighborhoods.
"I'll tell you how this process takes place," he began.
"You know, a building just
doesn't become abandoned,
abandonment where it's a
shell. I own a building where I
have no future in it and I see no
future. See, the worst part is
not only losing money, it's the
lack of expectation.
"I'm in a position where
because I do a lot of business
out of New York City, I have
the capita!, the financial ability
to keep a building even though
it loses money, if I have expectation. But if I have no expectation, I'd be J damn fool to
hold on to it. I could sell it to
someone with very low cash
just to get out and take as much
as I can and salvage as much of
my investment. And there the
process of deterioration starts,
because the building now goes
from strong hands like ours—
and I consider ours good,
strong management, financially
viable—to weak hands."
Sense of Futility
Are the problems of Catrina, Ziegelman and Sirulnik
typical? They are at least representative.
Well-managed
buildings in desirable neighborhoods can and do make money
in New York City. But these,
by all accounts, are in a dwindling minority. A sense of futility has come over the industry,
something that goes beyond the
rise in fuel prices. There is a
belief that the City no longer
cares, that the needs of property are not merely neglected,
but scorned. "Expectation"
has all but vanished.
"From all the years I've
been in business, I've always
heard landlords cry," says
Jack Weprin, a housing lawyer. "Now not only are they
crying, but they're giving up
their properties too."
He adds that with vacancy
decontrol, a 1971 law that mandated the gradual freeing of
controlled rents, "you felt a resurgence of hope. . . . People
who had gotten out of the New
York market were coming back
in. They felt they could operate
and make money."

Backlogs of Years
But the reform was
scrapped with the 1974 Emergency Tenant Protection Act.
A city plan of "maximum base
rents," designed to secure a
fair return for the owners of
controlled buildings, has been
indifferently administered, the
city concedes. Landlords say
that backlogs, notably for
"hardship" cases, sometimes
can be measured in years. Delays in getting out the 1974
"MBR" increases sharply
worsened an already strained
cash-flow situation, owners
charge.
According to HDA's Starr,
moreover, 55% of the city's
controlled buildings failed to
qualify for last year's rent increases because of maintenance infractions.
The city housing courts,
created by the legislature in
1973, play a pivotal role in deciding when and if contested
rents shall be paid. Judge Edward Thompson, deputy chief
administrative judge in charge
of the civil court, concedes that
a bias exists in favor of tenants,
not merely in housing court,
but also "throughout the city.
It's normal for a judge to
side with tenants," he says. So
important is housing to man's
well-being that such an "understanding," is normal and
just, he declares. Landlords,
for their part, say that the system hampers payments and
erodes their authority to collect
them. If tenants have arightto
decent housing, they ask, do
owners have a duty to provide
it, regardless of costs'1
Far simpler than the administrative history of rent control
is its economics: costs, which
are not controlled, have outpaced rents, which are. For
decades New York has sought
to provide decent housing at
low prices. But in pursuing this
goal, it has slighted an axiom of
economic life: government can
regulate the price of a commodity, or it can regulate the supply, but it cannot set both at
once. The city has seen to it
that many New Yorkers pay a
very low rent. (For example,
some 10% of all controlled tenants pay only 13% of their income for rent, a landlords'
group estimates, based on 1970

131
census data.)
But low prices call forth
less investment and less production, whether the commodity is natural gas or apartment
houses. And if prices are low
enough, the result is disinvestment or abandonment.
On a net basis. New York
City is losing about 10.000
apartments a year, HDA estimates. Construction during the
'Seventies has averaged only
20,000 units annually, down
from an average of 37,000 in
the 'Sixties. (Abandonment, in
large part, accounts for the net
decline.) Significantly, privately-financed housing has fallen
both in absolute terms through
1972 (the year of the latest
available figures) and as a proportion of overall construction.
The result, the city reports, is
"a critical and growing housing
shortage."
To the federal government,
if not City Hall, rent control
signals danger "It has been
determined," the Department
of Housing and Urban Development wrote in the February
26 Federal Register, "that
local rent control is a significant factor in causing owners
of FHA projects, especially
subsidized projects, to default
on their mortgage payments."
The result: rising mortgage
insurance claims, HUD concluded, and
abandonment.
Some 53 federally-insured or
federally-financed apartments
houses in the New York region
were in default on March 1,
roughly twice the total a year
ago. (There are 884 such projects in the metropolitan area.)
According
to
S. William
Green, HUD's New York administrator, most of the 53
buildings are rent-controlled.
He says HUD is by-passing

Forbidding Rules
HUD's intercession is the
latest change in the tortured
evolution of New York housing
law. So forbidding, so byzantine are the rules that govern
the operation of a New York
apartment house that few landlords can begin to understand
them. James M. Peck, cocounsel for CHIP, cites the example of 2146 Barnes Avenue
in the Bronx. Apartments in
the building, he writes, fall
under both rent control and
rent stabilization.
"Further," he goes on,
"there are units in the building
which are exempt from either
law. Two separate hardship
provisions govern the tenancy
of this building and there are
two separate and distinct procedures for obtaining capital
improvement increases."
There is more. "In the
building there are rent-controlled tenants, rent stabilized
tenants, tenants who were decontrolled by virtue of vacancy
decontrol, tenants who are recontrolled by virtue of the
Emergency Tenant Protection
Act of 1974 and tenants who
were restabilized by virtue of
ihe Emergency Tenant Protection Act of 1974. "The situation," he concluded, "if not
tragic, would be laughable."
That capital flees uncertainty is amply illustrated by
Metropolitan Life Insurance
Co.% builders of the massive
Peter Cooper and $tuyvesant
Town developments on Manhattan's Lower East Side. The
Met says it has not invested in
New York City housing since
1971. "You can't rely on income if every time you build
something they slap a rent control on it," says William F.
I eahy, vice president for real
local laws to raise rents for estate financing. "You can't
most of the defaulted buildings' control what you sell for and
tenants, typically between 15% not control what you buy for
without disaster."
and 17%




132
THE WALL

STREET JOURNAL, WEDNESDAY,

MAY 28, 1975

More Problems for New York City
By JAMES RING ADAMS

New Yorkers may think they have
enough to worry about, with a double crisis
this week over balancing next year's budget and raising enough ready cash to pay
off $251.4 million of notes due this Friday.
But as the city's fever chart has soared, a
much less spectacular malignancy has
begun to affect New York's finances,
threatening worse trouble ahead.
Throughout New York's perennial fiscal
crises, its mayors have always been able
to use a standard defense. By merely
pointing to the mile upon mile of immensely
valuable commercial, industrial and residential real estate, they have been able to
prove the huge tax resources of this city.
Unlike other financially troubled cities, the
assessed valuation of New York's real estate has steadily risen, to nearly $40 billion
this year.
But in the last two years, rising costs,
rent controls and tight money have combined to put rising numbers of apartment
houses, which make up 31% of this tax
base, deeply into the red. And the problem
has spread from the low-income walk-ups
of Brooklyn and the Bronx to luxury elevator apartments in the best sections of fashionable Manhattan.
"If left unchecked," said a recent warning from three civic groups, this situation "could mean the virtual collapse
of the housing inventory of New York City
and a massive erosion in the property tax
base which would have a devastating Impact on the city's revenue-raising abilities." The three groups—The Citizens
Housing and Planning Council, The Citizens Budget Commission and The Citizens
Union—had sought to dramatize the problem by the unprecedented step of agreeing
on a Joint press release.
According to estimates by the city itself, some $220 million, or between 7.6%
and 7.86% of the $2.9 billion projected real
estate levy for the current fiscal year will
go uncollected by June 30, the end of the
year. This means that' 33,000 apartment
buildings, 25% of all taxable multiple
dwellings, will be in default.
On a 'Slippery Slope'?
To the civic groups, this nonpayment is
the first step on the slippery slope of
"mortgage defaults, unpaid fuel bills, deferred maintenance and finally and inevitably, building abandonment and neighborhood decay." Mortgage defaults, they say,
"are rising in all classes of housing in all
boroughs." New York fuel suppliers have
cancelled lines of credit of some 10,000 residential buildings. And abandonments are
destroying from 35,000 to 50,000 housing
units annually, depending on whom one
talks to.
According to Finance Administration
records, the city may take over title to
nearly 6,000 buildings when the fiscal 197475 foreclosure proceedings reach their end.
The cause of this problem is hotly de-




bated between landlords and tenants, and
that in itself is part of the problem in a
city where 76% of the voters are tenants.
Landlords single out the labyrinthine rent
control restrictions of the city as the reason they haven't been able to cope with the
calamitous sudden increase in costs. The
city's rent control program dates from
1943. A separately-administered rent stabilization program was begun in 1970. At one
point, the state legislature tried to redress
the rigidity of the system by removing vacant apartments from rent control, but this
was repealed in 1974 by the "Emergency
Tenant Protective Act." Now some apartment buildings may have tenants in four
different stages of control or decontrol.
"It's all absurdity," says New York
University Professor Emanuel Tobier, who

While Mayor Beame is
wrestling with New York
City's latest fiscal crisis,
new signs of erosion are appearing in the city's celebrated tax base.
is chairman of the stabilization program's
Rent Guidelines Board.
Nevertheless, the political clout of the
tenant voters makes it almost certain that
landlords will never fully make good on
the undisputed rise in their expenses recently. Fuel oil has soared from 14 cents to
38 cents a gallon since 1973 and utility bills
have kept pace. In mid-May, the City
Council approved a "fuel pass-along" bill,
allowing landlords to charge tenants for
50% of this increased cost. But unmollified
landlord spokesmen say the bill gives too
little, two heating seasons too late.
Real estate taxes, which account for
about 30% of a typical apartment's operating and maintenance costs, are beginning
to hurt too. The current rate of $7.85 per
$100 of assessed value is expected to reach
$8.09 next year. This tax rate is directly
tied to New York City's mounting cost of
debt service. And if the present rate of tax
arrearages were to be factored in, says D.
Kenneth Patton, president of the Real Estate Board, the rate would have to climb
another 67 cents.
Samuel Lefrak, whose Lefrak Organization runs some 260,000 apartments in the
New York area, thinks the crunch will be
disastrous for small operators with high
mortgages and less chance to benefit from
the income tax benefits conveyed by some
types of New York real estate ownership.
He thinks his own organization "can live
with rent control," thanks to an intensive
two-year campaign to reduce corporate
debt. But, he adds, "the highly leveraged
people are going down the drain."
Professor Tobier himself believes that

rent control is only 10% to 20% of the cost
squeeze problem. Controlled rents in the
1960s showed some flexibility, he says, increasing 36% while free market rents rose
52%. The real problem, he maintains, is
the declining income level in the city, making it harder for tenants to afford the rents
they do pay. (A recent Census Bureau
study found an 8.3% decline in the city's
average wage to $10,039 in 1972 from $10,951 in 1970.)
Creeping Decay
Meanwhile, the process of decay has
begun to creep into neighborhoods and
types of buildings previously believed to be
in relatively good shape. Professor Tobier,
using previously untapped data, has analyzed delinquencies for the city's 122,000
walk-up tenements and 10,000 elevator
apartments. Of the tenements—the most
troubled and predominant part of the city's
housing stock—predictably some 32% in
the poorest quarter were in arrears. But in
the richest quarter of the city, so were
15%. Some 15% of the elevator buildings
were behind in their tax payments in the
poor neighborhoods. Yet even in the rich
districts, where this type of building
means high-income luxury, some 7%
couldn't meet their tax payments.
Since these figures were compiled, says
Professor Tobier, "the situation has deteriorated even further. If present trends continue, by the end of the fiscal year in June
1977, the city might face bringing foreclosure proceedings on from 200,000 to 250,000
housing units, most of which are walk-up
properties." (Total city rental housing is

estimated at 2.2 million units, about half
of which is in walk-up buildings.)
In theory the city would sell the buildings for whatever it can get, but Professor
Tobier's figures predict that the city might
find itself stuck with one-half to two-thirds
of the housing stock in some neighborhoods. Many of the tenants may still be
there, simply because it doesn't seem
there will be any place else for them to go.
The city vacancy rate is 1.5% and net new
additions to the housing supply have averaged only 7,500 per year during 1968-73,
and plans for new housing filed with the
Building Department dropped to a staggering low of 226 units for the first two months
this year.
The passage of such a large stock of
buildings into municipal hands would
make the city's Department of Real Estate
the biggest slumlord in town. But, says
Professor Tobier, "there's no indication
they're thinking what to do about it."
What effect would all this have on the
city's widely-discussed fiscal crisis? Obviously it won't help a city with a perennially unbalanced budget to have tax-paying private property transformed to a municipally-owned white elephant.




133
More immediately, non-collection of
taxes puts greater strain on the city's
short-term borrowing, which already is at
the point of collapse. Roughly a quarter of
the $5.7 billion outstanding short-term debt
consists of tax anticipation notes (TANs)
to be repaid by real estate taxes. It's surely no comfort to creditors that the sum
of all unpaid real estate taxes, including this year's projected delinquencies, approaches $600 million.
(Leaving aside this fiscal year, the total
of uncollected property taxes still exceeds
the total of unredeemed TANs by some $68
million. The city doe3 manage to pick up
some of this money through foreclosure
sales or late payment, but a good proportion of back taxes is written off, as courtordered abatements or simply as uncollectible.)

The Tax Deficiency Fund
The full fiscal impact of the real estate
tax problem won't be felt for several
years. The city can "roll over" its TANs,
that is take out new loans to pay off the old
ones, for five years before the law requires.
it to settle the debt. If tax money Isn't in
hand then, the Tax Deficiency Fund makes
up the difference. This fund normally gets
its money from city departments which
didn't manage to spend their full appropriations in preceding years. If this isn't
enough, the city makes up the deficit. For
the first time in several years, the city had
to do this this year, with a $29 million appropriation. This expense undoubtedly will
increase in coming years.
Of course, there is always the chance
that New York real estate will make a recovery. The city's delinquency rates are
still less than economically stagnant Camden and Newark, N.J. and are far below
the 26% rate they reached at the depths of
the depression. Perhaps the fuel passalong bill will do some good and New York
landlords will once more demonstrate the
astonishing capacity of humans to cope
with an absurd system of economic regulation. But, failing this, real estate will become a major feature of New York's next
financial crisis.
"The city of New York is going through
a nervous breakdown," says Samuel Lefrak, "and now real estate is going through
a nervous breakdown, too."
Mr. Adams is a member of the Jourtial's editorial page staff. An editorial
dealing further with New York's problems appears today.

134

el)c;\cmjjorkeimcs

Section O
Sunday, May 18r 1975

Point of View

'Blind' Subsidies Must End
By ALLAN R. TALBOT

Executive Director, Citizens Housing and Planning Council

The financial news these days may
suggest that New York City is the
great ship Titanic. It often seems that
everyone except Mayor Beame, who
is frantically searching for more
money, is paralyzed, unable or unwilling to take the required steps or
even to agree on what steps are
required.
Diminishing tax income and everincreasing expenditures are the problems facing the city, which—through
its health, education, recreation and
other systems—subsidizes its residents and others quite generously.
The city is giving away more than it
can afford.
Among the many areas in which it
does so is housing. Using Federal and
state funds as well as its own, New
York subsidizes the housing costs of
its residents like no other city in the
world. This subsidy system—including underassessment, tax abatement,
rent control, land-cost write-downs,
interest subsidies, tax exemptions
and welfare payments, among other
things—is incomprehensible to many
people. But the system's basic problem is its blindness—the subsidies
often make no allowance for the
ability of the recipients to pay.
Housing subsidies work in two
principal ways. They either shift housing costs to the public treasury, as
do tax abatement and interest subsidies for new construction, or they




require that building owners assume
more of the costs than they would in
a free market. Various rent control
regulations are a prime example of
the latter form.
The economic erosion of both
public-sector and private-sector housing is caused primarily by the city's
recent tradition of subsidizing as
many residents as possible.
In these difficult economic times,
it would appear sensible to ask resi-

annual rent income. Tenant organizations heartily dismissed the notion
that residents in rent controlled buildings should assume any of the 30C per
c*nt rise in fuel oil prices over the
last year. Their political clout accounts for the City Council's delay on
the fuel pass-along bill, though the
oil price emergency was more than a
year old.
Who was left holding the bag? Some
building owners were, if they were

New York gives away more than it can
afford and makes no distinction between
those who need it and those who don't
dents to assume a greater share of
their actual housing costs if they can.
Politically, that means taking away
some privileges and benefits; it means
controversy. The easier political
course is t6 continue blind subsidies,
allowing housing to go broke in both
the public and private sectors.
An enlightening glimpse into the
problem was presented by the Citv
Council's recent passage of*S bill
under which tenants and landlords
in rent-controlled buildings would
share the cost of fuel oil when it
exceeded a fixed percentage of the

solvent enough to absorb the %price
rise. Other owners decided to withhold their property taxes to pay the
fuel supplier. Or worse, they turned
off the heat, and the city's Emergency
Repair Program was forced to come
to the rescue.
In either of the latter cases, the
ultimate subsidizers of rent-controlled
housing weer other property-tax payers in New York, most of whom were
already bearing their share of heady
fuel costs. By its delay, the Council
was subsidizing the heating of rentContinued




135
Continued from Page I
controlled housing with no
consideration for the occupant's ability to pay.
Rent control, of course, !s
a massive blind subsidy, making no distinction whatever
among the 950.000 families
who benefit from it. The
$45,000-a-year family on Manhattan's West Side may pay
as little as one-eighth its income for shelter, but it is
treated the same, as the
$7,000»a-year family " Brookn
lyn that is paying one-third
of its income for a rent-controlled apartment.
Building abandonment, tax
arrears and deferred maintenance are the well-documented results of rent control, a subsidy that has made
it impossible for rental income to keep pace with
mounting costs.
The pernicious results of
rent control can be curbed
only by a far greater tenant
assumption of actual housing
costs. Rent increases must be
adapted to the tenant's ability to pay, using an incomepercentage formula for tenants to claim a hardship
exemption. When an increase
pushes the rent beyond a certain percentage of total in*
come, the landlord should
be allowed to deduct the uncollectible rent from his property tax.
The point is that while some
tenants will still have to be
subsidized, we will know
that they need it, which is
not the case now.
The problem of the blind
subsidy also arises in new or
recently completed publicsector bousing, much of
which is in great financial
stress. About 70 per cent of
the city Mitchell-Lama housing is in tax arrears or mortgage default The income
problem is like that of rentcontrolled housing—the tenants are unable or unwilling
to pay enough so that their
buildings can meet expenses.
Co-op City, the 15,000-unit
project in the Bronx, is also
in a financial bind.
One response to these problems is a series of bills in
Albany under which the state
would provide a subsidy for
some of the troubled projects,
including, for example, Roch-

dale Village and Co-op City.
Should the state bail out
its troubled housing investments in New York? On the
basis of New York's credit
standing alone, the answer is
yes. But befort tax money
is diverted to shore up recently completed public-sector housing, the public has
the right to know the difference between what oroject
tenants can afford and what
the project requires to meet
its obligations.
One possible method is a
means test. Residents in public-sector projects could be
spared rent or carryingcharge increases if the increases would push their
housing costs beyond an
agreed-upon percentage of
income.
In other words, before residents in public-sector projects are further subsidized,
they must demonstrate economic need as well as political clout.
We have, after all, insisted
for some time that families^
of low or moderate income,
pay a minimum percentage
of that income to live irt
public housing or federalljj
assisted housing. An agreement to pay as much as 25
per cent of income is also
the precondition for families
to benefit from the new Federal Section 8 housing subsidy program. The severity
of the housing crisis makes it
more than appropriate for
families of middle income to
lay out similar percentages
for their housing subsidies.
In the midst of the current
gloom about New York's economic condition, we tend to
ignore two important lessons
of history. The first is that
the city has faced and overcome far worse problems
than it has now. At the turn
of the century, when housing
was in far more wretched
shape than it is now, we
subsidized no one. Today
we're trying to subsidize virtually everyone.
The second lesson comes
from an 80-year-old shotshine man in the now defunct
Grand Central Barber Shop.
This Italian immigrant, asked
what the American experience meant to him, replied:
"There's no free lunch."

136
C I V I L COURT OF THE CITY OF NEW Y O R K
COUNTY OF NEW YORK

HOUSING A N D DEVELOPMENT A D M I N I S T R A T I O N
OF THE CITY OF NEW Y O R K ,

HP 186/1974

Plaintiff,
— against —
C O M M U N I T Y HOUSING IMPROVEMENT
PROGRAM, INC., SEYMOUR Z U C K E R M A N ,
W I L L I A M MOSES, SHELDON C. K A T Z ,
SANFORD SIROLNICK, JOSEPH S I R O L N I C K ,
PHILIP SIRONICK, LEONARD W E I N T R A U B ,
LAWRENCE GOLD, SHELDON R E A L T Y CORP.,
SARI R E A L T Y CO., W A Y P A R K R E A L T Y CORP.,
J & D R E A L T Y CORP., D A V I D R E A L T Y CORP.,
SANDY SIROLNICK R E A L T Y CORP., BENSON
R E A L T Y CORP., SEMINOLE R E A L T Y CO.,
H I C K L E Y R E A L T Y CORP., EXCEL R E A L T Y ,
MORRIS W E I N T R A U B ASSOC, M A Y F L O W E R
R E A L T Y CO., W E I N T R A U B ASSOC,

DECISION
SEPTEMBER 9, 1975

Defendants.

Before:

HONORABLE B E R N A R D




KLIEGER,

Judge.

ited as a Public Servi
by:

CHIP
575 West End Avenue
New York City 10024
799-9.348
596-7272

137
Appearances:




W. B E R N A R D R I C H L A N D , ESQ.
Corporation Counsel
Attorney for Plaintiff
Municipal Building
New York, New York
BY:

PETER S. H E R M A N , ESQ., of Counsel

S A X E , BACON, B O L A N & M A N L E Y , ESQS.
Counsel for Defendants
39 East 6 8 t h Street
New York, New York
BY:

ROY M. COHN, ESQ., of Counsel

M E L I K I A N & PECK, ESQS.
Counsel for Defendants
276 Fifth Avenue
New York, New York
BY:

JAMES M. PECK, ESQ., of Counsel

DR. L O R R A I N E M I L L E R
Chairman of the Housing Court Advisory Council
299 Broadway
New York, New York
Appearing as Amicus Curiae

138
Plaintiff New York City Housing and Development Administration (hereafter " H D A " )
is a superagency of the City of New York, with responsibility for enforcement of housing standards
set by state and local laws and regulations.
Defendant Community Housing Improvement Program, Inc. (hereafter "CHIP) is a
New York membership corporation composed of owners of real property in New Y o r k City.

The

other defendants are officers and members of CHIP'S Board of Directors, and owners of real property.

\_
HDA commenced this proceeding to enjoin defendants from a planned shutdown of
boilers for "maintenance" purposes, to take place December 5, 1974. A temporary restraining order
was granted by this Court and has been continued until this time.

Defendants have agreed not to

promote such a shutdown, and this Court finds that the proposed action was organized by CHIP to
dramatize certain housing issues not directly related to boiler maintenance. T o protect the public,
this Court now grants HDA's application for a permanent injunction.
A hearing on December 5 was adjourned to December 17, 1974, to afford CHIP the
opportunity to raise related issues, and there have been a number of subsequent adjournments.
Defendants answered on December 9 and pleaded t w o counterclaims. One counterclaim sought
$1 million for abuse of process. Plaintiff moved to dismiss this counterclaim or for a more definite
statement.

Plaintiff's motion to dismiss that counterclaim is now granted.
The other counterclaim of that date sought $750 million on the ground that HDA

had engaged in conduct calculated to destroy property.

HDA moved to dismiss that counterclaim,

or for a more definite statement. This counterclaim was not pursued at the hearings, and HDA's
motion to dismiss is granted.
CHIP added a third counterclaim on December 17, 1974, and asked the Court t o
order a "pass-along" of increased fuel costs to tenants in rent-controlled apartments.

HDA again

moved to dismiss. There was general agreement, and the Court took judicial notice of the fact,
that fuel costs had increased enormously in the previous 18 months and added a tremendous
burden to already beleaguered property owners.

However, the Court believes that alleviation of

that burden is primarily a legislative matter and now grants the motion to dismiss this counter-




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139
claim.

It notes that a fuel cost "pass-along" was enacted as Local Law No. 27 of 1975, having been

adopted by the City Council on May 9, and approved by the Mayor on June 2, 1975.
After prior notice to all parties, the Court utilized the provisions of New York City
Civil Court Act, section 110(c) and on January 28, 1975, ordered that hearings be held in search of
"remedies, programs, procedures or sanctions authorized by law" which might better achieve compliance
with required housing standards.

HDA then brought a proceeding to prohibit and enjoin the Court

fror,' holding such hearings, Joy v. Klieger, Supreme Court, Kings County, Index No. 1658/75.

An

order to show cause was granted by Hon. Frank Composto on January 27, 1975. After a hearing,
Hon. Irving P. Kartell ruled on February 5, 1975, that section 110 (c) authorized the proposed
utilization of Civil Court Act

§ 110(c) and denied HDA's application.

Hearings were held, expert witnesses testified and were cross-examined, the Court
visited various buildings in the City and studied reports by governmental agencies and knowledgeable
individuals. The Court extends its thanks to the officials, professors, representatives of organizations,
property owners, and others who came forward to assist the Court in its deliberations, and to the
attorneys for both parties who participated in the effort.
At the final argument on March 19, 1975, CHIP moved to conform the pleadings to
the proof, to include the claim that the rent control and rent stabilization laws violated due process
and equal protection provisions of the Constitutions of the United States and New York State.
HDA opposed this motion.
Plaintiff will neither be harmed nor impeded by the granting of a motion to permit
the defendants to plead the unconstitutional administration of the laws. Access to the courts is
meaningless if constitutional issues are prohibited to parties by the recognition of highly technical
objections.

It is the policy of the courts to permit a party to amend his pleadings in good faith

to raise and have determined all questions affecting his rights, Miller v. Cjty_oj._Philadelfjhi_a, 113
App. Div. 92, 99 NYS 93; Washington Life Ins. Co. v. Scott, 1 19 App. Div. 847, 104 NYS 898.
The New York City Civil Court may entertain any defense to a cause of action or
claim (New York City Civil Court Act, section 90

including the defense of unconstitutionality of

the act or ordinance under which plaintiff is proceeding (Cf. Lincoln Bldg. Assoc, v. Barr)
1 Misc. 2d 560, 149 NYS 2d 460, affd, 1 NY 2d 413).




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140
Various provisions of the applicable rent control and rent stabilization laws have
already been held constitutional by the Court of Appeals, 8200 Realty Corp. v. Lindsay, 27 NY
2d 124, 313 NYS 2d 733 (1970); Hartley Holding Corp. v. Gabel, 13 NY 2d 306, 247 NYS 2d
97 (1963); Plaza Mgt. Co. v. City Rent Agency, 25 NY 2d 630, 306, NYS 2d 11 (1969), and
this Court will not consider those matters anew.
But administration of these laws is a separate matter.
The United States Supreme Court held in the case of Boddie v. Connecticut,
401 US. 3 7 1 , 379, 28 L. Ed 2nd 113, 91 S CT 780 (1971):
" O u r cases further establish that a statute or a rule may be held constitutionally
invalid as applied when it operates to deprive an individual of a protected right although its
general validity as a measure enacted in the legitimate exercise of state power is beyond
question." (Emphasis ours.)
Where a party claims that a statute is unconstitutional as applied, it is the
function of the courts to grant him the opportunity to be heard. For, as Mr. Justice Douglas
said, dissenting in part in Lindsay v. Normet, 405 US 56, 84, 31 L.Ed. 2d 36, 57, 92 S.Ct. 8 6 2 :
" . . . due process entails the right 'to sue and defend in
the courts' a right we have described as 'the alternative
to force' in an organized society."
A party is deemed to have waived his right to have a statute declared unconstitutional unless the question is raised at the trial in some manner (Dodge v. Cornelius, 168 NY 242).
it may be raised by objection, motion, or exception, and certainly by answer (Rule 3 2 1 1 , CPLR;
Massachusetts National Bank v. Shinn, 163 NY 360; People ex.rel. Bush v. Houghton, 182 NY 301).
Accordingly, the motion by defendants to conform the pleadings is granted, to the
extent that the administration of the City's rent control and rent stabilization laws will be considered.
It is clear that the existence at the same time of both a rent stabilization law and a
rent control law creates confusion for tenants, landlords and public officials, and that these difficulties are confounded by the 1971 Vacancy Decontrol Law, the 1974 Emergency Tenants Protection
Act, and many other laws. There is little to be said for confusion.
a law may make it unconstitutional.




- 3 -

Further, chaos in administering

141
\\_
Discussions of housing conditions and standards in New York City invariably lead to
assertions that there is a "housing crisis". Yet, the "crisis" is quite subjective.

If the question is asked

"Is there a housing crisis?" most people will answer affirmatively; but on any agenda of individual
problems, or even New York City problems, housing seems to be far down the list. The mass media
consider the "housing crisis" of the same genre as the "education crisis", the "health crisis", the
"transportation crisis", etc.

It is worth noting that since the recent burgeoning of the City's "fiscal

crisis", the media have devoted little time and space to the "housing crisis".
To a large extent, present shortages in housing units are the product of the increasing
economically-forced abandonment of such units by landlords.
There was testimony that rental property is being abandoned at a rate exceeding
30,000 units a year, but the generally agreed-upon number by housing and planning agencies is
30,000. While cities without rent control may be suffering abandonments, it is clear however that
in cities with rent control, housing units are being pushed over the brink and abandoned because of
rent control.

Housing units are now regressing from "stable," to "deteriorating," to "dilapidated,"

to "vacant," to "unsafe," to "abandoned," as a result of many factors, the most significant of which is
rent control.
Nonpayment of real estate taxes has created several problems. One of these is the loss
of badly-needed revenue to the City, with total arrears now estimated at almost $600 million, and
that does not include arrears in water rents and sewer rents.

In almost all such cases, revenue from

a building is simply not enough to encompass the required payments, and property owners can not
pay taxes.
Further, there is a rent gap of some $750,000,000. a year created by the MBR
"system" as administered.
The rent gap is the difference between what landlords actually collect in rents and
what is needed to maintain housing units.
This rent gap makes it impossible for landlords to comply with building codes or to
pay for the labor for proper maintenance among other things.
- 4-

60-832

O - 75 - 10




142
The evidence has convinced the Court that rent control had a different impact on
building owners from 1943 to 1965, from that in the period since 1965.

In the earlier years,

owners were able to cut some services and maintenance. They had few vacancies.
interest rates were moderate.
was more strictly enforced.

Inflation and

But by the 1960's, no services were left to cut, and code compliance
A l l expenses since 1965 have increased far more rapidly, traumatically

compounded by the increase in fuel costs from Qi a gallon to 35cf a gallon in 1973-74. The MBR
system cannot digest such increased costs, and the irony may be that an MBR-type system may fail
in the 1970's, whereas it probably could have worked in the 1960's.

By using the w o r d " w o r k e d " ,

the Court means that a system of gradual, moderate, rent increases in the 1960's might have helped
much real estate; not that the kind of MBR system we have could have been administered better then
than now.

LU
A discussion of traditional rent control, now embodied in the MBR system, must start
with the period before 1970, when it was generally assumed that 1.2 million housing units were covered
by traditional rent control. Some units were decontrolled by the 1970 MBR law enacted by the City
Council, others by procedures in the traditional rent control law (e.g., for new construction), and
many more by the Vacancy Decontrol and Primary Residence laws enacted by the State Legislature in
1971.

A t present, estimated units under MBR are about 850,000 but the City Department of Rent

and Housing Maintenance stiil keeps reports on all units that were formerly under rent control, even
units in two-family houses that were decontrolled twenty years ago. Thus, the record-keeping task
itself is an enormous burden.
After New York City was given authority over rent control in 1962, it enacted a basic
rent control law and made adjustments periodically, by local law or regulation, as situations changed
or new problems emerged. Yet, with all the changes, the system could be administered, not least
because most tenants and most landlords could compute what the rent should be, and what increases
were appropriate, for a new tenancy or a capital improvement.

Requests for hardship increases were

being processed, as were requests for rent reductions because of reduced services.




- 5 -

143
After a series of consultant and task force studies reached the conclusion that rentals
had to be increased to protect the economic life of the City's housing, the City administration did not
suggest an easy-to-administer program of periodic moderate increases. It attempted to demonstrate
that "the brightest and the best" statisticians, economists and "urbanologists" could develop a system
that would do the job and be fair to everyone.

It was assumed that such a complicated system could

in fact be administered. The MBR law was enacted by the City Council in 1970.
Alexander Pope's apt description of what happened next is found in the Dunciad:
"Then rose the seed of Chaos, and of night
to blot out order and extinguish light"
After a year-long study of the implementation of the MBR system by the New York State (Scott)
Commission to Make a Study of the Governmental Operations of New York City, its executive director
concluded that the MBR system was an "administrative disaster", and issued a major report cataloging
the failures in implementation.
This Court has heard testimony about the MBR system. In general, no-one seems to be
happy with it. The City Council tried to repeal it in 1973. The most common criticisms of how MBR
operates are as follows:
1. The system contemplated increases tied to moderate cost increases
of the 1950's and early 1960's. It does not and cannot reflect the rapid cost
increases of the late 1960's and 1970's.
2.
In an attempt to enact the 1970 legislation, people who should
have known better overpromised the benefits the law would bring to landlords
and tenants. When the benefits did not materialize, the subsequent reaction
made it less likely for MBR to work.
3. The MBR system might have worked if it had been established as
a totally new system with two years for implementation. It could not be
implemented on top of an existing system by employees who had to administer
an existing law.
4. The MBR system could never have worked because it was too
complicated.
5. Everyone assumed that the "technology" (in the broadest sense)
was available. In fact, we do not have the technology to work such a complicated system for so many units, w i t h i n present budgetary parameters.
6. The implementation of MBR was sabotaged by officials in H D A ,
either by misfeasance or by nonfeasance.




-6

144
7. The MBR system has never worked, is not working, and can never be
made to work.
8. The MBR system is so non-functioning that the courts have t o
replace it periodically by ordering interim across-the-board rent increases.
If this pattern, having existed for five years, will be continued in the future,
then we do not need MBR — and it should be replaced by a simpler system
for annual increases.
9. Except in special cases, tenant requests for rent reductions for
improper landlord behavior or reduced services are not processed in timely
fashion.
10. Except in special cases, tenant requests to stop rent increases
because of landlord failure to comply w i t h housing codes or to provide
essential services, are not processed in a timely manner.
11.
Except in rare cases, property owner requests for hardship
increases, capital improvements, protests, rent determinations, etc. are not
processed in a timely manner.
12. Neither landlords nor tenants can get information in a timely
manner as to what the rent for any apartment was, is or will be in the
future under MBR.
13. While some people will defend what the MBR system was
supposed to do, no-one at the present time will defend the existing system.

Moreover, the administrator of Housing and Development Administration of the City
of New York the agency charged w i t h administering the MBR system testified that administering the
MBR presented "a very, very, odious administrative problem." (Starr testimony at hearing.)
The MBR law, as a " s y s t e m " of regulating rents and housing has been upheld, as was
the earlier rent control law.
in certain situations.

Part of this regulatory system was the potential for additional increases

A n examination of the administration of this law, however, shows an overly-

complicated system of regulation.
The testimony and exhibits at the trial established w i t h o u t contradiction or dissent
that the administration of these laws has resulted in wholesale deprivation o f property w i t h o u t due
process of law, as well as denial of equal protection.
The utter collapse in the administration of these laws has made such procedures to
protect property rights of both landlords and tenants as hardship applications and MBR protests
a mockery.

Literally years of delay and total inaction in processing remedial applications under the




- 7 -

145
laws has become the rule rather than the exception. A rent gap approximating 750 million dollars
has led to a deterioration in housing units, and enforced total abandonment of valuable property
on an unprecedented scale. There have not been funds to correct violations. The City of New York
is out some 600 million dollars in defaulted real estate taxes at a moment in its financial situation
when every dollar is needed. The defendants and those similarly situated have been deprived of
property without remedies that constitute the essence of due process and equal protection.

Tenants

have suffered inconvenience and hardship in many instances. A line of decisions from courts at all
levels has indicated growing impatience and concern.
Under all of these circumstances, the conclusion is inescapable that laws that were
constitutional ab initio have now become unconstitutional in their administration. Boddie v.
Connecticut, supra. A n enlightening analogy is to be found in two decisions of our Court of Appeals
regarding the constitutionality of a condemnation law.

In the first decision the Court of Appeals

reversed an Appellate Division holding that a law providing for condemnation of some of the surface
transportation lines was unconstitutional. The Court of Appeals held it to be constitutional.

The

matter reached the Court of Appeals again some years later when the City had failed to make certain
payments to the condemnee.

A t that point, the Court of Appeals warned that although it had

originally upheld the constitutionality of the taking, the City's subsequent conduct in administering
the ancillary protections to the condemnee was "verging" on making what had been constitutional
on its face, unconstitutional as a result of its subsequent administration.

In Re Fifth Avenue Coach

Lines, Inc., 18 New York 2d 7 4 1 . And so here, we face a situation where laws originally constitutional have collapsed in follow-through to the point that due process can no longer be said to exist.
It is incongruous that rent control laws that were enacted as necessary to cope w i t h a housing crisis,
have now in large measure become responsible for the exacerbation of the crisis they were designed
to correct.
In summary, the tactic of boiler shut-downs resorted to by defendants to dramatize
their problems is legally impermissible and a potential threat to tenants' welfare, and such conduct
is permanently enjoined. The plaintiff's motions to dismiss various of the counterclaims are granted
in accordance with this opinion.

Defendants' motion to amend to conform to the proof and thus

raise the constitutional questions dealt with herein is granted. The laws recounted which underlie




-8 -

146
the systems of rent control are found to have become unconstitutional as administered, and are
declared to be unconstitutional.
Under the circumstances, this Court may grant any type of relief w i t h i n the broad
jurisdiction conferred upon it by Civil Court A c t § 110 (c) appropriate t o the proof that the
aforesaid statutes are unconstitutional.

However, the implementation of this decision in so far as

it declares said laws to be unconstitutional will be stayed for a period of 60 days t o afford an
o p p o r t u n i t y to plaintiff and other appropriate authorities to present a plan for administering said
laws so as to cure the constitutional defects outlined herein. Settle order.




BERNARD KLIEGER
Judge

-9-

147

GEORGE
THOMAS
ROBERT
HERMAN
HAROLD

B.

HUBBELL,
. LAMBERT
LISLE
ELTZER

Oullen'/az/'ul

JJ^/Arrut?

O

EDWIN F. U S S E L L
J O S E P H P- STEVENS
P- SUCKER
FREDERI CK'E. WILLITS
ARTHUR" J30NN
ROY R. Bl SOVEC
C.GAYDE
WREN
EDMUND
JAMES P
PETER J . ASTAGLIO
GERARD
SHBERG
MICHAEL . BRINITZEf
ROBERT C . NIELSEN
ANDREW E .
RODGER
'. TIGHE

vesnt/h

t

,?*&€><

~tftt/>*don< lO,c-ty, ,y\'£€<y 'S/orA -/Jo-30
5 1 6 PIONEER 1 - 0 9 0 0

October 22, 1975

BROOKLYN OFFICE
177 MONTAGUE STREET
BROOKLYN. NEW YORK II2(

-u L ™- 9 ooo

Dear Senator Proxmire:
I am an investor in New York City securities and hold
a revenue anticipation note which is due on January 12, 1976. On
July 1, 1975 the Comptroller of the State of New York issued two
audits, one on accounts receivables and the other on real estate
taxes for the City of New York. I enclose copies of these reports.
The report on accounts receivables shows that the City of
New York has overstated such receivables by at least 324.6 million
dollars and has issued revenue anticipation notes against such
receivables. It was conceded that the City's Budget and Comptroller
representatives knew about this overstatement but did nothing. As
an example the City borrowed against a receivable of 121.4 million
dollars which consisted of a 36 million dollar claim disallowed by
the federal government, a 66.1 million dollar claim in excess of
ceiling limitations and state audit disallowance of almost 20
million dollars. The City's own agency classified this receivable
as "no good".
The report states "the significant overstatements of
receivables also meant that revenue anticipation notes issued by
the City and which were stated to be supported by federal and state
aid receivables were not so supported."
In sum, over the past two years the City has issued revenue
anticipation notes in the amount of 1.275 billion dollars against
404 million dollars in receivables.
The report on real estate taxes shows that the City of
New York has overstated such taxes as of June 30, 1975 by approximately 408 million dollars. It states "the available balance
is only $94 million. Most of these unpaid real estate taxes were




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148
pledged to repay $380 million of tax anticipation notes issued
by the City on June 11, 1975; therefore, the pledged support was
largely absent." It is admitted that the City has been aware of
such overstatements since 19 72.
These reports reveal that a massive public fraud has taken
place with the knowledge of elected and appointed public officials.
Our Mayor was the Comptroller of the City during the period of
these reports. Previously he had been the City's Budget Director.
The First Deputy Mayor of the City, James Cavanaugh, who previously
worked with Mayor Beanie when he was both Comptroller and Budget
Director, is reputed to be the father of these borrowing methods.
Your Committee has been taking testimony about this
financial crisis. I would ask that these reports..„be_spr^aiLjm
jthei record and that I be afforded the opportunity to plead the
case of the investor, who has so far been ignored. It seems
obvious to me that confidence in our system will not be restored
until the truth is out and public officials held responsible for
their actions. Additionally legislation should be adopted removing
the exemption of municipal securities from registration with the
Securities and Exchange Commission.
Very truly yours,

Thomas M. Lamberti
TMLres
Ends.




149
OFFICE OF THE STATE COMPTROLLER
DIVISION OF AUDITS AND ACCOUNTS
REPORT NO. NYC-26-76

REPORT ON NEW YORK CITY'S CENTRAL
BUDGETARY AND ACCOUNTING SYSTEM
(INTERIM REPORT NO. 2 - UNCOLLECTED
REAL ESTATE TAXES)

MANAGERIAL SUMMARY

Background
We are examining into New York City's central budgetary and accounting
practices in order to (1) identify shortcomings which have a bearing on
the accuracy of the City's financial statements, and (2) develop data
leading to the adaptation of the State Comptroller's "Uniform System of
Accounts for Cities" to the financial operations of New York City. Our
first report (NYC~3~76, dated July 1, 1975) concerned the validity of
amounts recorded as due from the State and Federal governments. This
second report deals with the collectibility of unpaid real estate taxes
due the City, as well as the City's procedures and practices in establishing
the assessment amounts which form the basis of the real estate tax rate.
The City Charter requires the City's expense budget to be balanced
by the real estate tax levy. To help finance the 197''i--75 expense budget
of $11.1 billion, the real estate tax levy amounted to $2.9 billion.
The City's budgeting and financial procedures make no provision for real
estate taxes which are not expected to be collected during the tax year,
nor do they provide for tax cancellations, abatements or other downward
revisions to be subtracted from the gross tax levy. These amounts, when
netted against collections of prior year real estate taxes, resulted in
a cash flow deficit of $232 million for the fiscal year ended June 30, 1975.
This was critical because the City does not have any reserves to cover
such deficits.
The City's records also show a decreasing trend in the collection
of real estate taxes in the year of levy. The collection rate of 95
percent in 19&9-70 dropped to 9 0 . ^ percent in 197^-75. The cumulative
uncollected taxes at year-end were two and one-half times higher - $502.3
million at June 30, 1975 compared with $20^.9 million at June 30, 1970.
This condition further aggravated the City's cash flow situation.
Major Observati ons and Conclusions
The City's budgetary practices result in an inflated estimate of
real estate taxes that it can reasonably expect to collect to balance
the annual expense budget. Unless expenditures arc reduced to make up-




150
the shortfall, the City's budget is automatically out of balance;
borrowings thus become necessary to meet the cash flow deficiency.
We estimate that the $502 million of real estate taxes receivable
on the City's books at June 30, 1975 are overstated by approximately
$^08 million; thus, the available balance is only $9^ million. Most
of these unpaid real estate taxes were pledged to repay $380 million of
tax anticipation notes issued by the City on June 11, 1975; therefore,
the pledged support was largely absent.
There are

two major causes for the tax shortfall:

1. The City included significant amounts of property on its
tax rolls which were not subject to real estate taxes or for which taxes
would not be collected.
2. The City made no provisions for the increasing volume of
caqcellations and abatements, and for the inability to collect from
defaulting taxpayers.
Our analysis of the uncollected
fo11ows:

real estate taxes at June 30, 1975

Total Uncollected real estate taxes
Less: Specific categories either not
collectible or not readily availablePub 1icly-owned property
Diplomatic property
Mitchell-Lama property
In rem property (pending foreclosure)
Penn Central property (bankrupt
corporat ion)

$502.3 million

$ 126.6
53.0

5h.k

3
43.
282..6 rni
ion
$219".7 mi 11 i o n

Less: Provision for estimated nonpayment
of other taxes
Estimated available amount

125. mi 11 ion
il
$ 9^. mi 11 i o n
•Si

The City's Finance Administration had prepared certain analyses of
real estate taxes receivable as of June 30, i972 and June 30, 197^.
Although we v/ere told that these analyses were prepared for other purposes
they showed an alarming growth not only in uncollected taxes, but also
in the amounts of real estate taxes due from publicly-owned properties primarily the City itself ($59 million out of $283 million at June 30,
1972, and $150 million out of $409 million at June 30, 197*0 •




151
The inclusion of publicly-owned properties on the tax roils resulted
in the City assessing significant amounts"of real estate taxes which
could not possibly be collected - at a rate of about $36 million a year,
leading to an accumulation of $126.6 million in uncollectible taxes at
June 30, 1975. Included in the 18,000 parcels in this category were
vacant land, City-occupied office buildings, an urban renewal land site,
Carnegie Hall and even a public park and high school. This practice
would continue until exemption certificates were processed; but, under
present City procedures, exemption certificates are not processed timely.
We found similar delays in reducing the tax rolls for diplomatic
properties and tax abatements 'on Mitchel1-Lama properties. For example,
the City's records showed $^+1.4 million due from Co-Op City (a MitchellLama property), when the amount should actually have been $1.8 million
because of tax abatements authorized under shelter rent exemptions.
Diplomatic properties were carried on the rolls unless the ov/ner
government initiated tax exemption requests. However, these governments
took very little action because they could not be required to pay the
taxes in any event.
(in this connection, we were told of efforts by
the Finance Administration and the City Commission on the United Nations
to secure their cooperation.)
Another tax loss results from tax cancellations (write-offs of prior
year taxes) which were increasing each year. For the last five years,
cancellations totaled $291 million. However, adequate provision for
these reductions were not made in the budget.
The inclusion of these inflated tax levies on the rolls served to
understate the tax rate, increase the City's overall debt limit, permit
borrowing against inflated receivables, and, of course, permit the City's
budget to appear in balance when it was actually out of balance. There
did not appear to have been any high level discussions of these facts
by City officials, or aggressive action to correct the situation; for
example, by compensating for these practices when preparing the City's
budget or borrowing on tax anticipation notes. The City needs to overhaul its real estate tax accounting, budgeting and reporting systems to
preclude further distortion of its financial status and to make available
accurate fiscal information on which to base decisions. Among other thin
the C i ty should:
. Analyze uncollected real estate taxes at June 30, 1975, write
off clearly uncollectible amounts, and establish reserves against amounts
partially collectible or not readily available.
. Remove exempt properties from the tax rolls.




152
. Establish an adequate reserve for uncollectible real estate
taxes in future budgets, in accordance with the requirements of the
State Comptroller's Uniform System of Accounts.
. Ensure that TAN's issued in the future are adequately
secured by collectible real estate taxes.




153
AUDIT REPORT ON
REVIEW OF NEW YORK CITY'S
CENTRAL BUDGETARY AND ACCOUNTING PRACTICES
INTERIM REPORT NO. 2 - UNCOLLECTED REAL ESTATE TAXES




Office of the State Comptroller '
*
Division of Audits and Accounts
Report No. NYC-26-76

154
- _

AUDIT REPORT ON
REVIEW OF NEW YORK CITY'S
CENTRAL BUDGETARY AND ACCOUNTING PRACTICES
INTERIM REPORT NO. 2 - UNCOLLECTED REAL ESTATE TAXES

Table of Contents

Page

A.

Introduction

I

B.

Uncollectible Real Estate Taxes

k

C.

Fixing the Real Estate Tax Rate

13

D.

Cancellation of Real Estate Taxes

]k

E.

Accounting for Real Estate Taxes

17

F.

Tax Anticipation Notes

20

G.

Conclusion and Recommendations

23




155
AUDIT REPORT ON
REVIEW OF NEW YORK CITY'S
CENTRAL BUDGETARY AND ACCOUNTING PRACTICES
INTERIM REPORT NO. 2 - UNCOLLECTED REAL ESTATE TAXES

A.

Introduct ion
1.

Purpose and Scope

We are examining New York City's centr.it! budgetary and account. no
practices in order to: (a) identify shortcomings in the central budgetary
and accounting practices which have a bearing on the accuracy of the
financial statements presented by the City; and (o) develop data leading
to the adaptation by the City of New York of the "Uniform System of
Accounts for Cities" promulgated by the State Comptroller.
Our first report on the City's budgetary and accounting practices
(NYC-3-76 issued July 1, 1975) evaluated the validity of Federal and State
receivables recorded as applicable to the City's fiscal years ended
June 30, 1973 and 197^ and still outstanding as or Karch 31, 1975.
This second report deals with the procedures used to establish
the assessment amounts which form the basis of the real estate tax rate
and with the techniques for evaluating the collectibility of unpaid real
estate taxes due the City. Most of these unpaid real estate taxes were
pledged to repay tax anticipation notes issued by the City. We reviewed
the policies and practices relative to the write-off of uncollectible
amounts and analyzed the real estate tax records maintained by the City's
Department of Tax Collections.
In a previous audit report on the "Operations of the Bureau of
City Collections, New York City Department of Tax Collections" (NYC-/'0-75,
issued May 16, 1975), we discussed the rising trend of uncollected real
estate taxes and the practices and procedures related to in rem foreclosures.
The audit is being performed in accordance with the State
Comptroller's audit responsibilities as set forth in Section 1, Article
V of the State Constitution and Article 3 of the General Municipal Law.
2.

Background

Section 1515 of the City Charter provides for a matching of
estimated receipts against proposed expenditures, and indicates an intent
to provide for a balanced budget by fixing a real estate tar rate 'which




156

will provide such additional

receipts as may be necessary:

"...The council shall deduct the total amount of receipts
as estimated by the mayor from the amount of the budget,
as fixed for the ensuing fiscal year, and shall cause to
be raised by tax on real property such sum as shall be
as nearly as possible but not less than, the balance so
arrived at, by fixing a tax rate in cents and thousandths
of a cent upon each dollar of assessed valuation."
For the year ended June 30, 1975, the City's expense budget of
$11.1 billion was to be financed in part by a $2.9 billion real estate
tax levy. This real estate tax levy was the amount required to balance
the budget for the fiscal year. However, the City's budgetary and
financial procedures do not include any provision for real estate taxes
levied but not collected during the tax year or for cancellations,
abatements or other downward revisions. These amounts totaled $279
million for the year ended June 30, 1975. Collections during the year
of prior year real estate taxes amounted to $^7 million, resulting in
a cash flow deficit of $232 million at June 30, 1975, exclusive of any
possible cash balance in the City's "Rainy Day" Fund.
The City has two accounts which can be used to cover tax deficits:
. The Tax Deficiency Account, established by Section 127 of
the City Charter, is intended to absorb real estate tax cancellations
and discounts for prepayment of real estate taxes. This fund had a
negative balance of $129.8 million at June 30, 1975 p based on our computation.
. The Tax Appropriation Reserve Fund and General Fund Stabilization
Reserve Fund, known as the "Rainy Day Fund", was established by Section
128 of the City Charter. Its purpose v/as to help reduce any deficit in
Genera] Fund collections, for internal borrowing in lieu of issuing tax
or revenue anticipation notes, and to reduce subsequent year taxes if
the Fund balance were to exceed a stipulated level. Thus, the intent
was to build up in "good" years an amount which could be drawn on if
revenue shortfalls were to occur in "bad" years. The City has waived
appropriations to the fund for seven consecutive years because of budgetary
problems; the cash balance at January 1, 1975 was $1.5 million according
to the City Comptroller's report.
(These two accounts are discussed
this report.)

in greater detail

later in

City records show a downward trend in the collectibility of
real estate taxes in the year of levy. The annual collection rate over
the past six years went from 95 percent in 1969-70 co 9 0 . ^ percent in




157

1974-75. The uncollected balances of .real estate taxes at the. end of
1974-75 were two and one-half times the balance for 1969-70, as shown
in the following table:
Annual Balances of Real Estate Taxes
Percent of
Tax Levies
Collected in
Year of
Tax Levy**

Real Estate
Tax Levies
(in mill ions)

90.4
92.8
93.8
94.1
94.3
95.0

$2,897.5
2,657.3
2,468.7
2,204.6
2,089.6
1,901.5

1974-75
1973-7^
1972-73
1971-72
1970-71
1969-70

Unco 11ected Taxes
Pertain ing
to Year of
Cumu1 ative_J^2Lj_ejOL.
(i n m i1 1 ions)

\

, $207.3
148.6
122.0
114.1
101.0
80.4

$502.3
408.5
337.5
282.8
241.9
204.9

v.-Cumulative due after allowing for collections, discounts, and
other deductions. These amounts include taxes outstanding for over
five years which have been transferred to the "Rainy Day Fund" as
recei vables.
-A-A'Tne City does not develop the eventual collectibility
each tax year.
3.

rate for

Discussion of Audit Results

Most of our audit observations were discussed with representatives
of the Finance Administration during the course of our review and upon
its conclusion.
In addition, draft copies of this report were furnished
to officials of the City Bureau of the Budget, the City Finance Administration
and the City Comptroller with a request for comments. Such replies as were
received were considered in the preparation of the final report.

(fr/Uj^

A.
Report Filed:

August 4, 1975

ARTHUR LEVITT
STATE COMPTROLLER

60-832 O - 75 - 11




U xJ-is^b*

158
- 4 -

B-

Uncollectible Rca1 Estate Taxes •

We concluded that the total amount of real estate taxes receivable
on the City's books as of June 3 0 , 1 9 7 5 0 ) exceeded the probable currently
realizable amount by about $408.3 million, as follows:
Balance Due at June 3 0 , 1975
Estimated Collectible Balance

$502.3 million
$4.0 mi 11 ion

Uncollectible or Not Readily
Avaliable

$408.3 mi11ion

The City's budgetary and accounting practices result in an inflated
estimate of real estate taxes to be collected to balance the annual
expense budget, and do not make adequate provision for taxes that will
not be collected. The result has been that budgeted real estate tax
amounts have not been realized; for the most part, the revenue shortfall
has been met. by continued borrowing.
This cumulative revenue shortfall cannot be cushioned by the Tax
Deficiency Account which had a negative balance at June 30, 1975 or the
Rainy Day Fund with a cash balance of only $1.5 million and mortgages
receivable of $7.4 million at January 1, 1975.
Two major causes for this shortfall are-,
(!) the City Included
properties in its tax rolls which were not subject to real estate taxes
or for which taxes would not be collected, and (2) there has been Insufficient provision for the increasing volume of defaulting taxpayers ar*d
tax cancellations and remissions. In a prosperous economy, the resale
revenues from the defaulted property would be expected to cover the taxes
due from such properties; current City experience does not show sufficient
revenues from this source.
Our analysis of the taxes due at June 30, 1975 shows that> of
$502.3 million outstanding, $282.6 million pertaining to specific
property categories was either not collectible or not: likely to be
collected in the near future. We also estimated, based on collection
experience statistics for prior years, that an additional $125// minjoii
is uncollectible. Therefore, out of a balance due of $502.3 million,
it is likely that only $94 million will be collected and available within
'a reasonable period. Details of our computation follow.

Note 1:

Based on the City's records as of July 22, 1975, when all
postings had not yet been made by the Comptroller. Based
upon past experience, postings are generally not completed
until December.




159

"Analysis of Uncollected Real Estate "faxes
As at June 30, 1975
(In Mi IHons)

Total
Total Uncollected Real
Estate Taxes (1)

?r\or
1974-75 1973-74 1972-73 1971-72 1970-71 Years

$502.3 $207.3

$105.0

$70.8

$52.9

$52.0

Less, Uncollectible or
Potentially Uncollectible (a)

^+,3
v

publicly-owned property 126.6
Diplomatic property
4.7
Mitchell Lama property
53.0
In Rem property
(pending foreclosure)
54.4
P.enn Central property
(bankrupt corporation) 43.9

36.0
.2
16.5

26.5
.2'
13.7

16.9
.8
11.2

12.4
.4
7.9

'.0.3
.2
2.4

12.0

12.0

12.0

12.0

6.4

9.5

9.0

8^2

7.^_

> ->
"
2.9
1.3

7.8 _.2.J0

Total (2)

282.6

74.2

61.4

49. 1

4(L L _J2"M._ ,JVV2

Balance (1-2)

219.7

133.1

43.6

21.7

12.8

Less, Provision for
possible non-payment
(b)

125.7

55.6

31.7

18JL

$ 94.0

$ 77.5

$11.9

Estimated Available
Amount
Notes:

4,9

3.6

$ 3.6

(a) Uncollectible amounts were determined from taxes reccr'abit c
printouts as of March 31, 1975 furnished by Finance A l n n < r.-,L; •
..i
which we updated to June 30, 1975, using their computer teiiui:
determine the current status of these properties. They aiso f
us with the parcel category breakdown. The aging of the r<••:•:'<
was accomplished on a sampling basis. Uncollectible, in-icii ->>
were estimated based on the analysis of seven in- rem aci.;o..; •
by the City, but not, as yet, finalized. There were ;boi.K. 1 L,
parcels in this category and the Finance Administration k'.% v.r
to furnish us with the amount of uncollected taxes applicable
this category. Since no agency information was available, trt
'.
total amount was distributed evenly over the past four years i
the balance in the fifth year.
(b) Represents the additional real estate taxes thot \j.z evisidr.
uncollectible, based on available statistics of ool lect i -. «.
experience for the previous six years. ) , reserves for each
ie
fiscal year were adjusted for the required writeoffs of the
uncollectible amounts determined by our analysis.




160

Similar data concerning the probable uncol lect ibi 1 i v y of rcai estate
.
taxes due was available at the Finance Administration. This Office had
prepared analyses of uncollected real estate taxes in October 197'* (as
of June 30, 197*0 a n c ! nac * made a partial analysis of arrears on high
valued property only in 1973 (as of June 30, 1972). V/e were advised by
the Finance Administration officials that the 1974 data were used in
support of fuel cost passalongs applicable to rent controlled properties
for making projections of 197^—75 tax arrears, and for newspaper articles
on tax arrears. There was nothing to indicate the extent to which this
data had been communicated to responsible budgetary and financial officials
outside of that agency. A Finance Administration representative told
us that there had been some discussions of these analyses with City
Comptroller representatives.
1.

Publicly-Owned

property

The 1972 and 1974 analyses showed large cumulative amounts of
real estate taxes due from publicly-owned properties ($59 million of a
total of $283 million at June 3 0 , 1972 and $105 million of a total of
$409 million at June 30, 1974). Almost all of the publicly-owned properties
belonged to the City, but were purportedly not being used for public
purposes.^ ' This practice has the effect of keeping properties on the
tax rolls which will not generate actual taxes. In effect, the City is
assessing real estate taxes on itself.
The Real Property Tax Law (RPTL), Section 300, states that all
real property within the State is subject to taxation "unless exempt
therefrom by law". Section 406 of the RPTL exempts municipally owned
property only if it is being held for "public use". Since the City cannot
collect real estate taxes on non-exempt publicly-owned property, this
should be;
. compensated for when the City prepares its budget,
. considered when the City analyzes its uncollected
taxes, and

real estate

. discounted when the City borrows against its .anticipated collections by issuing tax anticipation notes.

Note 1:

Jt has been held that property owned by a municipal corporation,,
but not being actually used for public purposes, is not entitled
to real estate tax exemption.
In order for municipal Iy-ov;nr:d
property to be deemed "held for public use" for the purpose nf
receiving tax exempt status, the property must be p i , - » i iy
rti:r
occupied, employed or availed of, by and for ( h benefit of "t'.c
•e
municipality at large; this implies a possession, occupation iind
enjoyment of the property by the municipality. This distinction
has no significance in New York City whore th.:.-c ii 011 iy OIK. r r M
estate taxing authority.
In other La;; jurisdictions, pr<y. 1 • / no
in public use might be taxed by school districts, etc. (C-cc the
annoted citations in Note 2, Section 406, Real Property Tax Law,
McKinney's Consolidated Laws of New York, Book 49A.)




161
7 -

Further, in view of the material amounts involved, this situation
and its ramifications should be fully disclosed by City officials in all
of the statements and reports concerning real estate taxes, estimates
and col lections.
There were 18,074 parcels included on the City's tax rolls as
publicly-owned property not being used for public purposes at Karen 31>
1975, and representing a cumulative total of $117.6 million of tax
receivables. Each quarter of the tax year generates an additional $9
million of tax receivables. Thus, as of June 30, 1975, we estimate
that the City will have $126.6 million in this uncollectible category
of receivables on its books. (The City had not closed its books for
the fiscal year at the time of our audit.)
Examples of such parcels are:

Block
and
Lot

Address/Location

Uncollected
Real Estate
Taxes as at
June 30, 1975
(in mill ions)
$2.0

City

Si te of Manhattan
Communi ty Col 1ege
(partially vacant land)

Own e r

-eel Use

142-1

187 Duane Street
Manhattan

153-1

276-86 Broadway
Manhattan

1.2

City

City occupied office
buiIding

170-6

346-48 Broadway
Manhattan

1.3

City

City occupied office
building

346-1

392 Grand Street
Manhattan

1.0

City

Land si te of Seward
Park Urban Renewal

2.0

City

1.4

City

1009-1 881-93 Seventh Ave.
Manhattan
4452,170

Vandalia St. Btwn
Penn Ave. and Van
Siclen Ave.
B rooklyn

Carnegie lial 1
Public Park

4142-1 Logan St. Btwn
Atlantic Ave. &
D insmore P1.
Brooklyn
16167- 100-14 Beach
99
Channel Dr.
Queens




City

2.0

Abandoned City
Waterworks

City

High School

162
- 8-

All of these parcels had multiple years of real estate I-^'JS
unpaid, and we were unable to obtain definitive information from the
City Assessor as to why they remained on the City's tax rolls. We
were able to ascertain that the City's Tax Commission grants exemptions
based on the owner's and/or the parcel's use as defined by law. This
procedure is contingent upon the owner filing an application for exemption
with the Tax Commission. Barring submission of an application, there
is no mechanism for the Finance Administration to exempt the property
regardless^ of who owns the property or for what it is used.
The absence of such a procedure has resulted in levying
significant amounts of real estate taxes on properties from v.hich
taxes will not be collected. There were 121 parcels in the computer
listing of publicly-owned property that had outstanding real estate
taxes of $100,000 or more, with nine of these '121 parcels having balances
of $1 million or more.
(We were advised by a Finance Administration
official that the City sought an exempt status ruling from the Corporation
Counsel ten years ago regarding the Carnegie Hall parcel and resubmitted
thi,s request this year.)
We must repeat that the City is generating a built-in rea\
estate tax collection shortfall by continuing the practice of including
its own property on the tax rolls. |n addition, the City's stated debt
limit is artificially inflated as a result of this practice. This
occurs because the City's debt limitation is based upon "the average
full valuation of taxable real estate" (Article VIII, Sections 4 and 10
of the State Constitution).
2.

Diplomatic Property

The need for some provision for uncollectible taxes is evident
in the City's handling of diplomatic property. The City has on its tax
rolls diplomatic properties v/hose status would be exempt if the proper
filing for exemptions were instituted by the owners. Thus, 40 out of
.a'total of 60 diplomatic properties have unpaid real estate taxes, wi th
most of the taxes outstanding for extremely long periods. We found ti'nt
15 of the 40 properties had balances of $100,000 or more. The City's
ability to collect these taxes is limited, since diplomatic properties
are exempt from in rem foreclosure proceedings.
Our review showed that one of these diplomatic properties
had about 10 percent ($48,509 of a total of $490,000) of its unpaid
real estate tax balance outstanding prior to the diplomatic owner's
acquisition. This means the City had a receivable rendered uncollectible
in the foreseeable future by a diplomatic purchase, unless recovery can
be effected from the prior owner.




163
- 9 -

We attempted to determine if the diplomatic owners kn<-.w of
the requirement to file for exempt status. For example, the Soviet
Union, one of the larger diplomatic property owners, recently filed
for exemption. Finance Administration officials advised us that they
requested the City's Commission to the United Nations in July 1973
to act as the City's intermediary to distribute exempt status filing
requirements. V/e were told that the forms were sent at that time to
the owners of properties believed to be entitled to exemption and that
direct correspondence was initiated with individual consulates (using
the City's Commission to the United Nations as intermediary) urging
compliance. V/e were also told that the City stopped applying its
earlier policy or not granting the exemption until arrears of the
so-called short-rent payments (involving very minor amounts of borough
and City-wide assessments), not subject to exemption were received.
The officials said that about 10 consulates secured their exemptions
as a result of these actions.
3.

H?tchel1-Lama

Property

Mitchell-Lama properties, by law, are permitted to apply for
shelter rent exemptions which, in effect, are an abatement of real
estate taxes. This procedure is lengthy and involves a number of
C i ty departments.
Our analysis of the computer listing of real estate tax
receivables as at June 30, 1975 showed 185 Mitchel1-Lama parcels with
$55.4 million in cumulative unpaid taxes/ ''One of these properties
was Co-0p City in the Bronx, which accounted for $41.4 million of the
listed unpaid real estate taxes. In view of the significant amount
outstanding, we performed a detailed analysis of the parcels involved
in Co-Op City and found that all but $1.8 million, represented overbi11ings.
We were told that the balance of $39.6 million will eventually be officially
cancelled by the City when negotiations are completed.
We were advised by an official of the Real property Assessment
Department of the Finance Administration that the overstated billings
for Co-Op City occurred because the tax was determined exclusive of
tax abatements authorized under shelter rent exemptions. There were
two reasons tor the delay in processing:
(1) the nonreceipt of certified
shelter rents from the Housing and Development Administration for the
1972-73 and 19/4-75 tax years; and (2) the pending outcome (delayed due
to irreconcilable differences between the development and the City as
to which parcels are eligible for shelter rents) of a Tax Commission
hearing held on May 21, 1975 which will affect the shelter rents certified
for 1970-71, 1971-72 and 1973-74. (Finance Admin i s t m t ion offi ci a ! s felt
that the Mitchel1-Lama law needs to be simplified, that present requirements as to tax abatements and shelter rent exemptions are difficult to
imp 1ement.)

Note 1:

We estimate that $2.4 milllion of this oinount is coilectii-le.




164
- io -

Our review of several other Mi tchel I -Lama projects ir.Gu.-Ucd
similar circumstances v/hich also resulted in overbi 1 1 ings. These cu'erbil lings represent another example of the lack of communication between
City departments. As previously noted, the inclusion of these properties
at full assessed valuation in the computation of the City's real estate
tax rate results in a tax shortfall and inflated debt ceiling (City's
Constitutional limit on borrowing).
k.

In Rem Property

In rem properties are those in the process of being foreclosed
because of nonpayment of real estate taxes. The Cio/'s procedures for
accomplishing foreclosures are painfully slow.
(This was discussed in
our previous report, NYC-^O-75. We found in rem filings as far back a:.
November 27, 1973 which were not yet finalized.) Although the City will
ultimately realize some revenue from the sale of these properties, the
amount that will ultimately be collected is uncertain. Meanwhile, the
full amount of the receivables is included in the City's total of
unco-llected taxes. The City should write off such amounts as soon as
the appropriate filings are accomplished and not wait for the actual
foreclosure, the procedure now followed by the City.
5.

Penn Central

Property

The Penn Central Corporation is in reorganization and the
collectibility, in the foreseeable future, of outstanding real estate
taxes is extremely doubtful. With such significant amounts involved
and the fact that normal in rem action cannot be taken--, a reserve for
uncollectible taxes should be established for the full amount, since
the potential revenues do not meet the test of "availability".
If
any portion of the taxes is ultimately collected, the revenues should
be recognized in the year of collection.
The Penn Central owns 1^7 parcels; 25 of these parcels have the
obligation for 93 percent of the $43.9 million of unpaid real estate toxos.
Ten parcels have unpaid real estate taxes of over $1 million and two of
these have balances of over $5 million.

-'According to the Penn Central Bankruptcy Court Order Mo. 1 (Section 9)
v/hich complies with Section 77 of the Bankruptcy Action (11 USC Sec. 205)
dated June 2 1 , 1970, all persons, firms and corporations are restrained
from interfering with, seizing, enforcing liens, etc., or in any mannerwhatsoever disturbing any portion of the assets, properties or premi s.-ts,
etc., belonging to or in the possession of the Debtor (Penn Cs.it ra I) ; s
owner, lessee or otherwise.




165

Examples of such parcels with.receivables in excess of $2
nil lion (all in Manhattan) follow.

Block
and
Lot

1280-30

Address and Use

Uncollected
Real Estate
Taxes as at
June 30, 1975
(In mill ions)

Owner

109-35 E. 42nd St.
Hotel Commodore

$5.9

Penn Central Trans. Co.

781-9002 1 Seventh Ave.
Privately occupied
office building

2.8

Land-Penn Central
Building-2 Pennsylvania
Plaza Corp.

781-9001 ^20-58 Eighth Ave.
Madison Square
Garden

4.2

Land-Penn Central
Building-Madison Square
Garden Corp.

1304-1

301-19 Park Ave.
Waldorf Astoria
Hotel

8.8

Land-Penn Central
Building-Waldorf Astoria Corp.

1278-20

333-39 Madison Ave.
Hotel Bi1tmore

4.3

Penn Central Trans. Co.

1303-14

520 Lexington Ave.
Barclay Hotel

2.2

Penn Central Trans. Co.

All of these parcels had multiple years of unpaid real estate
taxes. For two of the properties (2 Pennsylvania Plaza Corp, and Madison
Square Garden Corp.), the City has received the taxes due on the improvements (buildings) directly from the corporations. The uncollected ta;.es
shown are those due on the land of these two parcels which is owned by
Penn Central.
The three parcels ov/ned by the Penn Central Transportation
Company have not paid the outstanding taxes on both the land and the
improvements.
We were advised by an official of the Waldorf Astoria Corporation
that his corporation was depositing the real estate taxes due on this
parcel's improvement payable to Penn Central in an escrow account. Thus.
it may be possible for the City to negotiate a similar arrangement with
Waldorf Astoria Corporation as exists with the Madison Square Garden
and 2 Pennsylvania Plaza properties and collect the real estate taxe:>
directly from the Waldorf Astoria.
In the latter case, of the total .




166
- 12 -

$8.8 million outstanding taxes, $5.9 million is applicable to the
improvements. This negotiation is contingent on the contractual
arrangement between Penn Central and the Waldorf Astoria Corp.
Finance Administration officials advised us, in response to
our draft report, that special efforts are being made, principally by
the City Corporation Counsel's office, to secure payments of penn Central
taxes. They cited a recent law (Section 605, The Rail Reorganization
Act Amendments of 1975, Public Law 95~5, effective March 1, 1975) which,
they believe, strengthens the City's case for direct payment of taxes
.
s"
from Penn Central lessees. However, the interpretation of this law is
under dispute and the Court has not yet ruled on it. In addition, the
City believes it is reasonable to anticipate that it wi 1 1 make collections
when distributions are made, since taxes have a high priority, and where
properties have been sold, the liens have been transferred to the proceeds of the sale. Further, they stated that none of the tax liens have
been cancelled by the Court. For these reasons the Finance Administration
feels that Penn Central arrears should not be v/ritten off as uncollectible.
It also was noted that, during the ongoing negotiations, some of the
overdue taxes have been collected.
W e are not suggesting that the penn Central arrears be written
off. Rather, the arrears should be kept on the books and a bookkeeping
entry made establishing a provision for uncoilectibi1ity.
Such a provision
would be fiscally prudent, in that the central records would show the
amounts of taxes readily available to meet expenditures; it would also
prevent borrowing against taxes that either may never be collected or
may not be collected in the foreseeable future.




167
- 13 -

C.

I i x i n<j_ I he Kea 1 L state Tax Ho tc

Chapter 58, Section 1515 of the City Charter provides both the time
and the procedure for fixing each year's real estate tax rate. An
important preliminary to this action is the completion of assessment
rolls for the year, which is accomplished by the Finance Administration
after the Tax Commission conducts hearings to evaluate claims of dissatisfied property owners and applications for exempt status. The
time sequence is:
. Tentative assessment values established on January 25;
. Tax Commission's hearing period from February 1 to Hay 25;
. Determination of final Citywide taxable assessed values
as at May 25;
. Remission actions by the Tax Commission after May 25;
. City Council fixes tax rate by June 25.
Remissions are reductions in a property's assessed value, granted
subsequent to the finalization of the assessment roll on May 25. They
can take place from May 25 to June of the following year (13 months),
and may result either in a cancellation of taxes (where the tax bill
has already been issued) or in the issuance of a revised bill.
Remission
actions result in an actual real estate tax loss to the City because
the tax rate, once set, cannot by law be adjusted.
R e d u c t i o n s in assessed value granted subsequent to May 25 sire
not reflected in the final taxable assessed values, resulting in a
lower tax rate than that needed to balance the budget. For example,
in fiscal year 197^-75, the Tax Commission granted $535.6 million of
remissions of assessed values (to May 30, 1975) representing $39.3
million in taxes. Thus, the tax rate computed for 197^-75 did not include
the $535.6 million reduction in assessed value, and the City lost the
$39.'3 million which could have been collected from other taxpayers if
it had been deducted in sufficient time to have been included in the
rate make-up.
Our review showed that the Finance Administration does not maintain
one list of the amounts of remissions granted by tax year. We believe this
is a serious internal weakness because, in the absence of such data, management is not aware of the extent and significance of the remissions. Since
the tax on these remissions will not be collected, the City should provide
for this event by (a) an annual appropriation, or (b) giving consideration
to this factor in computing the tax rate.




168
i4

I).

Cancellation-of fteal Estate Taxes .

Tax cancellations represent the removal of real estate tax obligations
recorded as uncollected for prior years. The are generated by State
Supreme Court orders, Tri-Board rulings (Corporation Counsel, City Comptroller and Tax Commission) or the Tax Commission. For fiscal year
197^-75, $71.4 million of taxes for this year were cancelled. This
amount is considerably higher than the 1973-7*+ cancellation of $43.6
million. The amounts of the cancellations have progressively increased
and represent a significant revenue loss to the City. For the last five
years, cancellations totaled $291 million, as shown below and as further
detailed in the succeeding schedule.




1970-71
1971-72
1972-73
1973-74
1974-75

$ 51.8 million

45.7
57.9
64.0
71.4

»
"
"
"

$290.8 million

Tax C a n c e l l a t i o n s

Year
Cancelled

1974-75

1973-74

1972-73

1971-72

1970-71

1969-70
and prior

Totals

1974-75

$71,399,735

$20,385,518

$14,993,565

$ 8,591,112

$ 6,893,432

$ 16,025,311

$138,288,673

1973-74

-

43,595,020

12,599,981

10,485,519

7,765,678

22,987,858

97,434,056

1972-73

-

-

30,347,728

10,708,876

7,904,601

18,836,171

67,797,376

15,902,363

10,079,079

24,218,642

50,200,084

19,194,570

34,901,612

54,096,182

1971-72

-

1970-71

-

1969-70
and prior
Totals




$71., 399,7,3 5

$63,980,538

$57,941,274

$45,687,870

$51,837,360

15,118,694

15,118,694

$132,088,288

$422,935,065

170
16

Section 1 . of the City Charter states that all cancelled taxes
27
are to be charged to the Tax Deficiency Account and that an amount equal
to the net debit balance in the account as of February 1, if any, is to
be appropriated in the following year's expense budget. Accordingly,
$29.4 million was included in the 1975-76 budget for this purpose.
Between 1971 and 1975, the amount of taxes cancelled in the year
levied has increased almost 400 percent. Over these past five years,
it has averaged out at 2.35 percent of the tax levied. These tax cancellations have resulted in a large debit balance in the Tax Deficiency
l
Account of $129.8 million at June 30, 1975.
Percent of Real Estate Tax Collections to Tax Levy

Tax Year

.

In Year
Tax Levy
of Levy
(In mi 1 ions)
1

Taxes Cancel led
Subsequent
Percent
Years
Percent
(In mi 11 ions)

Total
Percent
Cancel led

1974-75

$ 2,895.9

$ 71.4

2.47

n/a

-

2.47

1973-74

2,657.2

43.5

1.63

$ 20.3

.76

2.39

1972-73

2,468.6

30.3

1.22

27.4

1.10

2.32

1971-72

2,204.5

15.9

.72

29.6

1.34

2.06

1970-71

2,089.6

19.1

.92

32.5

1.51

2.43

$12,315.8

$180.2




$109.8

2.35

171
- 17 -

C.

A cc oiiiitm g f o r Real Estate Taxes

Manual records are used by the City Comptroller to record real
estate taxes on the City's accounting records. The manual records
include a general journal and general ledger, and entries are made
monthly and posted to the ledger quarterly on a modified accrual basis.
In addition to the manual records, the City Comptroller maintains automated records which serve as the City's fund ledger recording the
appropriations, expenditures and appropriation balances for each fund.
At the start of the fiscal year, journal entries are made and
recorded in the general ledger to set up the- real estate taxes receivable
for that year as well as the adopted budget and appropriations. In
addition to recording the actual collections, the balance in the taxes
receivable account is reduced by remission orders and cancellations.
Separate accounts are not maintained for each year's taxes receivable.
Tax cancellations (including remission orders) are charged to and
recorded in the Tax Deficiency Account (TDA). Another charge to the
TDA is for discounts to taxpayers for prepayment of real estate taxes.
Credits to the account include collection of prior year delinquent real
estate taxes previously charged to this account, unspent balances from
prior expense budgets, proceeds from the sale of property taken over
by in rem actions, and gains on the extension of the tax rate to the
nearest hundredth of a cent.
On July 1, 197^ the Tax Deficiency Account, which is maintained on
a fiscal year basis, had a negative balance of $^-9,2.79,790; that is,
expenses charged to the account were greater than the income. Activity
for fiscal year 1975 included:
tax cancellations, abatements and cash
discounts amounting to $71,399,735; and cancellations of prior years
taxes amounting to $66,889,303. Thus, in total, $138,288,679 was charged
during the year to the TDA. Credits to the account amounted to $57.8
million. Using this data, obtained from the City Comptroller's office,
we determined that the TDA will have a negative balance of $129.8 million
as at June 30, 1975, as detailed in the following schedule.




172

Analysis of Tax Deficiency Account balance
as at June 30, 1975

In mill ions
Debit balance, July I, J9'A
Add: Credits during year Gains in extensions-tax levy 1974-75
Sales of in rem property
Redemption of Tax Anticipation Notes
from unused balances of prior year
appropriations
Total Credits

$ 49.3 (1)
$

.3 (1)
1.2 (1)

56.3 (1) (2)
57.8
$

Less: Charges during year Cancellations and remission of
taxes, and discounts allowed for
prepayment of taxes
Debit balance, June 30, 1975

8.5

138.3 (3)
$129.8 (4)

Notes:
(1) Actual amounts per City Comptroller's books
(2) Analysis:

Year
1974-75
1973-74
1972-73
1971-72
Total

Unused Balance (Per City Comptroller)
$54,627,388
1,012,399
641,833
18,380
$56,300,000

(3) Per Finance Administration

reports—basis for the City Comptroller's

entry
(4) The June 3 0 , 1975 balance of this account is more than $80 mill ion
h.ujher than this account's balance as at June 30, 1974, indicating that
the 1976-77 expense budget will probably require an appropriation of more
than $100 million to return the account to zero as required by the City
Charter.
(However, because of City Charter limitations, a maximum of
about $36 million may be appropriated to this account at this time.)




173
- 19

The t;ity Charter (Section 113) requires the City Comptroller Lo
report on the status of and the required appropriations to be made, if
any, to the Tax Deficiency Account and the Tax Appropriation and General
Fund Stabilizations Reserve Fund. This report is required to be prepared each February on a calendar year basis and presented to the Mayor,
City Council and Board of Estimate. At the end of calendar year 197^+
the TDA had a debit balance of $29.*+ million. We verified that this
amount was provided for in the 1975-76 expense budget, as required, to
return the account to a zero balance.
Section 128(b) of the Charter requires an annual appropriation to
be made in the expense budget to bring the balance in the reserve fund
up to an amount equal to 30 percent of the current year's tax levy.
However, the total amount appropriated for both the TDA and the Rainy
Day Fund cannot exceed 2 percent of the current year's tax levy, exclusive
of debt service. Fiscal 1967-68 was the last year for which an appropriation
was made in the expense budget for the Rainy Day Fund.
Transfers and borrowed amounts are required to be repaid to the
reserve fund according to the schedule set forth in the Charter; that
is, amounts are to be repaid in equal amounts in not less than three of
the six following expense budgets. Between July 1, I969 and June 30,
197^ transfers totaled $82.2 million, none of which has been repaid,
resulting in a cash balance of only $1.5 million at the close of fiscal
197^+. (There were $6.*+ million of transfers prior to July 1, I969.)
The fund's only other realizable asset is $ 7 . ^ million in mortgages which
will be collected in small amounts over a period of years.
Each year since 1969, legislation has been approved by the City
Council to suspend the necessary appropriations and repayments to the
Rainy Day Fund. This practice continued into 1975-76 by the adoption
of Local Law 3^ of 1975. The amount which should have been appropriated,
per the City Comptroller, in the 1975-76 budget is presented below.
Required Reserve Fund Appropriation

in 1975-76 Expense Budget

J. Current year's tax levy within the 2 ^ percent
'tax limitation $1,707,213,338

2 p e r c e n t of aboVe_^i1alkTiTrum~a73,propriation)
l e s s : Amount r e q u i r e d for Tax D e f i c i e n c y
Account
Balance A v a i l a b l e f o r Reserve Fund
2. Amounts borrowed and t r a n s f e r r e d ,
repaid
Total Required A p p r o p r i a t i o n

-832

0-75-12




$3^-, 1 V+,267
29,^+5,905
$ ^,698,362

not y e t
88,612,676
$93,3 M,038

174

I ax A n U c ipa I ion Motes
The (ily's cash flow situation requires frequent sale of tax and
revenue anticipation notes to provide operating funds pending receipt
of revenues. The collateral is uncollected real estate taxes for the
tax anticipation notes (TAN's) and other receivables for the revenue
anticipation notes (RAM's). Since the estimated tax revenue has been
overstated, TAN's should not have been issued for the full amounts
recorded as receivable.
The City issued $380 million of TAN's on June 11, 1975 secured by
$4A8 million of uncollected real estate taxes.. We found that real
"estate taxes that could be reasonably construed as "collectible" or
"available" would support less than one-third of these TAN's. According
to our analysis, only $106 million of the §kh8 million of uncollected
real estate taxes were potentially collectible at June 10, 1975, leaving
72 percent or $ 2 7 ^ million of the TAN's unsupported.
(Between June 10
and our later study as of June 3 0 , 1975, a total of $12 million was
collected or cancelled.)




Analysis of Unsecured TAN's
as of June 10, 1975

Year

1974-75
1973-74
1972-73
1971-72

Uncol1ected
Taxes
Reserve for cither
Taxes, per
Determi ned
Uncollectibl es,
to be
Comptroller 1 s
Based on Pri or
June 10, 1975 Uncollectible
Years
_
Cert i ficat ion by our Analvs i s
b
c
a
(al1 amounts in mill ions)
$218.7
105.3
70.0
54.0
$448.0

$ 74.2
61.4
49.1
40.1
__$224J5__

Maximum Amount
of TAN 1 s to be
1ssued
(Pifferences)
d=a-(b+c)

Amount of
TAN's
Actual ly
1ssued
e

$ 55.6
31.7
18.1
11.8

$ 88.9
12.2
2.8
2.1

$190.0*
90.0*
60.0**
40.0**

$101.1
77.8
57.2
37.9

$117.2

_JJ06_.0

$380.0

$274.0

*Sold to a consortium of banks
•*3oid to the newly established Municipal Assistance Corporation




Amount of Under
col lateralized
TAN's
f=e-d

176

The certificates issued by the City Comptroller included a certification
as to the amount of real estate taxes uncollected and not cancelled as of
June 10, 1975. However, the amount of potentially uncollectible real
estate taxes was not determined and deducted from the certified amount.
The pattern of borrowing by the City through the issuance of TAN's
over the last three fiscal years indicated a fairly large amount ($600
million-$800 million ) at the beginning of each fiscal year, a much
smaller borrowing ($90 million-$115 million) about mid-November, and
another borrowing ($265 mi 11ion-$380 million) about mid-June. While the'
TAN's issued earlier in the fiscal year would be fully supported by
collectible tax receivables, the year-end borrowings may not have been
fully secured by collectible receivables as shown in the preceding
i1 lustration.




177
- 23 -

G.

Conclus i on and Recommendations

The City must have reliable financial data on which to make its
financial decisions. This report provides strong evidence that the City
has not taken into account uncollectible real estate taxes in making
its decisions. Practically all the information on these uncollectible
receivables was readily available to City officials; however, the
Finance Administration did not distribute it and neither the City Couptroller's
Office nor the Budget Office requested it.
v
It is vital that the City overhaul its real estate tax accounting,
budgeting and reporting systems to preclude further distortion of the
City's financial status and to make available accurate fiscal information
on which to base future decisions. We specifically recommend.1. The City should analyze its uncollected real estate taxes at
June 30, 1975 for the purpose of establishing the extent to which they
are collectible or uncollectible. A reserve for uncollectible taxes
should be established in accordance with the requirement of the State
Comptroller's "Uniform System of Accounts for Cities". The term
"uncollectible" should be considered within the context of the availability of funds to meet current expenditures.
2. Appropriate changes should be made to the City Charter to
require the establishment of a reserve for uncollectible real estate
taxes.
3. Closer liaison should be established among City agencies to
assure consideration by the City Budget Office and City Comptroller's
Office of all appropriate data in establishing the necessary reserves
for uncollectible taxes and in taking other financial actions such as
the issuance of TAN's.
k.
Uncollectible taxes on publicly-owned and diplomatic properties
should be cancelled. Appropriate accounting entries should be made to
record
the resulting revenue loss as of June 30, 1975.
5. Necessary legislative revisions should be requested no eliminate
the inclusion of publicly-owned property not used for public use on the
City's real estate tax rolls.
6. The City Comptroller's office should verify the collectibility
of real estate tax receivable information used to secure TAN's.
7. Readily available totals by tax years should be maintained on
the amounts of tax remissions and cancellations granted.
8. The City should follow up on the collection potential of the
Penn Central properties.




178
Comments"of•New York City Comptroller on Audit Report

The conditions and practices identified in this audit report have
their roots in the City's budget making and spending processes. The
report properly criticizes the inclusion as revenue in the budget of
100 per cent of real estate taxes to be levied in the fiscal year. This
practice, though unrealistic, has been followed for many years and has
been one of the known factors in the process by which spending levels v
have been increased. Since the annual reports of the City Comptroller
have for many years documented that 100 per cent of real estate taxes
will not be collected in any one fiscal year, some time ago I issued
detailed guidelines recommending abandonment of this and related practices
in connection with the management of the City's budget.
Unfortunately, the spending levels authorized in recent budgets
have been sustained only through maximum borrowing against the revenues
on'which the budgets have been based. Once the City's budget provided
a specified level of expenditures, failure or refusal to carry out the
borrowings which alone could sustain the expenditures, would have placed
the City in a position where it could not sustain its budgeted obligations.
The State audit report, in short, exposes a fundamental flaw in
the City's fiscal operations. But the flaw is in the budgeting process
itself, even if it becomes more visible through the borrowing process.
Wherever it lies, however, it is but one of the unsound practices
which have allowed the City to inflate its budgets, year after year,
and have thus contributed to the current crisis. The provision of a
mandatory budget reserve for uncollected taxes, as contained in my plan
circulated in June for a restructuring of the City's accounting systems,
would remedy this condition.
As provided in applicable sections of the City Charter, the collection
o f i t h e real estate tax levy, after establishment of a tax rate by legislative
action, is the responsibility of the City Collector operating under the
Finance Administrator. The City Collector reports to the Comptroller's
Office the daily collections of current-year and prior-years' tax levies.
These daily reports of collections are entered on the books of the
C omp t ro11e r.
It is periodically necessary for the City Comptroller to issue Tax
Anticipation Notes to finance the operations of the Budget. When such
notes are issued, the Comptroller certifies that a given amount of a
particular tax levy remains uncolleeted and uncancel led as of a particular




179

date.
If the remaining taxes receivable, i.e., those still not collected
and not cancelled, are in an amount exceeding Tax Anticipation Notes
already outstanding and contemplated to be issued, the law specifically
permits the issuance of such notes.
The Tax Deficiency Account accumulates, as debits, the total
monthly cancellations as they are reported to the City Comptroller
by the Finance Administration. Various items are credited to this
account as delineated in Chapter 127 of the City Charter. As of the
end of the calendar year the City Comptroller reports publicly, in his '
"
February 15th Statutory Report, on the net debit balance in this account,
if such exists. This net debit balance must thereafter be eliminated
by an appropriation in the next Expense Budget. Such appropriation,
however, cannot exceed 2% of that portion of the current tax levy which
is within the 2J2% tax limitation. Thus, at June 30th of each year, there
is usually a debit balance in the Tax Deficiency Account representing
both that portion which has been appropriated in the next Expense Budget
and the additional cancellations charged to it for the six months since
the end of the calendar year.
When an appropriation to the Tax Deficiency Account has been included
in the Expense Budget, the total Tax Anticipation Motes issued and outstanding for the fiscal year may not exceed the total taxes outstanding
at a given date less the appropriation to the Tax Deficiency Account.
Although these and all other requirements of law have been meticulously
followed by the City, the audit report is correct in its bottom-line conclusion that large amounts of uncollectible real estate taxes have accumulated
on the City's books and should now be written off. Fortunately, the
refunding made available by the Municipal Assistance Corporation has given
the City an extraordinary opportunity to accomplish this.
To avoid any recurrence of this situation, 1 have instituted a
mechanism in the audit unit of the Comptroller's Office to verify on a
regular basis the collectibility of real estate taxes on which the City
budget is predicated and against which the City issues Tax Anticipation
Notes.




180
OFFICE OF THE STATE COMPTROLLER
DIVISION OF AUDITS AND ACCOUNTS
REPORT NO. NYC-3-76

REPORT ON NEW YORK C I T Y ' S CENTRAL
BUDGETARY AND ACCOUNTING SYSTEM
(INTERIM REPORT NO. 1 - PRIOR YEAR
ACCOUNTS RECEIVABLE)

MANAGERIAL SUMMARY

Background
We are examining into New York City's central budgetary and
accounting practices in order to (!) identify shortcomings which have
a bearing on the accuracy of the City's financial statements, and (2)
develop data leading to the adaptation of the State Comptroller's
"Uniform System of Accounts for Cities" to the financial operations
of New York City. This is the first of two reports concerning the
valjdity of amounts recorded as due from the State and Federal governments.
Reports on other aspects of the City's finances will be issued
as our audit progresses.
Pursuant to Section 1515 of the City Charter, New York City's
annual Expense Budget is required to be funded from estimated receipts,
with the difference between budgeted expenses and receipts to be made
up by real estate taxes. Approximately 38 percent of the City's $11.1
billion Expense Budget for the year ended June 30, 1975 (or $4.2 billion)
was budgeted as Supplementary Revenues to be received from the State and
Federal governments.
A large part of the aid payments made by the State and Federal
governments is related to expenditures incurred by the City under
specific programs. However, the timing of the expenditures made by
the City does not precisely coincide v/ith the payments made by the
State and Federal governments to the City. Although some advances are
made to the City, the State and Federal payments tend to lag behind the
City's expenditures. The lag is caused by a variety of factors, such
as statutory requirements concerning payment dates and the timeliness
of the filing for reimbursement by the City.
Because of the nature of the payment cycle, the financing of programs by the State and Federal governments would normally result in
"accounts receivable" on the City's books. The effect of this procedure
is that the City has a built-in need for short term borrowings. Under
a disciplined budgetary and accounting system all of the accounts
receivable would be collected and converted into cash in a relatively
short period of time. Borrowings could then be repaid from the actual




181

collections against the accounts receivable. To the extent, however,
that the accounts receivable are inflated or not collectible, then
the City would have a deficit which must ultimately be paid by means
of appropriations.
New York City's accounts receivable from the State and Federal
governments at March 31, 1975, according to the City Comptroller's
books, included $290.0 million applicable to the fiscal year ended
June 30, 197^ and $ 1 ^ . 2 million applicable to the fiscal year ended
June 30, 1973- We compared these amounts with the accounting data
on hand
in seven of the City's major agencies. We also confirmed
these balances with related agencies of the State and Federal governments.
Major Qbscrvations and Conclusions
The accounts receivable from the State and Federal governments
applicable to the years ended June 30, 197^ and June 30, 1973, recorded
in the City's central fiscal record!., as of March 31, 1975, are grossly
overstated. We examined $373-3 million out of $43zi.2 million of such
receivables, and found them to be overstated by $32'+.6 million.
Following
is a summary of the results of our examination, by department.
Acc.oui \ t s K e c e i v a I > I c
Per

VVA'

indicated

Audi t _
_

Oyj: r s ' oj. en icn ts
_ .

C i ty
.

Records

(In m i l l i o n s o f
hoard

ol
o!

Higher

$ 58.0
2. 1
31.5
152.9
100.0
15.6

t < . . - i ion
;|„.i.

Hoard
Human
l)c\tni

Resources
- n t - • 1 ol
1 i -

f.li.n i I a M "
lie., i I h
Fi>

Lduoation
Administration
r

.oc;i.il

Services

i n',i i I ul i o n s

v.'i / ii.^s A d m i n i si r a t i o n

d o Ila is)

$26.3
-05.2
-0~05.0

$

31.7
2. 1
20.3
152.9
100.0

lo.o

it (niiii'-iil.i I I'lotcet ion

loi.il
Other

lU"

Lxamined

Kec-ivnbie

$^3ZK2

A'p-iK. i'-s-Uol

[lie C i t y ' s

examined

inlernal

procedures

in. ) i i I oi i ii<] ', I a I o a n d
i
_
jheieloie,
linancial

one

upon

lo p r e s e n t

gro'.'. ov-ei • , l a I ••men t ol
'
ovei si a I ed

Fcdeial

i.aunol. r e l y

reports

i i . pi i o r

the

r e c o r d i n g , m a i n I a i n i ng
receivable

central

fairly

accounts

year

for

accounts
the

receivable

revenues.

enabled

borrow
the

against

City

c x p e r i enc.ed.




to

better

of

records

and

related

receivables.

that

the i.ily lias

it

a Is.) .'nabled

revenue

receivables.

year-end

and

inadeguaIe.

these

means

In e f f e c t ,

these o v e r s t a t e d

report

a<'c

accounting

status

|7>i i r LI i - x p e u d i I i res wi I hoiTF TTav i ng o t h e r
i
i
however,

^32'L-A

ii!LL.

$373.3
GO. 9

ci v.il. |,JS

Join I Ariouiils

1.0

12.2

I.3.JL

A d m i n i M roi ion

results

sources;
further,

I ban

it

Tlu>
similarly

the ( i Ly
.

the C i t y
this

actually

did,

182
- 3 -

A part of the problem may result from the diffusion of responsibility for the accuracy of these records. The City Comptroller keeps
the City's formal books of account: and issues the annual report; the
Bureau of the Budget is responsible for determining the accuracy of
receivable balances and for initiating any necessary adjustments.
(We were told that it was City Comptroller policy to accept whatever
adjustments were made by the Budget office.) But since each individual
agency is responsible for executing the programs for which State and
Federal aid is paid, the agencies probably have the most current
information as to the validity of the receivables.
The City's procedures provided for only limited monitoring of
these balances:
. The City Comptroller's office sends each City agency a
monthly fund statement which includes receivable balances and changes
to the balances. City budgetary and accounting personnel stated that,
although there was no written requirement, each agency should have
verified these statements and reported any inaccuracies to them. City
Budget and Comptroller representatives knew that most agencies were
not taking such action, but did nothing to obtain current data.
. Four months after the end of a fiscal year, agencies with
recorded receivable balances on the central accounts are requested to
reconcile the balances on their records with those on the central
books and to explain any difference.
(The reconciliation can be a
complex undertaking, involving many programs covering different years
and the accumulation of expenditure data from multiple sources.) Most
agencies do not provide a complete reconciliation and some do not
respond at all. Complete reconciliations are necessary to correct the
central records.
There was insufficient follow-through to assure that known changes
were recorded in the Comptroller's central records. Even though some
agencies reported that the receivables were inaccurate, appropriate
adjustments were not made.
In several instances where actual expenditures
were'below program estimates, the level of anticipated Federal and/or
State aid was not correspondingly reduced on the central accounts.
Our audit also showed that the City had included as accounts
receivable substantial amounts that were not collectible or where the
likelihood of collection w^_ex_Lxnme 1 y remo-te - such_as claims for cplmr,
b u r semen t of d i sajj ov/ed cos t s, c laims- »n ^xcess of_.st ipul a ted 1 imi tat, ions,
and claims that_hacl__been rejected' but were on appeal. The receivables
incTu'ded-one~group of items totaling $121.*+ million that the City Department of Social Services had characterized as "no good".




183
- k -

Among the effects of these overstatements of receivables was
that it delayed appropriations to make up the deficits and permitted
continued borrowings on account of revenues which would not be realized,.
The significant overstatements of receivables also meant that
revenue anticipation notes issued by the City and which were stated
to be supported by Federal and State aid receivable were not so supported.
We also found severaj instances where even the City's recorded receivables
were less than the amount borrowed. This could occur because the City's .
*
procedures did not provide for verification that receivable balances at
the date of the note, sale were at least equal to the amount of notes
sold.
The net effect of these budgetary and accounting practices is that
the City spent more than it collected or will collect; it therefore
has a substantial unreported budget deficit. We estimate that the totaj
deficit for the fiscal years ended June 3 0 , 1973 and June 30, 197*+ on
account of overstated State and Federal receivables will amount to
$292*mi11 ion, as shown below.

Indicated
Unencumbered
Overstated
Indicated
Appropriat ions
Receivables
Defi ci ts
(a)
(b)
(b) - (a)
(in millions of dollars)

Fiscal 1973
Fiscal 197*f
Total

$17.6
15.3

$191.5
133.1

$173.9
117.8

$32.9

$32*f.6

$291.7

This amount will ultimately have to be financed from current
appropriat ions.
The City needs to make immediate revisions in its budgetary and
accounting practices concerning the recording of revenues and accounts
receivable arising out of State and Federal aid. Specifically:
. All accounts receivable balances pertaining to the fiscal
years ended June 30, 1973 and June 30, 197^, which are still on the
books as of June 3 0 , 1975, should be examined for collectibility in
accordance with generally accepted accounting principles.
. To the extent that the June 3 0 , 1975 account receivable
balances are not "measurable" and "available", as discussed in this
report, they should be written off by a charge to an appropriate deficit
account.
. In the future, revenues and accounts receivable should be
recorded on the books only to the extent that they are "measurable" and
"available" in accordance with generally accepted municipal accounting
pri n iciples.




184

. Individual agencies should be required to reconcile its
records with the City~Comptroller's central records monthly, and
Tile a positive report attesting to such reconciliation.
. The City Comptroller should periodically confirm the accounts
receivable balances shown on his records with the City agencies and
with State and Federal funding sources.
. All adjustments to accounts receivable balances should be
fully explained and justified by all responsible City offices, including
the City Comptroller, the City Budget Director, and the City's operating agencies.

\

. All accounts receivable should be conservatively stated,
with appropriate reserves established if there are doubts as to
collectibi1i ty.
Borrowings on revenue anticipation notes should require a certification
that the stated receivable balances are based upon the City's most current
available data.




185
AUDIT REPORT ON
REVIEW OF NEW YORK CITY'S
CENTRAL BUDGETARY AND ACCOUNTING PRACTICES
INTERIM REPORT NO. 1 - PRIOR YEAR ACCOUNTS RECEIVABLE




Office of the State Comptroller
Division of Audits and Accounts
Report No. NYC-3-76

186
AUDIT REPORT ON
REVIEW OF NEW YORK CITY'S
CENTRAL BUDGETARY AND ACCOUNTING PRACTICES
INTERIM REPORT NO. 1 - PRIOR YEAR ACCOUNTS RECEIVABLE

Table of Contents

Page

A.

Introduction

B.

Accounting for Supplementary Revenues
Receivable

C.

Confirmation of Receivable Balances

11

D.

Revenue Anticipation Notes

25

E.

Conclusion and Recommendations

27

Appendix A - Comments of the City Comptroller on Draft Audit Report




187
AUDIT REPORT ON
REVIEW OF NEW YORK CITY'S
CENTRAL BUDGETARY AND ACCOUNTING PRACTICES
INTERIM REPORT NO. 1 - PRIOR YEAR ACCOUNTS RECEIVABLE

A.

Introduction
1.

Purpose and Scope

We are making an examination of New York City's central
budgetary and accounting practices. The purposes of the examination
are:
(a) to identify those shortcomings in the central budgetary and
accounting practices which have a bearing on the accuracy of the
financial statements presented by the City; and (b) to develop data
leading to the adaptation to the City of New York of the "Uniform
System of Accounts for Cities" promulgated by the State Comptroller.
Among the subjects that we are examining are:
the budgetary
practices and related accounting practices ?or recording the City's
revenues; the budgetary practices and related accounting practices for
recording of expenditures; the City's fund structure and the bearing
of the fund structure upon the financial statements issued by the City;
the City's practices concerning the issuance of long-term obligations
to finance operating expenses; the nature of the City's accounts
receivable, one of its more significant recorded assets; and the trends
concerning the City's short-term debt.
This report is the first of two concerning the City's accounts
receivable. The report deals with the procedures for recording amounts
due from the State and Federal governments, as well as the accuracy of
the amounts reported as due from those sources for the years ended
June 30, 1973 and June 30, 197^, as of December 31, 197^ and March 31,
1975. A subsequent report will be issued concerning the amounts due
from' the State and Federal governments for the year ended June 30, 1975.
Most of these receivables were pledged to repay revenue anticipation
notes issued by the City.
Our examination included a\comparison of the amounts recorded
in the City's central accounting records, maintained by the City Comptroller, with the data contained
in the records of seven major City
agencies. We also confirmed these balances with related agencies of
the State and Federal governments. The City agency balances that we
examined were; Human Resources Administration, Social Services Department,
Division of Charitable Institutions, Board of Education, Board of Higher
Education, Environmental Protection Administration and Health Services
Admin i strati on.




188
- 2

We have previously issued two audit reports on the subject
matter to be covered during this examination. Both reports will be
updated. The reports were:
. "Report on the Debt Structure of the City of New York",
(audit report NYC-^2-7'0 , issued May 16, 197^. This report discussed
the City's practice of identifying current operating expenditures as
eligible for debt financing in the capital budget, and reducing the
total operating budget by a corresponding amount.
. Report on the "Use of Special Accounts, New York City Fiscal
Operations"(audit report NYC-9-73), issued October 3 1 , 1972. This
report showed that the City significantly understated its revenues by
recording certain revenue items in a category of accounts called
"Special Accounts".
The audit is being performed in accordance with the State
Comptroller's responsibilities as set forth in Section 1, Article V of
the State Constitution, and Article 3 of the General Municipal Law.
• 2.

Background

By law, New York City is required to finance its expenditures
from current receipts - the balanced budget concept.
In formulating
the budget, the City must balance the level of services to be provided
against the receipts estimated to be available to pay for the services.
Thus, the expenditures for services to be provided in any one year should
be limited to amounts expected to be received.
A substantial amount of New York City's expenditures is financed
through State and Federal aid. The City's Expense Budget, which is
financed primarily from real estate taxes, other taxes, and State and
Federal aid, was $11.1 billion for the year ended June 30, 1975. Of
this amount, $^.2 billion or 38 percent was budgeted as Supplementary
Revenues to be received from the State and Federal governments.
(The
budget also includes additional State and Federal aid classified in other
categori es.)
The timing of the expenditures made by the City under programs
financed by the State and Federal governments does not precisely coincide
with the payments made to the City by the State and Federal governments.
In some instances, the City receives a full advance. (n other instances,
the City receives a partial advance and is paid the balance of its
expenditures upon the filing of a settlement claim.
In still other
instances, the City is reimbursed periodically (e.g., every three months)
after the submission of a claim.
If the City files a claim timely, then




189
- 3 -

reimbursement is relatively prompt; for example, each month the State
makes an advance to the City for 80 percent of the State's share of the
estimated expenditures under the public assistance program; a settlement of the balance due the City is made within three months after
the end of each quarterly period.
Because of the nature of the payment cycle, the financing of
programs by the State and Federal governments would normally result in
"accounts receivable" on the City's books.
(An account receivable
represents moneys due the City against valid expenditures made by the
City on programs funded by the State and Federal governments.)
Generally accepted budgetary and accounting principles permit
municipalities to record revenues to the extent that they are measurable
and available. An "available revenue" means that the item is a resource
that can be used to finance governmental operations during the year.
V/ith regard to City expenditures which may be reimbursable in whole or
in part from State and Federal grants - if the expenditure of funds
is the prime factor for determining the amount receivable, revenue
should be recognized at the time that the City makes the expenditure,
subject to statutory or other limitations. Thus, the City may record
these items as revenue, even though it has not yet received the cash
from the State and Federal governments.
The effect of such spend first-reimbursed later Federal and
State aid programs is that the City has a permanent built-in need for
short-term borrowings.
(The only way that this can be avoided or
alleviated is for the State and Federal governments to make earlier
payments to the City or for the City to make a special appropriation of
normal revenues to finance the working capital need.)
Under a disciplined budgetary and accounting system, all of
the accounts receivable would be collected and converted into cash
within a relatively short period of time. Borrowing needed to finance
the accounts receivable could then be repaid from the actual collections
against the accounts receivable. To the extent, however, that the
accounts receivable are inflated, then the municipality would have a
deficit which must ultimately be paid by means of appropriations.
New York City's accounts receivable balances at December 31,
197^ and March 31, 1975, applicable to the years ended June 3 0 , \S7k
and June 30, 1973, according to the books of the City Comptroller were
as follows:

60-832

O - 75 - 13




190
- 4

As at
December 31,
1974

As at
March 31,
1975

Applicable to the year
ended June 30, 1974

$427-5 mi 11 ion

$290.0 mi 11 ion

Applicable to the year
ended June 30, 1973

$261.1 mi 11 ion

$144.2 mi 11 ion

As a starting point for our audit, we examined the receivables
applicable to the years ended June 30, 1974 and June 30, 1973. Because
of the passage of time (most of the year-end receivables should be
collected v/ithin 90 days) it is reasonable to assume that the balances
in these accounts would be relatively small. Review of the receivables
applicable to the year ended June 30, 1975 is in process and will be
reported on shortly.
3.

Discussion of Audit Results

Host of the matters covered in this report were discussed
with representatives of the City Bureau of the Budget and the City
Comptroller during the course of our review. Such comments as were
received have been considered in preparing this report. A draft of
this report has also been furnished to those officials. The City Comptroller's
comments are attached as Appendix A.

Report Filed:

July 1, 1975

ARTHUR LEVITT
STATE COMPTROLLER




191
5 -

B.

Accounting for Supplementary Revenues Receivable

Section 1515 of the City Charter provides for a matching of estimated
receipts against proposed expenditures, and indicates an intent to
provide for a balanced budget by fixing a real estate tax rate which
will provide such additional receipts as may be necessary:
"...The council shall deduct the total amount of
receipts as estimated by the mayor from the amount
of the budget, as fixed for the ensuing fiscal
year, and shall cause to be raised by tax on real
property such sum as shall be as nearly as possible
but not less than, the balance so arrived at, by
fixing a tax rate in cents and thousandths of a
cent upon each dollar of assessed valuation."
Because the City's cash flow situation, tax and revenue anticipation
n o t e s ( 0 are sold in anticipation o{ the collection of receipts in
order to finance expenditures during the year. This' kind of short-term
debt.has more than doubled in the last five years. The percentage of
such outstanding notes at March 31, 1970 to the City's 1969~70 expense
budget was 16 percent. At March 31, 1975, these notes represented 39
percent of the 197^-75 expense budget. This resulted in continuing
and ever-increasing interest costs. The effect on higher interest
amounts has been magnified by the sharp rise in short-term interest
rates during this period.

Note 1;

Tax anticipation notes (TANs) are issued to meet cash needs
pending the collection of real estate taxes (Section 2^.00 of
the Local Finance L a w ) . The total life of TANs cannot exceed
five years. If an appropriation is required to redeem any
portion of these notes, the charge is made part of the debt
service paid by the expense budget.
Revenue anticipation notes (iy\Ns) are issued for the same
purposes as TANs, but other types of anticipated revenues
such as State aid and non-property taxes are earmarked for
their redemption (Section 25.00 of the Local Finance L a w ) .
RANs mature within one year and may be renewed for one
additional year.




192

The City's expense budget is funded.by three sources*
real estate
taxes; general fund revenues; and supplementary revenues.('/ Supplementary revenues consist largely of State and Federal aid. For fiscal
year 1974-75, the adopted budget showed State and Federal aid of $4.2
billion out of total expected supplementary revenues of $4.4 billion.
The total expense budget for the year was $11.1 billion (net).
1.

Control of Receivables

The accounts receivable applicable to the years ended June 3 0 ,
1974 and June 30, 1973, as recorded on the books of the City Comptroller
as of March 31, 1975, are grossly overstated. The City Comptroller's
books show accounts receivable in the amount of $434.2 million for
these fiscal years as of March 31, 1975. We revjewed the balances for
seven City agencies amounting to $373-3 million, and found support for
only $48.7 million. Hence, the overstatement of accounts receivable
for these years is $324.6 million. Furthermore, the City's procedures
regarding the recording and follow up of accounts receivable need substantial improvement; they were not adequate to ensure that the amounts
recorded on the City's fund ledger were accurate and up-to-date.
City agencies include the estimated State and Federal aid as
part of their budget estimates. The budget estimates are reviewed and
may be adjusted by the City's Bureau of the Budget. The agencies must
await publication of the Executive Budget to see if changes are made
in their budgets. (The Executive Budget is the Mayor's proposed
budget, which is ultimately the adopted budget after review and
approval by the City Council, Board of Estimate and the Mayor.)
The budgeted State and Federal aid is then treated as revenues
receivable on the central books of account maintained by the City
CompLrollcr. Subsequently, each agency receives monthly fund statements from the City Comptroller's office which include these receivable
balances and the credits against the balances. City budgetary and
accounting personnel advised us that they expected each agency to
systematically compare the amounts reported to them with the agency's
own records, and to notify the City Comptroller or the City Bureau
of the Budget of any required changes. This was not a formal requirement
and few agencies followed this verification practice. City Comptroller
and Bureau of the Budget personnel advised us that they were aware
that such verifications were not made.

Note 1;

The gross expense budget is also reduced by certain offsets
such as funding provided by the Capital Budget.




193

On or about October 31 of the following fiscal year, the
Bureau of the Budget and City Comptroller jointly request City agencies
for which receivable balances appear on the central books to reconcile
the balances recorded centrally with the agency records, and to explain
any differences.
Out of ^6 agencies for which accounts receivable
balances were recorded, only 30 were requested to reconcile their
balances with Lhe balances appearing on the City's central books.
Furthermore, only 7.k agencies responded to those requests.

The reconciliation is a complex task, because the City's
central records of these transactions and the records of the individual
agencies v/ere not kept in a uniform manner, showing program totals.
Some of the agencies maintained only limited memoranda of receivables
and did not reconcile receivable amounts with the actual claims for
Federal and State aid. The claims should have been reconciled to
applicable revenue and appropriation accounts.

For example, until recently HRA had not complied with State
requirements for reconciling its claims to applicable revenue and
appropriation accounts. Their representatives had contended that such
a reconciliation was not possible. In our audit report NYC-62-73
issued April 30, 197*+, vye demonstrated not only that it was possible
(by successfully reconciling two test months), but that it was necessary
on a continuous basis.
(We found significant errors in the claims,
such as duplications amounting to $3.*+ million. Other audit reports
had noted even larger errors.)
For the most part, this same kind of detailed analysis has
not been undertaken by the City Comptroller's Office, City Budget
Office or the various other City agencies. As a result, the validity
of amounts shown as due from State and Federal sources and remaining uncollected after a reasonable cutoff time are questionable.
Following is a summary of the extent to which the seven
agencies with the largest accounts receivable balances for the 197'+
fiscal year made the reconciliation requested by the Bureau of the
Budget and the City Comptroller.




194
- 8-

Submitted
Incomplete
Did not Submit
Reconciled Reconci1iat ion Reconci1iat ion
Board of Education
Board of Higher Education
Health Services Administration
Environmental Protection
Administration
Charitable Institutions
Human Resources Administration
Social Services

X
X
X
X
X
X
X

The City's Budget Bureau is responsible for adjusting the
accounts receivable balances, based on each agency's reconciliation.
The Budget Bureau has been completing the reconciliations for those
agencies which did not respond. However, the journal entries initiated
by the Budget Bureau to adjust the central record of balances were not
supported by written explanations.
(At our request, Bureau of the
Budget personnel provided explanations for adjustments we questioned
during the audit. The adjustments were often based on incomplete data,
as discussed later in this report.)
2.

Other Causes of Error
a.

Failure to Record Decreased Funding Levels

We noted that Federal and State aid towards various City
programs was often based on a percentage of total costs. Anticipated
Federal and State aid receivables for these programs were based upon an
estimated level of City expenditures. However, we found examples (Health
Services Administration and Board of Education, for instance) where program expenditures were below budget estimates. This would result in a
decrease of Federal and/or State aid, but such decreased aid levels
were not reflected in the records during the budget year.
b.

Failure to Follow-Up and Resolve Differences

A picture of the delays irnresolving differences between
agency and central receivable records, in an instance where the agency
responded to the central request for confirmation of receivable balances,
was demonstrated by a December 197^ Health Services Administration letter
to the City Comptroller's office.
It included the following comments:
"N.G.

(No Good) Receivables may be explained as follows:

. In my 12/27/73 letter to you,...I estimated
that as of 10/31/73, F.Y. 72-/3 State Aid Receivable




195
should reflect a total of $3,650,000 instead of
$29,235,7^6, the balance shown by your records.
In my letter, I accounted for the difference of
$25,585,7^6. Subsequently, instead of writing
off the full $25,585,7^6, your office only wrote
off $10,600,000 for a difference of $14,985,746.
. |n my 12/27/73 letter to you,...| estimated
that as of 10/31/73, F.Y. 72-73 Federal Funds Receivable
should reflect a total of $0 - instead of $6,737,885,
the balance shown by your records. In my letter, i
accounted for the difference of $6,737,885. Subsequently, instead of writing off the full $6,737,885,
your office only wrote off $6,043,489.
. N.G. Receivables (of $6,938,683) in F.Y. 73~74
may be explained as follows: Actual expenditures
will be substantially less than budgeted for the
program listed below. Since State aid varies directly
v i th expenditures, I estimate that actual State aid
y
will be less than budgeted by the following amounts,
as a result of the reduced expenditures.
Voluntary agency contracts
Municipal C.M.H.C.'s
prison Mental Health-P.S.
Bureau of Child Cuidance-p.S.
Other programs
(Sub) Total

$4,334,581
369,976
604,326
592,100
531,597
$6,432,580

. There were deviations between budgeted and actual
funding formulas for certain programs:
Voluntary agency contracts - State aid was
budgeted at 51.78'/, of total expenditures. Actual
State aid was reimbursed at 51.2%.
$7.19,097
Fringe benefits for Administration and
Pi'ison Mental Health - State aid was budgeted at
50/o of expenditures. Actual State aid was reimbursed at 28.4%.
$263,663




0the r p rogram dev i a t i ons
(Sub) Total

JLJL3 ? 343
$506,103

196
should reflect a total of $3,650,000 instead of
$29,235,7^6, the balance shown by your records.
In my letter, I accounted for the difference of
$25,585,7^6. Subsequently, instead of writing
off the full $25,585,7^6, your office only wrote
off $10,600,000 for a difference of $14,985,746.
. |n my 12/27/73 letter to you,...| estimated
that as of 10/31/73, F.Y. 72-73 Federal Funds Receivable
should reflect a total of $0 - instead of $6,737,885,
the balance shown by your records. In my letter, I
accounted for the difference of $6,737,885. Subsequently, instead of writing off the full $6,737,885,
your office only wrote off $6,043,489.
. N.G. Receivables (of $6,938,6'83) i n F.Y. 73~74
may be explained as follows: Actual expenditures
will be substantially less than budgeted for the
program listed below. Since State aid varies directly
with expenditures, I estimate that actual State aid
will be less than budgeted by the following amounts,
as a result of the reduced expenditures.
Voluntary agency contracts
Municipal C.H.H.C.'s
Prison Mental Health-P.S.
Bureau of Child Guidance-P.S.
Other programs
(Sub) Total

$^,33^,581
369,976
604,326
592,100
531,597
$6,432,580

. There were deviations between budgeted and actual
funding formulas for certain programs:
Voluntary agency contracts - State aid was
budgeted at 51-78/ of total expenditures. Actual
State aid was reimbursed at 51.2/,.
$219,097
Fringe benefits for Administration and
Prison Mental Health - Sta^te aid was budgeted at
5070 of expenditures. Actual State aid was reimbursed at 28.4%.
$263,663




Other program deviations
(Sub) Total

$ 23 ? 343
$506,103

197
- n -

C.

Confirmation of Receivable Balances

Because most revenues from State and Federal aid are collected
either as advances or in reimbursement of expenditures made, one would
expect that collection of outstanding accounts receivable'would not be
delayed for extended periods. We attempted to verify the accounts
receivable balances applicable to the fiscal years ended June 30, 1973
and 197*+, but still on the City Comptroller's books at December 197*+
and again at March 31, 1975, for the seven agencies with the largest
accounts receivable balances.
Our examination included an analysis of the accounts receivable data as shown on the seven agencies' records. This analysis was
compared with the balances on the City Comptroller's records. Our
determination of receivables due the City for fiscal year 1973 and 197*+,
based upon the agency records, was confirmed by telephone with Federal
and State funding sources.
In addition, we requested the cognizant
State and Federal agencies to provide us with written confirmations.
As o f June 20, 1975, we had received six of the twelve confirmations,
which were in agreement with the original oral confirmations.
(In certain instances State and Federal officials were unable to
confirm the extent of certain types of aid reimbursement due the City.
This usually occurred where the aid category was not subject to Federal
limitations on the amount incurred and thus subject to reimbursement,
i.e., they were open-ended appropriations.)
Our examination disclosed that the balances were substantially
overstated as of both cut-off dates. As of March 31, 1975 the overstatement in outstanding receivables disclosed by our sample audit was
$191.5 million for fiscal year 1973 and $133-1 million for fiscal 197*+,
or a total of $32*+. 6 million for both years. ( 0
Following is a summation of the results of our examination, together
with a more detailed discussion of the receivables pertaining to the
indivjdual City agencies.

Note 1:

These overstatements may increase if subsequent audit of
claims made to the Federal and State government for these
periods result in disallowances.




198
- 12

Accoun t s Rccei vab 1 e
(in millions of dollars)

Fiscal Year 1973
As of
As of
Dec. 31,
March 31,
197^
1975

Fiscal Year 1974
As of
As of
Dec. 31,
March 31,
1974
1975

Balance shown on City
Comptroller's records
for all agencies

$261.1

$144.2 '

$427.5

$290.0

Ci ty Comptroller
balances applicable
to the seven agencies
we examined

$298.4

$195.0

$245.4

$178.3

Balances applicable to
the seven agencies based
on agency data

19.6

3.5

91.3

45.2

$278.8

Overstatement

$191.5

$154.1

$133.1

Note: For fiscal year 1973, the accounts receivable for the seven
agencies whose balances we examined exceeded the total accounts
receivable shown on the City Comptroller's records. For the most
part, this was due to the receipt of about $48 million on account
of the Health and Hospitals Corporation which was applied to accounts
receivable. This amount, however, had not been recorded initially as
a receivable.
1.

Board of Education
Balances
Requi red
As Recorded
As Adjusted,
Dov/nward
by the City Based Upon Operating (Upward)
Comptrol \er
„ Agency Data
Adj ustments
(in thousands of dollars)

Fiscal Year 1973
As of December 31, 1974
As of March 31, 1975

$16,064
( 4,362)

$16,649
1,438

Fiscal Year 1974
As of December 31, 1974
As of March 31, 1975

$68,611
62,434

$45,122
24,924




($
(

585)
5,800)

$23,489
37,510

199
13 -

a.

Fiscal Year 1973 Balances

The City collected $2.2 million of fiscal 1973 receivables
during the period January 1 - March 31, 1975; and reduced its receivables
by writing off $18.2 million. Board of Education, State, and Federal
officials advised that $] .k million was still receivable for fiscal
1973. For the City to record the correct receivable balance as of
March 31, 1975, an upward adjustment of $5.8 million wogid be required
as follows:
State Aid
Urban Education
Records at the Board of Education disclosed
a receivable balance of $6.1 million. However,
officials at the State Education Department advised
us that only $2 million was still available to the
Board'of Education.
In order to reflect the correct
balance, the City Comptroller's fund ledger receivable
balances should be reduced by $.8 million.

$ .8

million

General Aid Textbooks
Board of Education representatives estimated
that expenditures less cash received resulted in a
receivable balance of $1.8 million. The City
Comptroller's fund ledger, however, showed a
negative receivable balance of $1.5 million.
Therefore, an upward adjustment of $3.3 million
is required.
State Aid Adjustment

( 3.3) mi 11 ion
($2.5) million

Federal Aid
Elementary and Secondary Education Act
Board of Education officials expect to receive
$10.9 million for fiscal 1973. The City^Comptroller's
fund ledger balance for this program shows only $2.7
million. Thus, an upward adjustment of $8.2 million
is required.




($8.2) million

200
- i4 -

Federal Emergency" Employment Act
Federal officials advised that New York
City had received the contract ceiling on program
reimbursement and that additional funds would not
be available to the City. The City Comptroller's
ledger, however, shows a receivable of $4.9 million,
which should be written off.
Total Federal Aid Adjustment
Net Adjustment
b.

$4.9

mi 11 ion

($3.3) million
($5.8) million

Fiscal Year 1974 Balances

The City collected $6.2 million for fiscal 1974 receivables
during the January 1 - March 3 1 , 1975 period. The difference of $37.5
million, as of March 3 1 , 1975, between the City Comptroller's receivable
balance and the data we found is accounted for as follows:
State Aid
Urban Education
The City Comptroller's records showed a balance
of $11.3 million in excess of that of the Board
of Education.

$11.3 mi 11 ion

General Aid and Textbooks
Board of Education records showed that only
$.4 million is still due for fiscal 1974. This
would require the City Comptroller to reduce the
accounts receivable balance by $11.3 million.
Total State Aid Adjustment

11.3 mi 11 ion
$22.6 mi 11 ion

Federal Aid
Board of Education and Federal representatives
confirmed that the City was owed a lower amount
than the balance shov/n on the City Comptroller's
books. The excess amounts were Elementary and
Secondary Education Act ($9.1 million) and the
Emergency School Assistance Act ($.2 million).
Amounts recorded as receivable under the Feden
al
Emergency Employment Act which were in excess of
contractual ceilings.
Total Federal Aid Adjustments
Total Adjustments




$ 9.3 mi 11 ion

5.6 mi11ion
$14.9 mi 1 lion
$37.5 mi 1 lion

201
15

2.

Board of Higher Education
Balances
I Required
As Recorded
As Adjusted,
Downward
by the City Based Upon Operating (Upward)
Comptroller
Agency Data
Adj ustments
(in thousands of dollars)

Fiscal Year 1973
As of December 31, 1974
As of March 31, 1975

$12,554
( 1,300)

Fiscal Year 1974
As of December 31, 1974
As of March 31, 1975

$36,511
3,399

a.

$-0
0

$3,862
0

$12,554
( 1,300)

$32,649
3,399

Fiscal Year 1973 Balances

The City Comptroller's fund ledger as of December 31, 1974
showed a receivable balance of $12.6 million. During the period January 1
March 31, 1975, $13.9 million was written off, leaving a negative balance
of $1.3 million. Our analysis showed that there were no receivables
for this fiscal year.
b.

Fiscal Year 1974 Balances

The City Comptroller's fund ledger at December 31, 197*+
showed a receivable balance of $36.5 million. However, $14.7 million
had already been received in June 1974 and recorded in a suspense
account. It was not transferred to the correct account until January 21,
1975. Subsequently, the receivable was further reduced by cash receipts
of $3.9 million and journal entries writing off $14.5 million, resulted
in a receivable balance of $3.4 million. Although Board of Higher
Education representatives believe that $133,000 of this total is
collectible, we were advised that no additional State funds are available for fiscal 1974 because the Board of Higher Education has already
received the total State-appropriated amount.
3.

Human Resources Administration (HRA) (Exclusive of the Department
of Social Services and Charitable Institutions)
Balances
Requi red
As Recorded
As Adjusted,
Downward
by the City Based Upon Operating (Upward)
Comptroller
Agency Data
Adjustments
( n thousands of dollars)
|

Fiscal Year 1973
As of December 31, 1974
As of March 31, 1975

$13,462
13,462

Fiscal Year 1974
As of December 31, 1974
As of March 31, 1975

18,162
18,017




$

0
0

$13,462
13,462

5,215
5,215

12,947
12,802

204
- 18 -

Our own analysis confirms the conclusion that the foregoing
items cannot properly be classified as accounts receivable. V/e were
told that the first item was related to a legal action that the State
was bringing against the Federal government. The State is indeed
developing data for an administrative hearing in the Federal Department
of Health, Education and Welfare to appeal a Federal denial of State
plan amendments under Titles IVA and XVI of the Social Security Act.
If successful, the State may be able to negotiate a retroactive adjustment for the period October 1971 through June 1972. To the extent
that New York City may benefit from this action, it would involve
primarily the programs of the Board of Education, Mental Hygiene, Drug
Addiction and Health Departments. We are unable to relate the City's
comments to this action. |n any event, the ultimate outcome of tnis
action is extremely uncertain. At this point, there is no indication
whatsoever that the State will be successful; and if it is successful,
how much additional funds may be received or when such funds may be
received. The item is not shown as a receivable on the State's books,
and cannot be classified as a valid receivable on the City's books.
Because the ultimate collectibility of the foregoing items
is extremely doubtful, the City Comptroller should adjust his receivable
records for fiscal years 1973 and 197^ to zero balances, as indicated
below.
Fiscal Year 1972-73
State Aid Adjustment
Federal Aid Adjustment
Total Adjustments

$ 60.k million
72.A- mi 11 ion
$132.8 mi 11 ion

Fiscal Year 1973-7**

State Aid Adjustment
Federal Aid Adjustment
Total Adjustments




$57.5 m i l l i o n
( 37.*+) mi 1 1 ion
$20.1 m i l l i o n

205
- 19

5-

Charitable

Institutions
Balances
Requi red
As Recorded
As Adjusted
Downward
by the City Based Upon Operating
(Upward)
Comptroller
Agency Data
Adjustments
(In thousands of dollars)

Fiscal Year 1973
As of December 31, 1974
As of March 31, 1975

$54,319
53,826

Fiscal Year 19/4
As of December 31, 1974
As of March 31, 1975

66,431
46,184

a.

$

$53,826
53,826

493

63,860
46,184

2,571

Fiscal Year 1973

The December 31, 1974 receivable balance in the City's
fund ledger was reduced by cash receipts collected during the January 1 March 31, 1975 period to $53.8 million. Agency records showed a receivable
balance of $34 million at March 31, 1975. The difference of $19.8 million
was caused by the Comptroller's recording less cash receipts than the
agency, resulting in an overstatement of receivables on the Comptroller's
records. Our tests indicated that the $19.8 million was credited against
other programs and/or other fiscal years. For example, a portion of the
difference was due to the City Comptroller crediting a March 1973 State
aid check of $38.4 million entirely to the Department of Social Services
(DSS). DSS 1 and Charitable Institutions' records indicated distribution
of the check as follows; $27.6 million to DSS; $5.4 million to Charitable
Institutions; and $5.4 million to the Health and Hospitals Corporation.
b.

Fiscal Year 1974

>
The City Comptroller's December 31, 1974 receivable balance
of $66.4 million was reduced by cash receipts during the January 1 March 1975 period of $2.6 million, and write-offs totaling $17.6 million,
leaving a March 31, 19/5 balance of $46.2 million. Charitable Institution
records showed a receivable balance of $44.4 million at March 31, 1975.
The difference in receivable balances was the result of the City Comptroller
recording $1.8 million less in cash receipts than the agency.
(Our
analysis showed that the difference was probably attributable to the
crediting of these receipts to incorrect accounts and/or fiscal years
on the City's fund ledger; see discussion in the preceding paragraph.)




206

c.

Uncollectible Receivables

Agency
d a t a showed a receivable balance at March 31,
1975 for the two fiscal years of $78.4 million; consisting of cash
advances made to voluntary hospitals totaling approximately $4-9 million
and a $30 million claim disallowed by the Federal government.
(Agency
records did not show to which fiscal years these two items was attributable.)
In any event, neither item can be classified as a valid account receivable.
. Advances made to voluntary hospitals totaling $49
million do not represent valid receivables. In effect, there are
advances made by the City pending the processing of payments to
the hospitals. Since the corresponding claims were not recorded
as accounts payable, the advances cannot be construed as accounts
rece i vab1e.
. A representative of the City advised us that the remaining
$30 million in this account involved the legal action discussed in the
preceding section on the Department of Social Services. Our comments
in that section pertain to this matter as well. The item cannot be considered as a valid account receivable.
Based on our review of the agency's data, the City Comptroller
should adjust his receivable balances for fiscal 1973 and 1974 to zero
balances as shown below.
Fiscal Year
State Aid
Federal Aid
Other

$

.4 mi 11 ion
53.6 million
(
.2) mi 11 ion

Total Adjustments
Fiscal Year
—

—




$53.8

mi 11 ion

1973-74

•

State Aid
Federal Aid
Other
Total

1972-73

Adjustments

t

$21.8 mi 11 ion
24.5 million
(
.2) mi 11 ion
$46.1

mi 11 ion

207
21

6.

Health Services Administration
^_

t

Balances

Requi red
As Recorded
As Adjusted
Downward
by the City Based Upon Operating (Upward)
Comptroller
Agency Data
(in thousands of doll ars)
Fiscal Year 1973
As of December 31, 197^
As of March 31, 1975

$15,616
887

0
0

$15,616
887

Fiscal Year 1974
As of December 31, 1974
As of March 31, 1975

$36,686
14,734

$12,768
5,025

$23,918
9,709

a.

Fiscal Year 1973 Balances

The City Comptroller's records at December 31, 1974 showed
a receivable balance of $15.6 million. Subsequently, cash receipts of
$.1 million and write-offs by the Comptroller's office reduced the
receivable balance to $.9 million at March 31, 1975.
Health Services Administration (HSA) representatives advised
that no additional funds will be received by HSA for fiscal 1973. This
was confirmed by State funding office representatives. The balance
should be written down to zero with the following adjustments:
Federal Aid
Less, State Aid
Total Adjustments
b.

$1.5 million
( .6)million
$ .9 mi11ion

Fiscal Year 1974 Balances

The City's fund ledger at December 31, 1974 showed a receivable
balance of $36.7 million. Cash receipts of $10.2 million and adjustment
entries reduced the balance to $14.7 million at March 31, 1975. HSA
officials advised, however, that only $5 million is still receivable
on account of the City's fiscal year 1974 expenditures. Therefore, the
balance should be adjusted downward by $9.7 million as shown on the
following page.




208
22

State Aid
Mental Health
A $^0 million ceiling was imposed by the
State Mental Health Department on this
category of costs. New York City balances
exceeded the ceiling limitation, and
accordingly will not be reimbursed.

$12.6 million

Public Health
The City's fund ledger reflected a negative
receivable balance of $.8 million applicable
to public health and gonorrhea control programs. USA representatives advised, however,
that $1.9 million is still to be received on
this program. The City's fund ledger records
.should be adjusted upward to reflect this
receivable balance.

(

2 .7)

million

j _

minion

• Alcohol ism Control
No additional funds are expected for this
Program.
Total State Adjustments
Federal Aid
Mental H e a U h

$]0>0

($

mi,1Jon

t

Alcoholism Control
These accounts showed negative balances. It
appears that the recorded receipts exceeded
'budgeted receivables. The entries to this
account should be reviewed, and the City's
fund ledger appropriately adjusted to reflect
a zero balance.

.6)

mil|ion

(

.8) mi 1 1 ic

Emergency Employment Act
Amounts recorded as receivable were in excess
of contractual ceilings.




| # 2 milli

209
23

Pub Ii c Health
HSA representatives advised that $1..
million was still to be received for
the Public Health Program.
Receivables
as recorded in the fund ledger were
understated.

($
($

Total Federal Adjustments

.4) mi 11 ion
.6) million

private Funds
The City's fund ledger reported $.5 million as
receivable from private sources. HSA representatives advised that only $.2 million is
collectible.

7.

.3

mi 11 ion

$ 9.7

Total Adjustments

$

m?11 ion

Environmental Protection Administration
Balances
Requi red
As Recorded
As Adjusted
Downward
by the City Based Upon Operating
(Upward)
Comptroller
Agency Data
Adjustments
(in thousands of dollars)

Fiscal Year 1973
As of December 31, 1974
As of March 31, 1975

$ 2,201
(
247)

$ 2,102
2,102

$
99
(2,349)

Fiscal Year 1974

As of December 31, 1974
As of March 31, 1975
-- ricludes
Al

inter-Fund
a.

$29,439
13,483

$20,994
'10,085*

$8,445
' 3,403

receivables of $8 million

Fiscal Year 1973 Balances

The City Comptroller's records at December 31, 1974 showed
a receivable balance of $2.2 million. Subsequent write-offs of $2.5
million reduced the receivables to a negative balance of $.3 million
at March 31, 1975. Our review showed that the receivable balance
should be $2.1 million, an increase of $2.4 million. The amounts
are al1 for State aid.




210
- 2k

Maintenance of sewage treatment plantAir po 1 1 u t i on con t ro 1 p rog rarn
Reduction in the City's v/rite-off of
sewage treatment State aid
Total Adjustment
b.

$2.3 million
- ( . 2) million
$2.1 million
.3

mi 11 ion

$2.^ mi 11 ion

Fiscal Year 197*+ Balances

The City's records at December 31, 197^ showed a balance
of $29.^ million. Cash receipts of $7.5 million and write-offs of
$8.4 million reduced the receivable balance to $13.5 million at
March 31, 1975.
Review of available receivable data indicated that the
City's receivable balance should be $10.1 million, or $3.^ million less
made up of the following adjustments.
State Aid
EPA officials advised that $2.1 million was due
for maintenance of sewage treatment plants. The
fund ledger balances reflected only $1.0 million.

($1.1) million

Federal Aid
Federal Emergency Employment Act
The City received the contract ceiling on
program reimbursement and additional funds will
not be available to the City.

.5

million

/
jnterfund Transfer (Special Accounts)
The City included in its receivables $12
million from Special Accounts. City officials
advised that only $8 million of special account
funds would be necessary to support EPA's
expenditures.
Total Adjustment




$*t-.0 million
$3.*+ million

211
- 25 -

D.

Revenue Anticipat ion.Notes

To meet its cash flow requirements, the City has issued revenue
anticipation notes (RANs). RANs are issued either (a) on account of
Federal and State receivables or (b) in anticipation of General Fund
revenues not yet collected.
In addition to its pledge of full faith
and credit, the City specifies which revenues are anticipated to support
the issuance of the RANs. Thus, the "Notice of Sale" with regard
to
the RANs shows the estimated amount of State and Federal aid receivable
to finance the expense budget, the collections to date against these
receivables, and the notes already outstanding. The remainder represents
the balance presumably available to support the new borrowing.
Type (b) notes are usually issued during the last quarter of a
fiscal year on revenues such as "accrued" water charges and repaid
during the first half of the next fiscal year. During fiscal 197*+ the
City issued $298 million of these General Fund type notes. Significantly
greater amounts of type (a) notes are issued throughout each year for
up to a one-year maturity. During fiscal years 197^ and 1975, the
City issued $*f.2 billion and $*f.7 billion respectively of type (a)
notes.
V/e found inadequacies in the City's procedures for determining
the amount of RANs it could issue in anticipation of State and Federal
aid.
1. The anticipated State and/or Federal aid supporting the note
issue, as reflected on the City's books of account, was less than
the amount of notes issued at the time of sale.
Internal procedures
did not provide for verification that the receivable balance at the
date of the note sale was at least equal to the amount of notes sold.
2.
In addition, large amounts of anticipated State and/ar Federal
aid will not be realized, as discussed in this report.
Several note sales illustrating these conditions are shown in the
following table.




212
- 26

Amount
of
RANs
Date of
1 ssue Maturi ty Issued
9-11-73 2-11-74 $225
2-28-7^+ 9-16-74
50
5-17-74 9-12-74
300
125
5-31-74 10-11-74
5 - 3 W 4 10-11-74
175
6-13-74 1-13-75
100
6-13-74 1-13-75
50
11-12-74 11-10-75
250

Balance
Against
Antici pated
Which Notes
Aid Receipts (1) M ight Have Been
State (S)
Issued, Per Reali zable
Amount Federal (F) City Books (3) Aid (2)
n
•^ 'S 4.9) (1 millions of do'i lars)
$338.« 1972/3 F
$ 215-7
$ 77.3
7.1
104.5 1973/4 F
-3.2
446.6 1973/4 s
293.1
159.1
128.5
134.8 1972/3 S
70.7
194.1 1972/3 F
183.7
45.3
2.8
136.6 1973/4 F
0
' 0
57.3 1973/4 S
0
185.8
51.8
259.5 1973/4 S _

Group To tals (in millions of dollars)
RANS 1ssued

$V75

Anticipated

' Ai<l Receipts
c

$1,667.2

Aid Anticipated,
per Books of Account
Realizable Aid (2)

$1,016.7
$404.2

When the anticipated receipts were insufficient to repay the note
holders on the due dates, the City used other revenues. For example,
on September 16, 1974 two RANs totaling $500 million became due. Because
anticipated revenues receivable were not realized, the City was_ compel 1ed
to use the proceeds from a following year's issue of RANs to redeem its
prior year RANs.
Notes*:
(1)
(2)
(3)

As set forth in notice of note sale.
As discussed in this report.
We were told that these amounts were taken from the latest
available monthly report of supplementary receivable
balances prior to the date of notice of sale.




213
27

E.

Conclusion and Recommendations

The gross overstatement of accounts receivable, as discussed in
this audit report, means that the City has similarly overstated its prior
year revenues. In effect,, it also enabled the City to incur expenditures
without having other revenue sources; the City did, however, borrow against
these overstated receivables. Further, this practice enabled the City to
report better year-end results than it actually experienced.. We estimate
that the total supplementary revenue shortfall applicable to fiscal years
1973 and 197*+ will amount to $292 million, as shown below. Ultimately, this
shortfall will have to be financed from current appropriations, because the
unencumbered appropriation balances for these two fiscal years are not
large enough to absorb this write-off.
Following is a summary of the results of our audit, showing the
1973 and 197^ unexpended appropriation balances reported on the City's
books as of March 31, 1975, the estimated uncollectible amounts for
each of the two fiscal years, and the effect of^the indicated receivable
wri te-offs.
1.

Summary of Overstated Accounts Receivable
Receivables
Per Ci ty
Indicated
Records
Per Audit Overstatements
(In millions of dollars)

Fiscal 1973 and 197^

Board of Education
Board of Higher Education
Human Resources Administration
Dept. of Social Services
Charitable Institutions
Health Services Administration
Environmental Protection
Administration
Other Agencies, Not Examined by us

$ 58.0
2.1
31.5
152.9
100.0
15.6
13.2
60.9
$43^4.2

2.

$26.3
-05.2
-0-05.0

$ 3K7
2.1
26.3
152.9
100.0
10.6

12.2
- (1)
$48.7

1.0
- (1)
$324.6

Computation of Deficit;, After Offsetting Overstated Receivables
Against Unencumbered Appropriation Balances
Total
Indicated
Balance of
Overstated
Indicated
Appropriations
Receivables
Defici ts
(a)
(b)
(b) - (a)
(In millions of dollars)

Fiscal 1973
Fiscal 197*+
Total

$17.6
15.3

$191.5
133.1

$173-9
117.8

$32.9

$324,6

$291.7

Note 1: The City should analyze the validity of those items not examined
by us. Such analysis may reveal an even greater amount of
uncollectible receivables.




214
- 28 -

The City's accounting is inadequate and the system of internal
controls is ineffective (or ensuring the accuracy of its estimated
supplementary revenues receivable. As a result, the data in the City's
central fiscal and accounting records cannot be relied on for reporting
to the Public and for management decisions as to budgetary status,
accounts receivable, and borrowings against these receivables.
The following recommendations are made;
1. The City should undertake an immediate analysis of
all accounts receivable recorded as due from the State and Federal
governments as of June 30, 1975. To the extent that the recorded
receivables cannot be characterized as "measurable" and "available",
as discussed in this audit report, they should be written off to an
appropriate deficit account.
2.
In the future, revenues and related accounts receivable
should be recorded as such in accordance with generally accepted municipal
budgetary and accounting principles; that is, they should be "measurable"
and "available", as discussed in this audit report. With regard to
State and Federal aid - where the incurrence of an expenditure by the
City creates an entitlement to such aid - revenues should be recognized
in the accounts upon the incurrence of such expenditures, subject to
appropriation, statutory, regulatory or other limitations oP the grant.
3. All City agencies should be required to attest to the
accuracy of their department's supplementary revenues receivable balance
at least quarterly.
Special attention should be given to those receivables which are reimbursements of costs incurred. These should be
monitored closely to make sure that budgeted receivables are adjusted
to reflect changes in actual and anticipated expenditure levels. As
part of the monitoring process, copies of all departmental claims for
aid and/or reimbursement should be filed with the responsible central
City agency.
h.
Where a question exists as to the collectibility of a
receivable, it should be confirmed with the responsible funding sources.
Periodic confirmations of all receivables should also be made.
5. All adjustments to accounts receivable should be processed with the written concurrence of the concerned agency and with
adequate explanation indicating the basis for the change.
6.
Internal City authorizations for the sale of RANs
should require a certification that the stated collateral balances
are based upon the City's most current available data.




215
- 29 -

7. Revenue anticipation notes which have as collateral
supplemental revenues receivable should be scheduled to mature no
later than the dates those revenues are expected to be collected.
8. Where there is doubt concerning the collectibility
of a receivable, a reserve should be created to the extent necessary
to assure that the stated receivables present fairly the amount reasonably
estimated to be collectible.
9.
Individual agencies should be required to reconcile
their records with the City Comptroller's central records monthly,
and file a positive report attesting to such reconciliation.




216
APPENDIX A

Comments of the City

Comptroller

on Draft Audit Report

Pursuant to the City's historic accounting practices, the City Comptrolle
books reflect revenue from all sources as estimated by the City Bureau of
the Budget and identified in annual budget documents.
Unless the Comptroller is otherwise notified by the Bureau of the Budget
subsequent to the adoption of the budget, the revenue estimates contained
therewith are retained on the Comptroller's books through the fiscal
year. Hence, those estimates have historically been the basis on which
required short-term borrowings deriving from cash flow needs have been
effected.
Differences between the State Comptroller's findings as to receivable
balances in Fiscal Year 1973 and Fiscal Year 197^ available to support
short-term borrowings by the City in those periods and the balances on
the books of the City Comptroller are further explained by the following:
•1.

The State Comptroller and the City Comptroller have referred
to different base dates for purposes of establishing balances
of aid receivables available to support borrowings. At the
time of the publication of notices of sale, the City has
historically relied on receivable balances as of the date
closest to the notice of sale date for which computer-run
revenue reports have been available. Such computer-run
revenue reports frequently antedated by many days the settlement dates on which borrowed funds were actually delivered
to the City. The State Comptroller's after the fact examination
has allowed him to test receivable balances on the actual date
of borrowings against the extent of the borrowings themselves.
Hence, actual outstanding receivable balances at the time of
a notice of sale may have been reduced by collections at
the later time of the settlement of a loan.

2.

Until December, 197^ the City's estimates of receivable
balances available to support borrowings in anticipation
of State and Federal aid excluded aid due to the Health and
Hospitals Corporation. This unnecessarily understated the
receivable balance, frequently by a large factor.

3.

Borrowing in anticipation of State and Federal aid has
historically been based on unaudited estimates of the
Budget Bureau. These estimates have not been revised
until six months after the close of the fiscal year.
Even
then, their revision has been based on information supplied
by City agencies, n C ^ confirmation by State and Federal
sources.
/v/f r




217
APPENDIX A
Page 2

As a result of reforms in the Comptroller's Office, computer data on aid
actually received is now produced weekly rather than monthly. Hence,
borrowings for the City are now based on more current receivable
balances.
Further, the City Comptroller has been designing a Federal and State
receivable verification system. This will enable the Comptroller to
update continuously the Budget Bureau's estimate of aid balances.
The City Comptroller has supplied the State Comptroller with a detailed
statement respecting recommendations for conforming New York City's
budgeting and accounting practices with standards established by the
State Comptroller and the Municipal Finance Officers' Association.
Audi tor's Comment: The reliance by the City on the latest available
computer-prepared revenue reports generally resulted in the use of
data which was #fte%\ a month old. As noted in the City Comptroller's
comments, there may nave been collections against these receivables
in the interim. However, it did not appear to be City practice to
reduce the amount of notes sold by the amount of such collections.
In any event, the receivables were substantially overstated, as indicated in this report.




218
New York City: A Short-Tern Solution—A Long-Term Plan
By:
J.A. Schnepper
Assistant Professor
Economics Department
Rutgers College
New Brunswick, N.J.
At 12:01 A.M. on July 1, 1975, Mayor Abraham D. Beame of
New York City Ordered "crisis budget" layoffs of 19,000
city workers—the result was an urban nightmare. Fun
City became "Mugger City" as outraged unions responded
to the first civil service layoffs since Fiorello La
Guardia was mayor. Firemen became sick, while the
entire sanitationnen's union imposed a wildcat walkout
which buried New York City in 28,000 tons of garbage
each day.
New York City was in trouble, and is in trouble today.
The problem is money. Very simply, the city's revenues
fall far short of their service required expenses. Like
the worker heading for bankruptcy, New York City is
spending more than it earns. It is the purpose of this
paper to examine the situation as it happened, what solutions have been proposed, the reasons for their failure,
and a final alternative to municipal" bankruptcy. We will
look at the actual causes of the crisis and the basic
restructuring that must be done to eliminate them. Finally, the potential impact of failure—default—will
have to be investigated.
Crisis recognition began in February 1975, when a lav;
firm (White and Case),
inexperienced in general obligation municipal underwritings, was asked by an executive
of Banker's Trust to examine a new city offering. When
financial figures v/ere requested, they v/ere found to be
unavailable. Unanswered questions led to more questions.
The true nakedness of the emperor soon became apparent
to all. Mayor Eeame's July budget made the proclamation
official.
ilather t - ? i recognize and deal with the true root causes
".;
of the problem, New York's financial wizards first attempted




219
to apply fantasy financial makeup. The city's first bluff
was the creation of a state agency, the Municipal Assistance Corporation ("Big Mac") to sell $3 billion of tax
exempt bonds. The attempt to redeem maturing short-term
debt with medium- and long-term securities soon fell flat.
The initial sale "of $1 billion worth of bonds soon sold at
deep discounts. The bonds were revenue bonds, to be paid
from income derived from the city's sales and stock transfer taxes, both to be collected from the state. Even with
a debt service coverage of 2.5 times (compared to a typical
1.5 times for revenue bonds), confidence in city issues was
gone. When Big Mac's offering statement admitted that
bondholders would have no lien on the taxes backing the
bonds, the game was up. With no lien, there really was
no backing, and a record coupon rate of 9.5% meant little
on the 15 year bonds. The credit risk was too high.
With Big Mac bonds selling at times over 20% below face
value, Beanie and New York Governor Hugh Carey developed a
brilliant plan to expand Mac borrowing authority from $3
to $5 billion. When the banks stopped laughing, a new
"solution" was developed.
The state, under quickly passed emergency legislation,
stripped the city administration of powers over revenue
and spending. In return, the city was to be granted a
three month financial reprieve. In a complicated $2.3
billion package, the city would receive $750 million from
the state, involving three monthly state note sales, $725
million from state and city pension funds, and various
other loans, securities' roll-overs, and investments. The
funds would be used to buy debt securities from Big Mac,
which would, in turn, channel the proceeds to the city to
pay its debts.
The state would substitute its own credit for that of the
city. In exchange, the final say on all city fiscal mat-




220
ters was ceded to a seven nan Emergency Financial Board
dominated by the state. Trie hidden faults in this "solution" soon became clear. The taint of the city fell upon
the state. The state1s first monthly sale of $250 million
of notes demanded a record high interest rate of 8.7>o.
The Court of Appeals subsequently decreed that the legislative mandate ordering State Controller Arthur Levitt to
invest state pension funds in Municipal Assistance Corporation bonds was unconstitutional.
Again, as in all cases where financial and managerial
ineptitude have created a monetary shortfall, supplicating
eyes turned toward Washington. Senator Hubert K. Humphrey
mobilized his .Joint Economic Committee to come to the aid
of New York City. Representative Tom R i e of California
f.s
introduced legislation to provide federal guarantees for
municipal bonds, guarantees which would operate in a similar manner to the loan guarantee provisions which bailed
out Lockheed Aircraft Corporation.
As of the first weeks of October though, federal aid plans
were still long shots. Both the Ford Administration and
most of Congress were opposed. Permanent solutions,
dealing with the causes of the problem and implementing
remedial structural readjustments, would take too long to
put into action to satisfy New York City's short term
needs.
Uhat is needed is a short term band-aid to stop the financial bleeding long enough to operate on the basic disease.
What I would like to propose, as a temporary remedy, is
the establishment of a state chartered "Bank of New York
City."
The crisis today is one of confidence. New York City and,
now New York State both lack the reputation of being




221
prudently managed financially.

The public therefore

refuses

to directly invest in "their high risk securities, without
any form of insurance.

If New York State would charter a

state run "Bank of Mew York City," that bank would

surely

attract deposits by public-minded unions, pension funds,
and individual city and state employees.

These deposits,

and the ban]; itself, would be protected by Arthur
Federal Reserve System.

Burns's

As a lender of last resort, the

Federal Chairman has already promised aid to brinks if they
get into trouble buying hew York City securities.

Time

deposits would be guaranteed by the Federal Deposit Insurance Corporation.

Thus, there should be minimum risk

full confidence in making these
its.

and

"New York City Bank" d e p o s -

They would be no different from checking and

saving

accounts in any commercial ban!:.
Using these deposits as reserve funds, the "Bank of New
York City City" would be able to finance the city by purchasing Big Mac bonds directly.

Assuming the

absolute

worst, that New York defaults on trie b o n d s , the depositors
of the bank would be protected by the normal safeguards.
In effect, the legislature of Mew York Sate would be securing back-door federal

insurance.

The bank's .charter must be short lived, though.
tion of the ban]; is a band-aid, not an answer.
be used as a permanent mechanism
sibility.

The creaIt must not

to avoid financial respon-

It cannot be allowed to develop into a state

printing press, fueling inflation and substituting p o l i t ical convenience for needed economic pragmatism.
it only as

I suggest

a temporary salve, to prevent the possible cata-

strophic effects of city-state default.
In the words of Federal Reserve Board Chairman B u r n s :

"If

this crisis isn't resolved, it could injure the recovery

60-832

O - 75 - 15




222
process that is under way in the national economy. Defaul
would create an irreversible exodus of business frcn the
city. Years of litigation and appeals would follow. Conflicting claims between lenders, employees, pensioners,
welfare recipeients, and others would have to be adjudicated. Massive layoffs and strikes would result. Despite
Federal Reserve support promises, the effect upon our
banking system, already weakened by holdings of dubious
real estate investment trust paper, would be a disasterous
destruction of public confidence. Liquidity would be
severely pinched by the freezing of large portions of bank
assets.
Potential default has already,for all practical purposes,
removed iJew York City from the financial markets for years
l^ew York State's credit rating, contaminated by the city's
troubles, has fallen deeply, too. Default fear has also
raised the cost of borrowing for every, municipality and
state agency in the country. Actual default could paralyze and potentially destroy the whole municipal capital
market. It, therefore, becomes imperative to buy time for
Hew York City. A "City Bank" would do this.
A "City Bank," however, would not tackle Mew York's real
problems. City officials just have not been able to control Uew York. Some of New York's problems are national
problems. Since World War II, roost large cities have
experienced a sharp shift in population, with poor people,
most of them black, moving in and middle income people,
most of them white, moving out. Business, too, has
increasingly deserted the cities, further eroding the
economic base. Each year since 1969, 400,000 jobs have
gone out of Mew York City. The 2 million middle income
persons who left for the suburbs have been replaced by
2 million poor blacks, Puerto Ricar.s, and whites.




223
Political games have been tried to cover up the problems.
It began in 1965, with then Mayor Robert Wagner getting
then Governor Nelson Rockefeller to have the legislature
passing a law allowing the city to market a new kind of
debt intrunent—Revenue Anticipation Notes—notes which
borrowed against money the city might get—maybe. But
what 'kind of real revenue was coming in to back these
notes? No less than 36% of all real property in the city,
with an assessed value of $22 billion, is exempt from tax.
If the VJorld Trade Center alone paid normal real estate
taxes, New York City would receive $40 million more per
year.
Tv/enty-seven percent of the city's budgeted revenues are
generated from real estate taxes. But this assessed taxbase of over $39 billion is decaying rapidly. Thousands
of vacant lots and abandoned buildings on which no tax
will ever be collected have been kept on the city tax
rolls by city accountants. The real vacancy rate in office
buildings is now estimated at' 10% to 12%. At least 10,000
apartments have vanished each year with slowed construction and increased abandonments. Collections are also
dying. Last fiscal year $200 million in property taxes
were not collected and $500 million in owed back taxes
remained unpaid. The present tax delinquency rate is over
7%, the highest level since the Depression.
The political games were not limited to accounting tricks.
Jobs meant votes. Since 1961, with no substantial increase
in the pospulaticn, the city has added 100,000 employees.
;7ith a payroll of approximately 320,000, New York has one
civil servant for every 24 citizens; Los Angeles has one
for 55, Chicago one for 73. The expense budget since 1961
as grown from $2 billion to over $12 billion. Cver half
of that has been in increased wages, fringe benefits, and




224
pensions. City pay rates have grown an average of 9%
a year since 1955—5C% faster than salaries in private
industry. During mayoral election years, the payroll
rise approached 14/4.
Vrhen John Lindsay became mayor, about 500,000 Kew Yorkers
were on v/elfare. Today over one million people are receiving payments. Even with state and federal help, the
city's direct v/elfare payments cost $799 million, increased
by an additional $282 million for welfare labor costs. Enriched services, like free day care centers for non-v;orkina
mothers, impoverish the taxpayers of Hew York. But they buy
votes.
Eew York City provides services unlike any other city in
the nation. Anyone v/ith a high school diploma can go to
the City University-—free! And they can be taught by
professors earning up to $36,000 a year for as little as
9 student contact hours a week for 30 weeks. At a pay
rate of over $1,300 per student contact hour, the city can
hardly be getting its money's worth.
I\ew York City has 123 hospitals. No coordination exists
between the municipal and private-voluntary hospitals.
ifhen one-fourth of the city beds are vacant and the voluntary ones are almost always full, why is there no
coordination?
In 1960 the Board of Education had 44,000 employees for
936,665 students. Today the payroll has doubled v/ith only
a 10?^ increase in student population. The average teacher
makes $17,000 for a 180 day v/ork year.
Why does the city pay $74 million per year for outside
consultants to duplicate functions that present city employees should have oeen doing all along? Uhy do we have
semi-useless agencies like the Taxi and Limousine Commission




225
-10-

v/ith 116 employees and an annual budget of $3.3 million?
Why are city sanitation costs three tines that for comparable work done by private concerns? Why does the Welfare
Department need its ov/n televison camera crew? Why must
the Human Resources Administration spend $1 million on
public relations? Why are not our firefighters allocated
and assigned in accordance with predicted geographical and
time related patterns of fires? Why were our pension cost
projections based on a ludicrously outdated 1914 actuarial
base? How can New York's mayor and controller differ by
almost a half billion dollars in budgeted current expenses?
The answer to the above questions is simple: the answer is
politics. Those in charge of Hew York City oversee it;
they do not govern it. Hard, unpopular decisions need be
made. These decisions do not engender ballot support. A
Wagner running for Governor, a Lindsay running for President, could not and did not make the hard choices.
While a "City Ban];" would buy time, maybe three years for
New York, what long term structural changes are necessary?
First a non-politically ambitious city mayor must be
elected. Perhaps a six year non-renewable term would
enable him or her to make the unpopular but right decisions
without having to face an angry city electorate every four
years.
The mayor's biggest challenge will come from the city
public employee unions. To aid the mayor here, compulsory
and legally binding final contract arbitration should be
mandated for collective negotiation impasses. Union
leaders would be judicially bound by the arbitrator's
findings, removing or at least lessening the impact of
union member pressure for "unacceptable" salary and pension increases. Public employee impasse arbitration
already exists throughout "ow York State except, geographically, for New York City.




226
The city must balance its budget. The real dollar numbers
and the assumptions behind them both must be made public.
Union mentality must be converted from "what can I get?"
to "what can we work out?" Maintenance of current positions
must be substituted for increases in benefits. Cooperation
must replace union-management competition.
The City University incurs labor costs alone of $507.5
million. With State and Federal Loan guarantees already
in effect, student loans of at least $1,000 a year are
available to even the most indigent. Therefore, not a
single student would be denied an education if tuition of
$500 a term were to be imposed. Considering New York City's
current financial position, it should be imposed.
The Civil Service can no longer continue as the sinecure
of the incompetent. If one cannot do the job, he or she
should be let go. A single board might be set up to review
dismissal decisions—but no "binding forever" atmosphere
should envelop the employment relationship. Productivity,
not longevity, must be the guideline.
Most welfare is a necessary expense. A moral social
responsibility exists where people cannot take care of
themselves. But costs can be cut. If ten welfare mothers
cannot work because of their children, train five to work
in a city day care center, so that the other five can look
for jcbs. If a single woman has five illegimate children,
public policy and state interest would mandate compulsory
birth control as a welfare; eligibility requisite. True,
the woman has a right of privacy to do what she v/ants with
her own body. But when she seeks public support for herself and the products of her unfettered rights, those
rights must be subject to a limited state control.
ilest import of all, an attitude of "jeitO" must be devel-




227
-12-

oped. "JeitO" is the Brazilian concept of finding a way.
A way exists for hew York City to extricate itself from
its financial crisis. A "City Bank" would be a short term
measure. Long tern solutions d o exist. They will involve
_
sacrifices, political, social, and"economic changes. They
will mandate a new "nonesty, a recognition of practical
realities. hew York City might well paraphrase the words
of hark Twain: the reports of its death, too, have been
gros s 1 y ex agger a ted.




Table 1
Per Capita City Service Costs
Police
& Fire
Mew York

He alth &
Ho.
spital

Education

Public Debt
Welfare Interest

$100

$151

$295

$316

$66

Atlanta

41

60

245

10

34

Chicacjo

69

30

260

21

24

Detroit

70

60

241

26

25

Los Angeles

75

51

260

144

15

Pliiladelphia

91

48

217

18
.

41




Pension
Fund

Other

Total

$80

$430

$1,446

12

252

650

14

297

715

5

266

693

21

309

875

22

294

731

229
Table 2

Hew York City's Budget

(in Millions of Dollars)

196 4-65

1974-75

$416

$2,421

Education

6 75

1,912

18 3

Debt Service*

470

1,435

205

Pensions

326

791

143

Police

236

734

211

Environment

144

330

129

Fire

120

307

156

Other

675

2,147

218

Total

$3,355

$11,104

Welfare

Percent

Increase
482^

231%

^Includes interest of $144.3 million in 1964-65
$646.6 million in 19 74-75.




and

230
Table 3
l!ew York City Budget Allocation
1966

19 74

Education and Library

23.7%

21.82

Health Services

12.4

8.5

Social Services

18.7

28.8

Public Safety

11.4

9.4

Pension Funds

5.7

7.4

12.5

7.0

2.0

4.5

13.6

12.6

100.0'/

100.0%

Debt Redemption
Debt Interest
Other




($3,084 million)

($10,249 million)

231
Table 4
Public Employee j _ Private Sector I J g Gains
y.
-ae
Average Annual
Increase
1955-73

Percentage Increase
1955-73

All Private Industry

4.72

129.3%

Manufacturing

4.6

124.0

Federal Govt. (Civilian)

5.9

182.9

All State and Local Govt.

5.6

165.2

*!~ote: The average annual increase for New York City
(1955-73) was 9%I




-14-

232
Table 5
Lew York C i t " S h o r t - T e r n Debt I - i a t u r i t v
i:otes due on:

Amount (millions of dollars)

Cctobe.r 17, 1975

$420

November 10, 19 75

250

December 11, 1975

400

January 12, 19 76

620

January 13, 19 76

200

February 13, 1976

290

March 12, 1976

341

June 11, 19 76

280

$2,801

Total




->5-

233
NEW YORK'S FISCAL CRISIS IN PERSPECTIVE
by
W. Philip Gramm

I am happy to have the opportunity to submit my testimony on New
York City's financial crisis to the Senate Committee on Banking, Housing
and Urban Affairs.

The principle conclusions of the testimony presented

below are:
(1)

New York City is not bankrupt or insolvent, but is illiquid.

(2)

New York City is capable of solving its liquidity problem in the

(3)

There is no evidence that the municipal bonds of cities have

same manner it did in 1932-33.

weakened relative to other debt instruments due to New York
City's crisis.
(4)

A default of New York City bonds will not cause a financial collapse
or destroy the market for quality municipals.

(5)

The disadvantages of federal intervention far outweigh the advantages.

When measured in terms of the value of its physical assets and income
flows susceptible to taxation, New York City is probably the richest city
in the world.

The $7.1 billion debt outstanding in March when the market

for the City's bonds and notes collapsed was but a small fraction of the
value of assets and income flows against which Lhe City could levy taxes.
While the bonded indebtedness of the Ci ty has gvnvr ty over' p.Q percent in
the last decade, the market for its bonds and notes has not collapsed because
the City lacks the ability to pay its interest liabilities or bonded indebtedness.

The collapse of the City's access to capital has occurred because it




234
has shown no willingness to either control spending or raise taxes to
offset budget outlays.

Despite the receipt of over $2 billion in revenue

sharing, the City government has allowed such a gap to grow between income
and spending that it has been forced to resort to unsound financial practices.
It has borrowed money to pay operating expenses, pillaged its contributions
to pension funds to meet current expenses, and over a third of its "capital
budget" will go to operating expenses this year.
Investors have known of these activities for over a year, and the
market for the City's bonds has reflected it.

Since October 1974 New York

has had difficulty marketing its bonds, and in December the City paid 9.5%
on $600 million of revenue and tax anticipating notes. In the same month the
rate on Bond Buyer's Average Index of 20 municipal bonds was 6.8%.

Because

the investors knew New York City bonds were "risky," given the level it was
spending relative to the level it was willing to tax, the City was forced to
pay about a 40% premium to borrow money by the end of 1974.
New York City became financially illiquid due to its unwillingness to
show investors any commitment to either control spending or raise taxes.
A significant gesture to control spending or raise taxes would solve the
liquidity problem by re-establishing the market for the City's bonds. In
the reforms of 1932-33, holders of City debt demanded several years of
economizing which reduced the City budget by 18% as a condition for extending
new credit.

A similar commitment to cut spending or raise taxes would not

only bail New York City out of its illiquidity problem, but would serve as
a needed step to re-establish its financial stability.

A once-and-for-all

federal grant would temporarily bail New York out of its illiquidity problem,
but would neither re-establish the City's credit nor solve its problem of




235
fiscal irresponsibility.
It has become politically popular to defend federal aid to New York
City on the basis of the assertion that the ability of other cities to
borrow is dependent on the fate of New York City.
torical data show such an assertion to be false.

Both current and hisThe investor is perfectly

capable of gauging which municipals are risky and which are not.

New York

City's problems have had no discernible effect on the rates other municipals
have yielded relative to a general index of credit instruments.

While

municipal yields have risen from 7% in July to 7.7% in October, prime bank
loan rates rose from 7% in July to 8% in October.

Those who have used the

rise in municipal rates as a justification for granting federal subsidies
to New York City to prevent further rises in municipal rates are simply
ignorant concerning current credit conditions.

While a default by New York

City may cause a s l i g h t ripple effect, there is no evidence to suggest
that the access to credit for cities operating on a sound financial base
will be impaired.

When Studebaker ended its U.S. production it had no

impact on the marketability of GM bonds or stocks.
The major source of the threat of default of New York City bonds is the
potential presence of federal intervention.

If the government of New York

City and its creditors were certain that there would be no federal intervention, there would be little chance of default.

Both the debtor and

creditors would have a mutual interest in finding an accommodation.

So long

as there is a good chance that Uncle Sam will intervene in the event of a default,
the City will not be forced to take the bitter pill of revamping its financial
base.




236
If New York City defaults it will be because the City
government expects the federal government to re-establish its
credit.

Only such a possibility makes default feasible.

Without

it, closing off access to credit would be avoided even if it
meant a capital levy on all property and a once-and-for-all tax
on income to prevent default.

The only real advantage of federal

intervention is in preventing a temporary default on City bonds
and a forced accommodation between the City and its creditors.
In the event of a federal bailout, the taxpayer of the City
will gain since he will temporarily escape having to pay the
bills.

The consumer of City services will gain since he can

then temporarily continue to live high on the hog, and the
holders of the City bonds will gain since they will get the
interest premium for holding a "risky" bond and will escape the
risk.

9.5% tax free bonds are a good deal if you can get Uncle

Sam to guarantee them.

It's not surprising that the City's

large banks hold over 40% of them.

The losers from a federal

bailout will be the federal taxpayers who will not only bear the
burden of bailing out New York City but may be forced to bail
out the host of other cities who will follow New York's example
if irresponsible spending is rewarded with federal grants.

The

private borrower who must compete for funds with a federally
guaranteed, tax free bond will also lose.
Debt is a powerful tool which must be used by government
and business alike only for productive investment which is selfliquidating.

If the Dutch traders, who bought Manhattan Island




237
for $24 worth of beads and trinkets, had borrowed that $24
(at 8% interest) on the credit of the future city, the value
of that debt v/ould be $17 trillion today and New York City
would be insolvent.

Fewer public decisions in the history

of our country have been as clear cut in terms of which course
of action serves the public interest.

I urge you to reject

federal aid to New York City.
W.Philip Gramm

60-832 O - 75 - 16




238
STATEMENT BY JERRY WURF, INTERNATIONAL PRESIDENT
AMERICAN FEDERATION OF STATE, COUNTY AND MUNICIPAL EMPLOYEES

Mr. Chairman, my name is Jerry Wurf, and I am president
of the American Federation of State, County and Municipal
Employees.
Our union has approximately 700,000 members and is
the bargaining representative for about one and a quarter
million workers in state and local government. We have more
than 100,000 members in New York City.
I am here in support of immediate federal action to
stabilize the credit market for New York State and New York City.
Our union supports solutions to the city's fiscal crisis
which involve a minimal cost and a minimal risk to the federal
government. We support solutions which preserve the separation
of powers between the federal government and state and local
governments — and which leave accountability for public
services in the hands of elected state and city officials.
We all know that some of the officials responsible for
the fiscal affairs of New York State and New York City have
made decisions which are coming back to haunt the public
in these times of economic distress. But the 8 mil 1 ion residents
of New York City must not be made to further suffer for the
mistakes of the public officials who govern them. It is
time now to define problems — and to seek solutions,
instead of scapegoats.
State and local governments rely on taxes that hit
hardest at working people whose incomes have fallen during this
recession. The U.S. Department of Commerce reports that
revenues from property taxes — which are by far the most
important source of local government revenues — rose by
only 2 per cent last year.
But double digit inflation has increased the cost of
government — the cost of supplies, the cost of fuel, and
the cost of labor.
The costs of government skyrocket. The revenues
that pay for government decline. The result is widening
budget gaps at all levels of government. In the absence of
federal assistance, the only options for local governments
are to raise taxes, to reduce services, — or to borrow money.




239
Many communities have exhausted their taxable capacity.
They have cut vital services to the bone. And they have
been forced into the municipal bond market — at a time when
the failure of national economic policies has made this market
chaotic.
The unreasonable monetary policy of the Federal
Reserve has played havoc with the overall levels of interest
rates. The market for tax exempt municipal bonds has been
especially victimized.
The incredible fact is — state and local governments
are being forced to pay higher interest rates for issuing
their tax-exempt securities than the federal government is
paying for its taxable borrowing.
During the past year, the interest rates paid on
municipal government bonds have risen to record levels...while
the interest rates on federal government securities have declined.
As recently as 1973, the average rate of interest
paid on high-grade municipal bonds was 5.18 per cent, according
to Standard and Poor's. The average rate on tax exempts
rose to 6.09 per cent in 1974, and, by mid-September,
1975, the average yield had risen to 7.28 per cent.
This phenomenally high rate actually understates the
magnitude of the borrowing problems faced by municipalities.
The 7.28 per cent average interest rate includes only those
municipalities that have been able to sell their bonds. The
figure does not include the local governments that have
been forced to withhold their debt issues after discovering
that the market demands exorbitant interest rates — or that
there is no market al all.
Last month, the spread between interest rates on highgrade municipal bonds and rates on Treasury bills reached nearly
1 per cent. This represented a turnabout from 1973 and 1974
when Treasury bills were nearly 2 per cent higher than municipals.
Why is the municipal financial market collapsing?
The nation's major banks, headquartered in New York
City, dominate municipal finance. These banks have a virtual
stranglehold on a municipal bond market that is very
narrow because only the wealthiest Americans have been the
purchasers.




240
Representatives of these banks — which have formed
a consortium to deal with New York City government — have
testified before this committee. While New York City
amassed $13 billion of debt, those banks did not complain
of fiscal irresponsibility by city government. They were
concerned with making profits selling and underwriting
the city's paper.
Now an economic climate that is characterized by a
severe monetary crunch and rising interest rates has created
new needs and opportunities for the major banks.
Recently they seized what they viewed as an opportune
moment to jack up interest rates on the city's bonds. But
what began as a scheme to increase bankers' profits culminated
in the loss of investor confidence in New York City. By
destroying the city's tenuous financial structure, the
bankers made it impossible to find customers for the
city's bonds — and left themselves holding virtually
unsaleable securities.
The bankers are enjoying the highest interest rates
ever. But city employees have entered into agreements
under which they accept layoffs, accept a wage freeze,
and accept changes in contractual work rules — all in
return for guarantees that regular city employees wi?1
not lose their jobs.
You have been told that New York City employees
are overpaid and underworked.
Alice Rivlin of the Congressional Budget Office
prepared an outstanding study of New York City's fiscal
crisis. The study finds — and I quote:
"Considering that New York's cost of living —
as measured by the Bureau of Labor Statistics'
intermediate family budget — is higher than all
but that of Boston, its wages are not particularly
out of line."
According to the Bureau of Labor Statistics, New York
City employees salaries rank behind those of municipal workers
in Los Angeles, San Francisco, and Detroit. Average monthly
salaries are:
$1,180.92
- - $1,144.87
$1,094.94
$1,062.07




in
in
in
in

Los Angeles
Detroit
San Francisco, and
New York City.

241
But, fundamentally, public employees do not write
out own contracts. Collective bargaining is a bilateral
process in which labor and management sign an agreement that
both think they can live with. In New York City, AFSCME
contracts have required approval not only by the mayor
but also by the City Council, the Board of Estimate, and,
directly or indirectly, by a politically hostile State
Legislature (as well as a generally hostile governor).
The concern for the problem of productivity in public
service — and it is a real problem — should be directed
towards the goal of professionalizing public management.
For too long, public managers have been named from the
ranks of the political faithful — or, if we're lucky,
from the ranks of leading law schools. America is alone
among the industrial democracies of the world in failing
to train and develop a corps of professional, non-political
public managers who are experts both in administration
and in the specific disciplines which they oversee. It's
time to eliminate political manipulations and demagoguery
from the delivery of public service.
In the current crisis, our union has been willing to
bargain in good faith regarding possible solutions to the
city's fiscal crisis.
We reached one agreement with the city, the s*"ate,
and representatives of the bankers. This agreement contained
the sacrifices I have mentioned —sacrifices which have
not been matched by any other segment of the New York community.
Now public officials and bankers — who reached this
agreement with us — are threatening unilaterally to
abrogate it. This we will not accept.
We will bargain with flexibility over the needs of
the city. But the corporate institutions and public officials
that caused this crisis - and profited by it — must not
unilaterally set aside the results of bilateral agreements
reached in good faith.
While our members are making considerable sacrifices,
the utilities, the banks, and the private vendors, and the
private contractors have not been told to lower their charges
to New York City.
These companies are raising their prices — to consumers
and directly to the city government. Meanwhile, the nonelected fiscal emergency boards, with their high-paid
adminstrators, lawyers, and publicists, have become a new burden
to the city.




242
The president of the New York Telephone Company,
William Ellinghaus, is a key member of the non-elected,
non-resident boards that are managing New York City. Since,
1970, this public utility has borrowed an average of $1 billion
a year for five years — a figure that dwarfs the city's
borrowing. The utility's charges to consumers went up
more than 30 per cent — a faster rate than taxes have
increased. Now the phone company is asking for a new
$488.8 million rate increase. New York Telephone is also
increasing its charges to the City of New York.
Meanwhile, the banks have not been able to restore
confidence in the city. Left with large amounts of city
securities in their portfolios, the banks have sought —
and received — assurances from Dr. Arthur Burns that the
Federal Reserve will come to the aid of any bank which might
suffer liquidity problems because of the New York City crisis.
Mr. Chairman, we know that the Ford Administration
stands ready to bail out the banks that hold New York City
paper. But what will happen to the 8 million people who
live in New York City and depend on public services?
In the debate over the federal role in New York's
fiscal crisis, one fact has gone virtually unnoticed —
New York City pays almost nine times as much in federal
taxes as the federal government returns to New York City.
The Journal of Commerce reported October 10 that
residents of New York City paid $26 billion in federal taxes
last year. Mr. Chairman, that figure accounts for approximately
one dollar out of every ten in federal tax collections.
In return, according to Presidential Press Secretary
Ron Nessen, the federal government sent back about $3 billion
to New York City.
We know that all federal tax dollars are not returned
to state and local governments. But, by any reasonable
standard, New York City receives a paltry share of federal aid.
To repeat, New York City accounts for 10 per cent of
all federal tax dollars. But, when these federal dollars
are shared with state and local governments under the General
Revenue Sharing program, New York City gets 4 per cent of
the total — $263 million of a $6 billion program.




243
Senator Humphrey has offered what may be the most
cogent formulation of the problem. He declared the question
before Congress is not whether the Federal Government will
act to aid New York City... but whether it will choose to
act before — or after — a default.
Default will
dislocations in the
the entire existing
arrangements, there

generate incredible uncertainties and
credit markets. Default will threaten
structure of intergovernmental financing
is no choice but to act.

What form should the federal assistance take?
The only meaningful assistance that can be offered
involves a federal guarantee of state and local debt.
This guarantee can take one of two forms:
- - A federal guarantee of tax-exempt securities, or
- - A federal guarantee of taxable securities, with
federal subsidy of 50 per cent of the interest cost.
In either case, participation in the federal guarantee
program would be strictly voluntary for state and local
governments. Those jurisdictions which choose to obtain
federal guarantees for their securities would be assessed
an insurance fee to cover the costs of potential default.
Initially the fee could be set at 1 per cent of the
value of the incurred debt. The fee could be adjusted as experience
dictates.
This mechanism utilizes essentially the same device
that operates under both the FHA and FDIC guarantee programs.
The cost of such a program would be negligible to the
Treasury. It would help forestall a fiscal catastrophe
that could shatter municipal finance mechanisms for years
to come.
This program is a first step towards creating a balance
between the responsibility to provide public service —
and the capacity to pay for it. This balance is essential
to the survival of a viable federalism — and to preserving
public services in these difficult times.




244
LAW

WALSH
SO
WILLIAM F. WALSH (RET)
ROBERT L. LEVINE
LAURENCE W. LEVINE
JAY H. LEVINE

OFFICES

AND

W A L L TOWER
NEW

(70

Y O R K , N.Y.

October

13,

LEVINE
P I N E STREET)
10005

1975

CABLE ADDRESS: LAWLEVI NEWYOR
INTERNATIONAL T E L E X : R C A
ZZZ9e

Hon. William Proxmire
United States Senator
Senate Office Building
Washington, D. C.
The present national debate over possible assistance to New
York City and other municipalities by either the Federal Government
directly or by some form of insurance company, is perhaps, one of the
Wealthiest things that has occurred in this country in a long time.
Unlike the decision in Vietnam which was covert and made by
a few people with the public getting wrong information, we are facing
an equally important national problem in a way in which I believe
the founding fathers intended the matter to be resolved and this is
the best picture that we can present to the nation and to the world
as to what this country is all about. Al Smith used to say that the
best medicine for a democracy is more democracy. What have we learned?
New York City starting with a Republican Mayor John Lindsay, violated a
basic principle that everyone else in the 1960's violated. We assumed
a never ending escalator up and Lindsay borrowed to fill yearly deficits
rather than for long term debt. Mayor Beame, first as Comptroller, then
as Chairman of the American Bank and Trust Company and Secretary Simon,
as a partner in Salomon Brothers, were only too happy to see these
borrowings.
When the economy was turned down in 1969 few people had the
vision to see the escalator reversing and that New York would lose its
preeminence in the brokerage and related service businesses connected
with the brokerage industry. We as a city have lost a substantial
number of jobs since 1969. The municipal fathers kept building and
borrowing and paid no heed to the warning of the banking community
which had to buy or sell these bonds.
When Mayor Beame came to office he continued to believe that
there were only 5 groups he had to deal with in order to straighten
things out. These were the heads of the Sanitation, Police, Fire,
Teacher and Subway unions whose roles had swollen during Lindsay's administration and prior ones.
The trouble started, as the Times points out, when the Mayor
and Comptroller sparred in a transatlantic shouting match over what the
extent of the city's debt actually was - a fact we did not know until
the day before the New York State Legislature met recently to offer
assistance. All of this unfolded in a drama of an uncensored press
where the trips, conferences and meetings of all concerned were




245
carefully followed.
Mayor Beame was given one respite and was supposed to fire
some city employees after the sale of some "Big Mac" bonds - but
relented and hired them back, thereby failing to take advantage of
an opportunity to change the national psychology on the attitude
toward New York. Finally, we saw New York State take over the
finances of New York City and here one master plan was knocked out
to be substituted for another where the courts have just ruled that
one part of the plan is not valid. Now the nation is witnessing the
final public drama of a great political debate that, in my opinion,
is as it should be.
The President of the United States and his Secretary of the
Treasury are claiming that a bankruptcy of New York or a default v/ill
not hurt the country or the bond and financial markets. The chief
financial manager of the nation, the Chairman of our Federal Reserve
Board, said the same thing until ver_, recently when he suddenly
changed his mind. In the meantime, he took the step of allowing the
banks to borrow 100% on these bonds if they go into default in order
not to permit a liquidity
crisis in the banks. This step was taken
three weeks ago.
While the above has been going on, the Presidents of the nation'r.
three most important New York banks wrote to Congmss and stated thaa default will not only hurt their banks but poss ly 100 other bank.
and a careful review of various news periodicals snow that other bank:^.
are beginning .o say the same thing.
On the Congressional side we are beginning to see the kind of
movement that only comes when an issue becomes important. Various
Congressmen and Senators are making public statements, several bills
have been introduced in both houses to create a federally bac ^d
insurance company and the matter, which a year ago was consi< .red a
joke, has taken on the dimensions it deserves.
The American people seem alert, interested and aware of the
problem. The national debate has done this. We finally see the two
New York Senators holding a joint press conference on the subject.
We see a public committee formed. We saw a 1975 version of Lady
Godiva on horseback at Times Square asking for help for New York.
(The original Lady Godiva paraded against taxes.) And on the home
front we see the Governor marshalling all of the assets of the State
to assist because he realizes that, as someone said, when the third
floor of a building is on fire the entire building ma burn down.
New York State notes which v/ere sold at $100 two weekii ago and pay
8% now sell at $93 and the State's credit could be in jeopardy.
We see the unions, which helped create this chaos, recognizing
that they too must help and pledging their financial support. And
finally we see the Mayor, now fortunately stripped of any power,
courting the bankers at Gracie Mansion when a few v/eeks ago he blamed
them for the fiasco. As the national debate continues and gets
louder, I suggest the following.




246
We are a democracy fighting to preserve a system which has made
this country the strong nation it is. More people are waiting on line
to get in here than to get out by a huge margin, so we do have a
good system. The greatest problem we have to face is time and getting
time may also be our greatest asset. As the debate continues and we
all realize that this is no normal recession we are in and that we
are not coming out of it quickly - the political leaders may realize
that this is a long term problem where, as a nation, I suspect we
shall probably spend the 1970's extricating and working ourselves from
the problems we got ourselves into in the 19 60's. That goes for
public business, private business and personal business.
I suspect that we all agree that New York City has been mismanaged and that the state has an obligation to assist it out of this
mess just as the Federal Reserve Board and Treasury have an obligation
to assist the government out of the mess it got into by spending 90
billion dollars more than it has as income.
Everyone became alittle too big for their britches and • ^ are in
a process of winding down. W. T. Grant and Penn Central and i hundred
others filed in Chapter XI. But the federal government did not wish
the Franklin Bank, The Security Ne! Lonal Bank or any other bank to
file, nor did it want I ckheed Aircraft to file. The federal government
has recognized that in ; : e national interest it will grant long term
.i
loans to Lockheed. The private sector has learned that it must help
work out the loans to some REITS - such as Chase Manhattan Realty
which has a negative net worth and the Federal Reserve bailed out a
few banks and assisted all the others.
The national debate will recognize that Lindsay and Beame
mismanaged the city and hat the state has now assumed management of
the finances through crt:.ition of some agencies controlled from Albany
and that the State intends to work with the private sector to straighten
the matter out. The Governor and Legislature have shown some
responsibility.
The mistake that Herbert Hoover made in 1929 was his great belief
in the capitalist system to the point where he would not realize that
to preserve it you must make accomodations according to the times.
Herbert Hoover -refused to permit the Federal Reserve Board to increase
the money supply in 1930. The problem that we face now in 1975-7 6 is
that the economies of the world, for a variety of reasons, will not
recover to the position the world was in in the 19 60's for a long time.
During the healing period during which time we have few trained doctors
and fewer medicines for the sickness of both inflation and recession
because we never suffered the disease before - accommodation will be
necessary in order to prevent a world wide depression^




247
There is, in my opinion, only one reason we do not have a major
depression today and that is because the Central Banks of every nat'on
from Argentina to the U.S. have stopped it. If in the United States our
Central Bank (Federal Reserve Board) had not intervened to lower the
federal fund rate last year from 12% to 4% and had not saved Franklin
and Security National Bank, we would have seen hundreds of bank
failures.
Help to New York one year ago would have been foolish because it
would have preserved incompetence and selfishness. But necessity is
the mother of invention and the State has done a great deal - possibly
all it can do. The healing process is beginning to take place and the
patient will recover if it gets some sympathy.
m
he argument that an insurance fund to assist all municipalities
is not good is simply not valid.
he setting up of such a federally
funded program of insurance for municipal bonds not only will assist
all municipalities but i- will set the tone for the century that is
*.
coming by setting up ce: ain criteria in order to be eligible for
that insurance, i.e., balanced budgets.

Furthermore, I believe that psychology is as important as anything
else in life. If such a fund is debated properly in Congress and in
the Senate :.d then set up - it will assist the recovery of the bond
and stock i u kets, restore confidence in the citizei: of this coun ry
r.
that a recovery is com: ig, and bring further dollars into the coun-'.ry
from abroad - strengthening the dollar at a time when we can use that
strength.
If that help is not forthcoming - the bond and stock markets will
collapse, as will many banks - and there will be a flight of dollars
and the government which has a 70-iO billion dollar deb' to finance
this year alone will not be able to sell its Treasury bi Is. When
the banks collapsed in the 1930's and we had a national catastrophe,
the government set up the Federal Deposit Insurance Corporation which
insures all savings accounts now up to $40,000. That fund not only
restored confidence in banks, resulting in the growth of this country,
but it has been called on very few times to make good.
A properly thought out bill will not only assist in preserving the
capitalist system and democracy but it will set up the guidelines that
cities will be required to do so that they are not mismanaged as New
York was.
New York is the center of the world. First in finance, education,
medicine, charity, media. It has been badly run and mismanaged but
that is being corrected. A default here, contrary to all that has
been said, will rock the boat in an economy already waterlogged.
As the debate gathers momentum and the public sees what Hew York is
doing to help itself I expect the President and his advisors to exercise
the statesmanship I think they have and to show this world that we as
a nation are not only good at building a defense establishment but
we know how to bend and accomodate a system that we are the leaders




248
in - in order to insure the continuation of the system, to show it
is viable, to restore faith to millions who are disbelievers and not
responsible for v/hat happened, and who will suffer greatly if New
York defaults and I don't mean necessarily only New Yorkers.
Respectfully,

Laurence w. Levine, Esq.
LWL:re




NEW YORK CITY FINANCIAL CRISIS
FRIDAY, OCTOBER 10, 1975
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS,

Washington, D.C.
The committee met at 10:10 a.m. in room 1202, Dirksen Senate Office
Building, William Proxmire, chairman of the committee, presiding.
Present: Senators Proxmire, Sparkman, Williams, Cranston, Morgan, Tower, Brooke, Packwood, and Garn.
Also present: Senator Abraham A. Ribicoff and Jacob K. Javits.
The CHAIRMAN. The committee will come to order.
This morning w^e are honored by the presence of a number of distinguished witnesses and particularly by our first panel and especially
by the Governor of New York, who is a former member of Congress and
served with a number of us on the Joint Economic Committee.
We have three witnesses here this morning on this panel. We will
have more on subsequent panels. Because we are all in such economic
straits, we can only afford two microphones.
We have Governor Carey of New York. We have Mr. Felix Rohatyn,
and we have the Honorable Simon Rif kind.
Gentlemen, you can present your testimony in any order and any
way you desire. We have other witnesses this morning. We would appreciate it if you would like to abbreviate your testimony. Anyway,
the statement will be printed in full in the record.
STATEMENT OF HUGH L. CAREY, GOVERNOR OF THE STATE OP
NEW YORK; SIMOND RIFKIND, PAUL, WEISS, RIFKIND, WHARTON & GARRISON; AND FELIX G. ROHATYN, LAZARD FRERES
The CHAIRMAN. We are graced and honored by the presence of the
senior Senator from New York.
Senator JAVITS. Mr. Chairman, I have asked for this privilege. Our
new Governor has had his share of trouble. We welcome him here
and commend him to the committee. He stood up to the trouble in a
most extraordinary way. New York has reason for hope and a great
deal of this comes from him. I would like to introduce one of our most
eminent financial authorities, Felix Rohatyn, and Judge Simon Rifkind has been my friend for at least 40 years. He is one of our most
distinguished lawyers and still is carrying on so importantly in the
public interest area coming to the rescue of our city which is in terrible
trouble now.
I am honored to introduce these distinguished New Yorkers to the
committee.




(249)

250
Governor CAREY. If I may, we are accompanied also by Nick DeNitzer, dean of the School of Public Administration of the New York
University, member of the Board of Municipal Assistance Corporation.
Mr. Chairman, I come to you today with as great a sense of urgency
as any Governor ever has felt in the history of this country. As a for*
mer Member of Congress, I know fully well how frequently you are
asked for financial assistance, for tax breaks and for the means to
enhance wealth or credibility. I come today on a very unique mission—to tell you that the default of New York City will cause not only
the bankruptcy of the State and city of New York, the devastation of
17 million people, but unforeseeable national consequences of such adverse and sizable nature that we have no choice but to prevent them.
I sense that among people in this Nation and their elected representatives there exists a strong feeling that New York City should be
punished for its past.
However you feel about New York City, a national policy of
punishment will only hurt 8 million innocent Americans who live
in New York City and another 4 million Americans who depend on
that city for their livelihood.
W h a t did any of those Americans do to deserve to suffer the uncertainty, the chaos, the slow death of their city which would result
from a default ?
I cannot stand here today and deny that New York City tried to
do too much for too many and that imprudent management was
certainly part of its problem.
But I do not wish to waste any further time discussing misconceptions about mismanagement or policies of punishment or apportioning blame.
I am here today to promote understanding. I am here to seek
recognition for all the State of New York and the city of New York
have done in recent months to repair the city's past and to prepare
for its future.
Last spring when investor confidence was so severely shaken that
the market for short-term city debt closed down, the State of New
York advanced nearly $800 million of State aid payments to the
city in order to provide time for an orderly review of the alternatives.
I felt it was my duty and obligation to keep the White House, the
Federal Reserve and the U.S. Treasury informed of the exact nature
of the city's financial problems and the severe consequences a default
would have on our State and Nation. I did that on several occasions.
I held lengthy conferences with all officials involved. I also sought
advice and constructive suggestions from those officials, and they
urged us to have the State step forward. They said that they would
only deal with the State in developing a possible Federal solution.
So on the advice of the highest Federal officials and on the advice of
highly qualified financial experts in our own State, we created the
Municipal Assistance Corporation—big MAC.
P a r t of the city's problem at that time appeared to be an excess
supply of short-term city debt, so MAC was designed to refinance
this short-term debt on a longer term basis. To secure MAC obligations
and to increase investor confidence in the political will behind this
effort, an important part of the city's revenue stream was diverted to
MAC. Finally, to restore investor confidence in the political will and




251
the managerial competence of city government. MAC was mandated
to work with the city in instituting managerial and budgetary reforms
which would restore the city's fiscal integrity.
Even after we accomplished all this, we were told by Federal officials
that all we had done was to exchange short-term debt for long-term
debt. They urged the State to do more.
Then over the summer it became apparent that the market had
not recovered from its qualms about New York City. For the sake
of that market and for the sake of the city, we determined we needed
more swift and more dramatic action.
Therefore, early last month I called the State legislature into
special session to consider the actions I felt were necessary to save
the city from default.
The legislature adopted my proposal for a commitment of State
and pension funds to meet the city's financing requirements until
December of this year. We appropriated $750 million of State funds
to help the city, as part of a $2.3 billion package. We put the credit
of the State of New York on the line. I t was a difficult decision, but
I believe we did the right thing.
The legislature also adopted my proposal mandating the city to
achieve a balanced budget in the fiscal year ending June 30, 1978, and
to show substantial progress toward budgetary balance in each of the
two intervening fiscal years. To assure the achievement of these goals,
the emergency financial control board was established, putting the
Governor and the State comptroller, the mayor and the city comptroller, and three qualified management leaders from the private sector
in charge of the city's 3-year financial plan.
The board has the power and the responsibility to assure a restoration of the city's fiscal integrity. I t will use that power to achieve fiscal
integrity. And with that integrity should come a restoration of the
city's creditworthiness in the market in due course in ordinary
circumstances.
The city must submit to the board a 3-year financial plan showing
a balanced budget in the fiscal year beginning July 1, 1977, and substantial progress toward a balanced budget in the two intervening
fiscal years. The board may approve, disapprove, or modify the financial plan to achieve the goal of a balanced budget.
To enforce the execution of this 3-year plan, the board has the
power to review and approve or disapprove a wide range of city contracts. I t may suspend municipal employee wage increases to the extent
it decides is necessary to achieve the objectives of the financial plan.
All city revenues are diverted to the Emergency Financial Control
Board which then disburses these funds to assure compliance with the
financial plan. In the event revenues in the board's fund are not sufficient to meet expenditures authorized by the financial plan, the board
is required by law to make payments on a schedule of priorities which
protects creditors first.
In the 33 days since the legislature approved mv special plan, the
Emergency Financial Control Board has proved it can meet the challenge of returning New York City to fiscal integrity.
Three outstanding members from the private sector—William Ellinghaus of the New York Telephone Co., Al Casey of American Airlines, and David Margolis of Colt Industries—have been appointed to




252
the board. We have met six times, and a spirit of utmost cooperation,
understanding, and unity has prevailed at each meeting. Each member
fully appreciates the board's critical mission.
We have determined accurate 3-year revenue estimates for the city.
At this week's meeting, a week ahead of schedule, the board received
the first draft of a 3-year financial plan from the city. The purpose of
that plan is to reduce city expenditures to match its revenues so that
when the city returns to the credit market, it will be a good investment.
We are in the process of reviewing city contracts and collective bargaining contracts. We are reviewing the city's tax revenues to determine which taxes would be extended, which should be eliminated as
counterproductive, and which should be adopted as substitutes where
necessary.
I n short:
I n a city with the strongest municipal unions in the Nation, there is
a wage freeze.
I n a city with the largest construction industry in the Nation, there
is a freeze on new capital construction.
I n the financial capital of the world, a State agency completely
controls New York City's access to money.
These actions, though harsh, are not inconsistent with the steps I
have had to take since the day I took office:
The actions we took to save the Urban Development Corporation.
A State hiring freeze which has resulted in more than 5,800 fewer
employees.
One of the lowest collective bargaining settlements in history in
which 140,000 State employees were held to a 3.5-percent increase on a
nonrecurrent basis.
None of these actions is inconsistent with what is happening in New
York City.
Last month, botli the Democratic and Republican leadership of the
State of New York faced a most difficult decision. I t was not easy to
decide to put the credit of the State of New York on the line to give
New York City time to survive. But both the Democratic and Republican leadership of our State government felt we had no other choice.
Now our State's resources are stretched to the limit. Now, I must
tell you, as a State, we have done all we can to help New York City.
The State of New York cannot guarantee the securities of New York
City. We have neither the resources nor the power. I n fact, our State
government is smaller than the government of New York City.
Now we seek recognition from the Federal Government for what we
have done. We need and we deserve Federal assistance. We are not
asking for a handout or a bailout. We are asking for a sensible solution—a limited guarantee of the securities issued by the Municipal
Assistance Corportion—the State financing agency for the city of
New York.
The securities covered by the guarantee should be of a relatively long
maturity—at least 10 years—so that with a guarantee on bonds with
a principal amount of $5 billion we can effectively handle New York
City's remaining short-term debt. With the effective action of the
Emergency Financial Control Board and this Federal guarantee, we
will make certain this is a nonrecurring problem.
We are proposing that these bonds be taxable for three reasons:




253
To prevent the downgrading of other taxable securities because a
tax-exempt and guaranteed security would be superior to every other
security in the market.
The removal of New York State from the tax-exempt market would
benefit other municipal borrowers in the country.
The taxes on the bond's income would yield revenue for the Federal
Government.
The City's Emergency Financial Control Board will see to it that
the city achieves a balanced budget so that the guarantee is never
drawn down.
If we get the Federal assistance we need, I can promise you that after
1977, New York City will never again have to borrow beyond its means
to meet its operating expenses. And I promise you that in the mechanisms and institutions I set up to meet this goal, I will not only insure
that this will be true during my administration, it wTill have to be the
policy of future Governor's who may succeed me.
One of the best ways we have of preventing major errors in foreign
policy is a sound system of intelligence.
A lack of intelligence information caused a great national disaster
on December 7, 1941.
I come before you today with intelligence information which you
must use to prevent an economic Pearl Harbor on December 75 1975.
While I can't predict for certain all the severe national and international effects of a default by New York City, I can tell you what
problems the situation has already caused in our State,
Our major State agencies—agencies with sound, secure revenues and
the certain ability to pay debt service—are in severe danger of default
because of the crisis in confidence in the Nation's municipal bond
market.
The New York State Housing Finance Agency which has financed
800 projects worth $5.8 billion over the past 15 years cannot find a
market for its sound securities.
Neither can our State's dormitory authority, environmental facilities corporation and our medical care facilities finance agency.
What will happen to $1.6 billion worth of projects underway by
these State agencies in New York ?
I can answer that.
Our State will be spotted with empty monuments to default, partially built classrooms, dormitories, public and private hospitals,
mental health facilities, day care centers, nursing homes, water pollution control facilities, and housing for low- and middle-income families, to name a few of the ongoing projects—will forever stand as only
steel and concrete, incomplete.
Our sick, our elderly, our children in need of education, our working
mothers, and all of our citizens will forever be denied the vital services
those facilities were designed to provide.
Billions of dollars in capital will be wasted.
More than 53,000 workers who depend on these four agencies for
their livelihood will be sent to the unemployment lines.
So I must ask, what will happen to the projects, the services, the
capital, and the jobs in 3>] other States with similar agencies?
New York State's localities and sewer and water authorities need to
accomplish $1.1 billion of their traditional, regular borrowing between
now and March.
60-832 O - 75 - 17




254
Yet local banks which in the past bought their paper without question because that paper was sound, have now turned their backs and
closed their doors.
So I must ask what will happen to local units of government across
our Nation who must have access to the credit market to meet their
cash flow needs and provide services to their citizens ?
Hundreds of NewT York State school districts will need to achieve
$1.2 billion in traditional borrowing between now and next June.
Local banks are closing their doors to our school districts.
This week I received a letter from the East Islip School District in
Long Island.
The finances of that district are and always have been sound and
secure.
That district needs to make three offerings of securities totaling $5
million between now and January 1976.
Local banks in their words "are not willing to deal with us at any
price."
On October 1, the school district was able to obtain a loan of $800,000
for 30 days at a 11.15-percent interest rate. So I must ask how will
the children of New York State receive their education in the future?
What will happen to the future education of all the children in our
Nation as the disease of default sweeps our country ?
We know that most of New York State's paper is sold in New York
State. But who owns New York Citv? Who will be hurt if New York
City defaults?
Individuals with their life savings invested in New York City—
not only banks—but business in every State of the Nation own New
York City. So we must ask ourselves, what will happen to businesses
whose future depends on loans they have secured with New York City
as collateral ?
The Congress of the United States must ask itself: What purpose
is there now to the National Housing Act passed last year?
For that legislation assumed localities would have access to the
credit market at normal interest rates.
W h a t will become of that legislation with the municipal market in
shambles ?
The Congress must also examine the effects of New York City's problem on its local revenue sharing programs.
I know of one respected economist who estimates that skyrocketing
municipal interest rates could cost localities across this Nation up to
$3 billion. That would negate one-half of the Federal general revenue
sharing funds. What Federal plan is there to help the citizens in
localities across this Nation faced with increased local taxes to pay
those interest costs?
If the purpose of nonintervention on the part of the Federal Government is to teach New York City a lesson and force it to economize,
there is a sense in which this policy might turn out to be both ineffective and extremely costly to other governmental units.
What notice will there be for the city workers to continue their
self-sacrifices and to provide vital services with the city as a trustee of
the Federal Government ?
A city in default is a demoralized city. Will a city under Federal
occupation and control have any motivation to pay its debts?




2,55
Those governmental units that have issued long-term bonds at higher
interest rates and do not default, on the other hand, will be forced to
continue to pay these higher interest rates over the life of the bonds.
The question is: Will most governments be willing to do this after
there is a New York City default? Or will they see default as an
accepted way to unload their debts? Do we, as a Nation, want to set
national policy which encourages local government to throw in the
sponge, to give up trying ?
New York wants to pay its debts, we want to attend to the errors of
the past. We simply seek recognition for all we have done.
I am the first to admit that under the system New York City used
to keep its books, it was difficult, to say the least, to get proper information on the city's financial situation. Now the books are not only open,
the figures are sound and dependable.
I invite any member of any congressional committee, or for that
matter, the administration to examine the books of New York City or
NewT York State. We invite constructive suggestions and advice.
I t seems I have raised as many questions as I have answered today.
The fact we have no answers to the questions points to the fact we
need in our Government an orderly system in which we can find these
answers, so we do not have to speculate on the unforeseeable effect
of default on our Nation's economy. Whoever is willing to stand up to
the questions I have raised today will never again be able to say that
the effects of a New York City default would be contained within the
borders of our city or State.
Whoever is willing to stand up to these tough issues will never be
able to deny that New York City's problems are national, indeed
international, in scope and effect. And no Member of the U.S. Senate
will be able to overlook the certainty, that if New York City is
allowed to default, the financial problems of New York City will
be in his State very soon.
The choice before the U.S. Congress is clear:
Either a limited guarantee of the securities of New York State's
bonds which will cost nothing, which will, in fact, add revenue to the
Federal Treasury;
Or a default of New York City, which I am certain would be the
most costly mistake in the history of this Nation, economically, in
dollars, in human suffering and in the erosion of our democratic institutions.
I cannot deny that there is a contagion in New York which is about
to sweep across the Nation. Don't kill us because we are ill.
We are asking for your assistance so that we can cure ourselves
and contain the contagion. I do not relish the prospect that on our
Nation's bicentennial anniversary, the citv which was this Nation's
capital in 1789, may be occupied by the Federal Government. Nor do I
look forward to the slow yet certain death the financial, cultural and
entertainment center of the world would suffer if it is denied Federal
assistance and allowed to default.
Mr. Chairman, I look forward to the Congress of the United States
in the great tradition of this bod>\ acting in the national interest in a
timely manner to help us cope with our condition.
The CITAIRMAX. Thank you. Governor.
Mr. Rohatyn.




256
Mr. ROHATYN. My name is Felix G. Rohatyn. I am a general partner in the investment banking house of Lazard Freres & Co. I am
here today in my capacity as Chairman of the MAC to ask for your
support for a Federal program to prevent the unnecessary default
of the city of New York. I believe that both from a banking as well as
a human point of view this is a tenable position. But let me first, as
an investment banker, talk about the city. There I am concerned
with certain issues:
1. Whether New York City is financially sound.
2. Whether it is viable from a management point of view.
3. Whether it can provide its services at an acceptable cost.
When Governor Carey asked me in late May to assist on a panel
to help resolve a mounting crisis, it was apparent that none of these
criteria were being met.
The, city had no credible financial plan to get to a balanced position.
The city's management could not demonstrate that it could deliver
the services required of it with the money available to it.
The city's management was not credible to the public and to the
institutions whose support was required to keep the city going.
We recommended creation of MAC. The Governor accepted it. And
it provided the bridge which enabled us to walk, or stagger, from
June to October. At least we can point with a certain amount of pride
to the fact that, as the Governor has pointed out, enormous strides
have been made, and we have so far prevented a default.
I believe that today we have the main elements required to put any
economic unit back on its feet. We have fiscal control, exercised by the
Financial Control Board, to determine how much money the city has
available to it and which sees to it that the city spending is held
within those amounts. We have the beginnings of a restructuring of
the operational management of the city. We have a financing vehicle
in MAC.
I think you would all agree that as of today there is a plethora of
talent—of business talent, of management talent that is being brought
to bear on city management practices and personnel. This talent is in
for the duration.
I would be less than truthful if I told you that everything today
is in place to run the city as I and investors all over the country might
like to see it run for the next 10 years. But the process has started and
will not be stopped. The MAC legislation and the emergency legislation passed last month required that the city's budget be in balance by
the fiscal year beginning July 1,1977. The men now involved are erecting a fiscal fence around New York City—they know how to read balance sheets, read profit and loss accounts, judge management methods
and systems.
The history of the past few months and specifically negotiations
which involved MAC with the municipal unions have convinced me
that the majority of the city's union leadership is anxious to see more
efficient city management.
They see it as the only way for the city to survive and for a smaller
stabilized work force to be secure about its future.
The city will get into balance because it has to. Period. Management will determine whether the city is a livable place or a fiscal
success but a social failure.
All of you know that any reorganization takes time. All of you
also know that it is far better, economically, professionally, and hu-




257
manly, to permit a sick situation to be cured over a period of time
than to chop it to pieces. The cure involves imposing stringent conditions on the city.
If I am right that the control mechanism is in place and the beginnings of sound management practices have been initiated, then the need
is for a financing mechanism to make it happen within the statutory
8-year period. From the outset we perceived MAC as the appropriate
financing mechanism. However, while the mechanism is sound, the
markets have closed down, not only around the city but on MAC and
the State.
Most experts agree today that neither MAC nor the State of New
York full faith and credit obligations are poor credits.
What they are facing today is nonmarketability which as you know
is a quite different matter.
However, lack of marketability can be as lethal as poor credit. I
believe that performance to date and the security behind MAC entitles it to a market at reasonable interest rates.
However, I question whether there is anything that we can do at
this point to open the market in the near future.
The problem we are facing is also the result of a more profound
and basic economic dislocation.
Whether a dramatic or conventional form of fiscal discipline is involved, one fact is clear. A severe, capital shortage is looming over the
next decade or two.
This shortage is going to affect every person in this room and every
city and State to which you are committed. It is going to put significant restrictions on this country and will create greater and greater
requirements for efficiency on the part of elected officials to enable them
to deliver services to their constituency.
Politicians will have to learn not only in New York City, but all
over this country that organizations requiring large amounts of capital must discipline themselves in order to have that capital made
available.
Looking back over the last 15 years it is easy to say that the problems
of the city have been caused by mismanagement and by fiscal gimmickry. It is easy to say and it is undoubtedly true. I t would be equally
true to say that money was made available to the city in ridiculous
amounts and on ridiculously easy terms. The financial community, of
which I am a member, has to bear its share of the blame for what happened to the city.
Financing vastly beyond the limits of prudence was obvious to even
the unsophisticated. What happened in New York City was written on
the wall. It was inevitable that sooner or later the crisis would occur
and the political process failed in preventing the crisis.
Certain of New York's problems are probably unique to it—but the
fact remains that New York City is not all that unique. I don't believe that most of you sitting here as you think it through will feel
that your cities and your States are all going to be immune from these
problems. What is the answer for us then ?
Over the last 4 months since the creation of MAC we have raised
approximately $2.5 billion dollars with the superb support of the
New York banking community, with additional support from other
local institutions, and with practically no support whatsoever from
out-of-State financial institutions. The Governor has told you what
actions have been taken.




258
The existing financing may see us through the beginning of December although there are uncertainties even during this period. If we do
reach December 1, we will have raised close to $4 billion, involved the
State to the extent of $750 million, and scraped every known resource
available to MAC, the city and the State.
By December 1 there may be some avenues still open to us in a
limited way but absent to an assured financing mechanism that would
enable us to fund out our 3-year plan, the odds against our winning
are exceedingly long.
When, in August, it became apparent that the markets for MAC
securities would be closed to it in September and the Governor asked
for recommendations involving possible State and/or Federal action,
we were mindful of the proposition that no Federal involvement could
be contemplated until the State itself had made a major commitment
both in terms of the control of the City's finances and in terms of the
State's financial involvement itself.
The legislation which the Governor asked the legislature to approve
contained both elements of this approach. The commitment of $750
million of State funds spread over a 3-month period of time seemed to
us to include a significant involvement of the State but in the light of
the State's resources and history, did not seem to threaten the State's
integrity significantly more than it wTas already threatened by a possible default of the city of New York.
The markets have, however, closed upon the State as well as upon
MAC, and as well as upon creditworthy State agencies, such as the
F H A . Without the State Comptroller's commitment of State pension
funds to acquire the $250 million of State notes prior to October 17, the
State would undoubtedly be unable to fulfill its commitment to make
$250 million available to the city as part of the fiscal package at that
time.
Although a default is technically defined as the failure to pay off a
debt as it becomes due, in my judgment, had the State failed to meet
its commitment to make $250 million available to the city in October,
as it is committed to do legislatively that would have meant an actual
default in real terms, quite as serious as the failure to meet a debt
maturity as it became due.
The present financial crisis of the city of New York, even after taking into account significant action taken over the past three months
by city, State, financial community, and the private sector, has successively shut off access to markets of city, MAC, State agencies and,
now, the State of New York itself. The total amount of indebtedness
involved of these entities is close to $30 billion, or about 15 percent of
the total municipal debt outstanding in the United States.
Many arguments have been heard recently on either side of the question of the impact of a default of the city. I have given it as my professional judgment that an impact of a city default would inevitably
lead to default of major State agencies, and of a possible default by
the State of New York itself.
I believe the impact of such a series of defaults is not containable
without major cost to the economy, and to our international position.
I believe that domestically the economic recovery would be seriously
damaged and that in New York City itself an irreversible exodus of
corporations and businesses would condemn the city's tax base to a
fatal downward spiral. Abroad it would seem to me that such a failure




259
would be attributed to either a fundamental structural failure of the
capitalist system, or to be the result of divisions within this country
so profound as to paralyze its will to act.
I realize that these are judgments, and that human judgment is
subject to error. It seems to me, however, that the assumption of a
major needless, and I emphasize needless, economic and social risk in
the name of fiscal prudence, is neither good logic nor good policy.
We are looking for Federal involvement to maintain an orderly
market in our obligations, so that we can bring our program to a
successful conclusion and pay our debts 100 cents on the dollar.
There are several approaches that could accomplish that purpose and
we are open to different possibilities. As far as MAC is concerned,
our choice would be for a program of Federal guarantees to MAC
bonds, with taxable interest on those bonds at the time the guarantee
goes into place.
We do believe that only State agencies such as MAC should be
eligible for such Federal guarantees and that approval by Federal
authorities in addition to the Emergency Fiscal Control Board of the
city's 3-year fiscal plan would have to be involved. We believe that an
appropriate insurance premium and the possible pledge of Federal
revenue sharing to protect the Federal Government would be
appropriate steps for discussion.
The hour is very late. A financial virus has existed in New York and
we want to keep it from contaminating the rest of the country. You
have witnessed the spread of this virus in spiraling municipal interest
costs and deteriorating investor confidence. Assured access to markets
while the city gets into balance is the best way to vaccinate the rest
of the country against this virus.
At a time of early economic recovery a massive default anywhere is
dangerous. A default of mammoth proportions, involving city and
State, that was both unnecessary and avoidable would be an inexcusable tragedy.
Thank you very much.
The CIIAIRMAX. Thank you.
Mr. Rifkind, do you have a statement?
Mr. R I F K I N D . I shall make no statement. I shall be available to
answer questions should they occur within my field of competence.
Governor CAREY. I have before the committee a letter dated yesterday and I carried with me today a copy. The letter is signed by
former Treasury Secretary C. Douglas Dillon and former Secretary
of Treasury Henry IT. Fowler. It addresses this problem in great
detail.
In brief, its recommendation is that the Federal Government adopt
an appropriate affirmative role in this crisis and it indicates on page 2
at the top, first paragraph, that no one can predict accurately the
consequences of default in the city's debt obligation.
But there is no doubt in the words of Secretaries Dillon and
Fowler "that it would threaten serious damage to the city, State,
and Xation."
I ask that the letter be included in the deliberations of this committee
in the appropriate form.
The CIIAIRMAX. That will be done. These are both former Secretaries
of Treasury, both of whom served within recent years.
[The document follows:]




260
The Honorable
William Proxmire
Chairman
Senate Banking and Currency Committee
Room 5300
Dirksen Senate Office Building
Washington, D. C. 20515

October 9th, 1975.

Sir,
The undersigned submit this to you, and through you, to the m e m b e r s of the
Senate Banking and Currency Committee for inclusion in the record of the current
hearings on the New York City and State financial situation.
We believe that the Congress at this session should promptly authorize
an appropriate affirmative action role for the federal government to work in
cooperation with states in preventing the financial collapse of local government
that would adversely affect the national interest. This legislation should be
applicable to any state faced with a financial c r i s i s affecting units of local
government that is beyond its r e s o u r c e s to solve effectively.
The current financial c r i s i s of New York City, in which the State of
New York has intervened, makes this policy determination desirable and timely,
New York State has assumed overall control of the City revenues and
expenditures through the Emergency Financial Control Board. It has established
a special state agency, the Municipal Assistance Corporation, to undertake
financing designed to restructure the City's debt obligation by, among other things,
transforming the City's short t e r m debt into long t e r m obligations. It has
committed substantial State financial r e s o u r c e s to its rescue attempt.
Despite these efforts, continued lack of access to the private financial
markets and state constitutional and legal hurdles will lead to an early default
on the City's debts unless the federal government lends the state a hand. That
is the considered opinion of the state and city authorities, the knowledgeable
bankers, the credit rating agencies and those involved in the day to day operations
of state and municipal finance.
Under these circumstances the State seeks meaningful federal participation
in its program to r e s t o r e financial and fiscal order to the City.




261
No one can predict accurately the consequences of a default on the City's
debt obligations. But there is no doubt that it would threaten serious damage to the
City, state and nation.
For a few examples.
1.

The credit of the City would be impaired indefinitely, disabling it
from effectively providing essential local public services for the
millions of people who live, work or travel in New York City. The
risk of collapse of these services if New York City cannot borrow,
while the Emergency Control Board and the Municipal Finance Corporation readjust the City's finances to a credit worthy position, is grave.
The ensuing damage could be incalcuable, and the social and economic
consequences intolerable.

2.

The financial position of the City's creditors, not only in New York City,
but throughout the United States, including banks, other non-bank financial
and business organizations, and many thousands of individuals would be
seriously impaired.

3.

The iinpact of a City default on New York State credit would surely threaten
the ability of the State and the various state and city agencies to c a r r y on
their financing programs through the normal financial and credit market
mechanisms. They a r e already jeopardized.

4.

Municipal and local governmental unit borrowers all over the United States
would find their costs of borrowing appreciably higher and, in many cases,
their very access to credit markets questionable. Even before a default,
the m e r e threat has caused interest rates on much local financing to
increase far out of proportion to increases in corporate bond r a t e s .

5.

The real and psychological effect of a failure by New York City and New
York State to resolve this financial c r i s i s would injure the badly needed
recovery of the national economy - witness Dr. Arthur Burns.

6.

Leading foreign bankers and financial leaders voiced their apprehension
frequently in the c o r r i d o r s of the recent Annual Meeting of the World Bank
and International Monetary Fund concerning the international repercussions
of the New York City default. These low key fears have now been publicly
reinforced by the forthright comments of Chancellor Helmut Schmidt in
the United States last week and attributed statements of European financial




262
leaders in recent news dispatches. The shock of confidence, with its
"domino" or ripple effect could have a serious impact on capital m a r k e t s
everywhere. As one foreign expert put it, "Investors would invest l e s s .
Consumers would buy l e s s . " Or as another commented, "The whole
system of lending money would otherwise experience a serious setback. "
Given the State action described above, the urgent request of its leaders
for federal help, and the vital national interests threatened by this financial
c r i s i s involving the financial capital of the United States, affirmative action by the
National Government to a s s i s t the State in its efforts is wholly consistent with
the constitutional framework of federal-state relationships.
Indeed, a refusal by the federal government to act, thereby assuring a default, is likely to plunge federal judicial, legislative and executive agencies
directly into the local administration of a bankrupt city.
Of course, this legislative policy of federal participation in state efforts
to avert a financial collapse of a local government must be established on suitable
guidelines.
The method and pattern of assistance should be in keeping with the constitutional standard of appropriate federal state relationships. The a r r a n g e m e n t s
provided for must be with the state and its agencies upon the application of the
state. Direct channels between City Hall and Washington should be avoided. The
p r o g r a m must be burden sharing and not buck passing.
The assumption of a role of lender or guarantor should be on t e r m s and
conditions that do not place any additional burden on the federal taxpayer, or add
to the cost of federal debt servicing. The role of the federal government should
be as a lender of last r e s o r t , not a subsidizer of financial mismanagement.
These t e r m s and conditions should make the extension of assistance contingent upon an undertaking by the state to impose stringent fiscal and budgetary
practices upon the local government that will assure an orderly stoppage of debt
accumulation and an early transition to a meaningful p r o g r a m of debt r e t i r e m e n t .
The rates of interest on a federal loan or the charge for a federal guarantee
of a state or local security should be at a level sufficiently high to discourage other
states and localities from turning to the federal government in this type of situation
except as a last r e s o r t , when other more attractive solutions a r e not available.
These rather harsh standards applicable to financial rescue parties should




263
not imply an opinion that there should not be a re-examination of other separate
longer t e r m m e a s u r e s by the federal government or the states to relieve urban
centers, such as New York City, of costs that should not be saddled on the local
unit or are inequitably distributed. Time does not permit these answers to be
worked out for inclusion in the proposed financial legislation.
We would not wish to attempt to pass judgment on the exact choice of means
to be employed for federal action in this particular financial c r i s i s involving
New York. In our view, the authorizing legislation should be rigid in the standards
and t e r m s and conditions for federal participation along the lines outlined, but
flexible in the instruments and methods to be authorized.
Both federal loans or federal guarantees of state or local securities should
be made available. But interest payable on state or local securities issued in the
public market or through private placement with the guaranty of the federal government should be subject to federal taxation in the same manner as federal Treasury
securities. Moreover, as indicated above, a suitable premium should be paid
by the borrower to the federal Treasury for the use of the loan guarantee. This
premium would be designed to induce the ultimate borrower to conduct its affairs
so as to reduce its debt burden and to regain ready access to the private capital
market rather than to continue reliance on the federal guarantee.
On the same reasoning, a direct loan should be at interest rates that include
a spread over the cost to the U.S. Treasury of the financing that will avoid any
subsidy to the city taxpayer or place any added expense on the federal taxpayer
and that will be conducive to earliest possible repayment.
It seems undesirable and counterproductive for federal participation to
be conditioned on an agreement that all holders of existing securities by the City
or the Municipal Finance Corporation defer payments of interest and principal
so as to assure repayment within a short period of years.
There is much doubt that an agreement could be secured in time and if
secured it would be clearly labelled as a forced default, however technical or
managed.
A more appropriate alternative is to use interest rates on federal loans
or premiums on federal guarantees that include spreads over the cost of
financing to the U.S. Treasury sufficient to induce repayment as soon as practicable and to encourage renewed access to private capital markets and sources
of credit on the more favorable rates normally available to creditworthy municipal
borrowers.




264
This alternative avoids a bail-out of the local taxpayer at the expense of
the federal taxpayer. It encourages elimination or reduction of reliance on the
federal participation. It does not repel the private investor or lender from
renewing its participation in a return of New York City securities to the
private capital market. It does not convert the federal participation into
forcing what amounts to a technical managed default with much of the real
economic and psychological shock to confidence in municipal securities p a r t i cularly, and debt instruments generally, to say nothing of the damage to the
future of New York City.
This course seems clearly preferable to a forced stretch out, even of the
obligations of the largest c r e d i t o r s , who should be encouraged to take part in the
return of New York City financing to the private m a r k e t .
The federal and state authorities should be encouraged to negotiate
voluntary agreements with these large creditors and investors holding existing
New York City or agency paper to exchange longer t e r m paper for obligations
maturing in the next few y e a r s . This action will relieve some part of the cash
flow problem inherent in the pay off of early maturing obligations. It will also
reduce the scale of the utilization of federal loans or federally guaranteed
securities at the penalty interest rates contemplated.
The size and scale of the federal package to be authorized will undoubtedly
be a matter of some debate. We do not feel qualified to deal with the precise
n u m b e r s . However, there is one rule of thumb that has some m e r i t . The amount
authorized for loans or the limits for federally guaranteed securities to deal with
New York's situation, should be sufficient to enable the City and the State and City
agencies caught up in this c r i s i s to stay out of the public capital m a r k e t s for an
appreciable period of time. In addition to this amount, their should be a r e a s o n able allowance for similar problems that may occur in other states.
This breathing period free from the day-to-day c r i s i s atmosphere will be
n e c e s s a r y to provide an opportunity for the remedial budgetary and fiscal
m e a s u r e s now being launched to become understood, appraised and evaluated.
It is this process which is a necessary preliminary to any r e - e n t r y of
New York City securities into the public m a r k e t s for private financing.
We do not believe that given the onerous conditions prescribed above, the
t e r m of the federal loans or the federally guaranteed security issues should be
short. Of course, they should give the borrower the option to pay off without




265
penalty well in advance of the maturities along with the interest rate or premium
inducement referred to above. But the very essence of most debt induced problems
of state or municipal financing is an excessive reliance on short t e r m debt. This
oftimes gives r i s e to cash flow problems and sometimes creates market access
difficulties that threaten default where none should occur. In most cases fundamental credit worthiness or the risk of an ultimate loss to the creditor is not the
case. Nor do we believe it is the case with New York.
Therefore, the federal government should be willing to lend long provided the
other t e r m s and conditions described above are satisfactorily met.
While the maturities of the direct or guaranteed loans authorized should
be sufficiently long to permit an orderly working out of this financial problem,
the law itself should terminate within a few years so that additional loans and
guarantees initiated beyond that termination date cannot be processed.
This termination will a s s u r e an orderly review of the situation before
the date of termination to determine whether conditions then existing make a continuation desirable or permit the federal government to r e t i r e from this activity.
In conclusion, having observed this New York financial c r i s i s develop at
close range over the last few months, we submit that the time for affirmative federal
action has arrived.
The means ultimately chosen and the t e r m s and conditions a r e the proper
subject of deliberation and debate. But the ultimate outcome - a helpful and
timely federal partnership with the State to manage this type of local c r i s i s towards
a constructive solution that does not reward fiscal irresponsibility but puts the
local governmental authority back on the path to financial soundness - should not be
in doubt.




Respectfully submitted,
C. Douglas Dillon
Henry H. Fowler

266
Governor CAREY. I have correspondence from Hon, Robert V.
Roosa, Undersecretary of the Treasury formerly and he's assessed
this in like manner. He has a slightly different recommendation to
make with regard to loans and guarantees.
In effect, he also underscores the fact that default by New York
City would have unforeseeable and grave national and international
consequencies.
The CHAIRMAN. Thank you very much, Governor.
I submit that for the committee record as well.
[The document follows:]




267
ROBERT V ROOSA
5 9 WALL STREET
N E W Y O R~K, N. Y I O O O 5

October 6, 1975

Dear M r . Governor,
You and your associates have really made i m p r e s s i v e
p r o g r e s s since we first began, s e v e r a l months ago, talking
about the inescapable need for the State to exert responsibility
in the New York City situation. T h e r e is no doubt that the a p proach to c o r r e c t i v e action that began with establishment of the
Municipal Assistance Corporation has been essential in p r e venting thus far an outright default by New York -Gity* - T h e r e i s r
also no doubt in my mind that the further c o r r e c t i v e action b e i n g taken under the influence of the new Emergency Financial Control
Board is a n e c e s s a r y p r e r e q u i s i t e for toning, as now m u s t be
done, to the F e d e r a l government for m o r e direct participation.

-

My own contacts with financial institutions a c r o s s the
country and around the world have long ago persuaded m e that d e fault by New York City would be a d i s a s t e r of resounding significance. A confidence c r i s i s in the financial capital of the world
could spread rapidly through the many delicately balanced econom i e s of other countries which a r e still so heavily dependent upon
the use of the dollar for their r e s e r v e s , t h e i r t r a d e and their i n vestment.
This does not m e a n , as I mentioned in one of our meetings
s e v e r a l months ago, that I would urge a F e d e r a l guarantee of the debt
obligations of New York City, nor even of New York State. During
my s e r v i c e in the U. S. T r e a s u r y I steadfastly r e s i s t e d the s t r e t c h ing of Federal guarantees to cover obligations at the State or local
level because I thought t h e r e would be no end to the p r e s s u r e s that
would then be placed on the credit of the F e d e r a l government. And
indeed, as Seer >tary Simon has so often repeated, that kind of g u a r a n tee would make the obligations of these other l a y e r s of government
clearly preferable in the marketplace to the direct obligations of the




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U. S. itself. But Secretary Simon should not, in my view, regard
the rejection of guarantees as the whole answer to any call for
Federal government involvement in the emerging New York financial
crisis.
The answer, as I see it, is to deal with this situation as an
unusual emergency. If time only permitted, the best approach
would be through establishment of a Federal agency to cope with the
succession of financial crises that have been created by the distortions
which inflation (and at times even mismanagement) have brought to
the American economy — ranging from the Penn Central to the Franklin
National and Lockheed and now New York City. Time is too pressing,
though, to permit establishing an entire new organization, patterned
after the old Reconstruction Finance Corporation, to cope with the p r e s ent problem. The form of any emergency action should, however, be
such that it could later be "folded into" a "Disaster Finance Corporation."
Such a Corporation, under a more felicitous name, should be created
with all possible dispatch once ad hoc arrangements have been established
for the current New York crisis. The immediate arrangements should
consist of an emergency loan program, which Congress could create
within a few days, and should be under a special administrator appointed
by the President. Later on, the studies being initiated by the Administration to reappraise the Federal contribution to various programs within
the New York City budget, will no doubt lead to further appropriate
assistance on the revenue-side. But that cannot meet the maturing obligations of the coming weeks.
As I see it, there should not be a direct relationship, however,
between the emergency Federal loan program and the City of New York.
Respect for the principles of federalism do, I believe, call for the extending of any emergency assistance, as authorized and appropriated by
the Congress, directly to New York State. It should be for the State in
turn to continue employing its leverage — and the leverage further introduced by the conditions established for Federal lending — to assure those
corrective actions that can bring a balanced budget to New York City within the next three years.
There is much more that should be said to articulate the approach outlined in these few comments. I am very sorry that unshakeable commitments will keep me abroad from October 8 through November
4. I trust that some form of emergency action at the Federal level will




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have o c c u r r e d during this interval. As you know, if t h e r e i s
any way in which I can be of a s s i s t a n c e on my r e t u r n , I will
certainly b e ready and willing. With admiration for your courageous effort and with all good wishes,
Sincerely,

The Honorable Hugh L. Carey
Governor of the State of New York
1350 Avenue of the A m e r i c a s
New York, New York 10019

P . S. P l e a s e feel free to use this letter in any way that you
consider helpful.

8T - 9L ~ O

SS8-0!




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The CHAIRMAN. YOU gentlemen have given us forceful and persuasive argument. You say, Governor, on page 6, " I invite any member of any congressional committee, or for tliat matter the administration to examine the books of New York City and New York
State." You invite suggestions and advice.
On page 3 you say this week you have determined accurate 3-year
estimates for the city. 1 feel it will be difficult for the Congress to
put together and pass and get enacted into law liie kind oi assistance measure requested. I t is not impossible. WhaD we need above
all is the facts.
This committee, I think all of us recognize the great seriousness
of this matter. We want to examine the iacts carefully. If you will
give us the draft of the 3-year financial plan, keep up to date as you
get the information, pass it on; this committee will be grateful for it
and we will put our stall" to work on it and we will w^ork on it ourselves.
Governor CAREY. We will do so, Mr. Chairman. We have intended
to speed up our schedule anticipating that these facts were needed
to be known. Had you asked for that in early summer, we could not
have provided it because of the condition of the city's records. We
now can do that.
That has been a vast undertaking to straigthen out the records of
that city to accurately reflect its condition. We can do that now.
The CHAIRMAN. We have to see what is possible here. Not what
we would like to provide. W h a t we can get through, I think, will
be limited. You have suggested a guarantee.
Would it be possible to have that guarantee a partial guarantee
rather than a 100-percent guarantee ?
Governor CAREY. Indeed, in the Judgment of the committee, a parttial guarantee would more clearly involve the city as a matter of risk
and make more stressful the discipline that involves the city as a
monitor with the State and Federal Government; that form certainly
deserves consideration.
The CHAIRMAN. Yesterday Senator Javits suggested that the
revenue-sharing entitlement of New York be used as collateral or
partial collateral at least for this kind of guarantee.
How far would that go ?
Governor CAREY. The total State revenue-sharing funds are $623
million. The city share is $230 million. Certainly the State and city
share being obligated as well as other block funds such as the housing stipend under section 8 are identifiable for indemnification case for
the need of defaulting of the guarantee. Those funds are recurrent.
The ttoal revenue sharing of the country, I believe, is $5.6 billion.
If I'm correct, the recommendation of the administration is that
be reenacted in that sum. The city's and State's share together would
exceed $400 million on an annual basis.
The CHAIRMAN. H O W much of these funds could and would, in fact,
in your judgment, be made available as a pledge or guarantee or
mortgage for this guarantee ?
Governor CAREY. We were assuming that the guarantee wrould not,
in effect, be implemented. So the moneys are, frankly, devoted now
principally to the areas of needed local support, law enforcement to
government city activities in the better handling of its sanitation and
other problems. State moneys unlike the city moneys in some cases
are obligated to educate. If the—the moneys are under the control




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of the Secretary of Treasury to disburse the fund according to the
revenue-sharing law. If they were called to back the guarantee, we
would have to accommodate that.
The CHAIRMAN. What I'm getting at is I understood you to say
the Federal Government would lose nothing and would make money
on this.
Governor CAREY. On the taxable side and premium.
The CHAIRMAN. What assurance could we give the Congress and
American public that this was a collateralized safe guarantee, that it
is a matter of providing a guarantee so you can get back into the
market and solve your cash flow problem? So that New York will
be in a position where it will be sound. The guarantee would in all
likelihood be redeemed.
Governor CAREY. We are suggesting that the guarantee flow to a
State agency such as the municipal assistance corporation. The State
is liable to the Federal Government.
Would the State for any reason fail to exercise in disciplinary function and monitoring under the emergency planning control board, obviously the funds under revenue sharing are under the control of the
Treasury. With the guarantee called into effect the Secretary of Treasury—as the law is worded he has the responsibility in preliminary, before the monevs are expended in revenue shares to have a plan from the
State or locality involved.
Our plan would have to reflect the fact that the guarantee was being
picked up. Our plan would have to indicate to the Secretary of Treasury that the moneys were being made available to him and he would
hold them.
The CHAIRMAN. For the record, would you and Mr. Rohatyn spell
out clearly and specifically as possible how the Federal Government
could be safeguarded and protected against any possible loss, calling
of the guarantee which would cost the Federal taxpayers money ?
Mr. KOTTTYN. A default can occur for twTo reasons. One, because an
entity becomes not credible. Secondly, it can occur even though an entity is perfectly credible, it can be denied access to the market.
In the latter case, the guarantee obviates that possibility totally. It
is by definition impossible not to have access to the market if you have
a Federal guarantee.
It seems to me that the areas where the Federal Government needs
protection is the area of an entity that continues to run a deficit. I t
would seem to me if you're dealing with a revenue-sharing number in
the area of $800 million a year which the Governor mentioned and
you're using that to support a total borrowing over a period of time
of $5 million, that you would use that revenue to pay down any amount
of that borrowing that went into default or by reason of the city all of
a sudden getting out of balance again.
The program we would try to get into play would be as the city
gets into balance and MAC becomes eligible for normal financing is to
run the guarantee down over a period of time as you begin putting out
strips of financing on a nonguaranteed basis.
I would think that the revenue-sharing collateralization would apply to making up any deficits caused by the city itself going out of
balance. I t is hard for me to see by definition that if the city becomes
a balanced entity how there could be a default, because the technical
default




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The CHAIRMAN. There wouldn't be a default if there was a 100-percent guarantee. Let me move to something else.
I would like whatever reenforeement you could give us on the basis
of this brief colloquy. Governor, you make a very strong case that New
York has already taken some severe steps. You have frozen hiring.
You have had a low wage increase this year.
Governor CAREY. That is the State. The State has a 3.5 percent nonrecurrent pay increase to employees. The State basically froze wages.
I t is on a wage deferral program.
The CHAIRMAN. The Chairman of the Federal Keserve Board suggested that as a matter of redeeming New York's honor and assuring the country—this may be useful if it is practical—that New York
State impose a tax that would cover half the operating deficit, perhaps
$400 million or $500 million for 1 year in order to showT that they are
making this sacrifice, that they are going this far and, also, as Secretary Simon said yesterday, as an indication that this is a very stringent
spartan requirement and you are not being bailed out, but you are
helping yourself with a minimum amount of Government protection.
Governor CAREY. We welcome the spartan approach, but we are not
prepared to sack apples.
We proposed, which is unknown to the officials involved, $330 million of new taxes on the city of New York to cope with this condition
in June of this year.
We already know that some of those taxes are counterproductive
and we are losing employers and payroll and employees.
The suggestion that NewT York "redeem its honor" by imposing new
taxes fails to recognize that New York State is the highest taxed State
in the Nation, New York City the highest axed locality in the world.
To impose a tax to cover the deficit in a short term—I don't know
how much the deficit of the Secretary means should be covered
The CHAIRMAN. I am talking about Chairman Burns who said that
half of the operating deficit which, as I understand it, would be
Governor CAREY. $800 million.
The CHAIRMAN. YOU had a $10 billion budget. That would be 8
percent of your budget, $800 million, the deficit for the—full operating deficit.
Governor CAREY. For this year.
The CHAIRMAN. That would be $400 million. I t would be 4-percent increase in your taxes.
Governor CAREY. NO. Because we have only half a taxable year
left.
The CHAIRMAN. On an annual basis.
Governor CAREY. We will welcome constructive suggestions from
any agency that would help us.
When we hear from the Secretary of the Treasury or Federal
agencies that we impose such a tax, let me say that 1 percent on the
sales tax would produce that.
The sales tax in New York City is 8 percent. In order to increase
that to produce $200 million on a cash basis between now and the
end of the fiscal year we would need to levy a 4-percent tax.
That means one-eighth of every dollar, 1-percent sales tax, or every
citizen of New York City where we have a huge poor population.
I don't believe we can tax ourselves out of this. The imposition of




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such a tax would relieve the city of the need of the discipline we are
trying to impose so we don't need additional revenues which would
make it unlivable.
The CHAIRMAN. I agree wholeheartedly that 8-percent sales tax
is crushing and difficult. You have income tax and other taxes. We
are not talking about New York City—not just the city—New York
State deciding on a tax on its IT million people.
Governor CAREY. We are taxing everything that moves and breathes
in New York City. We are trying to get out of that position.
The notion we should tax our way out of this problem at the time
when the Federal Government has a proposal to reduce the taxes so
the Federal Government can balance the budget in 3 years seems to
us to be coming from the wrong source.
Senator TOWER. YOU are willing to spend yourself into the problems, but not willing to tax yourselves out of them.
Now, you have been a distinguished Member of Congress. You are
a very distinguished Governor. You know about the influence of the
electorate on public officeholders. What we all have to consider is
how the people in our respective States respond to this.
If we are going to help you out. we have to justify it to them. Right
now we have difficulty doing it.
I want to cite some figures here.
1971 figures show the expenditures in New York City were greater
than the combined expenditures of the next 24 largest cities.
According to the tax foundation, New York City spends at the rate
of $1,244 per capita while the average for all other cities in the
country is $295 per capita. New York City has 51 employees for
every 1,000 inhabitants. In most other cities the ratio is 85 to 1,000.
According to one study, the city operates 19 municipal hospitals
and has 10,000 more employees than it did 10 years ago, even though
the patient load dropped 25 percent.
Educational employees approach 80,000 today. The number of students lias not changed since it was in the 40,000 range.
Now, are we going to ask the $10,000 worker in private industry
to subsidize a $13,000 worker in New York City?
You said vou can't expand your tax base any more in New York
City.
Governor CAREY. We don't want to ask the $10,000 employee to subsidize New York City. Absolutely not.
Senator TOWER. I understand that. But I will tell you it will be
awfully difficult for me to sell Texans on the idea to bail out New
York City.
We have to be shown clearly that something will be done about it.
You know it yourself that New York has the strongest municipal
unions in the Nation. I suggest they are too strong. The salaries are
inordinately high in New York. I don't think you got the manned
productivity that maybe you got when the salaries were half that.
I think it is time to face up to the powerful organized labor.
A man can get wage increases and fringe benefits that have no relationship to productivity. A flagrant example of that is New York City.
If this Congress agrees to do anything about bailing out New York
City or establishing even a guarantee program I think that New York
will have to be prepared to accept some tough strings indeed because




274
you know that through category all grants in aid, we do maintain
strings on what communities do up here.
Congress doesn?t like to return money to State and local governments without describing how it is going to be spent.
When it is obvious that New York City has been profiting, they
will insist on strong strings.
Do you think the city will take it and the municipal unions will be
willing if they have to to accept reductions in wages which are already
inordinately high ?
Let me ask this: why can't funds from the State be diverted from
other purposes to help New York City if it is so important to avoid a
default in New York City ?
Can you think of programs in your State that can be cut or done
away with and let that money be diverted to New York City ?
Governor CAREY. We have done that. We have advanced $750 million of State funds for New York City to carry it to December.
As I indicated in my testimony, the resources of the State are more
limited than those of the city.
The State budget is $1 billion less than that of the city. Sixty percent of the budget is in local aid. Forty percent of the budget is under
the control of the Governer to disburse in any fashion.
This budget is applied to mental health, hygiene.
According to the rating agency, New York State has its credit
rating reduced because of our extension of aid to the limit of our
powers to that city.
Let me say, Senator, I agree with you that you have correctly cited
the condition in New York City that brought us to this point.
Realize, please, Senator, that the very unions you talk about have
participated in a wage freeze. Pensions are frozen. They are no longer
accumulating increments at higher levels.
I know you well recognize that New York City got into some of its
activities and actions for help to the poor, community action programs,
because I was convinced by a great Texan this was a right thing to do
for the cities of our country.
Lyndon Johnson told us to do these things, and we did.
Let me say as well it is very hard to compare New York City with
any other.
The distinguished comptroller of the city of Houston indicated on
public television that Houston has $17 million surplus, but he said that
city could be adversely affected by a default of New York.
Houston does not maintain a hospital system or school system. New
York City may be doing too much.
We need a way to face some of these, as you say. We would like to
see less of the money committed to welfare which costs $1 billion of
city funds for 1 million people in New York City. We can no longer
afford that. We need time to work out from under those burdens.
I cannot disagree that the city spent too much. We need time to
make that city accept the discipline which you rightly indicate have
to be applied. We have done that in short term.
To talk about the condition as it exists and say it cannot be cured
means in effect we should accept failure.
The city should be made to live up to its responsibility and we as a
State are prepared to step forward and make the city accept its
responsibilites.




275
I sit as chairman of the board to implement the changes you suggest.
We welcome those.
We want the Federal Government to be a partner to see that no
other city falls into the condition that New York City finds itself in
and help us to cope wTith this.
We want those things to happen.
If we can show we can control the condition in New York, it will
not spread to the rest of the cities.
Let us be an object lesson to cure the condition, but not as a failure.
Senator TOWER. Governor, I can't be sure that the city is doing
everything it can to solve its problems. According to the New York
Times October 8, you yourself said agreement to end a future strike
gravely violates nine cities' fiscal recovery.
Governor CAREY. That is the first time an agreement was sent back.
Senator TOWER. Isn't it that the city is unwilling to do what is
necessary ?
Governor CAREY. The city was not a party to any negotiations. The
board of education negotiated that. We have an unworkable conditin—a city in regard to a costed agency couldn't control the negotiation. The emergency financial control board has no such thing as a
costed agency. We have said you had to rework that contract. Yes. The
employment levels of New York City with regard to similar cities in
terms of ratio of taxpayers to employees has been high. Realize that
we have eliminated since December of 1974 to July 11, 1975, 23,000
employees in New York City. They are no longer working. Our unemployment rate has gone to 12 percent. The fiscal plan in the works now
calls for the elimination of 47,000 to 50,000 employees from a total
work force of 280,000 in the next 2 years. That is unprecedented in
terms of public employment.
Senator SPARKMAN. Mr. Chairman, I shall be brief.
Governor, I share the statement made by the chairman in reference
to the very fine statement you have given us, both of you gentlemen.
I want to ask you this: You had this up sometime recently with President Ford or at least with the administration, and I believe both the
President and Secretary Simon said they could not go along with it;
did they not?
Governor CAREY. They said certain things had to be done. They
wouldn't deal with the city because 20,000 cities would be in the White
House door. They said the State should step forward. We did. I was
told by the Vice President that now that wTe have formed the Municipal Assistance Corporation, that is what they were waiting for. We
were told as well by the Secretary when we had to adopt a balanced
budget; we have done those things. We followed carefully the advice
and recommendations of those officials you speak about, including the
President.
Senator SPARKMAN. That is reassuring.
That is just about all I wanted to ask about. I thought you had had
it up with the administration. Certainly initially it didn't seem you
irmde very much headway.
Governor CAREY. We were somewhat confused. Senator, because it
was said by the President—he mentioned a tax. He was not suggesting one. Later we heard a tax should be imposed. We do not know
at what level we should propose the tax and what level it should be.




276
We would like to see if the tax in any form would bring forth some
Federal action. We are optimistic to any suggestion except default.
Senator SPARKMAN. We are concerned with the situation confronting New York City. I think if New York defaulted it would have
terrific impact throughout the country, not only with individuals,
but with cities themselves that might be confronted with problems
even greater because they have such—a smaller amount of financing
ability to back them up.
That is all, Mr. Chairman.
Senator BROOKE. Governor, I'm sure we all sympathize with you.
You have taken on one of the hardest and toughest jobs in the country
and you are trying to clear up a crisis which is not of your own making. I want you to know you have sympathetic listeners to your cause.
You seem optimistic a^out what you can do with the city of New York.
You said you can make them do certain things. I wonder if you really
can. You said you couldn't put on more of a sales tax because you are
taxed heavily already. You are not tied to a sales tax. Are there other
taxes that would help alleviate the problem?
Governor CAREY. I n the package wTe passed in the State legislature
in June, we imposed $330 million in new emergency taxes on the city.
Stock transfer taxes, bond taxes, additional taxes, real estate levy is
at the limit of the constitutional level. We have every tax you can
specify, an unincorporated business t a x ; we have city income tax. We
don't want to tax ourselves into a condition where, frankly, New York
becomes unlivable, because the burden of taxation falls heavily on a
different population in our citv. One million middle-income people
have moved out of our city. One million people moved in of lesser
means. They can barely afford the sales tax when they purchase shoes
and clothes. We do not want to tax into dependence people among the
working poor.
Senator BROOKE. I understand you do not propose any further taxation for New York.
Governor CAREY. It has been, frankly, the consensus and judgment
of the private management people who are working with the control
board, that further taxation imposed on New York Citv would be
counterproductive. We couldn't get our economy back. We couldn't
reduce the 12-percent unemployment. We couldn't bring business back
to a city that lost 99,000 additional private sector jobs last year. We
don't want to accelerate the exodus of private sector jobs out of New
York City.
The CHAIRMAN. If you don't get additional taxes and revenue you
have to cut back in your expenditures.
Governor CAREY. We are incorporating growth of revenues in our
budget. We are not doing it at optimum level. Realistically we are
programing in 2 percent growth. We hope to get more than that, but
that depends on the national economy.
Senator BROOKE. I read from newspaper reports that New York
City is threatened with a general strike.
Governor CAREY. That is the possibility, but the State law does not
permit a strike.
Senator BROOKE. Even though your State law doesn't permit it, you
agree that there is a possibility and maybe even a probability at this
time that you would have a general strike. If you did have a general




277
strike, do you think the city or State of New York is capable of giving
us reliable assurances that the Federal Government would not have
to pay on these guarantees because New York's finances will be on an
unsound basis?
Governor CAREY. Because of a strike, I believe that our State laws
are adequate to cope with the condition where the strike won't endanger public health and safety.
I would like to point out that the atmosphere aside from the talk
of the strike, among the leaders and rank and file of the municipal
labor unions, has been one of cooperation. They have invested their
pension fund. They accepted a wage deferral. They gave back a 6percent wage increase. But as to taxation, yes, I served on the Ways
and Means Committee, but a resident of New York who has carefully
assessed the impact of taxation on our economy is sitting here.
Senaor BROOKE. Before that, do you think it is wise to put the Federal Government in the position where it would have to bargain with
municipal unions in order to protect the Federal loan guarantees ?
Governor CAREY. NO. NO. On the contrary. We are asking the Federal Government to deal with the State. Let us conduct the local
affairs. We will in every way
Senator BROOKE. That is one of the problems, isn't it ?
Governor CAREY. If indeed default occurs under the statute the
Federal Government will be in trusteeship. I use the word "occupation." They will be dealing with those employees. I don't consider
that to be an attractive prospect for the Secretary of the Treasury or
whoever is appointed, to be in daily contact and trying to quell the
conditions that would occur as part of a total work stoppage in New
York City. I don't think that is the proper Federal role. Let us do our
job. We will cope with that condition. We have and we will.
Mr. ROHATYX. On the question of taxation, I'm not opposed to
studying some form of temporary tax increase in the city to alleviate
the problem here. When MAC studied the situation in August before
the creation of the Control Board, we came to the conclusion that the
best discipline for the city is work down its deficit through management improvement and reduction in expenditures, with an expenditures freeze and tax freeze. We have in the program for the next 3
years that to resort to new taxation should not be given as an option
to our elected officials in order to solve the problems of the past. One
of the things you ought to bear in mind—again I speak as a private
citizen of the city—that wre have enormous parts of our city that look
like Cologne after the war. We will have to rebuild the city at some
point. We can't create a situation which would be similar to a business where you are cutting expenditures, but your revenues keep decreasing at a higher rate than your expenditure reduction, and you
create a downward suction. As part of the program, it might be worth
studying some temporary form of taxation as part of a major program consisting mostly of expenditure and reductions. The true discipline on the city is management. Without management reforms and
really strict management reforms, this will never happen.
Governor CAREY. This may not be called a levy, but in terms of
take-home pay, it is. At the instance and suggestion of the administration, we increased the fares on the mass transit system of New York
City by 25 percent. For 25 percent of the people who travel that
system, that is their only way to travel.




278
Senator BROOKE. Governor, you have addressed yourself to city
taxes. What about State taxes ? Have you gone as far as you can go
in State taxes ?
Governor CAREY. We are the highest taxed State in the Nation.
Again
Senator BROOKE. YOU are the highest everything in the Nation.
What about the State taxes? Can you go further in State taxes? If
you can't tax New York City anymore, what about the State of New
York?
Governor CAREY. Well, Senator, the State of New York currently
is running a deficit by reason of revenue short-falls of $600 million. I
proposed a tax program when I ended office in January 1975. The
legislature in its wisdom and determination, as far as the majority was
concerned on the Republican side, said no new- taxes would be passed
and they refused to enact any t axes. I must reckon with the condition
I faced. No new taxes were imposed. Even if taxes were enacted, I
doubt very much, as a matter of reality if the entire State would accept
a tax that would be applied to the benefit of New York City.
Senator BROOKE. But you want us to have the votes to have the Federal Government do it?
Governor CAREY. If I were here asking for money from Massachusetts or any other State to be applied to the problem of New York
City, I could not in conscience ask that. I'm asking instead for a
guarantee in order to help us.
Senator BROOKE. A guarantee that may be called on.
Governor CAREY. YOU will be reimbursed. Then we would have to
impose a tax. The guarantee would carry a premium which would
be put into a fund moneys that would be there to indemnify the guarantee. By making the security taxable, there would be a 40-percent gain
in revenue. Those are benefits to the Federal Government in exchange
for the guarantee.
Senator BROOKE. Are there any other cities in New York that are
near financial crisis as New York City is ?
Governor CAREY. The city of Buffalo attempted to float $17.5 million in general income bonds and heretofore had found access to
markets and was able to fund its regular needs. I t hasn't been able to
do so at this time. They have an interest rate 4 percentage points higher
than it has borrowing. Buffalo may have to tax its residents with a
17 percent unemployment rate.
Senator BROOKE. Buffalo may be in the same position ?
Governor CAREY. NO. Their budget deficit is not as high as New
York City. We can handle Buffalo's situation.
Senator EIBICOFF. YOU are one of the most impressive witnesses I
have ever heard before the Senate. Your sinceritv and passion for
New York and New York City is most commendable.
I would like to put a few things in perspective. What was the overall
indebtedness of New York when you came to office? I want to know
what the indebtedness was for New York ?
Governor CAREY. The city of New York had $13 billion debt outstanding ; 6 short and 7 long.
As far as the State of New York, if we include our moral obligation bonds, moral obligation agencies, our total flow to debt was $15
billion, depending on the extent of the borrowing that is in prospect.




279
Total debt of 13 and 15—moral obligation agencies do not have
the full faith and credit. They are supposedly free standing. Instead
of free standing, they were toppling. UDC had a debt of $1.2 billion
accumulated when I took office. I t had 12-days' cash on hand. I t had
negative cash flow of $1 million a day.
The total debt was near $30 billion for the city and State.
Senator RIBICOFF. When you came to office in New York State, the
State debt was in place, basically. You were stuck with it as the
Governor of New York.
Governor CAREY. We have added nothing to the debt of the State.
Senator RIBICOFF. Since you have taken office?
Governor CAREY. NO ; we have passed nothing that would increase
the debt of the State. We have tried to decrease the debt by putting a
freeze on public employment, by putting an austerity budget in and
cutting the department.
We are doing our best to bring the State house in order.
Senator RIBICOFF. Was that the situation as far as Mayor Beame was
concerned when he came to office ? That was in 1973.
Was New York's debt in place when Mayor Beame came to office?
Governor CAREY. There was indeed a sizable amount of short-term
debt outstanding. As the mayor himself admitted, he added to the
short-term debt in the amount of $11/2 billion during the time he was
there, borrowing to meet operating expenses on the short-term, and
that borrowing should not have been done.
Had the investors known the condition of the city, I doubt very
much if they could have extended short-term debt and funded under
the applicable laws of our country. That is an unfortunate condition.
The city was borrowing beyond its means and no one knew what the
debt condition of the city truly was and how much debt it could
support.
We meet the debt by insisting that the city
Senator RIBICOFF. Today's New York Times has this statement:
"Because of lawsuits and other problems, the city may not be able to
use the sources of cash it is depending upon to divert default on $453
million worth of notes maturing October 17."
That is this week.
Mr. ROHATYN. Senator, this is a standard procedure for us practically every other week. We do face—we face several uncertainties in
the package leading up to a week from today. One of them is legal action with respect to the State comptroller's investment which will be
argued today, I believe.
A second one is a continuing valid commitment on the part of certain of the municipal pension fund in terms of the continuity of their
commitment.
The third is the possible requirement for MAC to raise another $70
million or so as a commitment.
I would say to you that this is a fairly shaky scaffolding we are
standing on. I would guess the chances are that we will make it through
the 17th, but it is far from a sure thing.
Senator RIBICOFF. There is a basic problem.
You have the short-ran^e problem, but you have a long-range problem, too, as far as New York is concerned.
Isn't it true that practically every Federal revenue sharing program,
or matching program of every kind, is weighted against New York.




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Governor CAREY. Very definitely, Senator.
If you want to cite the drug addiction program, we have perhaps
one-half of all those hard-drug-addicted persons in the country in New
York City. The number is in excess of 225,000 persons on hard drug
addiction.
We get a population share of the national drug addiction program.
That is weighted against us in coping with that problem which is a
source of crime and breakdown of the living fabric of our city.
As far as the mandating of welfare programs, Senator, I know of
none more expert in this field than you are. We don't have an option
with regard to the million persons on welfare to everyone who applies
for it and meets the condition.
Senator RIBICOFF. Many of the people on welfare come from States
that receive from the Federal Government 80 percent of the welfare
costs against New York's 50 percent.
Governor CAREY. That is correct.
If we wanted to choose Mississippi, 80 percent of the welfare costs is
paid by the Federal Government, and New York gets 50 percent.
Senator RIBICOFF. The revenue-sharing formula is weighted against
the urban areas that have poverty factors and high welfare costs.
Governor CAREY. We don't get the poverty and welfare factor in the
revenue-sharing formula. We don't do that badly. We get the largest
share on the revenue sharing of any State in the Union.
Senator RIBICOFF. Basically, most formulas that affect the cities
and States are passed with the most consummate cynicism. The time
has come to blow7 the whistle on it.
Every time a formula is put out and every time an amendment is put
out, there is circulated on the desk of all Congressmen a breakdown as
to howT it will affect every district and every State.
The formulas are drawn to make sure you get one more than half to
pass it in the Senate and House. These are voted on irrespective of the
national interest, but to take care of every State, program after program.
The city of New York and New York State are on the short end because there are too few negotiations, is that right ?
Governor CAREY. That is correct. I cannot be less than realistic and
indicate that it has been a problem that New York has been looked on
as a high-wealth State and high-wealth area.
People thought we should not be treated with generosity. Whether
it is the Hill-Burton program or a program designed for housing,
sometimes unworkable limitations are put in that program because
they are felt to be needed.
They work against the flexibility we need in New York to cope with
our own condition.
Senator RIBICOFF. What is your estimate of what New York City and
New York State generate by way of tax revenues that go into the
Federal Treasury ?
Governor CAREY. For the city as a source we use a figure of $20 billion that we send to the Federal Government in terms of taxation. The
rest of the State, we have estimated a figure as high as $42 billion.
To be perfectly fair, we are the headquarters of many national
corporations that send their returns in from New York but their subplants may be located elsewhere.




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On a hard basis, it was indicated by a spokesman from the White'
House that substantial funds come into NewT York City from the
Federal Government and great aid was there. I t included individual
reimbursement, social security, and things of that kind.
Senator RIBICOFF. I saw that, and that was the most invidious statement I have ever seen in my life, because social security and welfare
are things you can do nothing about. These are part of Federal programs. You are the repository of the entire problem of the United
States.
What are the figures of the last 5 years? What employment have
you lost and what population have you lost ?
Governor CAREY. The number of private sector jobs in the last 6
years in New York State declined by 387,000. There was a corresponding increase in public employment during that period of 250,000.
In other words, the way to better New York's economic condition
was to put people on the public payroll as they went off the private
payroll. That was not a sound way to operate the State.
Now we need to trim the public payroll and not overtax ourselves so
we can attract the private sector and hold jobs in New York.
Senator RIBICOFF. If you overtax, you will have a continuous flight
of the white middle class out of New York and influx into New York of
the minorities and poor and aged.
Governor CAREY. April 15, in the New York Times, there appeared
an ad very well drawn, where it said, "It is April 15th, income tax day
in New York State." It showed aspirin bottles pouring into a teaspoon.
I t raid, "Get away from your headache. Move to Connecticut."
Senator RIBICOFF. That is right.
As a Senator from Connecticut who is pleased to see the growth of
the State, I am concerned for New York because Connecticut is not
isolated. Nor is New Jersey, or any other of the 49 States.
If you destroy New York City and the State of New York you will
find that the ripple effect will be fantastic—affecting the State of Connecticut and other States in the Union as well as other nations around
the world.
Governor CAREY. We recognize that, Senator. We are mindful of the
taxes paid in New York City by residents of New York State.
Senator PACKWOOD. Governor, I start with a warm spot for New
York City. I went to law school in NYU. I lived in an apartment on
Washington Square. I liked the subway and New York Times and
the theater. I thought it was wonderful that the city made available
cutrate tickets for students.
I am curious about something you said in response to, I think,
Senator Tower's question about the board of education—you referred
to it as a covered agency.
Governor CAREY. The Health and Hospital Corp., New York City
Board of Education, and some others were created as entities which
supposedly are freestanding in that they are given revenues in the
aggregate and they have to live within the revenues.
Senator PACKWOOD. They have to?
Governor CAREY. Theoretically. If the Health and Hospital Corp.
goes over because the patient load or contract settlement was agreed
by the covered organization and it turned out in practice and implementation to cost more than the parties had calculated, then the money
has to come from somewhere.




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That somewhere is the treasury of the city of New York.
Senator PACKWOOD. I S the city legally obligated if the covered
agencies by chance come up with obligations or contracts greater than
their designated revenues '(
Governor CAREY. U p to now it has been. One of the powers we inserted in the Emergency Financial Control Board regards none of the
agencies as covered agencies.
We have the power to review the contracts and make certain there
will not be an adverse impact on the financial position of the city.
Some of the consequences of overspending resulted from the fact that
covered agencies exceeded the aggregate limitations placed upon them
by the city budget.
Senator PACKWOOD. You're asking for a $5 billion guarantee. How
did you come to that figure ?
Governor CAREY. By the way none of covered agencies could have
been created in that fashion without the assent and willingness of the
State government to assist the city in creating those agencies.
Senator PACKWOOD. I seldom run across a situation where an agency
is relatively free to commit itself to its charges and have somebody
else standing behind it. How did you come to the $5 billion guarantee'?
Governor CAREY. That's the amount that would be needed to finance
the amount of short-term debt that we need to cover and take that debt
long term, bring down the debt service cost so we would then pay the
amounts necessary to keep the city operating. We chose $5 billion.
The $5 billion would be a $5 billion guarantee cover. Under that $5
billion we would hope to move additional debt not covered by the
guarantee, step by step out so we could take ourselves down range and
manage what we cannot now manage, the short-term debt requirements. We need between now and July 1 roughly $3 billion that we
have not covered by the financing limitations of the MAC operation.
That would be part of $5 billion we are talking about. To cover the
additional short-term needs, to get the short term converted into long
term and bring down debt service the $5 billion figure was looked at.
It's $5 billion in guarantee. We would hope that the very placement
of the guarantee would be the kind of a blessing and recognition that
would change the conditions in the marketplace so we can get back
to the market. More than anything else in our attempt to secure capital market, we have been hurt by the expressed attitude of tine
administration.
When the public hears only negatives about bailing out New York
and New York being a lost city and New York going into default and
that New York is being looked on as an acquisition by the Shah of
Iran, it is hard in the public mind to see that NewT York is worthy of
credit.
There has been a negative impact on our attempts to get credit by
the irresponsible impact of the administration's statements.
Senator PACKWOOD. If we assist New York City, it will be for three
reasons. One, Ave think New York is more deserving. That is not an
argument we will sell in this country. Two. that the bank accepts the
large portion of the debt and the banks will increase the ratios by
tightening their credit. Yesterday the American Bankers Association
voted 2 to 1 against any help to New York City. That covered a cross
section of banks and variety of sizes of banks.




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Governor CAREY. That was taken on Monday before the presentation by the Emergency Financial Control Board on Tuesday. That
presentation may have changed a few minds. The bankers were asked
should there be a bailout of New York City. My answer would be no
as well. We don't want a bailout. We don't want money from Oregon
to be placed in New York City. The guarantee would take us out of the
tax-exempt market. The guarantee produces money for the treasury.
The guarantee would be enforced if New York did not live up to the
strict conditions imposed by the guarantee. The guarantee is little more
than recognition by the Federal Government, if we adhere to the schedule we have applied or accept suggestions that may be made, that we
will work our way out of our problem by paying our debts, freezing
wages, stabilizing the wrork force. We are doing all the things we can
humanly do.
Senator PACKWOOD. I understand that. I want us to justify it in the
mind of Congress. The third reason
Mr, ROHATYN. If you took a poll of the 50 largest banks of this
country that handle prepondering amounts of country's financing, you
wTould find that probably a different answer wTould be resultant.
Senator PACKWOOD. A third reason is that our municipalities will
not be able to market their bonds or there will be an increased interest
rate which would be prohibitive. I don't understand why Boston,
Portland, Oreg., and Boise, Idaho, will not be able to market their
bonds if New York City defaults if they have good credit ratings.
Governor CAREY. Massachusetts Housing Agency was unable to get
a market with their bonds.
Senator PACKWOOD. Why is it related to New York City ?
Governor CAREY. I t has terrified people in regard to investing in
public issue. That is true not only in Massachusetts but in my testimony I indicated a study being made up now with information on
total cost in terms of interest rates because of the New York condition.
Going back to the default of UDC that has produced borrowing cost
of $2 billion additionally.
Senator PACKWTOOD. Mr. Solari says that if the city defaults, it can
have a standard cash flow with adequate reorganization. With respect
to the consequences of default—I do not share the view7 that default
by New York would have a bad impact on the bond market of the
country.
Governor CAREY. Mr. Moak is an authority and he thinks differently. Mr. Wille has indicated that 271 banks supervised by the F D I C
hold New York bonds, said the banks are situated in 34 States. Those
are the banks that make up the municipal offering in their locality.
They couldn't do it if their credit was impaired.
Mr. ROHATYN. The New York problem has shut the State of New
York out of the capital market for all intents and purposes. If that
isn't a crisis I don't know what is. Credit is a tenuous thing, as you
know. I t is intangible but the element of uncertainty is an enormous
disease that drives money to the most secure places. I think what will
happen here if this thing continues is a great tiering of the municipal
market where only the most assured blue chip municipal credits will
have any money available to it. And a series of medium and lowermedium credits will be badly hurt. Whether that is a disaster or not is
something we can discuss. That will be the impact.




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Senator PACKWOOD. I n fairness, isn't that what should happen?
Shouldn't the best credit-rated cities and counties have the best ratings
and the worst pay more ?
Mr. ROHATYN. It's a question of whether you want to deny access to
market because of technical and cyclical conditions. That is not the
basis for economic development in this country.
Governor CAREY. Out of 62 counties in New York State two have
triple A. They have had to pay additional interest costs. Regardless
of the rating Houston, Tex., will pay more, a triple A city. State of
California enjoys a triple A rating. With an offering of $50 million
they came in at 8y2 percent. That is the highest rate they have experienced. Undeniably much of it rests to the uncertainty traceable to the
New York condition. We want to move New York City from the municipal markets. We are asking to do that.
Senator PACKWOOD. Thank you very much.
The CHAIRMAN. Senator Williams.
Senator WILLIAMS. Thank you, Mr. Chairman.
Governor Carey, I echo what Senator Ribicoff observed—the clarity
of your statement and its persuasive effect. I t was just a year ago, as
I recall, when you were one of us. You were then most helpful to us in
developing a mass transportation program for the country. You helped
persuade the Congress to adopt more equitable methods of funding for
the large cities of our country. I t has been a very short year for you
since you were last here. Were there any early warnings of the fiscal
problems you would face in the following year, when you were a
candidate ?
Governor CAREY. I might have doubled the revenue-sharing bill if
I had the opportunity to do so. As far as the urban mass transit system
is concerned, it is good legislation. I t is needed. One of the difficulties
we face is we have a rundown—frankly indescribable system of mass
transportation which the people must use. If we had the opportunity
to do so, we could put people to work, make capital improvements,
bring down the cost of that system, reduce the energy consumption in
that area, and that is what we should be doing. We can't do that because
if the city is in default, I don't know how we will run that system
day by day.
Senator WILLIAMS. That was landmark legislation that did include
a partial Federal contribution to operating expenses. But again, you
have to have a working system, and I gather the problems which you
faced even though you have raised the fares were not anticipated
Governor CAREY. I t wasn't even a good decision. I t was one we were
given as a result of no choice. We couldn't continue the subsidy with a
city that was unable to meet its daily expenditures. I t was said by the
administration you ought to raise your fares. Show people you are
doing something drastic. We have done something drastic to the takehome pay of the people using that system. We are seeking recognition
that the metropolitan area of the tristate region in which you and I
live has a bad transportation problem. We can only cope with it if we
can get the same kind of help as building the Metro system here in the
capital area. I t would save energy. I t would be a good investment.
Senator WILLIAMS. What has happened to the construction projects
for transportation which were underway ?




285
A lot of the Federal money requires a local matching share. I wonder
what you have been doing in this area of capital expenditure or what
has the city been doing ?
Governor CAREY. We won't be able to use the programs because we
won't have the money to match. Match money for the needed improvements either in rolling stock or in improving track conditions and
cleaning up the system and putting in conditions to make it secure,
economic, and efficient, will be impossible because we won't be able to
put up the local match.
Senator WILLIAMS. Then if the basic transportation plan isn't improved, the system gets worse, and this will have a spiral effect.
Governor CAREY. Well, the Metropolitan Transportation Authority
which serves three States in its commuter rail and local transportation
system, would project a deficit of $470 million because ridership drops
when fares go up.
More people go to the automobile with that ridership drop, and you
know what happens then.
Senator WILLIAMS. I do. I will say everybody is demanding a greater
contribution from New York. I can tell you the city of New York has
tightened its belt. Parking fees, for example, have gone astronomically
high.
We wish there were a way to walk across from New Jersey.
I sense a theme running through your statement that there is an
attitude of punishment abroad in this land, a desire to punish the city
of New York for its mismanagement.
You stated that you sense among the people of this Nation and their
elected Representatives a strong feeling that New York City should
be punished for its past.
You suggest there is a national policy of punishment.
I wonder if you could amplify this a bit and suggest ways that
you feel this has been expressed and from what quarters.
Governor CAREY. I have heard officials in the land state that New
York City frankly has been lording it over the cities of the world,
and people are grinning now because it is getting what is coming to it.
I find that hard to equate with the conditions of life in New York
City.
The punishment we hnve is 12-percent unemployment. People who
want to work can't find jobs.
The punishment we have is a welfare system we know is inadequate,
but which we must make available to everyone who comes by Federal
law for our city and our State.
We are crippled now because of a debt condition that accumulated
over the years because, frankly, the city and State were not managed
effectively.
Perhaps we tried to do too much. Perhaps that is the punishment
we are suffering.
We are not saying we will stop doing things for people. We have
to live within our means. The means wTe have at this time are insufficient because we have to carry a crushing burden of $1.6 million debt
in a budget, That is our second largest item.
That money is no longer available to provide needed services.
The punishment can be seen in the scars across our neighborhoods
and on people's lives. We are not yet willing to give up.

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I don't know what the new punishment should be, to teach New
York a lesson that we should not have lived on the Federal Government and go into the programs like the 236 program, that we shouldn't
have planned ahead to build housing for those who need it, that indeed
we try to do too much in building a public school system where those
who did not speak our language could receive bilingual education.
These are the punishments that are visited on us for a city who tries
to do too much, God help us.
Mr. ROHATYN. May I speak as a private citizen?
Senator WILLIAMS. I earlier had a note to say that the reaction
which this citizen had when he read that you had faced this responsibility and accepted it, was one of the most refreshing developments
of the crisis of last spring.
Mr. ROHATYN. That is flattering, and I thank you.
My reaction as a private citizen to the question of punishment is
twofold.
First of all, I think from a purely dollar-and-cent point of view,
for the record you ought to bear in mind we uncovered a $3 billion
past deficit. That deficit is being eaten now over the next 10 years
at a rate of $300 million a year.
We are transferring out of the capital budget expense items of $500
or $600 million.
The total controllable budget of the city of New York is $3.5
billion.
Over the next 10 years, 10 percent of that amount is gone before we
open the doors on a new fiscal year to make up the past deficits.
I n a broader sense, from someone who lives in the city the question
of punishment seems to me to raise the question whom are we trying
to punish.
The people who are being punished are most of the 8 million people
who live in the city.
Their crime as far as many is concerned is twofold. Thev are poor,
and second, most of us voted for a succession of inept public officials,
present company excepted.
If that becomes a problem in this country, we have to build a lot
of jails.
Mr. R I F K I N D . I have heard comment—I sense there has not been a
full appreciation of the full significance of this emergency control
board to which the Governor alluded.
When you consider that the city of New York is composed of 8
million residents and has had a long tradition of self-government and
home rule and you suddenly find that its major decisions are now
made by a State and not a municipal agency, the emergency control
board, that the city may not borrow a dollar, spend a dollar, or commit
its credit in any respect to enter into any major contract except with
the approval the kind of custodianship the city is now in and the
power that has been generated to bring its management and its operations into control so that this deficit can come to an end.
I think that is a tool of enormous dimensions and enormous power.
I t is a real credit behind which the Government of the United States
should help us.
Senator JAVITS. Mr. Chairman, I am grateful to the committee for
affording me this opportunity. I would like to join the committee mem-




287
bers in the fine reception which has been given to Governor Carey's
highly expert and spirited and impassioned testimony attributable to
his great responsibility and his real love for the city and State he
serves.
I join that approval of the Governor's actions here.
One thing about this punishment matter that interests me—I dealt
with it yesterday when I testified.
In the first place it seems hardly American to punish other Americans. That is not the way we work. You don't even work that way in
jails or with criminals. At least that is not anything we are proud of.
Yet that is the expression of the Secretary of the Treasury of the
United States who used the word punitive about New York.
I hope the Congress won't think that way.
I believe, Mr. Governor, if you get any help and we get any help it
will be from the Congress.
I have practically given up on the administration. I am devastated
to say that. I think it is so unfair, but that seems to be the case.
Governor, as I see the situation too, the risk which we are asked to
take is pretty much the judgment of the financial part of our Government. That is certainly the Secretary of the Treasury who intimates
it may be better to let New York City go.
That risk would have enormous repercussions, as you can testify.
The alternative you offer the United States is a secured guarantee to
carry you over a period of great difficulty and avoid that risk.
I t just seems inconceivable to me that we should not do something
which would cost the United States nothing except the extension of its
credit. Not to take that risk would be reckless in my view.
I would like to call our attention to one point which is critical—the
United States will be doing business with the State and not the city.
I see somewhat of a difference between you and Mr. Rohatyn. I think it
should be made clear.
Early in your statement you say I come today on a very unique mission to tell you that the default of New York City will cause not only
the banks of the city and State of New York—now, Mr. Rohatyn says
on page 7 of his statement I have given it as my professional judgment
that an impact of a city default would inevitafely lead to the default of
major State agencies and possibly default by the State of New York
itself.
That is a milder assessment.
I think it is really a national crisis if the State of New York will be
brought down by New York City's default.
Therefore I believe either now or at some time the representation to
the committee ought to be very authoritative.
Governor CAREY. In the testimony before me, to refine that point, I
changed it. What it says and what I testified to is as follows: that the
default of New York City will cause not only the default of the State
agencies—I am referring to the moral obligation agencies which would
be in default on October 15 in terms of $89 million had we not scraped
the bottom of the barrel and used the available funds in-house.
We can do that no more. The State agency has a credit need of $1.6
billion in the period November to June and they will not be able to get
to market and those notes will default.




288
With State agencies in default, we have seen the relationship in the
public investor mind is not discrete. I t shows that anything with New
York on it can't get to market.
As a result, when the comptroller of the State of New York, one of
the most reputable, distinguished fiscal officers in the country, took
our State credit to market, which had been able to borrow at 5.29 in
March—we were unable to cover our own needs except by having the
State comptroller pick up his own paper through the investment of
pension funds.
We didn't find our way to market. That tells us what happened before default.
If the city defaults and the State agencies cannot meet their obligation, moral obligations, I don't know how the wards in the State, villages, towns, will find access to capital markets.
I t is not a question of the State being defaulted but the State will
be unable to borrow because the market will not be there because no
one will invest in New York State.
Therefore I say deal with the manageable problem. If not, you may
be forced to deal with a State problem which the Government has
never had to deal with before in its history.
Senator JAVITS. Thank you very much for that clarification. I t was
pointed out yesterday that even if New York defaulted—even if it defaulted on its debt service, it would still have an additional borrowing
need for the cash-flow gap of about $1.2 billion in round figures between December and March, which will be compensated for by $830
million cash flow "surplus" between April and June.
I have predicted that that could cause enormous chaos in the city.
I t would cause the picking up of the pieces by the United States and
could be four or five times more expensive even than the cynical estimates that we have heard.
Mr. ROHATYN. Those figures assume that next spring the State of
New York can make a similar advance to the city which it made last
year. If the State of New York is shut from the market, there is no
way to do that.
I would like to support what the Governor was saying. Whether the
State would go into default or not is conjecture because the State's
needs are in the spring. There is a high risk that absent Government intervention at that time in terms of State financing, the State w^ould be
in default.
Senator JAVITS. Mr. Rohatyn, I have a question for you: The Secretary testified yesterday, if you had all the Spartan things he said you
have to do, that you could have instant confidence in the investor; the
theory being you could meet what you are facing on December 1, because you were taking Draconian action. The investors would, therefore, come flocking back to New York Securities. Is there any reality
to that?
Mr. ROHATYN. We could lay off 50,000 people tomorrow, put the
transit fare at $2, hang the mayor of the city of New York and we
couldn't make it.
Governor CAREY. If that be the course of action, I would like the
same treatment as Thomas More, and you can hang me along with him.
The CHAIRMAN. Senator Cranston ?
Senator CRANSTON. I want to thank you for arranging these hear-




289
ings, which are timely and important. I would like to ask your permission not to ask questions, but to make a brief statement. I want to
underscore my strong belief that this committee, and this Congress,
and the country has an obligation to help in the crisis of New York
City.
As your Governor pointed out, the Wall Street crash occurred in
New York but it had terrible repercussions in every village and community of our Nation, and all across the Nation and the world.
If there was a default in New York, that would have again, I believe,
disastrous repercussions in all of the communities of our country and
also elsewhere.
I am convinced we must act to be of assistance. I am therefore joining with the fellow Californian in a slightly different approach to this
problem in an effort to be helpful. We feel your problem is our problem. The Californian I refer to is Congressman Tom Rees of Los
Angeles, who is perhaps, I think, the expert in Congress on municipal
finance, having worked in that field in the State legislature before coming to Congress.
The administration appears to be advising that we do nothing. I t
seems we can have no confidence in the advice of this administration
on economic matters. We have not been doing very well in economic
matters in previous decisions that have been made by this administration.
I would like to cite two examples of their contradictory and uncertain hand on the economy. President Ford suggested we cut taxes
a year ago. He suggested we increase taxes a year ago. That would
have been an absolute disaster. Congress took no such action. Ninety
days later there was a 100-percent about-turn and the administration
recommended a tax cut. The Congress followed suit and we had a tax
cut. And that was the beginning of the end of the worse aspect of the
recession.
Incredibly, on September 30, William Simon, Secretary of the
Treasury, appeared before the Budget Committee and the trust of his
testimony was against continuing the current tax cuts into next year.
On October 7, Secretary Simon appeared at the White House to advocate a tax cut for greater than the tax cut than we enacted this year,
indicating total confusion, absolute uncertainty, and no ability to guide
the Nation, in my opinion, on the problems that confront us.
The proposal that I am making with Congressman Rees, and I introduced the bill late last night before we recessed to accomplish this,
would be to amend the Emergency Loan Guarantee Act to permit the
Board to guarantee the bonds of States and municipalities when those
governments face financial disaster.
I would like to point out that strangely enough, after all of the
concern about what a disaster guaranteeing Lockheed would impose
upon the country, the facts are that it has been a good way not only
to save Lockheed and many subcontractors and others from bankruptcy and many jobs, but on June 30 of next year, the U.S. Government will have earned $22.4 million in profit from the Lockheed
loan by a one-quarter percent fee it has charged for making its guarantee available to back up the Lockheed loan.
We suggest the exact same steps be taken in regard to New York
with slight changes. It would seem to be a way not only to help New




290
York City and the State of New York and the Nation but to help balance the budget by increasing the revenues we have coming in. This
is totally different from suggesting any handout or Federal loan to
New York City. We are not proposing that any money be given by
the Federal Government to New York City.
To summarize what this bill would do, it would guarantee the bonds
of States and municipal localities. The legislation permits the guarantee of bonds issued by State and local government. I t does not authorize the Federal Government to loan money to these divisions.
This is a major assertion of Federal authority into local affairs. But
it is an assertion required by the extreme circumstances which confront
a municipality seeking the full faith and credit of its sister cities and
States in the Union to come to its aid.
I have just a bit more I want to say about it. The default of New
York City on its municipal obligations would have a great and disastrous impact on the credit market and the economy of our Nation.
The rate of recovery from the recession would be severely affected.
State and political subdivisions in every section of the country would
find it more difficult to sell municipal bond issues at reasonable rates.
That is already occurring in California and elsewhere.
State and local taxpayers everywhere would be the ultimate losesr
by higher interest costs, delayed capital programs, et cetera. As States
and cities slow down capital investments, the economy could be into a
deeper downward slide.
Protecting the credit economy of the credit system is a Federal responsibility. Congress demonstrated its recognition of this responsibility on many occasions. The Federal Reserve system is the best example
of our commitment of maintenance of an orderly monetary system.
The impact of a default of New York City would not be limited to
our shores. We who are close to the scene may have a different understanding of the resiliency of our economy and political system than
those making decisions millions of miles away.
Finally, let me say now is not the time for fiscal brinkmanship to be
played by public and private interest as some are now seeking to
achieve in this atmosphere.
Congress must keep its eye on the real target, the stability and smooth
functioning of the world's best credit and monetary system. We should
not be distracted by other issues surrounding this problem.
I n closing, I would remind my colleagues of something they probably remember. When the Lockheed loan was before the committee,
I offered an amendment that there be a change in the management of
Lockheed because there had been obvious failures in that management.
I am not suggesting any change in management in New York City
where there are elected representatives who basically have been making decisions. I do suggest in the legislation that Tom Rees and I have
proposed restrictions on their flexibility and tough standards in return
for this assistance.
I know, Senator Javits, this is somewhat analogous to something
you have introduced. I think we are going in the same general direction. I think possibly the approach Tom Rees and I are suggesting is
one that would serve the mutual interests of the country and New York
community in a slightly superior way.
The CHAIRMAN. Thank you, Senator Cranston, very much for your
constructive proposal.




291
The hour is late. I would like to ask a couple of more questions.
There were loose ends or they may be loose ends that only you gentlemen can help the committee with real authority.
Mr. Eohatyn, you have been quoted as saying you are running out of
fingers to plug in the dike. You seem to have more fingers than a centipede has toes. I want to be sure the committee understands what you
are telling us. As I understand it, it is your best judgment and I address it to each of you gentlemen that there would be no way to avoid
a default of the city of New York probably by the end of the year
unless the Federal Government provides assistance such as a guarantee.
Mr. EOHATYN. Senator, I'm not omniscient. I can only tell you in
my judgment the likelihood of our making it well into December or
into the early part of the new year is very, very low, absent Government involvement.
The CHAIRMAN. Could you say without a guarantee that at some
time over the next 6 months or a year the default is clear.
Mr. EOHATYN. Based on the present situation, as I see it, I would
answer that affirmatively, yes, sir.
The CHAIRMAN. I think nobody knows more about the available
fingers in the dike. How about the pension funds ? Can those be tapped
further ?
Mr. EOHATYN. Senator, we tried to mandate the State pension fund
and we lost in court. We have had discussions with the Municipal Pension Fund and City Pension Fund. The total amounts available to
them—I think the total corpus of those funds is some $7 billion. It
seems to me very, very difficult from a fiduciary point of view, leaving
aside the question as to whether you are trying to create the first commune in the United States by this mechanism that you could get $5 billion committed from the Municipal Pension Fund to the program
and absent being able to fund out the while program, it would seem
to me very questionable that this could be done.
Aside from the Municipal Pension Fund, we have failed with the
national financial community and maybe other people have fingers
that I have run out of.
The CHAIRMAN. YOU are saying Governor Carey, as I understand,
that in the event there is New York City default that sometime next
spring there is a strong likelihood that New York agencies and New
York itself will be unable to raise money in the market and therefore
would have to default.
Governor CAREY. Agencies, and the State, more obligation agencies
would be unable to cover their notes or make their payment. The
State itself would lack a market for its orderly sound borrowing full
faith and credit. The localities, school districts, villages and towns
would not have access to market. What could we do? I suppose we
would have to issue some crushing burden of taxation to generate
cash. I don't think that is feasible. You pointed to the possible use
of funds. We tried to mandate the pension fund and the Court of
Appeals found in its wisdom that that was unconstitutional.
Were we to possess a Federal guarantee, a variety of sources of
credit would open up to us that are not open now.
I t would be feasible then with a federally guaranteed security to
attract pension funds to be invested, given the principal of diversi-




292
fication and balance in the investment of those funds. W h a t is not
now available could become available with the guarantee. As a question of where to get the money, you pointed to the fact that the
guarantee would make a difference.
We could attract pension fund investment.
The CHAIRMAN. If you don't get the guarantee and you do default
then, as I understand it, the city under law has to meet at least certain
of your financial obligations before you have money available to pay
services, is that right ?
Governor CAREY. That is an excellent question. The Secretary of
the Treasury said funds would be available for central services. I don't
know what he means or where the city will get the money to meet
those services except by infusion of Federal money. We don't have
access to cash. I t is constitutional we must make payments in regard
to the bond obligation that are outstanding.
The CHAIRMAN. Does that mean that you may not be able to pay
your firemen, policemen, and sanitation workers ?
Governor CAREY. I don't know where the money would come from.
With inability to borrow we don't generate money except to the tax
levies.
The CHAIRMAN. May I ask Mr. Rifkind ?
Mr. R I F K I N D . The Governor was responding to your question by
giving you a fiscal answer. He said regardless of what the law may
require, since the city runs a deficit intrayear with respect to its
service obligations, its salary obligations, it would not have the funds
if it couldn't borrow, regardless of what the law may be as to whether
employees come first or the bonds come first. If there were enough
to do both, there wouldn't be any problem. If you have enough to pay
your bondholders but not your salaried employees, you are entering
a gray area. There is no bankruptcy statute relating to municipalities.
The statute you have is not designed to serve a city of the size of
New York or any municipality of comparable size or lesser size. I t
would come to a question of how the courts would deal with the
problem. There would be an intervening period of chaos. Without the
proposed program, firemen, teachers, hospital employees would go
without compensation. There is no question about that.
The CHAIRMAN. The city employees would go without compensation for a period of time ?
Mr. RIFKIND. Without question.
The CHAIRMAN. What happens if the State of New York defaults
in these terms ?
Governor CAREY. A S to the State agencies that are building the hospitals and university buildings and facilities for mentally retarded
and the emotionally disturbed, the work stops on this project. There is
a decline in value because the projects are abandoned. That is the material and physical fact which we would add to our unemployment.
With regard to funding, however, we could not be the court of next
resort to make the cash available to the city because our cash flow
would be interrupted. Inevitably you are coming to this. In order to
maintain the vital life services, what the Secretary called the central
services, it appears to me you would either have to put in Federal
money or Federal troops. I don't know what the cost of that would be.
He can reckon that cost.
The CHAIRMAN. What you are telling us is whether the Federal
Government provides a guarantee now or not, the Federal Govern-




293
ment is almost certain, in your judgment, to have to act to assist New
York. I t is simply a matter of when and how; is that correct?
Governor CAREY. Yes. And the unfortunate fact of life is, given the
current condition of the Federal Code and the statute governing insolvency, there is not a workable statute for the city of New York.
There wasn't even a workable statute to handle the Urban Development Corporation. We looked at it and had to discard it. We found out
we couldn't work out the plan because of the variegation of holders
and the remoteness and lack of identification who owed the debt. That
was only with regard to $1.2 billion. I don't know how you will find
out who owns the debt of $13 billion.
The CHAIRMAN. If the city acts with a guarantee, it is your contention that it will not cost the Federal Government any expenditure or
any appropriation, but simply the guarantee that is necessary. We
could monitor the progress, discipline the progress, and control the
progress. On the other hand, if we do not provide the guarantee, we
will, in all likelihood, have to expend substantial Federal money to
assist New York.
Governor CAREY. Let me suggest, for those who are dependent, S S I
people, there are Federal support programs. The aid for dependent
children program is 50 percent being supported by the Federal Government. Absent money for that program and absent, or with, a standard which the courts have upheld must be maintained, I suggest that
probably the Federal Government will have to reckon with undergirding the entire welfare program in New York Citv for the short
term. That alone would have an immediate impact on the Federal taxpayers of an additional billion dollars. We in the State would struggle
to keep up our share of the payment. If we can't borrow, we can't
give assistance to localities. We would do our utmost, but I see a
heavy burden of immediate expenditures forced upon the Federal
Government as the trustee in place in control of New York City. I
don't know where that money is coming from under present programs.
Mr. ROHATYN. Senator, I think you have other immediate potential,
theoretical costs here. If you take the total of city, State agencies, and
State obligations as $30 billion and if you had a default of those three
groups of entities which require a writedown of 50 percent throughout
the country and most of the banking system, you have a $15 billion loss
that would run through the economy. I can't say what everybody's tax
treatment is. Assume we run a 50-percent tax rate across the figure,
which is probably an incorrect and crude figure, you could have a $7.5
billion tax reduction as a result of that simply by a recognition of
losses throughout the system.
The CHAIRMAN. The Federal Government would lose how much ?
Governor CAREY. $7.5 billion.
Mr. ROHATYN. If those figures are correct, it could lose $7.5 billion
in tax receipts over a period of time. They are crude figures.
The CHAIRMAN. Gentlemen, thank you very, very much for superlative testimony. You have been most enlightening and helpful.
Senator CRANSTON. I want to compliment you, Governor Carey, on
your statement. I think it is a magnificently stated, deeply held presentation of the problems that you as Governor face. I'm delighted to
find what you recommend is close to what I have decided should be
done.
[Prepared statements of Governor Carey and Mr. Rohatyn follow:]




294
STATE OF NEW 'YORK
EXECUTIVE CHAMBER
HUGH L. CAREY, GOVERNOR
Robert Laird, Press Secretary
518-474-8418
212-977-2716
FOR RELEASE:
10 A.M., FRIDAY
OCTOBER 10, 1975
TESTIMONY BY GOVERNOR HUGH L. CAREY
BEFORE THE SENATE COMMITTEE ON BANKING,
HOUSING AND URBAN AFFAIRS, DIRKSEN SENATE
OFFICE BUILDING, WASHINGTON, D.C., FRIDAY,
OCTOBER 10, 1975, 10 A.M.
I come to you today with as great a sense of urgency as any
Governor ever has felt in the history of this country. As a former
member of Congress, I know fully well how frequently you are asked
for financial assistance, for tax breaks and for the means to enhance
wealth or credibility. I come today on a very unique mission—to tell
you that the default of New York City will cause not only the bankruptcy of the State and City of New York, the devastation of 17 million
people, but unforeseeable national consequences of such an adverse and
sizeable nature that we have no choice but to prevent them.
I sense that among people in this nation and their elected
representatives there exists a strong feeling that New York City
should be punished for its past.
However you feel about New York City, a national policy of
punishment will only hurt eight million innocent Americans who live
in New York City and another four million Americans who depend on
that City for their livelihood.
What did any of those Americans do to deserve to suffer the
uncertainty, the chaos, the slow death of their City which would
result from a default?
I cannot stand here today and deny that New York City tried to
do too much for too many and that imprudent management was certainly
part of its problem.
But I do not wish to waste any further time discussing misconceptions about mismanagement or policies of punishment, or apportioning blame.
I am here today to promote understanding, I am here to seek
recognition for all the State of New York and the City of New York
have done in recent months to repair the City's past and to prepare
for its future.
Last Spring, when investor confidence was so severely shaken that
the market for short-term City debt closed down, the State of New York
advanced nearly 800 million dollars of State aid payments to the City
in order to provide time for an orderly review of the alternatives.
I felt it was my duty and obligation to keep the White House,
the Federal Reserve and the U. S. Treasury informed of the exact
nature of the City's financial problems and the severe consequences
a default would have on our State and Nation.
I also sought advice and constructive suggestions from those
officials and they urged us to have the State step forward; they said
that they would only deal with the State in developing a possible
federal solution. So on the advice of the highest federal officials
and on the advice of highly qualified financial experts in our own
State, we created the Municipal Assistance Corporation—Big MAC.




295
Part of the City's problem at that time appeared to be an excess
supply of short-term City debt, so MAC was designed to refinance this
short-term debt on a longer-term basis. To secure MAC obligations and
to increase investor confidence in the political will behind this
effort, an important part of the City's revenue stream was diverted to
MAC. Finally, to restore investor confidence in the political will and
the managerial competence of City government, MAC was mandated to work
with the City in instituting managerial and budgetary reforms which
would restore the City's fiscal integrity.
Even after we accomplished all this, we were told by federal
officials that all we had done was to exchange short-term debt for
long-term debt. They urged the State to do more.
Then over
recovered from
market and for
swift and more

the summer it became apparent that the market had not
its qualms about New York City. For the sake of that
the sake of the City, we determined we needed more
dramatic action.

Therefore, early last month I called the State Legislature into
Special Session to consider the actions I felt were necessary to save
the City from default.
The Legislature adopted my proposal for a commitment of State and
pension funds to meet the City's financing requirements until December
of this year. We appropriated $750 million of State funds to help the
City. We put the credit of the State of New York on the line. It was
a difficult decision, but I believe we did the right thing.
The Legislature also adopted my proposal mandating the City to
achieve a balanced budget in the fiscal year ending June 30, 1978, and
to show substantial progress toward budgetary balance in each of the
two intervening fiscal years. To assure the achievement of these
goals, the Emergency Financial Control Baord was established, putting
the Governor and the State Comptroller, the Mayor and the City
Comptroller, and three qualified management leaders from the private
sector in charge of the City's three-year Financial Plan.
The Board has the power and the responsibility to assure a
restoration of the City's fiscal integrity. It will use that power
to achieve fiscal integrity. And with that integrity should come a
restoration of the City's credit worthiness in the market in due
course.
The City must submit to the Board a three-year financial plan
showing a balanced budget in the fiscal year beginning July 1, 1977,
and substantial progress toward a balanced budget in the two intervening fiscal years. The Board may approve, disapprove or modify
the financial plan to achieve the goal of a balanced budget.
To enforce the execution of this three-year plan, the Board has
the power to review and approve or disapprove a wide range of City
contracts. It may suspend municipal employee wage increases to the
extent it decides is necessary to achieve the objectives of the
financial plan.
All City revenues are diverted to the Emergency Financial Control
Board which then disburses these funds to assure compliance with the
financial plan. In the event revenues in the Board's fund are not
sufficient to meet expenditures authorized by the financial plan, the
Board is required by law to make payments on a schedule of priorities
which protects creditors first.
In the thirty-three days since the Legislature approved my special
plan, the Emergency Financial Control Board has proved it can meet the
challenge of returning New York City to fiscal integrity.
Three outstanding members from the private sector--William
Ellinghaus of the New York Telephone Company, Al Casey of American
Airlines and David Margolis of Colt Industries—have been appointed
to the Board. We have met six times, and a spirit of utmost cooperation, understanding and unity had prevailed at each meeting. Each
member fully appreciates the Board's critical mission.




296
We have determined accurate three-year revenue estimates for the
City. At this week's meeting, a week ahead of schedule, the Board
received the first draft of a three-year financial plan from the City.
The purpose of that plan is to reduce City expenditures to match its
revenues so that when the City returns to the credit market, it will
be a good investment.
We are in the process of reviewing City contracts and collective
bargaining contracts. We are reviewing the City's tax revenues to
determine which taxes would be extended, which should be eliminated
as counter-productive and which should be adopted as substitutes where
necessary.
In short:
— I n a city with the strongest municipal unions in the Nation,
there is a wage freeze.
— I n a city with the largest construction industry in the Nation,
there is a freeze on new capital construction.
— I n the financial capital of the world, a State agency completely
controls New York City's access to money.
These actions, though harsh, are not inconsistent with the steps
I have had to take since the day I took office:
— T h e actions we took to save the Urban Development Corporation.
— A State hiring freeze which has resulted in more than 5,800
fewer employees.
— O n e of the lowest collective bargaining settlements in history
in which 140,000 State employees were held to a 3.5 percent increase.
None of these actions is inconsistent with what is happening in
New York City.
Last month, both the Democratic and Republican leadership of the
State of New York faced a most difficult decision. It was not easy to
decide to put the credit of the State of New York on the line to give
New York City time to survive. But both the Democratic and Republican
leadership of our State government felt we had no other choice.
Now our State's resources are stretched to the limit. Now, I
must tell you, as a State, we have done all we can to help New York
City.
The State of New York cannot guarantee the securities of New York
City. We have neither the resources nor the power. In fact, our
State government is smaller than the government of New York City.
Now we seek recognition from the Federal government for what we
have done. We need and we deserve federal assistance. We are
not asking for a handout or a bailout. We are asking for a sensible
solution—a limited guarantee of the securities issued by the Municipal
Assistance Corporation—the State financing agency for the City of
New York.
The securities covered by the guarantee should be of a relatively
long maturity—at least ten years—so that with a guarantee on bonds
with a principal amount of five billion dollars we can effectively
handle New York City's remaining short-term debt. With the effective
action of the Emergency Financial Control Board and this federal
guarantee, we will make certain this is a non-recurring problem.
We are proposing that these bonds be taxable for three reasons:
— T o prevent the downgrading of other taxable securities because
a tax exempt and guaranteed security would be superior to every other
security in the market.




297
— T h e removal of New York State from the tax exempt market would
benefit other municipal borrowers in the country.
--The taxes on the bond's income would yield revenue for the
federal government.
The City's Emergency Financial Control Board will see to it that
the City achieves a balanced budget so that the guarantee is never
drawn down.
If we get the federal assistance we need, I can promise you, that
after 1977, New York City will never again have to borrow beyond its
means to meet its operating expenses. And I promise you that in the
mechanisms and institutions I set up to meet this goal, I will not
only insure that this will be true during my administration, it will
have to be the policy of future governors who may succeed m e .
One of the best ways we have of preventing major errors in
foreign policy is a sound system of intelligence.
A lack of intelligence information caused a great national
disaster on December 7, 1941.
I come before you today with intelligence information which you
must use to prevent an Economic Pearl Harbor on December 7, 1975.
While I can't predict for certain all the severe national and
international effects of a default by New York City, I can tell you
what problems the situation has already caused in our State.
Our major State agencies—agencies with sound, secure revenues
and the certain ability to pay debt s e r v i c e — a r e in severe danger of
default because of the crisis in confidence in the Nation's municipal
bond market.
The New York State Housing Finance Agency which has financed
800 projects worth 5.8 billion dollars over the past 15 years cannot
find a market for its sound securities.
Neither can our State's Dormitory Authority, Environmental
Facilities Corporation and our Medical Care Facilities Finance Agency.
What will happen to 1.6 billion dollars worth of projects underway -by these State agencies in New York?
I can answer that.
Our State will be spotted with empty monuments to default,
partially built classrooms, dormitories, public and private hospitals,
mental health facilities, day care centers, nursing homes, water
pollution control facilities, and housing for low and middle income
families, to name a few of the ongoing p r o j e c t s — w i l l forever stand
as only steel and concrete.
Our sick, our elderly, our children in need of education, our
working mothers and all of our citizens will forever be denied the
vital services those facilities were designed to provide.
Billions of dollars in capital will be wasted.
More than 5 3,000 workers who depend on these four agencies for
their livelihood will be sent to the unemployment lines.
So I must ask, what will happen to the projects, the services,
the capital and the jobs in 33 other states with similar agencies?
New York State's localities and sewer and water authorities need
to accomplish 1.1 billion dollars of their traditional, regular
borrowing between now and March.




298
Yet local banks which in the past bought their paper without
question because that paper was sound, have now turned their backs
and closed their doors.
So I must ask what will happen to local units of government
across our nation who must have access to the credit market to meet
their cash flow needs and provide services to their citizens?
Hundreds of New York State School Districts will need to achieve
1.2 billion dollars in traditional borrowing between now and next
June.
Local banks are closing their doors to our school districts.
This week I received a letter from the East Islip School District
in Long Island.
The finances of that district are and always have been sound and
secure.
That district needs to make three offerings of securities
totaling 5 million between now and January 1976.
Local banks in their words "are not willing to deal with us at
any price."
On October 1, the school district was able to obtain a loan of
$800,000 for 30 days at a 11.15 per cent interest rate. So I must
ask how will the children of New York State receive their education
in the future? What will happen to the future education of all the
children in our nation as the disease of default sweeps our country?
We know that most of New York State's paper is sold in New York
State. But who owns New York City? Who will be hurt if New York
City defaults?
Individuals with their life savings invested in New York City -not only banks — but business in every state of the nation own
New York City. So we must ask ourselves, what will happen to
businesses whose future depends on loans they have secured with
New York City paper as collateral?
The Congress of the United States must ask itself:
What purpose is there now to the National Housing Act passed
last year?
For that legislation assumed localities would have access to
the credit market at normal interest rates.
What will become of that legislation with the municipal credit
market in shambles?
The Congress must also examine the effects of New York City's
problem on its local revenue sharing programs.
I know of one respected economist who estimates that skyrocketing
municipal interest rates could cost localities across this nation up
to 3 billion dollars. That would negate one-half of the federal
general revenue sharing funds. What federal plan is there to help
the citizens in localities across this nation faced with increased
local taxes to pay those intei*est costs?
If the purpose of non-intervention on the part of the federal
government is to teach New York City a lesson and force it to
economize, there is a sense in which this policy might turn out to be
both ineffective and extremely costly to other governmental units.




299
What motive will there be for the city workers to continue
their self-sacrifices and to provide vital services with the city
as a trustee of the federal government?
A city in default is a demoralized city. Will a city under federal
occupation and control have any motivation to pay its debts?
Those governmental units that have issued long-term bonds at
higher interest rates and do not default, on the other hand, will be
forced to continue to pay these higher interest rates over the life
of the bonds. The question is, will most governments be willing to
do this after there is a New York City default? Or will they see default as an accepted way to unload their debts? Do w e , as a nation,
want to set national policy which encourages local government to throw
in the sponge, to give up trying?
New York wants to pay its debts, we want to attend to the errors
of the past. We simply seek recognition for all we have done.
I am the first to admit that under the system New York City used
to keep its books, it was difficult, to say the least, to get
proper information on the city's financial situation. Now, the
books are not only open, the figures are sound and dependable.
I invite any member of any congressional committee, or for that
matter, the administration to examine the books of New York City
or New York State. We invite constructive suggestions and advice.
It seems I have raised as many questions as I have answered
today.
The fact we have no answers to the questions points to the fact
we need in our government, an orderly system in which we can find
these answers so we do not have to speculate on the unforeseeable
effect of default on our nation's economy. Whoever is willing to
stand up to the questions I have raised today will never again be
able to say that the effects of a New York City default would be
contained within the borders of our city or state.
Whoever is willing to stand up to these tough issues will never
be able to deny that New York City's problems are national, indeed
international, in scope and effect. And no member of the United
States Senate will be able to overlook the certainty, that if New York
City is allowed to default, the financial problems of New York City
will be in his state very soon.
The choice before the United States Congress is clear:
-- Either a limited guarantee of the securities of New York
State's bonds which will cost nothing, which will, in fact, add
revenue to the federal treasury;
-- Or a default of New York City, which I am certain would be
the most costly mistake in the history of this nation -- in dollars,
in human suffering and in the erosion of our democratic institutions.
I cannot deny that there is a contagion in New York which is
about to sweep across the nation. Don't kill us because we are
ill.
We are asking for your assistance so that we can cure ourselves
and contain the contagion.
I do not relish the prosepect that on
our nation's bicentennial anniversary, the city which was this nation's
capital in 1789, may be occupied by the federal government.
Nor
do I look forward to the slow yet certain death the financial,
cultural and entertainment center of the world would suffer if it
is denied federal assistance and allowed to default.




300
STATEMENT OF FELIX G. ROHATYN, GENERAL PARTNER, LAZARD FRERES & Co.

Mr. Chairman: My name is Felix G. Rohatyn. I am a general partner in the
Investment Banking House of Lazard Freres & Co. I am here today in my capacity as Chairman of the MAC to ask for your support for a Federal program to
prevent the unnecessary default of the City of New York. I believe that both from
a banking as well as a human point of view this is a tenable position. But let
me first, as an investment banker, talk about the City. There I am concerned
with certain issues:
1. Whether New York City is financially sound.
2. Whether it is viable from a management point of view.
3. Whether it can provide its service at an acceptable cost.
When Governor Carey asked me in late May to assist on a panel to help
resolve a mounting crisis, it was apparent that none of these criteria were being
met.
The City had no credible financial plan to get a balanced position.
The City's maangement could not demonstrate that it could deliver the services
required of it with the money available to it.
The City's management was not credible to the public and to the institutions
whose support was required to keep the City going.
We recommended creation of MAC. The Governor accepted it. And it provided
the bridge which enabled us to walk, or stagger, from June to October. At least
we can point with a certain amount of pride to the fact that, as the Governor has
pointed out, enormous strides have been made, and we have so far prevented a
default.
I believe that today we have the main elements required to put any economic
unit back on its feet. We have fiscal control, exercised by the Financial Control
Board to determine how much money the City has available to it and which sees
to it that the City spending is held within those amounts. We have the beginnings of a restructuring of the operational management of the City. We have a
financing vehicle in MAC.
I think you would all agree that as of today there is a plethora of talent—of
business talent, of management talent that is being brought to bear on City
management practices and personnel. This talent is in for the duration.
I would be less than truthful if I told you that everything today is in place
to run the City as I and investors all over the country might like to see it run for
the next ten years. But the process has started and will not be stopped. The MAC
legislation and the emergency legislation passed last month required that the
City's budget be in balance by the fiscal year beginning July 1, 1977. The men
now involved are erecting a fiscal fence around New York City—they know how
to read balance sheets, read profit and loss accounts, judge management methods
and systems.
The history of the past few months and specifically negotiations which involved
MAC with the municipal unions have convinced me that the majority of the City's
union leadership is anxious to see more efficient City management.
They see it as the only way for the City to survive and for a smaller stabilized
work force to be secure about its future.
The City will get into balance because it has to. Period. Management will
determine whether the City is a livable place or a fiscal success but a social
failure.
All of you know that any reorganization takes time. All of you also know that
it is far better, economically, professionally, and humanly, to permit a sick
situation to be cured over a period of time than to chop it to pieces. The cure
involves imposing stringent conditions on the City. If I am right that the control mechanism is in place and the beginnings of sound management practices
have been initiated, then the need is for a financing mechanism to make it
happen within the statutory three-year period. From the outset we perceived
MAC as the appropriate financing mechanism. However, while the mechanism
is sound, the markets have closed down, not only around the City but on MAC
and the State.
Most experts agree today that neither MAC nor the State of New York full
faith and credit obligations are poor credits.
What they are facing today is non-marketability which as you know is a quite
different matter.
However, lack of marketability can be as lethal as poor credit. I believe that
performance to date and the security behind MAC entitles it to a market at
reasonable interest rates.




301
However, I question whether there is anything t h a t we can do a t t h i s point
to open the m a r k e t in t h e n e a r future.
T h e problems we a r e facing is also the result of a more profound and basic
economic dislocation.
W h e t h e r a d r a m a t i c or conventional form of fiscal discipline is involved, one
fact is clear. A severe capital shortage is looming over the next decade or two.
This shortage is going to affect every person in t h i s room a n d every city and
state to which you a r e committed. I t is going to put significant restrictions on
this country and will create greater and greater requirements for efficiency on
t h e p a r t of elected officials to enable them to deliver services to their constituency.
Politicians will have to learn not only in New York City, but all over this count r y t h a t organizations requiring large amounts of capital m u s t discipline themselves in order to have t h a t capital made available.
Looking back over the last fifteen years it is easy to say t h a t the problems of
the City have been caused by mismanagement a n d by fiscal gimmickry. I t is
easy to say and it is undoubtedly true. I t would be equally true to say t h a t money
was made available to the City in ridiculous amounts and on ridiculously easy
terms. The financial community, of which I am a member, h a s to bear its share
of the blame for w h a t happened to the City.
Financing vastly beyond the limits of prudence was obvious to even the unsophisticated. W h a t happened in New York City was w r i t t e n on the wall. I t was
inevitable t h a t sooner or later the crisis would occur and the political process
failed in preventing the crisis.
Certain of New York's problems a r e probably unique to it—but the fact remains
t h a t New York City is not all t h a t unique. I don't believe t h a t most of you sitting here a s you think it through will feel t h a t your cities and your states a r e all
going to be immune from these problems. W h a t is the answer for us then? Over
the last four months since the creation of MAC we have raised approximately
$2.5 billion dollars with the superb support of the N.Y. banking community, with
additional support from other local institutions, and with practically no support whatsoever from out of state financial institutions. The Governor h a s told
you w h a t actions have been taken.
The existing financing may see us through the beginning of December although
there are uncertainties even during this period. If we do reach December 1, we
will have raised close to $4 billion, involved the state to the extent of $750 million, and scraped every known resource available to MAC, the City and t h e State.
By December 1st there may be some avenues still open to us in a limited way
but absent to an assured financing mechanism t h a t would enable us to fund
out our three-year plan, the odds against our winning a r e exceedingly long.
When, in August, it became apparent t h a t the m a r k e t s for MAC securities
would he closed to it in September and the Governor asked for recommendations
involving possible State a n d / o r Federal action, we were mindful of the proposition t h a t no Federal involvement could be contemplated until the State itself had
made a major commitment both in terms of the control of the City's finances
and in terms of the State's financial involvement itself. The legislation which
the Governor asked the Legislature to approve contained both elements of this
approach. The commitment of $750 million of State funds spread over a threemonth period of time seemed to us to include a significant involvement of the
State but in the light of the State's resources and history, did not seem to threaten
the State's integrity significantly more than it was already threatened by a possible default of the City of New Y'ork. The markets have, however, closed upon
the State as well as upon MAC, and as well as upon creditworthy State agencies,
such as the F H A . Without the State Controllers' commitment of State Pension
F u n d s to acquire the $250 million of State Notes prior to October 17, the State
would undoubtedly be unable to fulfill its commitment to make $250 million available to the City as p a r t of the fiscal package a t t h a t time.
Although a default is technically defined as the failure to pay off a debt as it
becomes due, in my judgment, had t h e State flailed to meet its commitment to
make $250 million available to the City in October, as it is committed to do legislatively t h a t wouly have m e a n t a n actual default in real terms, quite a s serious
as the failure to meet a debt m a t u r i t y as it became due. The present financial
crisis of the City of New York, even after taking into account significant action
taken over the past three months by City, State, financial community, and the
private sector, has successively shut off access to m a r k e t s of City, MAC, State
agencies and, now, the State of New York itself. The total a m o u n t of indebtedness
involved of these entities is close to $30 billion, or about 15% of the total municipal debt outstanding in the United States.

60-832

O - 75 - 20




302
Many a r g u m e n t s have been heard on either side of t h e question of
the impact of a default of the City. I have given it as my professional judgment
t h a t an impact of a City default would inevitably lead to default of major State
agencies, and of a possible default by the State of New York itself. I believe t h a t
the impact of such a series of defaults is not containable without major cost to
the economy, and to our international position. I believe t h a t domestically the
economic recovery would be seriously damaged and t h a t in New York City itself
an irreversible exodus of corporations and businesses would condemn the City's
t a x base to a fatal downward spiral. Abroad it would seem to me t h a t such a
failure would be attributed to either a fundamental s t r u c t u r a l failure of t h e
capitalist system, or to be the result of divisions within this country so profound as to paralyze its will to act.
I realize t h a t these a r e judgments, and t h a t h u m a n j u d g m e n t is subject to
error. I t seems to me, however, t h a t the assumption of a major needless, a n d I
emphasize needless, economic and social risk in the n a m e of fiscal prudence, is
neither good logic nor good policy.
We are looking for Federal involvement to m a i n t a i n an orderly m a r k e t in our
obligations, so t h a t we can bring our program t o a successful conclusion and pay
our debts 100 cents on the dollar. There are several approaches t h a t could accomplish t h a t purpose a n d we a r e open to different possibilities. As f a r as MAC
is concerned, our choice would be for a program of Federal g u a r a n t e e s to MAC
bonds, with taxable interest on those bonds at t h e time t h e g u a r a n t e e goes into
place. We do believe t h a t only State agencies such as MAC, should be eligible
for such Federal guarantees and t h a t approval by Federal authorities in addition
to t h e Emergency Fiscal Control Board of the City's three-year fiscal plan would
have to be involved. W e believe t h a t an appropriate insurance premium and the
possible pledge of Federal revenue sharing to protect t h e Federal Government
would be appropriate steps for discussion.
The hour is very late. A financial virus h a s existed in New York and we w a n t
to keep it from contaminating the rest of the country. You h a v e witnessed the
spread of the virus in spiraling municipal interest costs and deteriorating investor confidence. Assured access to m a r k e t s while the City gets into balance is
t h e best way to vaccinate the rest of the country against this virus.
At a time of early economic recovery a massive default anywhere is dangerous.
A default of mammoth proportions, involving City and State, t h a t w a s both
unnecessary and avoidable would be an inexcusable tragedy.

The CHAIRMAN. The committee is going to proceed.
The next witness will appear now and proceed as far as you can.
The third panel will appear this afternoon.
The next witnesses are Brenton Harries, Paul Markowski, Wallace
Sellers, William Solari, and Edward Kresky.
STATEMENTS OF BRENTON W. HARRIES, STANDARD & POOR'S
CORP.; EDWARD M. KRESKY, WERTHEIM & CO., INC.; PAUL J.
MARKOWSKI, ARGUS RESEARCH; WALLACE 0. SELLERS, MERRILL LYNCH; AND WILLIAM J. SOLARI, DONALDSON LUFKIN
The CHAIRMAN. Gentlemen, we are very grateful to you for appearing. You are the outstanding experts in the country on municipal bonds
and on the consequences of whatever action the Federal Government
may take or may not take.
You have concise statements. We would appreciate it if the statements could be abbreviated under the circumstances.
Do proceed and give us as much information as you can. Your
statements will be printed in full in the record, so we can question you.
Our first witness will be Mr. Brenton Harries.
Mr. HARRIES. I would like to emphasize that the immediate problem
of New York, the city, State and its agencies is one of cash flow. We
believe that the credit problem is one of cash flow. Our credit ratings
attempt to measure ability to repay debt.




303
An integral part of this analysis is a judgment as to the ability to
borrow.
I n the case of the city and New York State agencies, they have lost
the ability to borrow to meet maturing short-term debt. This makes the
problem of default on short-term notes an immediate and constantly
recurring need.
May I interject ? This is a different problem from what the Governor
was talking about. New York State does not have volumes of shortterm debt that must be met by borrowing again. New York State
liquidates its short-term debt primarily from revenues. We do not
look for default of the State itself. I t does not have huge amounts of
short-term debt that have to be met by selling new debt.
Normally, borrowing is for capital improvement, and I emphasize
that in the case of the city the borrowing is for debt repayment and
inability to borrow triggers immediate default.
I t is our belief that outright default by New York City would shut
down completely—for a prolonged period—the ability to borrow for
various New York State agencies, and that this in turn would make it
impossible for New York State to tap the note markets as it has
historically done for many years to provide advance payments of
State aid to New York State school districts, towns, and counties.
I would like to point out something that indicates the degree to
which the market has recognized the erosion of values totally out of
proportion to the actual risk. I appeared on the "Wall Street Week"
program a few weeks ago. I received many letters. One was from a man
who purchased a 6% percent coupon bond of Battery Park City
Authority maturing in 2014. He paid approximately 100 or $1,000 per
bond. Because market psychology says everything about the bond is
wrong, that is, the authority is located in New York City, New York
State, and is backed bv the "moral obligation" of the State, it has
three strikes against it. The bond today is quoted at 45 or $450 while, in
fact, behind each bond there is still some $700 from the original bond
proceeds invested in U.S. Treasury obligations.
For another example, New York State 5.37-percent notes sold last
May and due to mature on March 31 of next year—just 5% months
from now—are currently being offered at an unheard of discount of
seven points. This is equivalent to an annual yield in excess of 20
percent.
Mv third reason for advocating Federal involvement is because of
the Federal Government's crowding out of borrowers in the capital
market by the huge demands being made to finance the Federal budget.
In the last decade the Federal Government has preempted one-quarter
of a trillion dollars in the Nation's money market. Surely it must share
some of the responsibility for allocation of capital and rising debt
service requirements.
The legislation would provide for direct loans to the State or an
agency set up by the State as a conduit by the Federal financing bank.
The rate of interest should be whatever the Federal financing bank
has to pay, plus an amount to cover service charges—perhaps 1 percent. The rate, in any event, should not be a bargain to the State.
Mr. Chairman, in the interest of time, I will pause.
[Complete statement follows:]




304
STATEMENT OF
BRENTON W. HARRIES, PRESIDENT, STANDARD & POOR'S CORPORATION
TO THE U. S. SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS
WASHINGTON, D. C. - OCTOBER 10, 1975

The fiscal crisis in New York, the City, the State, and its various agencies,
has been well documented and I will not dwell on it further other than to say
that the immediate problem is one of cash flow.

Our credit ratings attempt to

measure ability to repay debt. An intregal part of this analysis is a judgement
as to the ability to borrow.

In the case of the City and New York State agencies,

they have lost the ability to borrow to meet maturing short-term debt. This
makes the problem of default on short-term notes an immediate and constantly
recurring need.

Normally, borrowing is for capital improvement, and I emphasize

that in the case of the City the borrowing is for debt repayment and inability
to borrow triggers immediate default.

It is our belief that outright default by

New York City would shut down completely - for a prolonged period - the ability
to borrow for various New York State agencies and that this in turn would make it
impossible for New York State to tap the note markets as it has historically done
for many years to provide advance payments of State aid to New York State school
districts, towns and counties.
The State has set in place a financing mechanism called the Municipal Assistance
Corporation and a control mechanism, the Emergency Financial Control Board, to
oversee the budgetary and financial affairs of the City.

These mechanisms appear

sound and well conceived through the dedicated efforts of the Governor and leading citizens. However, this new system requires time to become fully operative
in managing the City's finances.
term debt matures each month.

But time is running out, and the City's short-

In our opinion, it is an absolute certainty that

New York City will default without the infusion of cash to repay maturing debt and




305
the only avenue open to the City is the State and the market for the State notes
also has now closed.
I believe the intervention of the Federal government is absolutely essential
to provide the State sufficient time to regain the credibility necessary so that
the State, its agencies and the City may once again return to the public debt
markets.
There are three specific reasons why the Federal government should become
involved.
First, there has been a massive erosion in the value of municipal securities
nationwide far out of proportion to the actual risk.

This adverse market

psychology has caused many bond issuers to pay abnormally high interest rates.
For example, in the secondary market for municipals, bonds of the Battery Park
City authority provide a horrendous example of market erosion.

I received a

letter from an investor who purchased this bond in 1972 when it was issued at a
6 l/87o coupon maturing in 2014. He paid approximately 100 or $1,000 per bond.
Because market psychology says everything about the bond is wrong, i.e., the
authority is located in New York City, New York State, and is backed by the
"moral obligation" of the State, it has three strikes against it.

The bond today

is quoted at 45 or $450 while, in fact, behind each bond there is still some $700
from the original bond proceeds invested in U. S. Treasury obligations. For
another example, New York State 5.37% notes sold last May and due to mature on
March 31 of next year - just 5 1/2 months from now - are currently being offered
at an unheard of discount of 7 points. This is equivalent to an annual yield in
excess of 207o'.
Secondly, there will be a major negative impact on the entire economy of the
State if access to the borrowing market continues to be denied the State and its




306
agencies.

Failure of the Housing Finance Agency to float notes to finish

various projects under construction will harm the state's economy while
jeopardizing the completion of needed facilities.

In addition, the State

historically enters the short-term market in the Spring to provide funds to
cities and towns for welfare, education and social services.

Failure to

obtain these funds would trigger defaults across the State. May I emphasize
that I am referring constantly here to the inability to borrow. The bonds of
the State continue to be well secured and the bonds of the Housing Finance
Agency are well secured by revenue-producing, completed projects.
My third reason for advocating Federal involvement is because of the Federal
government's "crowding out" of borrowers in the capital market by the huge demands
being made to finance the budget.

In the last decade the Federal government has

preempted one quarter of a trillion dollars in the nation's money market. Surely
it must share some of the responsibility for allocation of capital and rising
debt service requirements.'
How should Federal money be transmitted to the State?

I apologize for being

unable to keep up with the various legislative ideas emanating from the Congress.
I recognize in several of the Bills pieces which fit my proposal so let me state
my ideas briefly.
The legislation would provide for direct loans-to the State, or an agency
set up by the State as a conduit, by the Federal Financing Bank.

The rate of

interest should be whatever the Federal Financing Bank has to pay plus an amount
to cover service charges - perhaps 1%.

The rate, in any event, should not be

a "bargain" to the state. The loan should be administered with very stringent
budgetary and payment conditions and the screen to examine the qualifications
should include the following criteria:




307
1. The State should have exhausted all other possible remedies and be
no longer able to obtain credit from any other source.
2. There must have already been passed legislation within the State
for complete takeover of the afflicted local government's finances,
such as the Emergency Financing Control Act in New York State.
3. And, lastly, there should be the absolute and real threat of imminent
default.
In order to assure continuing State bond holder protection, the Federal
loan should be subordinated to the first lien of the State1s general obligation bond holders.

I believe this step is necessary because of various state

constitutional requirements of voter approval to incur additional general
obligation debt.

It would not obviate the necessity of the State providing

a precise plan for repayment of the Federal loan within a set time period.
Additional Federal sanctions should be imposed as deemed appropriate.




308
The CHAIRMAN. Mr. Kresky.
Mr. KRESKY. Thank you, Mr. Chairman.
I'm speaking in two capacities as vice president of Wertheim & Co.,
Inc., and I'm a member of the board of the Municipal Assistance Corporation for the city of New York.
The fiscal crisis facing New York City has been building up for a
number of years. The roots of the problem are widespread and need
not be rehashed again today. That the city of New York has lived beyond its means is self-evident. That the city, after recognizing the fact
that it was drowning in its short-term-debt problems last year still
failed to act vigorously enough to curtail expenditures was most unfortunate. This, of course, contributed to the credibility gap regarding
the city's abilities of self-discipline which, in turn, manifested itself
in the closing of the money markets for New York City.
I n June of this year the State of New York attempted to aid the
city through the establishment of the Municipal Assistance Corporation, empowered to stretch out a portion of the city's short-term debt
until the city could regain entrance into the money market; and MAC
was also designed to help order the city's fiscal affairs. Unfortunately,
MAC by itself, armed only with powers of persuasion as to city finance,
could not restore investor confidence.
The control board, and the powers given to it, are unprecedented in
the history of State-city fiscal relations in this country. Hopefully,
this program, when it is fully operative on October 20, will prove to
be the effective tool needed to restore investor confidence in New York.
But, if these sweeping efforts fail, New York City and perhaps some
of the agencies of the State government, face the clear prospect of default.
Today, the municipal market is a state of disarray. As a result,
the market increasingly is failing to meet the legitimate needs of not
only New York State and its local governments, but of State and local
governments from one end of the country to the other. Tax-free interest rates are at awesome levels. For example, the Bond Buyer Index
is at a record level of 7.67 percent, up 113 basis points from January
of this year and up 249 basis points from January 1974.
Default by New York City will further worsen the difficulties State
and local governments are presently experiencing in their attempts to
raise capital funds. I n my judgment, neither the market or an individual can accurately "discount" default by the Nation's largest
city and center of its financial activities. Such waters are unchartered.
Ripples can become waves, waves can become heavy storms, heavy
storms can become hurricanes.
I won't cite the examples in my testimony regarding the high rates
of interest and great expense to taxpayers elsewhere in the country.
What is happening in Washington, Florida, North Carolina, and the
city of Buffalo is being repeated on a daily basis.
The market is beginning to eliminate more and more bond issues
resulting in job losses in the construction industry and in other areas
of the economy. The postponement of worthwhile projects needed to
meet the people's needs will be experienced increasingly in all sections
of the Nation.




309
To the question as to whether the Federal Government should intervene, I believe that the Federal Government must intervene in this
crisis if it is not to grow into a disaster situation. I t is, in my view,
in the best interest of not only the Federal Government, but of the
communities of this Nation, for the Government to provide necessary mechanisms to prevent the economic and social dislocations that
would stem from default by New York City.
I am not suggesting, nor have I heard a New York City or State
official suggest, a Federal "bail out" program wherein New York
City, or any other city or State instrumentality that may in the
months ahead be closed off from the money market, be given a free
ride. Any program involving Federal intervention or assistance properly should be accompanied by Federal requirements mandating that
the city put its house in order, and rapidly.
As to the exceedingly complex question as to how the Federal Government should act to Kelp in the New York City crisis, I would suggest a three-step program.
First, the Federal Government should step in quickly and provide
a one-time guarantee of city or MAC bonds in the amount of $3 to
$4 billion. This need not be a high-risk undertaking at all. Working
through and with the State and its emergency financial control board,
the Federal Government could help in stabilizing the New York City
fiscal picture while the city moves toward clearly living within its
means and systematically reducing its budget deficit.
Second, during the weeks ahead, the Congress and the administration, working together, should consider the development of a
longer term solution to the problem of raising capital for needed
State and local government activities nationally.
There is, in my judgment, merit in a Federal municipal bond insurance program available to State and local governments and their
instrumentalities. Premiums for such insurance, the cost of which
would be borne by the municipality, would be based on the risks involved. Again I would suggest that the Federal Government would
have to monitor this program through some type of State control
body.
Under such programs of Federal guarantee or insurance, the bonds
issued probably should be subject to Federal taxation. On the other
hand, those State and local governments with easier access to the
money markets and having no need for these programs, could continue to issue tax-exempt securities.
Third, there is need to revise chapter I X of the Federal Bankruptcy Act to make it more workable in the event a municipality the
size of the city of New York should ever default.
Again, thank you for the opportunity to comment on this issue
which is of such importance to the future of our economic and social
order and to our Federal system of government.
[The complete statement follows:]




310
SUiiemcnl by Ed^orci M. Krci-ky b<. fcr-.. the
Committee on Banking, Housing and Ur!. :-.r\ Affairs
of the United States Senate,
Friday, October 10, 1975

My name is Edward M. Kresky and

I am a vice president and director of pub-

lic finance activities for the investment banking firm of Wertheim S Co.,
Inc.

Prior to joining Wertheim

in 197'»

New York State and local government.

' spent more than 20 years in

I am a representative member of the

Board of the Municipal Assistance Corporation for the City of New York.

At the outset, may

I express my appreciation for the opportunity to ap-

pear before this distinguished committee.

The fiscal crisis facing New York City has been building up for a number
of years.

The roots of the problem are widespread and need not be re-

hashed again today.
is self-evident.

That the City of New York has lived beyond

its means

That the City, after recognizing the fact that it was

drowning in its short term debt problems last year still failed to act
vigorously enough to curtail expenditures was most unfortunate.

This, of

course, contributed to the credibility gap regarding the City's abilities
of self-descipline which, in turn, manifested

itself in the closing of

the money markets for New York City.

In June of this year the State of New York attempted to aid the City through
the establishment of the Municipal Assistance Corporation, empowered to stretch
out a portion of the City's short term debt until the City could regain entrance into the money market; and MAC was also designed to help order the
City's fiscal affairs.
ers of persuasion
dence.




Unfortunately, MAC by itself, armed only with pow-

as to City finance, could not restore investor confi-

311
In ?<:ot.: I'-er, the State, in Special Session of the Legislature, acted decisively by providing financial assistance to the City and by establishing
an Emergency Financial

Control Board, headed by the Governor, with broad

powers to police and generally supervise New York City's finances.

The Control Board, and the powers given to it, are
in the history of state-city fiscal

almost unprecedented

relations in this country.

ly, this program, when it is fully operative on October 20, will

Hopefulprove

to be the effective tool needed to restore investor confidence in New
York.

But, if these sweeping efforts fail, New York City and perhaps some of
the agencies of the State government, face the clear prospect of default.
Default by a City the size of New York, the financial capital of the nation, must have national and international

Today, the municipal market
market

increasingly

implications.

is in a state of disarray.

As a result, the

is failing to meet the legitimate needs of not only

New York State and its local governments, but of state and local governments from one end of the country to the other.
are. at awesome levels.

Tax free interest rates

For example, the Bond Buyer

Index is at a record

level of 7.67 per cent, up 113 basis points from January of this year and
up 2^9 basis points from January 197*+.

Default by New York City will

further worsen the difficulties state and

local governments are presently experiencing
capital

funds.

in their attempts to raise

In my judgement, neither the market nor an individual can

accurately "discount" default by the nation's largest city and center of
its financial activities.

Such waters are unchartered.

Ripples can be-

come waves, waves can become heavy storms, heavy storms can become hurricanes .




312
A few examples, all taken from lie last month.
-- the State of Washington sold AAA public power supply bonds at a
net interest cost of 7-72%.

Just three months earlier this security sold

at 7.04%.
-- the State of Florida sold full faith and credit AA bonds at 7.08%.
One year earlier, they sold at 6.02%.
-- the State of Arizona's Salt River District sold electric
bonds at 8.17%.

revenue

In April of this year they sold at 7.60%.

-- the North Carolina Housing Finance Agency on Tuesday, this week,
suspended a $50 million bond sale for 2500 housing units because they couldn't
sell the bonds at rates that would have made the project feasible.
-- the City of Buffalo is experiencing the most severe difficulties
in attempting to remain in the money market.

This is now being repeated on an almost daily basis.

The market

ning to eliminate more and more bond issues resulting

in job losses in

the construction

industry and

in other areas of the economy.

is begin-

The post-

ponement of worthwhile projects needed to meet the people's needs will be
experienced

increasingly

in all sections of the nation.

To the question as to whether the Federal government should
believe that the Federal government must
is not to grow into a disaster situation.
interest of not only the Federal

intervene, I

intervene in this crisis if it
It is, in my view, in the best

government but of the communities of this

nation, for the government to provide necessary mechanisms to prevent the
economic and social dislocations that would stem from default by New York
City.

I am not suggesting a Federal "bail out" program wherein New York City, or
any other city or state instrumentality that may




in the months ahead be

313
closed off from the money market, be given a free ride.
volving Federal
by Federal

Any program in-

intervention or assistance properly should be accompanied

requirements mandating that the city put its house in order,

and rapidly.

The Federal government might consider requiring that the

individual states set up control board type mechanisms to insure that its
municipalities are meeting the Federal

requirements.

As to the exceedingly complex question as to how the Federal

government

should act to help in the New York City crisis, I would suggest a three
step program.

First, the Federal government should step in quickly and provide a one
time guarantee of City or MAC bonds in the amount of $3 to $4 billion.
This need not be a high risk undertaking at all.

Working through and

with the State and its Emergency Financial Control Board, the Federal
government could help

in stabilizing the New York City fiscal

while the City moves toward clearly living within

picture

its means and system-

atically reducing its budget deficit.

Second, during the weeks ahead, the Congress and the Administration,
working together, should consider the development of a longer term
solution to the problem of raising capital
government activities nationally.
a Federal municipal bond

for needed State and local

There is, in my judgement, merit in

insurance program available to state and local

governments and their instrumentalities.

Premiums for such insurance,

the cost of which would be borne by the municipality, would be based
on the risks involved.

Again

I would suggest that the Federal govern-

ment would have to monitor this program through some type of state control
body.




314
,U*nder such programs of Federal guarantee or insurance, the bonds
probably should be subject to Federal

taxation.

issued

On the other hand, those

state and local governments with easier access to the money markets and
having no need for these programs, could continue to issue tax exempt securities.

Thirdly, there is need to revise Chapter IX of the Federal Bankruptcy Act
to make it more workable in the event a municipality the size of the City
of New York should ever default.

Again, thank you for the opportunity to comment on this issue which is of
such importance to the future of our economic and social order and to our
federal system of government.




315
The CHAIRMAN. Mr. Markowski.
Mr. MARKOWSKI. Because of a commitment which held me up, I have
not written a statement. I agree with Mr. Harries I would prefer a
direct loan to the State of New York rather than guarantee of the
municipal bonds of the city or "Big MAC" bonds. I will provide a
further written statement.
[Mr. Markowski's statement follows:]




316
BANKING AND THE ECONOMY
Submitted to Senate Committee on Banking,
Housing and Urban Affairs
October 10, 1975
"Federal Underwriting of Municipal Risks:
Who Bears What Costs?"
Paul Markowski,
Chief Economist
Argus Research Corporation

Many of the more dramatic claims about the impact of New York
City's troubles on the municipal bond market have not bothered to complicate the issue with any reference to the facts.

In particular, there

has been a somewhat understandable inclination to attribute any and all
increases in the yields of municipal securities entirely to the possibility of a New York default, rather than to fiscal troubles in other
municipalities, or to a general rise in many interest rates having nothing
to do with New Yoxk*s situation.
From the last week of July to the week ending October 3rd,
yields on Moody's new Aaa municipals rose 56 basis points and the Bond
Buyer's index of 20 municipals rose 50 basis points.

In the same period,

however, vields on new Aaa utility bonds also rose 36 basis points, and
20-year U.S. Government bonds rose 32 basis points.

So, a good portion

of the recent well-publicized increase in the yields on municipals simply
reflected a fairly general upward movement of interest rates arising from
heavy Treasury borrowing, inflation expectations, and the Federal Reserve's




317
efforts to reverse the excessively rapid growth in the money supply during
the second quarter.

Thus, it is incorrect to attribute the broad rise

in many interest rates solely to the turbulence in the market for municipal securities.

If investors shy away from municipals, that would

tend to increase the demand for alternative securities, raising their
price and lowering their yeilds .
It is true, of course, that the yield spread between municipals
and some other securities, particularly Aaa-rated corporate bonds, has
been closing for many months.

This shift in relative yields reflects

greater awareness of the hidden risk involved in some municipal

financing

-- risk which exists quite apart from the outcome of New York's difficulties.
There may also be some investor skepticism regarding ratings of municipal
securities

(Moody's only recently lowered New York City's rating below

" A " ) , which would tend to add a premium to yields to compensate for the
uncertainty, and would make comparisons with non-municipal
more difficult.

securities

In any case, the effect of growing disclosure of fiscal

problems in many municipalities

(not just New York) is sometimes exag-

gerated by comparing the yields on top-rated corporate securities with
the yields on some index of municipal securities which is composed of
various

(and sometimes declining) ratings of quality and risk.

Care

must be exercised not to compare oranges and onions, or at least not to
be surprised that the oranges smell much better.
It cannot be plausibly argued that all municipal yields have
already risen substantially in ant i c i cation of a single possible default.
while simultaneously arguing that those yields will rise substantially
more if the widely anticipated default becomes a reality.

Either the

effect has been largely anticipated, and the appropriate adjustments

60-832 O - 75 - 21




318
made, or it has not.

Capital markets are not easily surprised, so the

effect has probably already been largely discounted in the form of higher
municipal yields.

And since uncertainty adversely affects any capital

market, almost any resolution of New York's problems —
but excluding repudiation —

including default,

could help to stabilize the municipal market.

Some of the hysterical rhetoric being used to describe the
impact of default has been needlessly inflammatory, and perhaps more
damaging than default itself.

It is literally inconceivable that delayed

payment on some city notes could cause an "international catastrophe,"
"worldwide depression," or collapse of "the entire credit system."

Nor

is there any reason to suppose that a default would mean that the city
would 3top paying municipal salaries, thus provoking a "revolt" by city
workers (although the city workers appear likely to revolt over any plan
to limit expenditures).

One of the main reasons for a default would be to

avoid paying interest to note-holders, precisely in order to continue paying routine expenses.
salaries.

There is no reason to default on both notes and

Finally, it is simply not true that New York's problems have

made it "impossible" for financially sound cities and states to borrow
"at any price," although it is true that bad risks neither can nor should
get infinite credit.

In fact, state and local governments sold a third

more long-term bonds in the first nine months of this year than they did
a year before.
If the Federal Government comes to the aid of New York City,
there will surely be strings attached.

This implies another giant step

away from our traditional system in which the residents of each community
exert significant control over their own community affairs.
cost which must be weighed against any perceived benefits.




That is a
And what

319
sort of message would the officials of other communities receive from
any conceivable plan to rescue the city?
more fiscal risks —

Surely the message is to take

to please the local electorate by spending more and

taxing less, always looking at the short run and ignoring the future —
secure in the knowledge that the burden could safely be shifted to the
federal taxpayer.
Where would the federal government get the money to aid bankrupt
cities?

Most federal tax revenue comes from the already heavily taxed

residents of cities, and there are distinct limits to the opportunity to
shift the burden of urban spending to rural taxpayers.

Getting the

money from increased federal borrowing just means more trouble for prospective borrowers among cunsumers, business and municipalities, who are
already having a rough time competing with a flood of Treasury securities.
There is always the temptation to say that if there isn't enough money
to go around, then the Federal Reserve should print more.

But more money

cannot create more real resources, and rapid growth of the money supply
must ultimately dilute the purchasing power of each dollar, leaving nobody
richer in real terms.
There is considerable interest in schemes to guarantee municipal
securities, on the dubious grounds that this would be something less than
a "bail-out."

In fact, such a precedent would be evnn more ominous for

the municipal securities market than a direct federal loan or grant.

The

practice of guaranteeing the worst of municipal securities would render
the ratings of those securities absolutely meaningless.

Thereafter, the

riskiest of municipal securities, which would normally carry a higher yield
to compensate for that risk, could be expected to become absolutely safe
on a moment's notice.




320
Municipal authorities would have little incentive to maintain
high ratings on their securities, since all municipal securities would be
essentially risk-free for the investor.
just disappear.

But the fiscal risk would not

Cities could still spend more than their revenue base

could support, and they would in fact have even more incentive to do so.
The constraint of declining ratings on city securities, with a consequent
rise in borrowing costs, would have been removed.

Any costs of default

would simply be shifted from the investor in municipal securities to the
federal taxpayer, and it is difficult to conceive of any method of
forcing the cities to repay the money which would be consistent with
any semblance of home rule.

How, for example, would the federal govern-

ment deal with a general strike among New York City workers?

To ask such

questions is to suggest the answer: the federal government should not
get involved in the first place.
In the absence of federal intervention, a default by New York
City is likely

in December, if not sooner.

The reverberations from such

a default could make it impossible for New York State agencies to float
additional debt, which, in turn, could make it extremely difficult for
the State itself to tap the capital market.

A chain reaction such as this

could then force a default by New York State or by other cities within the
state which depend on state aid.

There could also conceivably be some

"ripple effect" on distant municipalities, beyond those already discounted,
although such "guilt by association" is not likely to seriously affect
top-rated state and local borrowers.
Even under the worst possible scenario, short of assuming that
investors would suddenly become totally irrational regarding their own
wealth, there is no reason to suppose that a default by New York City or




321
State would halt recovery in the private economy.

Indeed, any pinch on

municipal .borrowing would tend to increase the supply of lendable funds
available to consumers and businessmen.
Nor is there much basis for assuming that a New York default
would provoke an unmanageable "run" on Certificate of Deposit money in
New York banks.

These banks have protected themselves against such

withdrawals by acquiring ample CD money in the past year or so, and the
Fed, FDIC, and other regulatory bodies have ways of minimizing the impact
of default.

The most serious threat facing the New York banks is pro-

bably the threat of stockholder lawsuits prompted by the banks' purchases
New York City and MAC bonds.

A problem for the municipalities

themselves

is the understandable hesitancy of bankers to add municipal bonds to their
portfolios, whether as an asset or as a trading vehicle, particularly since
the Comptroller of the Currency prohibits banks from purchasing municipals
rated below Baa.
It is, of course, possible that urban interests, municipal
bond dealers, and the affected banks may wield sufficient political clout
to extract more federal aid for New York.

The politics of the situation

are not as obvious as they appear to the New York press, however, since
rural antagonism toward profligate big cities is a very real force in
the House of Representatives.

If aid comes, it would be least damaging to

the municipal securities market if it were in the form of a loan to the
state - contingent upon appropriate fiscal reform, subordinated by state
assets, and issued on terms sufficiently unattractive to discourage emulation.

The municipal unions could, of course, wreck any plan for trimming

expenditures, no matter how tidy the plan looks on paper, so a credible
fiscal reform would have to come to grips with that problem.




322
The practical difficulty with a federal loan, however, is that
it would be difficult to get the legislation through the required Congressional committees (Banking, Appropriations, Finance, Ways and Means,
etc.) in time to beat a default.

A federal guarantee of New York City

or State securities could probably be expedited more quickly, and is therefore a more likely outcome.

But as we have already observed such a pre-

cedent of turning a bad risk into a sure thing would play havoc with the
ratings of municipal securities.

The message to investors, as the Wall

Street Journal put it, is that the greatest safety lies in the biggest
bubbles.

The result would be a wasteful allocation of scarce capital.
If New York City does in fact receive sufficient federal aid

to get past its immediate crisis, the municipal securities market may
just face a protracted interval of uncertainty and turmoil.

For anything

other than an unlimited blank check against the federal treasury will
leave open the possibility that default has merely been postponed.




323
The CHAIRMAN. Thank you, sir.
Mr. Sellers.
Mr. SELLERS. I'm speaking today on behalf of the public finance
council of the Securities Industry Association.
We think the consequences of a New York City default would be
serious and far reaching. Their full scope is unpredictable, and the
risks are large. The impact of the city situation has already spread
to State agencies and the State itself, which have been denied market
access despite admitted underlying credit-worthiness.
The council believes that the time has come for Federal assistance
in the problem of market access, even though it has endorsed the policy of keeping pressure on city and State to effect the necessary longrange budgetary and management reforms.
That pressure should be maintained through the terms of a Federal
assistance program. Such assistance should be available only on application of a State which has enacted a financial control program
giving the State or a special State board or agency effective control
over the financial operations of a municipality in difficulty with a
view to the restoration of that municipality to financial viability.
The application to the Federal Government should show that :
(1) The State has exhausted all credit resources available, including the public markets and use of trust investments within the generally accepted rule of prudent investing.
(2) A clear case of financial emergency exists within the State.
(3) A plan for loan repayment has been submitted, with a complete analysis of the taxes or other revenues available and certification
that the plan has been properly enacted and meets the requirements of
the State constitution.
Federal assistance should be aimed at the problem of market access,
and should not include any subsidy, either of the cost of borrowing
or of repayment. The conditions that I have outlined above should be
sufficiently onerous to discourage any use except in extraordinary
financial emergencies.
A recitation of some foreseeable consequences of default is outlined
in the next part of this statement, and a plan for Federal assistance
that would avert default and its consequences is outlined in the last
part.
If I may, I will run through a couple of the mechanisms.
We suggest that a Federal corporation should be established by
Congress, the directors of which would be the Secretary of the Treasury, the Chairman of the Federal Reserve Board and three other members to be named by the President with the advice and consent of the
Senate. I t could be named the "Emergenev Public Finance Corporation." The three appointed members would not be or become Government or corporation employees. The Corporation would be staffed to
the extent necessary by existing employees of the Treasury and
Federal Reserve Board.
The general purpose of the Corporation would be to provide, to
or through a State, emergency financial assistance for local governmental units. Such assistance could be provided only under the following conditions:
(a) The State's legislature must declare that a period of financial
emergency exists for the State by reason of the threatened financial
collapse of a local governmental unit within the State.




324
(b) The Governor and the chief financial officer of the State must
declare that the resources of the State are inadequate to prevent a
default of the local governmental unit or of the State; that, to the
extent permitted under the State's constitution, the State government
has taken every feasible step to deal with the problem; and that there
is in place a State apparatus for the control of the budgetary practices
and expenditures of the affected State or local governmental unit.
(c) The Secretary of the Treasury or the Chairman of the Federal
Reserve Board must declare that a default by such State or local governmental unit would have economic and financial consequences of
more than local or regional significance.
(d) A majority of the directors of the Corporation must agree with
the foregoing declarations.
The Corporation would have an authorized line of credit of $10 billion with a limitation that no more than 50 percent thereof could be
loaned to or through any one State at any time.
We are again joining in the estimate that $5 billion would be adequate assistance.
The Corporation's obligations are to be purchased by the Federal
Financing Bank, with no corporation obligations to be marketed to the
general public.
The Corporation would be authorized to make loans only to the State
itself or to a State agency specifically authorized by the State legislature to make such borrowings. The Corporation would be prohibited
from making any direct loans to the affected local governmental unit
other than the State agency mentioned above.
Local governmental units would be defined to include State agencies and local agencies as well as municipalities and other political
subdivisions.
We avoid the guarantee for practical reasons. We think the market does not fully reflect a guarantee. A direct Treasury obligation
will sell considerably better than a guaranteed obligation.
The limitations on loans by the corporation would include:
The interest rate must be 1 percentage point higher than the current
rate obtained by the Federal Financing Bank on other obligations of
comparable maturity it is purchasing.
The term of any loan made would be the period that the corporation determines is the least necessary in the circumstances with a maximum of 5 years, but renewable by the corporation for up to an additional 3 years.




ses
Any drawdowns of an authorized loan may be used only to pay maturing debt obligations—both bonds and notes—of the affected State
or local governmental unit that were issued prior to the authorization
of the loan.
The State, or its specifically designated agency, must submit to the
corporation at the time of applying for a Federal loan a plan for its
repayment, and if the loan is not paid at maturity, the corporation may
require the State to pledge its, or the affected local governmental unit's,
share of general revenue sharing. In the New York State, this would
represent $400 million. We do not suggest that Buffalo or Syracuse
revenue sharing should be pledged, only that of New York City and
the State.
I n the event that the Federal Government during the term of any
loan assumes functions theretofore performed by the affected governmental unit—for example, a reorganization of the Federal welfare
system—the amount of any fiscal burden from which the local governmental unit is thereby relieved must be applied by reduction of the
Federal loan.
Any State to or through which such loans are made, and any local
governmental unit receiving assistance, must adopt within 1 year
thereafter Municipal Finance Officers Association—or even more stringent—accounting standards and publish at least annually finanical
statements in conformity with such standards, together with a full
disclosure document.
[The complete statement follows:]




326
Public Finance Council
Securities Industry Association
October 9, 1975

Summary Statement

The Public Finance Council of the Securities
Industry Association believes that the consequences of a
New York City default would be serious and far-reaching.
Their full scope is unpredictable, and the risks are large.
The impact of the City situation has already spread to
State Agencies and the State itself, which have been denied
market access despite admitted underlying credit worthiness.
The Council believes that the time has come for Federal
assistance in the problem of market access, even though it
has endorsed the policy of keeping pressure on City and
State to effect the necessary long-range budgetary and
management reforms.
That pressure should be maintained through the
terms of a Federal assistance program.

Such assistance

should be available only on application of a State which
has enacted a financial control program giving the State
or a special State board or Agency effective control over the
financial operations of a municipality in difficulty with a
view to the restoration of that municipality to financial
viability.

The application to the Federal Government should

show that (1) the State has exhausted all credit resources
available, including the public markets and use of trust




327
investments within the generallyaccepted rule of prudent
investing;

(2)

a clear case of financial emergency exists

within the State;

(3)

a plan for loan repayment has been

submitted, with a complete analysis of the taxes or other
revenues available and certification that the plan has been
properly enacted and meets the requirements of the State
constitution.
Federal assistance should be aimed at the problem
of market access, and should not include any subsidy, either
of the cost of borrowing or of repayment.

The conditions

as outlined above should be sufficiently onerous to discourage any use except in extraordinary financial emergencies.
A recitation of some foreseeable consequences of
default is outlined in the next part of this statement, and
a plan for Federal assistance that would avert default and
its consequences is outlined in the last part.




328
Consequences of Default by New York City

A default by New York City would be a financial
event of the first magnitude, surpassing anything of like
character since the banking holiday of 1933. Such an event
would have many consequences, not all of which are fores e e a b l e . Among those which can be speculated upon are the
following:
1.

One or more New York State Agencies might
be forced to default through an inability to roll
over maturing notes or to pay them off with the
proceeds of new bond i s s u e s . Indeed, there is even
now grave danger of default by an Agency. Should
an Agency default, projects under construction and
development could not be completed, with consequent
layoffs, lawsuits by suppliers, and all the attendant
problems that became so familiar during the UDC
crisis.

2.

The credit of New York State would come under very
heavy pressure, as indeed has already occurred.
The State could roll over maturing obligations only
at extremely high rates; and it is quite possible, a s the
events of recent days indicate, that psychology might deteriorate so drastically that the State might have difficulty
selling debt at any price.

3.

Medium and lower quality municipal credits, which
are even now being forced to pay higher rates than
otherwise because of the New York situation, would
suffer an impairment in their ability to raise funds
at economic rate levels, probably for years on great
numbers of people throughout the country with real and
legitimate needs for public facilities and s e r v i c e s .




329
The economic recovery now under way could be
endangered by default, a point explicity recognized by Dr. Burns. To cite only one of several
avenues through which such impairment could
occur, it may be noted that state and local outlays are
projected by many economic analysts to rise by
about $2 0 billion this year— about 25 per cent
of the approximately $80 billion increase in
total GNP foreseen by many forecasters. State
and local out lays are thus being relied upon
heavily as a positive force in economic recovery.
A default and its consequences would obviously
have an adverse impact on such outlays.
Many small investors across the country would
suffer losses on their supposedly safe investments, with consequent impact on retirement
income.
New York City's position as the world's financial
center might be seriously impaired. The tax
burden would surely rise, and municipal services
would be cut beyond anything now contemplated.
Such a state of affairs would hardly be appealing
to foreign entities which are already here or
which are contemplating entry here.




Default and its consequences would in all likelihood accelerate the exodus of productive
businesses and individuals from the city. Hence
default would not br rejuvenating; it would
be debilitating. And its effects would be long
lasting.
The immediate market reaction to default most clearly
would be substantial price declines in both fixed
income securities and equities, with only the
Treasury bill market spared as investors sought
a safe haven. If default on City obligations
were shortly followed by default in the debt

330
of one or more State agencies, the disorder in
the markets could continue for some time. Prospective borrowers would not wish to pay the high
rates that would obtain in such circumstances.
And prospective lenders would wish to place their
funds in very short-term instruments of the highest
quality. Thiis the functioning of the capital
markets could easily be impaired.
There would undoubtedly be other consequences of
default that are not readily foreseeable.

Those

enunerated

above are of such significance, and would involve risks of
such magnitude, that we believe the federal Government should
promptly enact machinery by which default could be avoided and
which would not involve the establishment of unwanted precedents.




A proposal for such machinery follows.

331
Proposal for a Federal Loan Program to States for
Benefit of Distressed Local Governmental Units

1.

A Federal corporation should be established by

Congress, the directors of which would be the Secretary of
the Treasury, the Chairman of the Federal Reserve Board and
three other members to be named by the President with the
advice and consent of the Senate.

It could be named the

"Emergency Public Finance Corporation".

The three appointed

members would not be or become Government or Corporation
employees.

The Corporation would be staffed to the extent

necessary by existing employees of the Treasury and Federal
Reserve Board.
2.

The general purpose of the Corporation would

be to provide, to or through a State, emergency financial
assistance for local governmental units.

Such assistance

could be provided only under the following conditions:

(a)

The State's legislature must declare that

a period of financial emergency exists for the State
by reason of the threatened financial collapse of a
local governmental unit within the State.
(b)

The Governor and the chief financial officer

of the State must declare that the resources of the
State are inadequate to prevent a default of the
local governmental unit or of the State;




that, to

332
the extent permitted under the State's constitution,
the State government has taken every feasible step to
deal with the problem;

and that there is in place a

State apparatus for the control of the budgetary
practices and expenditures of the affected State or
local governmental unit.
(c)

The Secretary of the Treasury or the

Chairman of the Federal Reserve Board must declare
that a default by such State or local governmental unit
would have economic and financial consequences of more
than local or regional significance.
(d) A majority of the directors of the Corporation
must agree with the foregoing declarations.

3.

The Corporation would have an authorized line

of credit of $10 billion with a limitation that no more than
50% thereof could be loaned to or through any one State at any
time.

The Corporation's obligations are to be purhcased by the

Federal Financing Bank, with no Corporation obligations to be
marketed to the general public.
4.

The Corporation would be authorized to make loans

only to the State itself or to a State agency specifically
authorized by the State legislature to make such borrowings.
The Corporation would be prohibited from making any direct
loans to the affected local governmental unit other than the
State agency mentioned above.




333
5.

Local governmental units would be defined to

include State agencies and local agencies as well as
municipalities and other political subdivisions.
6.

Limitations on loans by the Corporation

would include:
(a)

The interest rate must be one percentage

point higher than the current rate obtained by the
Federal Financing Bank on other obligations of
comparable maturity it is purchasing.
(b)

The term of any loan made would be the

period that the Corporation determines is the least
necessary in the circumstances with a maximum of five
years, but renewable by the Corporation for up to an
additional three years.
(c)

Any drawdowns of an authorized loan may

be used only to pay maturing debt obligations (both
bonds and notes) of the affected State or local governmental unit that were issued prior to the authorization
of the loan.
(d)

The State, or its specifically designated

agency, must submit to the Corporation at the time
of applying for a Federal loan a plan for its repayment, and if the loan is not paid at maturity, the
Corporation may require the State to pledge its, or
the affected local governmental unit's,share of
general revenue sharing.

60-832

O - 75 - 22




334
(e)

In the event that the Federal govern-

ment during the term of any loan assumes functions
theretofore performed by the affected governmental
unit (e.g.

, a reorganization of the Federal welfare

system), the amount of any fiscal burden from which
the local governmental unit is thereby relieved
must be applied by reduction of the Federal loan.
(f)

Any State to or through which such loans

are made, and any local governmental unit receiving
assistance, must adopt within one year thereafter
Municipal Finance Officers Association (or even more
stringent) accounting standards and publish at least
annually financial statements in conformity with such
standards, together with a full disclosure document.




336
The CHAIRMAN. Thank you very much.
Mr. Solari.
Mr. SOLARI. Mr. Chairman, I will be brief and to the point.
I am very reluctant to endorse any of the proposed legislative bills.
In summary, I believe the cost disadvantages—as outlined, Mr. Chairman, in your opening statement—appear to outweigh the advantages.
In particular, I cannot in any way visualize a set of controls which
would be stringent enough to limit the application of Federal assistance to New York City alone. Rather, I believe such a program, if instituted, would represent a wide open invitation for public officials to
make irresponsible fiscal decisions. I t is my belief that a Federal aid
program would impair the bargaining position of city administrators
throughout the country in their budgetary process, for example, labor
negotiations.
I am also very disturbed that the aid program will produce a dramatic transformation in the criteria employed by investors in their
bond selection process. I t is very possible that they will gravitate to
securities issued by municipal entities which demonstrate the weakest
credit characteristics—with a view toward the likelihood that the
Federal Government will be the ultimate obligor of these bonds. This
shift in investor attitude, of course, will directly penalize the most
credit-worthy borrowers.
In respect to the consequences of default, I do not share the viewpoint that a New York City default would have a devastating impact on
the municipal bond market. My opinion, however, is contingent upon
the two following conditions which must accompany a default proceeding :
First, a contingency plan would be necessary to insure that the
city's cash flow requirements would be satsified in order that the city
could continue to deliver essential services.
The second condition to an orderly default proceeding would be a
well conceived reorganization plan which would encompass the enactment of adequate fiscal measures in actual dollars and a rearrangement of the city's debt structure. The latter would include an extension
of the city's debt and the creation of an acceptable borrowing vehicle
as part of a much needed long-term solution to attempt to restore investor confidence.
I t is possible—but by no means assured—that a city default under
these conditions would—within a short period of time—produce a positive reaction in the municipal bond market.
There are significant differences of opinion as to what will happen.
Contrary to the opinion of other members of this panel, I believe the
possibility exists that investor sentiment in the municipal bond market
would improve if New York City's problems were resolved by a debt
reorganization plan. My observation does not in any way minimize the
seriousness of default. Also, I am not suggesting that a debt reorganization plan be pursued as an acceptable alternative to default. However, if one assumes that such a plan was implemented, it could prove
beneficial by removing the uncertainty of whether the city will be able
to meet its next debt payment. Consequently, the credit of New York
State would be divorced from the city, a circumstance which will—in
my opinion—enhance the ability of the State to retain access to the
market. I t is also conceivable that the market value of city securi-




336
ties would improve if the plan documented the capacity of the city to
service its debt over the long term under a revised maturity schedule.
The depressed price levels of city securities today reflect the fact that
the investor is unable to predict this possibility at this time.
[The complete statement follows:]
STATEMENT OF WILLIAM J. SOLARI, VICE PRESIDENT, DONALDSON, LUFKIN & JENRETTE SECURITIES CORP.

I am William J. Solari, Vice President of Donaldson, Lufkin & Jenrette
Securities Corporation. Situated in New York City, the firm is involved in the
various activities of the securities business and serves primarily an institutional
clientele throughout the country. We are a major underwriter and distributor of
fixed income securities through the operation of our corporate, government, and
municipal bond departments. I am directly responsible for bond research, including the credit analysis of tax-exempt securities issued by states, their
agencies, and local municipal subdivisions.
My comments do not necessarily reflect the viewpoint of my firm—DLJ.
Clarification of this point is required because the Chairman of DLJ Securities
Corporation, Mr. George D. Gould, is a Director of the Municipal Assistance
Corporation for the City of New York, and Chairman of its Finance Committee.
I am very reluctant to endorse any of the various legislative proposals to
guarantee or insure municipal securities. In summary, I believe the cost disadvantages (as outlined in Chairman Proxmire's opening statement) outweigh
the advantages. In particular, I cannot in any way visualize a set of controls
which would be stringent enough to limit the application of federal assistance
to a few financially hard-pressed municipalities. If an aid program is instituted
it would likely represent a wide op;m invitation for public officials to execute
irresponsible fiscal decisions to qualify. It is my belief that a federal aid program
would impair the bargaining position of city administrators in their budgetary
process, i.e., labor negotiation, etc.
Also, I am very disturbed that the aid program will produce a dramatic
transformation in the criteria employed by investors in their bond selection
process. It is very possible that they will gravitate to securities issued by municipal entities which demonstrate the weakest credit characteristics—with a
view toward the likelihood that the Federal Government will be the ultimate
obligor of these bonds. This shift in investor attitude, of course, will directly
penalize the most credit worthy borrowers.
In respect to the consequences of default, I do not share the viewpoint that a
New York City default would have a devastating impact on the municipal bond
market. My opinion, however, is contingent upon the two following conditions
which must accompany a default proceeding:
1. A contingency plan to insure that the city's cash flow requirements would
be satisfied in order that New York City could continue to deliver essential
services. Needless to say, civic chaos would evolve if a default impaired the City's
ability to meet expenditures for payroll, welfare, etc. While I do not have direct
access to reliable information as to the actual dollar imbalance of city monthly
receipts vs. expenditures for operations during the period ending June 30, 1976,
rough estimates suggest that the deficit figure is less than $1 billion. It is
probable that sufficient resources are available and could be employed to meet
this cash operating deficit—as compared to the less manageable figure of approximately $4 billion to prevent default during the next eight months.
2. A well conceived re-organization plan which would encompass the (a)
enactment of adequate fiscal measures in actual dollars, and (b) a rearrangement
of the City's debt structure. The latter would include an extension of the City's
debt and the creation of an acceptable borrowing vehicle as part of a much
needed long term solution to attempt to restore investor confidence.
It is possible—but by no means assured—that a City default under these
two conditions would—within a short period of time—produce a positive reaction
in the municipal bond market. The marketplace has been anticipating a New
York City default for many months. A resolution of the problem would provide
long awaited relief by removing the uncertainty which has lingered since the
market was closed to the City earlier this year. New York State, for example,
has been denied market access because investors have recognized that the
State's credit is directly intermingled with the City's. If the New York City




337
problem is resolved, it is likely that the market for State general obligation
securities would re-open.
In closing, I would like to emphasize that my observations do not in any way
minimize the seriousness of default and that a debt re-organization plan should
not be pursued as an acceptable alternative to the continued efforts to avoid
default at the state and local level. Also, it is my strong conviction that one of
the major reasons that the Committee is facing this serious dilemma today is
the failure of New York City to provide sufficient credit information to investors.
Whatever course the Committee and Congress decide to follow, it is imperative
that serious consideration be given to mandating state and local government
officials to provide adequate credit information. Hopefully, the requirement to
provide a constant flow of data will signal credit problems early enough so that
adequate steps may be taken to insure municipal issuers continual access to the
market.

The CHAIRMAN. Thank you, gentlemen.
Mr. Harries, you indicated you think the default of New York
State is unlikely, but you indicated that some of the agencies might
default.
Mr. HARRIES. That's correct.
The CHAIRMAN. I realize we have a gamut of opinion here. I n the
event New York agencies did default, do you still feel that the State
would be able to raise money in the capital market despite the fact
that New York City defaulted and some of the agencies defaulted?
Mr. HARRIES. Mr. Chairman, it is important to understand that
the State does not need money in the capital market to meet its own
maturing debt. If the State stayed out of the capital market, it would
be fine. I t meets its maturing short term debt out of general revenue.
The State each year in the spring borrows between $3 billion and $4
billion in notes, payable for revenues that come in all year long. I t
currently has outstanding $2.5 billion notes, which it will meet with
the tax revenues that come in through the end of March.
The call on the State that has come from New York City—and we
told the State 3 weeks ago that this was all they could do because the
State will end its fiscal year with a deficit of a half billion dollars
which must be funded—has complicated the State's problem. I t is required they fund their deficit. If they don't fund it, they may be
violating the law, but they have no debt to meet, and there is no
default. The State bonds, we rate double A, and continue to think of
them as a fine credit. The State doesn't have to borrow to meet maturing bonds. I t redeems its maturing bonds out of income.
The CHAIRMAN. YOU made your point clear. That is helpful. The
State itself, the agencies of the State, however
Mr. HARRIES. New York State Housing Finance Agency bonds are
well secured by facilities that are operating filled with people who
pay rents and so on. Their problem of default, again, is with the maturing short-term debt. The New York Housing Finance Agency has
$1.1 billion of notes coming due in the next year. I t is this that could
trigger a default; that is, if they are stopped from going to the market,
and they are shut out of the market now.
The CHAIRMAN. If New York City defaults, then some of the agencies could default on their notes ?
Mr. HARRIES. They will default on their notes; yes, sir.
The CHAIRMAN. What effect do you think that would be likely to
have on interest rates for municipal bonds generally around the
country ?




338
Mr. HARRIES. I think it will be bad, but it is blown a little out of
proportion.
The CHAIRMAN. I t may increase the yield by half a percent or 1
percent?
Mr. HARRIES. On the better credits, it may go up half a percent. On
the lesser rated credits, higher.
The CHAIRMAN. In view of the fact there is about $200 billion of
obligation being funded, the cost would be $1 billion or $2 billion.
Mr. HARRIES. NO, the annual rate of net new debt issuance each year
is $20 billion. Your figure would apply to that.
The CHAIRMAN. $1 or $2 billion over a period of years, period of
10 years in view of the fact that the bond life might average 10 years.
The cost would be $10 billion if this should last a year. That may be
disseminated all over the country as well as New York.
Mr. HARRIES. Yes, sir. I do think a default at the agency level in
New York will close the market to many entities in New York. If New
York State cannot sell its notes, the mammoth amount of notes they
normally do in the spring, they will be unable to give the cash to
some 220 school districts to finance their schools. Many of the schools
have borrowed from the local banks contingent on the money coming
in in April. If that money doesn't come in April, they will default.
The CHAIRMAN. Mr. Kresky, you indicated that the amount of the
guarantee should be around $3 to $4 billion. The Governor, as I understand, has told us they wanted about $5 billion. Their capital requirement over the next 6 months I understand will be added u p to $5.1
billion.
As I recall, they turn over $2.8. Their deficit is $800 million; $1.7,
then, for capital requirement.
How do you shave that to 3 or 4 ?
Mr. KRESKY. The recommendation I gave, Mr. Chairman, dealt only
with the short-term, uncovered New York City debt from that December date until the end of the city's fiscal year of June 30.
I understood the Governor's reasoning. I don't disagree with the
reasoning. I do think if the Federal Government were to give a guarantee to MAC of $3 billion which is about the existing statutory
capacity of MAC's borrowing capacity—it could be altered if revenue
flows were set up accordingly—I would think that a $3 to $4 billion
guarantee, which is what my testimony called for, would probably
do the job of beginning the restoration process.
As you quite clearly indicated, the five of us have very different
views. My view regarding the ability of the State of New York in
April to raise the necessary billions of dollars Mr. Harries referred
to which in turn impacts upon the school districts and local governments throughout the State, is that it is a serious problem.
If the city is in default in December, as Mr. Eohatyn says, is a
strong possibility, if the agencies of the State are in default which
the Governor indicated is a strong possibility, and if the pension
funds are shut out or available only in a limited manner, I have some
serious doubts in my own mind that the State of New York can raise
those necessary billions in April and that the end result would find
school districts and local governments throughout the State in
deep peril, and a community of 18 to 19 million people in this country shut off from money markets and not available to get capital funds.




339
The CHAIRMAN. Mr. Solari, you regard that as most unlikely. You
told us you do not think the Federal Government should act in this
case.
Mr. SOLARI. I am reluctant at this time to endorse any of the proposals. Mr. Chairman.
If the disaster scenario which Mr. Kresky refers to were to become
a reality, and then units of government could not provide essential
services throughout the State, obviously, one would have to reconsider the position of Federal assistance.
At this time, I don't believe it is necessary.
The CHAIRMAN. We have to act very rapidly, of course, to do any
good as far as New York City is concerned. Congress doesn't act the
way an individual acts—we have to take it to the committee and to the
floor and get it to the President to be signed. We don't have the luxury
of being able to wait.
Under these circumstances, do you advise the committee not to
proceed in view of the timing here? We are told that December 1 is
probably the last day on which in all likelihood New York could avoid
default. If there is no real progress by then, they are in very, very
serious jeopardy.
Don't you agree with that ?
Mr. SOLARI. I do agree with it. The city is in very serious jeopardy of
defaulting at any time.
The CHAIRMAN. I beg your pardon. I understood you to say if the}T
did default, however, you feel the repercussions would not be as
serious as others have said.
All right. Accepting that, you say they will not be as serious as
far as New York State is concerned.
Mr. SOLARI. They may not be. With respect to the default implications on the market, there is a possibility that it would be treated
as relief by investors, that the State's credit would no longer be
impaired by further efforts to rescue the city from default. As such,
the State may restore its credit dignity in the market because it would
be divorced from the city.
The CHAIRMAN. Does it seem logical that having had New York City
unable to pay its obligations that banks and other investors would
say, "We will not invest in New York agency obligation." If you wTere
the head of a bank, would you advise that they invest in that ?
Mr. SOLARI. I would think the process here would be subject to
analysis. If the State, as Mr. Harries indicated, had notes and they
had the capacity to retire those notes with adequate receivables, and
you could demonstrate the credit of the State of New York w^as adequate, perhaps the State and its agencies could survive in the market.
The CHAIRMAN. Perhaps the State could survive.
You are with a fine brokerage firm. Would you advise your clients
to go into a municipal bond in the wake of New York City default ?
What do you think would be the reaction of a customer if you tell
them that New York City has defaulted, and you say this is something you should invest in.
Mr. SOLARI. If you could demonstrate to the investor that the issue
you are referring to has the capacity to repay the debt obligation,
there is reason to sell the securities to him.




340
The CHAIRMAN. Don't you think in many cases investors are cautious atfer a catastrophic event of that kind? They have read about
it and watched it on television.
Don't you think they would say, "Let's stay out of New York" ?
Mr. SOLARI. An alternative, Mr. Chairman, is that there is no reason
to expect that the investor, just because the city went into default,
would expect that the State doesn't have the capacity to pay its bonds.
The CHAIRMAN. I take it you would personally advise your customers
to purchase State paper.
Mr. SOLARI. I'm not doing that now, sir, for the obvious reason that
the Governor and his financial adviser have stated publicly that the
State may default in the spring if the city defaulted. However, circumstances are likely to change and there may be an opportunity
to have a rational analytical discussion with the client to purchase
State securities at a later date.
The CHAIRMAN. Mr. Markowski, why a loan to the State instead
of guarantee? A loan is legislatively harder. We have to get appropriations for the loan. We have to go through different committees.
If we set it up as you have suggested, we have to confirm the nominees of the President. Timing is important. We can't investigate the
fire department, we have to send them to put the fire out.
Mr. MARKOWSKI. The guarantee of the bonds and notes of the State
or city would only open up a Pandora's box to other municipalities.
The CHAIRMAN. Why won't a loan do the same thing ?
Mr. MARKOWSKI. I don't think so. If there were strings attached to
it, I think the loan would do a better job. I t would mean for an orderly
municipal bond market. We may well do away with rating systems.
The CHAIRMAN. The guarantee would require an issue that is taxable. I t has to be an issue that comes in under circumstances where you
require a premium to be paid. That would probably be required. I t
would have to have the full faith of the State to get it. You have to
agree to have a financial plan with a balanced budget; all these
things.
Mr. MARKOWSKI. Yes, under those circumstances I would, but I
think it opens up a Pandora's box.
The CHAIRMAN. YOU mean you think the guarantee's difficulties
would be minimized ?
Mr. MARKOWSKI. Minimized, yes, but I am still not in favor of
guarantees.
Mr. HARRIES. I would like to make a comment. My provision for the
loan calls for the loan to be subordinated. Most States cannot assume
general obligation debt without voter referendum. My suggestion is
the Federal loan be subordinated to the general obligation bonds of
the State.
The CHAIRMAN. When you say that, what you are saying is if we
provide a loan, it should not go at the top of the payoff. I t has to be
subordinated while previous debt is paid off.
Mr. HARRIES. New York State cannot borrow $5 billion from the
Federal Government and call it a general obligation. Under the constitution of the State of New York, such obligation requires voter
referendum approval.
Senator PACKWOOD. Mr. Solari, Mr. Harries talks about a bond—
he says has three strikes against it today. As a matter of fact, that
would be a good investment today.




341
Mr. SOLARI. I believe the bond you refer to is the Battery Park city
authority.
Senator PACKWOOD. Eight.
Mr. SOLARI. There is risk in that bond at the present time as to the
ability of the authority to service the debt over a long term because
the bonds were sold to finance the construction of a housing project
which has yet to be completed. Actually, it hasn't even started. I t is a
site off of Lower Manhattan. Until they complete the construction of
the housing units, and you have an opportunity to analyze the cash
flow from those units to service the debt
Senator PACKWOOD. What you are saying—let me interrupt you.
You are saying this bond is depressed by more than just psychological
reasons ?
Mr. SOLARI. There is a credit problem.
Senator PACKWOOD. I got the impression from Mr. Harries' statement that there was nothing more to it than psychology.
Mr. SOLARI. Perhaps Mr. Harries was referring to the fact there
is approximately $150 million in a construction reserve account that
may be used for project construction, but also may be used—but not
required—to service the bond.
Senator PACKWOOD. This morning Governor Carey or Mr. Rohatyn
testified that many of the major New York banks were buying New
York municipal bonds in greater quantities than they should have.
They also were to blame. The bonds were rated higher than they
should have been. Some banks were in too heavily. Is that a fair
statement ?
Mr. HARRIES. I t is important to recognize two things: One is the
net worth position of the New York securities in the banks. The second
thing was the fact that New York banks stood up and ate all of these
securities that New York City came in with.
Senator PACKWOOD. What kind of rating were the city bonds carrying from Standard & Poor ?
Mr. HARRIES. We had an A rating until 6 months ago.
Senator PACKWOOD. Were the banks pressured into buying them?
Mr. HARRIES. I can't speak for the banks. Increasingly, the amount
of short-term money the city had to borrow was up. Yes, there was
pressure to underwrite that.
Senator PACKWOOD. The banks could have been buying better rated
municipals ?
Mr. HARRIES. They were underwriting city issues where they were
buying to resell to the national market. What they put in their trust
accounts and portfolios, we don't know.
Senator PACKWOOD. Were they successful in reselling them?
Mr. HARRIES. N O . That was the problem. The stream of bonds and
notes became too great.
Senator PACKWOOD. They could have underwritten better municipal bonds around the country that would have been easier to sell, but
for some reason, they felt a moral obligation to take New York bonds ?
Mr. HARRIES. The New York market began to close when we saw
other banks around the country dropping from the underwriting accounts, such as maior California banks, Texas banks, and Chicago
banks. They said, "We can't take any more because the portfolios are
out of balance."




342
Senator
writing ?

PACKWOOD.

The New York banks had to do this under-

Mr. HARRIES. Yes, sir.
Senator WILLIAMS. Thank

you very much.
I regret I wasn't here for all of the testimony of this distinguished
panel. Mr. Harries, I wonder if you have spelled out why it is you feel
that a Federal loan in this situation would be superior to the guarantee approach ?
Mr. HARRIES. I approach the question that Senator Proxmire posed
to me in his letter last week from two sides. Should the Federal Government become involved in New York City? and two, how?
I n commenting on the other bills, I took what I thought would be
the easiest, safest, neatest approach. And Senator Proxmire enlightened me a few moments ago by saying it is difficult to get a direct
loan. I do think a loan is the easiest way to do it. I t gets the best
interest rate because Treasury securities sell at the finest rate in the
country. No Federal agency sells at as good a rate.
I took the approach of a loan so there would be direct control. If
that can't be done quickly, I am willing to back up to a guarantee. But
guarantees sell at discounts. We saw in the public housing issues that
were backed by a Federal guarantee that they sold at different interest
rates. You would have 35 cities selling in one day and the spread could
be one percentage point. The ultimate backing behind the bond was
the Federal guarantee. That is why I believe the loan route is the most
direct. I thought it was the easiest, but I guess it isn't.
Senator WILLIAMS. We have tried to persuade Administration officials' of the superiority of this approach for specific situations. I t
is neat and clean. I agree with you. If you can get it on the books
in certain circumstances, it is the most efficient way to reach your objective. But is very hard to get congressional support for such an approach. We have had a difficult time with direct loans for example for
housing for the elderly.
I agree with you, Mr. Chairman, this would be a difficult approach.
Now we have had—I gather you have been hit with many legislative
ideas. There are several bills and we have had another approach just
suggested by Senator Cranston's bill. As he described his idea, it made
sense to me. At any rate, in your statement you talk about the great
discount of some municipals in New York; for example, that the
discount makes no sense in terms of the security which is behind it.
I am just wondering whether you have observed, and I am sure
you have, whether the ripple effect which we all fear has gone beyond
New York and New York City and New York State to other places.
I have heard bits and pieces of opinion that it has already, to the detriment of other borrowers.
Mr. HARRIES. Battery P a r k project has a questionable backing. Ithas the moral obligation of the State, the same wording which the New
York State Housing Finance Agency does, Dormitory Authority of
New York State does, which in essence is a budget make up.
If I can bring us closer to home to New Jersev, Senator Williams,
the New Jersey sports exposition has the same wording. Those bonds
sold at par with a seven and one-half, coupon and thev are currently
selling in the 60s. If they had to sell bonds to finish the project next
week, if they didn't have enough monev to finish it, thev would have
to come, to market with 13 or 14 percent to equal the yield on the bonds
that are presently outstanding.




343
The CHAIRMAN. 13 or 14 percent interest ?
Mr. HARRIES. Yes, tax free. That is what the bond is selling for
now with the moral obligation of the State of New Jersey and we rate
New Jersey triple A, Senator. That is a ripple across the Hudson.
Senator.
Mr. KRESKY. I would like to comment on that, too, Senator Williams. I would like to further discuss the Battery Park city bond which
has a credit problem. One of the problems is that there is a landfill and
there has been nothing built. I t has been that way for 4 years. Let's
take the housing finance agency, which sold over $5 billion worth
of securities, almost $4.25 billion worth of bonds and $1 billion worth
of notes presently outstanding. It is an agencv with a great track record that built the State university system in New York and a number
of other things, with a highly regarded management. Their bonds
are selling in the thirties and forties. Current yield on the bonds are, as
Mr. Harries indicates, 13 and 14 percent for one of the most highly
regarded agency pieces of paper in the business.
The effect of this situation has been a very cruel one. I t is getting to
be increasingly cruel. I referred in my testimony to the North Carolina Housing Finance Agency. They were unable—they withdrew a
$50 million bond issue on Tuesday of this week because of interest
rates that would have made the project unfeasible.
Now I say we are not talking about ripples any more. We are now
at waves. I am deeply concerned that these waves grow taller in the
weeks and months ahead. I agree with the position the Governor has
taken and the position that MAC has taken regarding a guarantee because of the swiftness to put off what I think would be a very, very
great fiscal disaster. On this I would have to disagree with my good
friend Bill Solari. No one has discounted it because no one has experienced what we possibly may have to experience.
Senator WILLIAMS. NOW I will try to condense this and I am not
sure I have the skill to do it in the area of finance. As I understand it,
default is—you arrive at a default when the issuer cannot meet its obligation and the first obligation is that periodic intrayear short-term
interest payment being made.
Now it was explained earlier that in order to meet these intrayear
expenses, you have to be able to go to the market and borrow shortterm to pay recurring intrayear expenses; is that right ?
Mr. HARRIES. Through issuing debt, yes, sir.
Senator WIILLIAMS. Yes, we are talking about debt. Now, our earlier
witnesses said that the New York entities, city and State, can't go to
the market today.
Mr. HARRIES. That's correct.
Senator WILLIAMS. That puts me in Mr. Solari's position. I don't see
where we are. Where is New York State going to get that money if it
can't go to the market.
I know there are a lot of potential purchasers for a great New York
State asset. The developers would love to get their hands on the
Adirondack State Park. I know it is a matter of absolute fact. They
are waiting to get their pieces of Adirondack P a r k to develop.
I don't know whether that is socially, economically or in any other
way wise. What will they do without selling capital to pay debt expenses ?




344
Mr. SOLARI. I t is mv understanding that the State does not need to
raise money in the capital market to pay debt expenses.
Mr. Chairman, it is not my intention to turn this panel discussion
into an open debate, but since I share the only viewpoint that the New
York City problem has been discounted in the market, I believe it is
appropriate to elaborate on this point. Testimonv was given earlier
today by Mr. Eohatyn who accurately identified that New York State
and its agencies have encountered market rather than credit problems.
The unsuccessful effort to sell "MAC" securities to investors outside
New York State was directly responsible—in my judgment—for this
marketing problem. The unprecedented 11-percent coupon placed on
the last public "MAC" issue reduced the value of other New York State
"moral obligation" bonds in the market, including H F A securities. The
reduction in market value of these securities was not the only problem
created by "MAC." The failure of "MAC" to continue to finance itself
in the public market stimulated concern by investors that other State
agencies would be closed to the market. This scenario apparently set
into motion the decision by investors to liquidate their New York
holdings, regardless of credit standing. The market was closed to the
State following the legislature's decision to sell its securities to assist
the city. Therefore it is logical to reason that the various efforts at
the agency and State level to assist the city has been the primary
cause of the problem. For this reason, it has been discounted in the
market. If the city problem was resolved by a reorganization, is it
not probable that the State and agencies securities would have a better
chance to get back into the market—since the burden of the city would
be removed ?
Mr. SELLERS. I disagree with you somewhat. If New York Citv goes
to default, it will be many, many years before they can issue bonds
again. What we think would happen is that the agencies' notes would
go into default, State agencies' notes, various ones and some school
districts would go into default, because of a lack of market access.
This would mean a substantial number of people that would be
unable to construct any new schools or courthouses or firehouses or
what have you. I would suggest it is unlikely that the U.S. Congress
would not act if this developed.
The pedagogical benefits of New York City's mistakes have been
gained. If Congress acts to redress this situation, it seems appropriate
to do it now when it can be done easily. If the mechanism were put
into place, it might never be needed.
Number one, it would not have to be used until it was necessary.
To take the risk just seems unnecessary.
Senator WILLIAMS. I won't go on. Thank you very much.
The CHAIRMAN. Mr. Solari, you said a well-conceived plan of
handling the rollover could be worked out and in that event default
wouldn't be so bad. I t could be handled rather smoothly and might
not have an adverse effect.
Here's what concerns me as I look at the arithmetic. In the next
6 months, there will be a rollover of the $2.8 billion in short-term
obligation. In the next 6 months deficit in the operating budget of
$800 million. I n the next 6 months there will be capital investment
commitments due of $1.5 billion. That is $5.1 billion.
Where will the money come from? If you could tell the rollover




345
people too bad we can't pay you off, you will have to refinance on
10- or 20-year basis, that wouldn't solve the problem. You would have
a $2.3 biliion problem that wouldn't go away. Where will you get the
money for that ?
Mr. SOLARI. Since it is not possible to validate the figures that you
are referring to, I will refrain from answering this question. Between
September and June, I understand the city's cash flow problem is in
the area of $1 billion for operating expenditures. If you would include
a billion dollars for capital improvements then perhaps the plan
would call for a reduction in the financing of those capital improvements
The CHAIRMAN. They put that into effect. That is, take into account
the fact they have put a freeze on all newT capital construction. The
1.5 is for the capital needs already underway. You stop constructing
schools, hospitals, et cetera, and stop that cold at a time when unemployment is one of the most serious economic problems.
Mr. Sellers thought under these circumstances, he thought likely
the Federal Government would come in rather than see this kind of
catastrophic development in one of the biggest States and the biggest
citv in the country.
Mr. SOLARI. I would think that the Federal Government would
come in.
The CHAIRMAN'. If the Federal Government steps in, then isn't that
worse than coming in with a guarantee now that will avert all this
misery when New York has already done so much ? They have frozen
their hirings. They have already refused to increase pay at all. They
have agreed to a balanced budget over the next 3 years.
Even their management is under the discipline and control of a
State appointed body that has the right to approve every expenditure
and every borrowing.
Mr. SOLARI. My only answer to that is that it has not been enough
to convince investors. One of the reasons for this, Mr. Chairman, it
has not produced a reduction in hard dollars.
The CHAIRMAN. What can they do ? Suppose you were mayor in this
position, what would you do ?
Mr. SOLARI. Until I had access to all of the information, I cannot
answer that, sir.
The CHAIRMAN. Mr. Kresky has access to a great deal of this information as one of the members of MAC. His advice and he is an honest
man I'm sure, as I understand it—you can tell us; Mr. Kresky—he
thinks there are no resources there. Am I right or wrong?
Mr. KRESKY. I would have to say, Mr. Chairman, that the city
performance has been accelerating. I t was at zero 6 months ago.
MAC helped it. The Control Board and MAC working together now
has greatlv accelerated it.
As the Governor indicated earlier today, the wage freeze, freeze on
new hirings, and all these other factors—the fact of the matter is in
an inflationary time, to cut back a budget is quite an accomplishment.
Under the Emergency Control Board on the 15th of this month, we
will get a plan and on the 20th, they put it into effect.
Importantly, from the 20th on, as Judge Rifkin indicated, every
single piece of revenue for the city. Federal aid, State aid, tax money
is in the hands of the Control Board. They will dole it out and I hope
they dole it out very, very gingerly.




346
I think that the progress being made is now increasingly significant.
I don't believe that it is possible in one fell swoop to lop off 60,000 or
70,000 employees, or as Mr. Rohatyn said, $10,000 tuition charges and
the other matters in order to restore immediately investor confidence.
We need a planning program. We need turnaround money which
could best come from a Federal guarantee and it would be a very lowrisk guarantee.
The CHAIRMAN. Finally, let me ask Mr. Sellers and the rest of you
to comment, if you would like, if New York City falls and the New
York clearinghouse banks face up to writing off their losses, can we
be sure that large certificates of deposits holders, the big depositors
won't withdraw their funds from New York bands and do so pretty
promptly ?
Mr. SELLERS. One of the problems with this type of thing is that it
is—I think investors tend to be a nervous type. You don't know what
might happen. That is obviously one of the risks.
The CHAIRMAN. We have been concentrating on the fact that the
banks holds 10 to 20 percent of their capital in New York City obligations. But that is a relatively small amount in view of their total
aesets. I t is less than 1 percent. It could trigger, nevertheless, a serious
run on the part of big depositors. I don't say it will occur but it is a
possibility.
Mr. SELLERS. I think that is right. I t is a small amount in relation
to total assets. There is not a rational danger, but you never know with
a loss of confidence what may happen.
The CHAIRMAN. Any of the rest of you like to comment ?
Mr. MARKOWSKI. I agree, Mr. Chairman, there would be some risk
that there would be a run off on certificates of deposits. As an observer
of the money market, I believe every since May or June of this year
that the New York City banks have been so aggressive borrowers in
the certificates of deposits market, in the intermediate 6 months, year
market, to offset the potential runs that may occur.
Mr. HARRIES. The total capitalization of the 11 clearinghouse banks
in New York is about $8 billion. New York paper is about $1 billion
of that. Chairman Burns said he would permit a period of time for this
to write that down. Even though a municipality goes into default, it
is not a Lockheed. Lockheed was subject to dismemberment. New York
will not fall into the earth.
The CHAIRMAN. Unfortunately, we saved Lockheed. I did my best to
stop that.
Mr. HARRIES. Penn Central or Lockheed. I think the immediate run
on certificates of deposit would be short. I t w^ould be primarilv in the
foreign market. Foreign governments think we are crazy to talk about
this so much because they wouldn't even let it happen in England and
France. The history of municipal defaults in France is zero. I think
their preachings about international impact on banking are a little
hysterical.




347
The CHAIRMAN. This is something else. Dr. McCracken who is a distinguished economist, Chairman of Economic Advisers a couple of
years ago and conservative gentleman generally, he said the precarious
plight of New York made it difficult to make forecasts about the trend
of the national economy.
Mr. HARRIES. I look for a default of New York to be a national
catastrophy for us. I t would cause default in government agencies.
When the city of New York goes into default, it would make massive
efforts to make principal and interest payments on bonds, even to the
point of skipping a payroll. If you skip a payroll, there will be calls
for a general strike. There will be job actions and there could be unrest
in the civil population. These are the things I fear.
To correct that requires Federal action far and above what we are
talking about here today.
I would like to say, too, Mr. Chairman, the idea of having to see
the Governor of New York and its elected officials come to the Federal
Government to ask for aid is abhorrent to me. I look on what we are
trying to do today as the lesser of two evils and one to be done away
with as quickly as possible.
The CHAIRMAN. Thank you gentlemen very, very much. That was
most helpful testimony.
We will reconvene at 2:30 to hear four distinguished witnesses in
the Banking Committee hearing room.
[Whereupon, at 1:30 p.m., the hearing was recessed, to reconvene at
2:30 p.m., this same day.]




AFTERNOON SESSION

The CHAIRMAN. YOU gentlemen are very patient. I am grateful to
you for coming this afternoon.
This morning it was a prolonged hearing. There was no way for us
to let all of the Senators ask questions and get through with everyone until now.
Our next witnesses are Grady Fullerton of Harris County, Houston,
Tex.; Joe Torrence, Metropolitan Government, Tennessee; John M.
Urie, Kansas City, Mo.; and John Petersen.
STATEMENTS OE S. GRADY EULLERTON, HARRIS COUNTY AUDITOR,
HOUSTON, TEX.; JOE E. TORRENCE, DIRECTOR OE FINANCE,
METROPOLITAN GOVERNMENT OF NASHVILLE AND DAVISON
COUNTY, TENN.; JOHN M. URIE, DIRECTOR OF FINANCE, KANSAS
CITY, MO.; AND JOHN PETERSEN, MUNICIPAL FINANCE OFFICERS ASSOCIATION
The CHAIRMAN. Any order you gentlemen would like to go ahead in
is fine with me.
Mr. Urie will be No. 1.
Mr. URIE. Thank you, Senator Proxmire, and thank you for inviting us and allowing us this time. I have a summary statement that has
been handed to you. I ask that it be made a part of the record.
The CHAIRMAN. That will be printed in full in the record.
[Complete statement follows:]




(348)

349
SUMMARY OF STATEMENT

S. GRADY FULLERTON
Harris County Auditor, Houston, Texas
JOE E. TORRENCE
Director of Finance, Metropolitan Government, Nashville & Davidson County, Tenn.
JOHN M. URIE
Director of Finance, Kansas City, Missouri
JOHN E. PETERSEN
Washington Director, Municipal Finance Officers Association
On behalf of the
MUNICIPAL FINANCE OFFICERS ASSOCIATION
Before the
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS, U. S. SENATE

October 10, 1975

The Executive Board of the Municipal Finance Officers Association has
adopted the attached resolution calling for immediate Federal action to
establish Federal credit assistance for states and localities that, in the
absence of an ability to borrow in the capital market, are faced with imminent
default.
The resolution essentially calls for a Federal "lender of last resort".
It is tailored to the immediate crisis at hand, one of an actual or impending
insolvency that is caused by a lack of confidence, a lack of willingness or
ability of investors to accept the uncertainties involved in lending to certain
major and hard-pressed governments.

It asks that such assistance be available

only under extraordinary circumstances, that its terms and conditions be
stringent and that there be direct State involvement in the rapid restoration

60-832

O - 75 - 23




350
of the financial integrity of the recipient of the assistance.
The resolution is not aimed at creating a large-scale or indiscriminate extension of Federal credit assistance to States and municipalities.
The great majority of governments prefer direct use of a free market and
they are both willing and able to finance themselves in that market, if
market conditions permit.

But, unfortunately, the market for state and

local securities is in general despair and, for some, it has ceased to function altogether.

Because of the depressing psychological

effects of a massive default —
tion of such an event —

and economic

already much in evidence just in the anticipa-

market conditions are exacting a heavy toll on all

governmental borrowers, restricting credit and pushing our costs of borrowing
to unreasonable and intolerable levels.
Not all of the problems of the municipal market are attributable to New
York City and State's difficulties.

But their financial trauma and the sheer

enormity of their involvement in the market are magnifying other factors that
contribute to the present stringencies all out of reasonable proportion.

There-

fore, unless we can solve their problems in an orderly fashion and clear the
air, there is a grave and unacceptable risk that losses of value and confidence
will continue to drag down the market for all State and local securities.
Without the functioning of fair and rational market for our bonds and
notes, State and local governments cannot operate effectively or efficiently
in the interests of all taxpayers.

It is they —

whether it be in paying back

defaulted bonds or in servicing high-cost, but perfectly sound debt -- that
will bear the burden for years to come.

In these circumstances, a "beggar

thy neighbor policy" is shortsighted and self-destructive and, ultimately,
inimical to maintaining a national credit market for our State and local
governments.




351

A

RESOLUTION

MUNICIPAL FINANCE
OFFICERS ASSOCIATION

ON EMERGENCY FEDERAL CREDIT ASSISTANCE TO STATE AND LOCAL GOVERNMENTS

Recognizing the continued deterioration of the nation's municipal bond
market, the obvious erosion of investor confidence in that market, and the
vast uncertainties and costs involved in the occasion of a default on indebtedness by a major State or local general unit of government, the Municipal
Finance Officers Association hereby resolves:
That the Congress and the Administration take immediate action to
provide credit assistance to such State and local general governments

that,

having exhausted all other feasible legal and fiscal remedies, are no longer
able to obtain credit from any other source and, therefore, are faced with
imminent default.
Furthermore, the MFOA believes such assistance should only be provided,
in the case of local governments, where there is active State sponsorship
and supervision of the local government in question to ensure that the finances
of that government will be so managed as to repay the indebtedness arising
from Federal credit assistance as rapidly as is consistent with the continued
provision of vital governmental services; and
That such credit assistance should not be used as a vehicle to subsidize
the cost of borrowing or to lower it below that paid by State and local
governments that have maintained their creditworthiness, but rather should be
equal, at a'minimum, to the full cost to the Federal government or its agencies
of providing such assistance; and
That such Federal credit assistance should be so designed as to discourage
any widespread use by governments and to restrict its application to extraordinary
financial emergencies to which the only immediate alternative is a default.
Adopted October 8, 1975




382
Mr. URIE. The Executive Board of the Municipal Finance Officers

Association has adopted the attached resolution calling for immediate
Federal action to establish Federal credit assistance for States and
localities that, in the absence of an ability to borrow in the capital market, are faced with imminent default.
The resolution is as follows:
Recognizing the continued deterioration of the Nation's municipal bond market,
the obvious erosion of investor confidence in that market, and the vast uncertainties and costs involved in the occasion of a default on indebtedness by a major
State or local general unit of government, the Municipal Finance Officers Association hereby resolves:
That the Congress and the administration take immediate action to provide
credit assistance to such State and local general governments that, having exhausted all other feasible legal and fiscal remedies, are no longer able to obtain
credit from any other source and, therefore, are faced with imminent default.
Furthermore, the MFOA believes such assistance should only be provided, in
the case of local governments, where there is active State sponsorship and supervision of the local government in question to insure that the finances of that government will be so managed as to repay the indebtedness arising from Federal
credit assistance as rapidly as is consistent with the continued provision of vital
governmental services; and
That such credit assistance should not be used as a vehicle to subsidize the
cost of borrowing or to lower it below that paid by State and local governments
that have maintained their creditworthiness, but rather should be equal, at a
minimum, to the full cost to the Federal Government or its agencies of providing
such assistance; and
That such Federal credit assistance should be so designed as to discourage any
widespread use by governments and to restrict its application to extraordinary
financial emergencies to which the only immediate alternative is a default.

That is the extent of the resolution. The resolution essentially calls
for a Federal lender of last resort. I t is tailored to the immediate crisis
at hand, one of an actual or impending insolvency that is caused by a
lack of confidence, a lack of willingness, or lack of ability of investors
to accept the uncertainties involved in lending to certain major and
hard-pressed governments. I t asks that such assistance be available
only under extraordinary circumstances, that its terms and conditions
be stringent and that there be direct state involvement in the rapid
restoration of the financial integrity of the recipient of the assistance.
The resolution is not aimed at creating a large-scale or indiscriminate
extension of Federal credit assistance to States and municipalities.
The great majority of governments prefer direct use of a free market
and they are both willing and able to finance themselves in that market,
if the market conditions permit.
But, unfortunately, the market for State and local securities is in
general despair and, for some, has ceased to function altogether. Because of the depressing psychological and economic effects of a massive
default already much in evidence just in the anticipation of such an
event, market conditions are exacting a heavy toll on all governmental
borrowers, restricting the credit and pushing our costs of borrowing to
unreasonable and intolerable levels.
Mr. Chairman, the statement continues.
I will stop here and I think the other gentlemen on the panel have
comments to make.
The CHAIRMAN. Mr. Fullerton ?

Mr. FULLERTON. I am S. Grady Fullerton, county auditor of Harris
County, which contains the city of Houston. I am a CPA. I would like
to call the committee's attention to several facts and facets I believe




353
are important in the deliberations. There has been a traditional separation of financial powers between State and local government and the
Federal Government. I believe the separation should continue.
The resolution we have presented is a compromise of a number of
viewpoints. Some of the viewpoints are so strong as to say that the
Federal Government should have nothing to do with this matter and
let the State of New York and city of New York suffer the financial
consequences. A number of commentators are now saying that if the
city of New York defaults, it will have a serious impact on the financial
community. The fact that the city of New York and State of New
York is a significant percentage of the total municipal debt outstanding in the country, causes this problem to be viewed in a different perspective. I, therefore, believe that the U.S. Government should take
some action.
I would limit the action to a one-time program to provide assistance
to the city of New York with no provision for any other units of
government, because of the impact of those units of government on
the national scene, which does not approach the impact of the city
of New York.
I am concerned about the tax-exempt status of local government
bond being maintained. This is a vital factor in local government
financing. There is a quid pro quo. In the past the local governments
have not levied taxes on the Federal Government and Federal Government has not taxed the interest income on local debt. Every city
and county provides services for the Federal Government that would
be compensated for by taxes, if the Government were operated as a
private industry.
I do not wish to change this. I feel the preesent environment is
appropriate, but the continued assault on tax-exempt status of State
and local bonds causes me concern.
I would suggest there are ways of approaching this that would
include the use of the Federal courts by enacting legislation to permit
the matter to go to a Federal district judge and have him surprise
the debt of New York City, as it is worked out.
This position of M O F A is a compromise between many extremes.
I support the resolution, but I recommend that any action taken by
the Federal Government be extremely limited and the strongest controls be maintained bv the Federal Government over the operations
of the city until the city is again solvent and is able to meet its debt
as it matures.
I would like to say a couple of other things. I would like to offer
testimony to you today that is 180 degrees variance with some of the
testimony you heard yesterday.
I would assert there are generally accepted accounting and reporting standards applicable to units of local government. They have
been documented in the accounting literature for years. In 1936 the
Municipal Finance Officers Association published a textbook called
"Municipal Accounting Statements." That book was updated in 1951,
entitled "Municipal Accounting and Auditing," published by the
Municipal Finance Association. That book was again updated in
1968. I t is called "Governmental Accounting and Financial Reporting," published by the National Committee on Governmental
Accounting.




354
The Federal Government itself had representatives that worked
on each of these books as they were published. The American Institute
of Certified Public Accountants has recognized this as being the generally accepted accounting standards for units of local government.
The American Institute of Certified Public Accountants published
an industry audit guide. I t became effective for fiscal years beginning
January 1, 1974. Every audit report published by a firm of independent certified public accountants contains a statement such as Harris
County's audit report, such as the city of Houston's audit report. Both
of the entities are audited by firms of certified public accounants with
national reputation. The public accounting firm takes the statements
of management as prepared by the chief financial officer of the unit
of government and audits them. The public accounting firm says^
"we have examined all these financial statements and in our opinion
they are in conformity with generally accepted accounting principles
applied on the basis consistent with that of the preceding year," the
same way as any nationally-owned company whose stock is traded
stock on the New York Stock Exchange.
Many units of government are so audited. The Municipal Finance
Officers Association has long advocated not only basic accounting
statements, but supplemental accounting statements to provide all of
the information that bond dealers, rating agencies and investors would
want. That is what this book does. I t goes into detail, not only of
basic accounting statements, but a great deal of supplemental information, including 10-year summaries of tax collections, levies.
I was utterly amazed to hear the Governor of New York State
if we had the records we would have known the city of New York
was in bad shape. I was utterly amazed to hear financial advisers of
outstanding reputation admit that they had invested millions of dollars in the city of New York securities without having financial statements to back them up.
M F O A has done a great deal of work along this line.
Mr. Petersen will talk about a credit study we have made. We
have been involved in a great many training sessions for helping
municipal financial officers do a better job. For instance, every time
the Sun comes up I would like to think we have earned $31,000 on
the interest of temporary surplus cash we have invested and not
letting it lie idle in the banks.
The information that the bankers need and investors need is available. All they have to do is ask for it. There has been a breakdown
in the basic systems of checks and balances in the fiscal controls of
the city of New York.
One thing I would caution you to be careful about is the integrity
of the estimate of revenue. One of the games that financial people
play is to overestimate the revenue. Then, when it does not yield—
whenever the yield from the estimate of revenue doesn't meet the
estimate—they have, in effect, overspent the budget that year.
So, whatever plan you come up with, control of that estimate of
revenue is vital. I feel you must keep the city of New York's feet
to the fire as long* as there is any Federal involvement. There must be
rigid and unyielding fiscal discipline. There must be a failsafe mechanism that the city and State will keep the commitments thev a^ree
to. They are willing to agree to almost anything now to receive Federal




855
assistance. Once they get the assistance, it must be monitored with
enough clout to see that they comply with the terms of the agreement.
I recommend you invite the American Institute of Certified Public
Accountants to submit comment about generally accepted accounting
principles applicable to units of local government.
I believe you can find creditable men who will support what I have
said to you here. Senator, the local government can operate in a fine
environment. I suggest to you the annual report of the city of Milwaukee, Wis., which has a " A A A " credit and has won the coveted
"certificate of performance," which says its financial report conforms
to the principles set forth in this textbook.
Mr. McCann is certainly outstanding in the field. He will testify
to you, yes, there is a way of getting all of the financial information that the bank and bankers need. I t has been made available to
them.
I feel, in summary, that perhaps the Federal court would be the
best place to monitor this retrieval of New York City from a bad
situation. But because New York is so big and it will have an impact on the market I feel the Federal Government should make some
steps in this direction immediately.
Mr. TORRENCE. Senator, my remarks will be very brief. I'm Joe
Torrence from Nashville, Tenn. I'm past president of MFOA. I
am currently chairman of one of the important standing committees
of the association, the committee on public debt administration. We
on the committee have been watching, and as far as that is concerned,
thousands of members of M F O A have been watching the New York
situation closely for months and months. I think I would like to
reiterate two points. I suggest that congressional action here and
now be taken to solve New York's crisis as a one-time single solution to a single problem.
The situation should not be used as an opportunity to completely
reorganize the tax-exempt market and drastically change the whole
scope of Federal, State and local government relationships.
If it is time for a change in these relationships, by a new policy
at the Federal level, it should be done separately from the New York
case and be done in a more calm, less crisis-like situation.
Another point I would like to reiterate is that any Federal assistance
program to New York or any other such case, where there is default
or near default, be afforded only when the State government is involved
in a major way of responsibility. I say that because I think it is highly
imnortant that the State government some way or another be included
in these situations. In my own personal opinion, I feel that probably
to some degree all of the troubles of New York City have come about
as a result of direct relationships between New York City and the
Federal Government, wherein the State had nothing to do about it or
knew very little of what was going on.
Thank you very much.
The CHAIRMAN. Thank you, sir.
Mr. PETERSEN. Thank you Senator.
I will try to make my statement equally brief.
Reference has been made to a study that the Municipal Finance
Officers is sponsoring and now conducting. I t is under a grant from
the National Science Foundation, having to do with the planning for




368
Mr. PETERSEN. N O .

Mr. FULLERTON. Senator, there are members of the executive board
who feel almost that strongly, but in view of the total aspect of the
problem, they came to a compromise that this resolution is fair, and
support it. We would like to see the Federal Government stay out of it.
But this problem is of such magnitude we feel you should help.
The CHAIRMAN. YOU said the assistance should be immediate. Can
you explain that ? Why is it necessary, in your view, to be immediate ?
Mr. U R I E . Quoting Will Rogers, all I know is what I read in the
newspapers. I t looks as if default is imminent within the next 60 to 90
days. If steps are to be taken to prevent the default, they will have to
be taken rapidly or default will have occurred.
The CHAIRMAN. We should pass legislation as quickly as we can.
Steps would have to be taken after the legislation is enacted. You say
State sponsorship is necessary. What does that mean? Would you
regard—you were present this morning. Would you regard what the
State of New York has done so far being what you have in mind ?
Mr. URIE. All local units of government are creatures of the State.
Generally, we like considerable autonomy. We fight for that out in the
States. When you are facing the kind of situation New York City is
facing, where default is imminent, then we feel we must give up the
reins and accept guidance and control from the State level.
The CHAIRMAN. YOU said that the action should not subsidize the
cost of borrowing. Obviously if you provide a guarantee and that is
all, the present obligations or instruments like it, you would be subsidizing the cost of borrowing because it would be at a far lesser rate
than anything else. What would you do ?
Mr. URIE. GO to a taxable bond.
The CHAIRMAN. YOU support a taxable bond. I wasn't sure about
that. I thought Mr. Fullerton opposed a taxable bond.
Mr. FULLERTON. Not in this case. Where the Federal Government is
putting up the guarantee, then there need be no tax exemption.
The CHAIRMAN. I n addition to that, the Federal obligations now,
particularly compared to the kind of rating New York has had over
the last 5 years, are at lower yields even though they are taxable, than
the nontaxable New York obligations. I take it you might accept as
appropriate under these circumstances, a premium to be paid to—
perhaps for the service costs and so forth ?
Mr. URIE. Yes; that is what we are suggesting.
The CHAIRMAN. What action do you think would 'be appropriate to
protect the Federal Government's interest, so that it would be unnecessary for the Federal Government to take a significant risk under these
circumstances ? I have difficulty eliciting much of an answer from the
Governor, although I thought he did a fine job, and Mr. Rohatyn.
On that score, they are a little bit unclear in my mind.
Mr. URIE. I'm not sure I can answer that question. I will open it
up to all members of the panel.
Mr. TORRENCE. This may be a far-fetched, theoretical thing, but in
the first place, I don't believe that the Federal Government has a part
to play in this matter unless it really is determined that a crisis exists.
With reference to New York, in this case, that is so far reaching in its
impact that it has widespread disadvantages to other economic
situations. When the impact is in that category—if it is, and I think it




359
is—then I think that the Government, Federal Government, surely is
justified to move in for the general welfare, and do whatever is necessary, even if there is a risk of the Federal dollars involved. I think
there is precedent for this everywhere you look.
The CHAIRMAN. I'm inclined to agree with that. But we have a
selling job to do with the admintetrattion and our colleagues. I think
one of the prices that may have to be paid for this is we have to have
positive assurance that the Federal Government will not have to make
the guarantee good. You are experienced finance officers. You have more
experience and better judgment in this than the Members of the
Senate. Are there suggestions you would make to at least reduce the
risk of the Federal Government, if not limit it?
Mr. FULLERTON. I would like to suggest that the estimate of revenue
is the key. A Federal district judge with supporting assistance as he
would have—advice coming from all sources—could say, based on this
tax package, that it is his considered judgment it will yield this number of dollars. He could say, "City of New York, here is the maximum
amount of money you can budget this year."
The CHAIRMAN. YOU say a Federal court %
Mr. FULLERTON. In the event of bankruptcy, perhaps.
The CHAIRMAN. I wonder if a court would have more competence
than the kind of people the State of New York has assigned. I'm impressed with the kind of people the State has assigned. I have great
faith in our court system, but I doubt if they would be able to assemble
that kind of information or superior competency here. Why would a
Federal court have to supersede the authority and competence of a
State like New York.
Mr. FULLERTON. Sylvia Porter writes a column in the newspaper.
She also publishes a newsletter about interest rates. She points out in
the current issue that there are several different advisory groups on
this problem already, but they have no power. They are only advisory.
We found a lot of times
The CHAIRMAN. The Municipal Assistance Corp. has present power.
They have the power to veto expenditures by the State, power to veto
additional —Emergency Financial Control Board, I should say. They
have power to prevent any wage increase. They have power to prevent
capital expenditures. I t is a massive power.
Mr. FULLERTON. Senator, I feel the district judge, in handling this
case and seeking advice from the same sort of people, would have the
Federal court backup and control. I think assistance will have to be
monitored. I t is like a man—an alcoholic wanting another drink. He
would say, "Give me money and I will promise you anything." Once
he gets it, he takes off on a spree again.
The CHAIRMAN. D O you think there are problems because the State
is involved and the State is involved with the same constituency and,
therefore, it would have less disciplinary force ?
Mr. FULLERTON. I really feel when a private corporation goes into
bankruptcy
The CHAIRMAN. The question was how do you do the job without
default?
Mr. FULLERTON. They are already there de facto. The city of New
York has been unable to meet its debt as it matures. I t has gone to
extreme measures.




360
The CHAIRMAN. I t may be de facto. They are not in default yet. That
is what we are trying to stop.
Mr. FULLERTON. They could apply, with certain enabling legislation, to a Federal court to take over and say to creditors, "stand back
until we can get this thing worked out." But, it would take enabling
legislation.
The CHAIRMAN. Don't we want to avoid that? When you say
creditors stand back until we work this out then not only New York
is in trouble but all cities and States in the country are in trouble
because the potential investors would say they have been told by a court
in New York to stand back. They are not able to protect themselves.
Why not proceed with guarantee and supervision coming from the
Federal Government on top of the State's responsibility?
Mr. FULLERTON. I would accept that. I want to be sure there is
enough supervision by the Federal Government to guarantee that the
State will perform and the city of New York will perform, that they
will not be allowed to take the money and go their merry way.
The CHAIRMAN. I understand your position. Now you say there is
a common tendency to overestimate revenues.
Mr. FULLERTON. Yes,

sir.

The CHAIRMAN. That is helpful advice for us. I have that feeling.
I don't think it had been explicitly called to our attention before. Precisely how do we prevent that kind of thing? There are, after all, legitimate differences of judgment on revenue. We have failed to estimate
our own Federal revenue repeatedly.
Mr. TORRENCE. Senator, I don't know if it would work on a Federal
level, but in some local jurisdictions and in mine particularly there is
spelled out in the charter of our local consolidated government the
specific provision that the director of finance is the only person who
can certify revenue investments. I have had that challenged in times
past. Where there is no provision for this kind of certification that
presumably cannot be toyed with, there is a tendency to be liberal in
your revenue estimates and in local governments when budget time
comes and drastic things are being considered to be dropped and sometimes this includes people on the payroll, at the local level, there is
tremendous political pressure to do something. To overestimate is one
of the things easy to suggest. We have a local option sales tax and in
our past budget we were urged by the school people, because it so
happens that the sales tax is earmarked for public education, more
than once to be liberal in our estimate of revenue for local optional
sales tax. The truth of the matter is in our last budget, I think I
probably was $500,000 too liberal, but that is yet to be seen.
The CHAIRMAN. Couldn't that be handled by taking the historical
record, seeing what was received in tax revenue in the most recent
period and then making the most careful and conservative adjustment
as to increase and being well aware of making full allowance for
obvious decreases.
Mr. TORRENCE. Whoever certifies revenue should not feel put upon if
he is called to explain his estimates and his explanation is what you
have to go with. Past experience plus any change in local economy or
legislation or what have you that will influence it.
Mr. PETERSEN. There are a lot of ways vou can do this sort of
thing. I think the city of Atlanta can only appropriate 98 percent of




301
the previous year's tax collection. Any aditional approriation they
have to do on a supplemental through the tax year as the money
comes in. It's like a P T A budget where you will decide you can
budget only 80 percent of the anticipated revenues until the money is
in hand. I n terms of the Federal Government being assured of getting
its pound of flesh as security, there were discussions this morning of
using revenue sharing. How do you tie in revenue sharing? Perhaps
use that as a form of security, as a form of execution money to make
sure borrowers are living up to the terms of the loan condition.
I t seems to me, as Mr. Torrence pointed out, that the committee is
meeting to decide the national interest here. I find it inconceivable
that roughly 20 percent of State and local governmental debt will be
renounced, especially to the Federal Government. We have here a cash
flow problem as much as anything. New York needs a bridge loan.
That is how we see it, and, believe me, it has been difficult to work
out our compromise position.
The CHAIRMAN. My understanding is that the guarantee should
solve the cash flow problem. Presumably if they get a guarantee they
can raise the $5.1 billion they need in the next 6 months.
Mr. PETERSEN. I t looks like the only thing to solve it unless they
can dragoon in pension fund money or do other things which probably won't be sound policy even were it politically possible.
The CHAIRMAN. Then the question is, as Mr. Fullerton properly
said, how do you hold their feet to the fire during this period. I'm
somewhat inclined to feel that maybe the guarantee should go only
to the short-term obligation so if they failed to live up to the agreement you would threaten to cut it off and make sure they stay in line.
One of the purposes of this is to move New York out of the short-term
market into long-term obligations. That is the reason they are in trouble. If they did what every other city does, which is to finance their
deficit wTith long-term money, they wouldn't have gotten into this serious problem. What is the best way to stay on top of this and to make
sure once the guarantee comes through they won't relax and you get
the unions coming in and getting big compensation, hiring freeze is
off and you begin to get in trouble again. How do we prevent that ?
Mr. TORRENCE. I didn't try to rebut Mr. Fullerton on his idea. Even
though he would suggest a Federal judge as being the monitor of this
thing, he agreed that the State—as in the case of New York, which
is coming in with a strong setup of control—can monitor it. I think it's
important. I am for the Federal monitoring and done effectively. I am
not sure in my own mind whether it should be a Federal judge or some
other setup. I feel very definitely sure that in these situations wherein
they are so drastic that the Federal Government has to come to their
assistance. The State ought to be a party all the way through.
I think the local government before it can be eligible to apply for
the Federal Government assistance, has got to go to the State and
every effort has to be made at the State level to work the situation out
before they go to this, what I call court of last resort.
The CHAIRMAN. Mr. Urie.
Mr. URIE. Senator, I think some of the mechanisms already established in New York are good. The board of control is an excellent
mechanism. However, I must say that we all have those same kinds of
problems in every city. We do have a lot of pressure from the unions.




362
We have just completed a strike of our firemen in Kansas City, Mo.
They agreed to go back to the fire stations and we are now at the
negotiating table again. We were prepared for a long strike. We
brought in the National Guard and volunteers and we were prepared to
hang on for a long period of time. The firemen found they would not
have public support and they felt that some lawsuits were hitting them
pretty hard. The agreed to come back to the bargaining table.
We do have those kinds of problems. I can't say we will always
handle them 100 percent of the time. But somebody has to take a
tough stand in those situations. They have to face them. One of the
unfortunate things in New York City and other cities is that your
community leadership, once they become affluent, go to the suburbs and
you lose the leadership living in the city.
The CHAIRMAN. On monitoring, we must have a prompt and accurate report so we know exactly how much is being disbursed, what
the obligations are if they change, and what progress we are making or
not making.
Is there anything else we can crank in here ?
Mr. URIE. We have a system of quarterly estimates where we try to
estimate, each quarter of the fiscal year, revenues to the end of the
fiscal year and expenditures at the end of the fiscal year.
Last year we found we had a shortfall of revenues. We did not collect as much as we estimated, it turned out.
We immediately took steps and started freezing positions well in
advance of getting into any financial difficulties. You have to have
an accounting system that gives you advanced warnings. This is one
of the things that New York lacks.
If they had followed the accounting concepts we have in Kansas
City, they would have had advanced warning and could have taken
steps to correct these things years ago.
The CHAIRMAN. YOU need the information on a timely basis. When
you get that information, you need the continuous supervision as long
as there is a guarantee in the hands of the Federal Grovernment to
prevent any increase in expenditures, a negotiated union increase, for
example, or capital expenditure that would be a burden: anything of
the kind that would disrupt the situation and endanger the progress
toward a balanced budget.
Mr. U R I E . Right. Force them to live with the financial plan that
they have made to bail themselves out of the situation.
The CHAIRMAN. Mr. Torrence, you said this should be a matter of
Congress acting now on a one-time basis. I t should not be done as part
of the general problem.
We have a number of Senators—Senator Cranston, Senator Jackson, Senator Humphrey, and others have put in bills, and every one of
them is a general bill.
The feeling is understandable. I t is hard to justify things for one
State or one city. A great majority of Senators, 98 out of 100, come
from other States and other cities. We don't see why we should do it
for one group and say if the situation develops for Wisconsin, Texas,
Alabama, or any other State, that they should not be entitled to the
same treatment.
I understand your feeling that this should be ad hoc. At the same
time, you are a gentleman with experience in politics. You can under-




363
stand our difficulty, perhaps, if we try to confine this to a single shot
at the New York situation alone.
Mr. TORRENCE. I think I didn't make myself entirely clear on that
point.
What I had in mind was that this be an effort on the part of the Federal Government to deal not only with the New York situation as it
exists, but to set up machinery by which this situation can be dealt
with now. If, by chance, there are others down the road that we don't
know about, you will already have a system by which to deal with it.
What I was trying to make clear is that I hope that the Congress
will not, on the occasion of this rare, traumatic situation in New York,
come in with a broadside of legislation that attempts to do more, having
to do with the tax-exempt market, and having to do with this whole
business of our balanced federalism between local and State and Federal Government, which indirectly it involves.
I would hope that the Congress would deal with this as a particular
problem. Just now it affects New York and New York City. Next week
or next month—I hope not—we could have the problem somewhere
else. That is what I had in mind.
I hope that the legislation which finally comes forward from the
Congress will deal specifically with this kind of situation and not be
a broadside effort to redo the whole tax-exempt market and be a drastic
change in the relationship between Federal, State, and local government that has existed all this time.
The CHAIRMAN. Mr. Petersen, you told us about the helpful National
Science Foundation study that is going on now, as I understand it.
Has that developed any information which w^ould be useful in this
case ?
Mr. PETERSEN. Senator, I believe it has. The work is in progress. We
actually started with the research itself in May. We have, as I said,
devised model guidelines for official statements.
There have been for years official statements promulgated. I n many
cases they weren't read and in many cases they were not understood.
We have surveyed the entire area for a couple of months, what the
investors and underwriters are getting in the form of a prospectus, in
order to analyze thoroughly to what use the information is being put
and how to better provide the information.
We are trying to provide information that develops good security
analysis and limits our exposure under the antifraud provisions of
the Securities Act. That is one phase.
Another phase is to develop what is sorely needed, good leading indicators to fiscal conditions in cities, counties, and States throughout
the Nation.
This is an area, ^uite candidly, where there has been little work done.
For years, the m irket rolled along taking the credit ratings pretty
much as given by the agencies, not doing a lot of their own analysis.
We have data problems in the State and local government area in
many cases. What we are trying to see is how more mileage can be
gotten from the available data. We have been in a period of sustained
growth in the State and local sector, occasionally with fiscal stress,
but certainly the strongest sector in the economy.
Now we have plateaued. I n some cases, there has been entrenchment
going on. For the first time, analysts are dealing with a different
economic phenomena in this sector.




364
How do we deal with this ? How do we evaluate this ? There are many
other aspects to the study; it is a multif aceted study.
As I pointed out earlier, we will be providing information to the
committee as it flows along. We are studying the impact of various insurance programs, something that has been spoken about earlier.
Senator Jackson's bill contains a section of reinsurance of private
carriage of municipal bonds. We have two private carrier insurance
programs in operation now. We are doing a cost-benefit analysis on
this.
How do the premiums really compare with the saved interest costs
in this particular case ? They are technical studies, but I think they will
have a great deal of policy value, Senator.
The CHAIRMAN. YOU gentlemen, I think, represent as expert and
responsible a group of witnesses as we wil have in this area as far as
the situation of the lenders are concerned, and also recognizing the
importance of fiscal integrity and responsibility on the part of municipalities.
One objection to this kind of guarantee is that it could induce not
only investors who ignore risks in the future because they might assume that if somebody gets into difficulty, the Federal Government
will come along and guarantee them. Why worry about ratings ? W h a t
difference does it make ? Why worry about whether or not a particular
city had been operating within a budget plan and had been responsible
or not?
The Federal Government will guarantee they will take care of it.
There is one way to continue this discipline. I t would be to provide
a limited guarantee with a penalty involved that would have at least
a modest, limited adverse effect on the people who have the securities.
This would also act to keep the cities, it seems to me, keep them on
their fiscal toes in the future as well as keep investors aware of the fact
that good judgment and care in investment will continue to be necessary in this field.
W h a t is your reaction to that ?
Mr. URTE. Senator, in the financing of any city in the situation where
the city needs the help, if their bonds are removed from the tax-exempt
market and they have to pay the cost, that will be enough of a penalty.
We don't think there should be a punitive penalty in addition to

that.

The CHAIRMAN. Why should the investor be concerned with quality
in the future? That is the fundamental discipline for persuading
people.
I have heard municipal officers argue that they have to hold down
expenditures, they have to be fiscally responsible. They have to worry
about capital investment. They want to maintain their rating.
Will they be able to forget about their rating if we go ahead with
this?
'
.
Mr. URTE. NO sir, and the last paragraph in our statement says that
such credit assistance should be so designed as to discourage any widespread use by governments.
If there is an occasional situation where Federal guarantee has to
come into play, they will not affect the overall municipal market.
The CHAIRMAN. Why won't it affect an investor? I t is a precedent.
If you say yes to New York, it is hard to say no to Peoria.




365
Mr. URIE. They will not be in the tax-exempt market.
The CHAIRMAN. But they started off in the tax-exempt market. If
they came in late, they will get a pretty handsome premium.
Mr. U R I E . I t will cost them if they go out of the tax-exempt market
into the taxable market. I t will cost them. If they also pay the cost of
the Federal guarantee, it will cost them.
The CHAIRMAN. Suppose an investor came along 3 or 4 months ago
and bought some of the New York obligations. He was able to buy
them at a pretty good premium, maybe $60 for $100 bond.
He will be making a beautiful profit on this. He is doing it on the
basis of really ignoring the quality and the rating and so forth.
Is that fair to give him that kind of capital gain ?
Mr. PETERSEN. Senator, for the first time I can recall in Senate proceedings we are talking about municipal bonds as hot issues. That is
the thing we are trying to prevent.
If that investor had bought New York City or State bonds a month
ago he wouldn't be looking too good today. That is the problem. I t
has been going down and down. I t can be a self-fulfilling prophecy.
Your statement is directed to Peoria.
The CHAIRMAN. He would be looking good if we provide a guarantee.
Mr. PETERSEN. If.
The CHAIRMAN. We
Mr. PETERSEN. I am

may provide that guarantee.
not sure the bondholder will look that good, but
the noteholder, yes. If you are sitting on a 20-year New York City
bond
The CHAIRMAN. If you get a guarantee everything is good.
Mr. PETERSEN. Credit assistance given to this city and State over
the next 5 years will not change the basic deterioration of the economy
of that city. Noteholders are a different situation. That is true.
We are talking about a way of meeting their payments.
The CHAIRMAN. I have heard those complaints from responsible
members who want to help. They don't want to be in the position of
assisting those who were speculators.
I t is hard to not discriminate.
Mr. PETERSEN. If we could isolate the problem to New York City
and the New York City noteholders, we can dismiss the proceedings.
But we are talking about the impact to the rest of the market. Money
is going from other tax-exempt bonds and we are having to compete
with higher rates with the other securities and it is harming other
borrowers.
Mr. WEINTRATJB. We have a problem of—which has been raised by
a number of people whereby some people bought New York City notes
with their eyes wide open and we are getting 9 percent returns on them.
There is a risk involved in doing that.
We are coming to the point where we say let's guarantee New York
City securities through a State agency which would reimburse these
people dollar-for-dollar when their notes mature.
That is an invitation of sorts for continued attention, overattention
to yields and underattention to risk.
Now, how do we deal with that.
Mr. FULLERTON. I think your point is very valid. I bought a New
York-New Haven Railroad bond the other day. I paid $40 for it, I
bought it with my eyes open. If you do not pay the notes off at par
when they mature, then the city is insolvent.

60-832

O - 75 - 24




3QG
I don't know that there is a lot you can do with speculators.
On the basis of Government testimony today, there will be a number
of insurance companies buying those bonds saying, hey, they will bail
us out at par.
I think the Senator asked a question a moment ago I would like to
respond to. Any enabling legislation would say to the local government that you must or you are mandated to follow the accounting principles of the financial reporting standards as promulgated by the
Municipal Finance Officers Association of the United States.
This is necessary, that you keep your books where we can read and
find out Avhat is happening.
I would have you say those units of government must be audited by
independent public accountants who will express their independent
accountants' opinions on the financial statements.
The CHAIRMAN. That has not been the case with New York City.
Mr. FULLERTON.
The CHAIRMAN.

No.

They have not had independent C P A reporting
and they have not used the principles of yours.
Mr. FULLERTON. That's correct. I have seen their financial statements. It is astounding.
I could not make heads or tails out of them.
Mr. WEINTRAUB. Let me ask you this question. Suppose we could
find a way and maybe you can help find a way in which instead of
giving back dollar-for-dollar to the noteholders as the notes mature,
we gave back something less than a dollar.
Suppose there was a way to do that, would you favor it ?
Mr. FULLERTON. The Government has said we want to borrow your
money and on January 1976 we will give your money back. Any failure
to do that breaches the faith in the Government.
The CHAIRMAN. If we had that it is default. You have all the consequences of default in the municipal bond market all over the country.
Mr. FULLERTON. Every time somebody dies the undertaker makes
a profit.
Mr. PETERSEN. I t is a question of ethics. The reason we are here is
because of the severe doubt and worry about the pledge to pay made
by State and local governments; 99 percent of the cases it is a needless
worry.
We are all suffering because of that.
The transitory gains that some might enjoy because they bought
depressed obligations are small in terms of the potential national costy.
They are doing nothing more than following the preachments out of
Washington. Establish and keep a private market going for the bonds.
That is where the market was.
Mr. WEINTRAUB. Surely it is de facto and not de jure default.
It may be a healthy default.
Do you agree it may be healthy to do this in this case?
Mr. TORRENCE. It seems to me that if this approach is contemplated, I believe I would take another look at letting them go into
default. Because default is the result of some sort of a catastrophe.
You are talking about a planned bailout that really doesn't solve
the problems as far as the market is concerned, and certainly not as
far as New York is concerned.




m
The CHAIRMAN. From a political standpoint, it could be bad, because you have the worst of both worlds. You have default on one
hand, and bailout on the other. We are in a tough position on this
committee. If we provide for the guarantee, the people who think
that New York has been an improvident prodigal son, and uncle
shouldn't bail them out, are mad at us.
If we let New York go down, then the prudent property taxpayer
in every town, village, and city of the country is going to say, "You
idiots, you could have prevented this increase in the property tax, and
municipal bond rate by providing for a guarantee." You understand
those circumstances; it seems we have the worst of both worlds.
Mr. FULLERTON. Senator, I think that is the reason some come to
the conclusion that the U.S. Senate would be very wise to check this
to the Federal court and let the Federal courts work out the
bankruptcy.
Mr. URIE. I would like to speak to your earlier question. I don't
know the extent of the speculation in these bonds. Historically, most
municipal bonds and notes have been held by institutions, commercial banks, and other institutions.
Only recently has the market changed so there are more individuals in the market. I'm sure there is speculation in New York bonds
and notes. I do not know the extent of that. I think it's very small.
I think if you render assistance, you are rendering assistance to
the holders, institutional holders of those notes and bonds, and most
of the holders of the notes and bonds are your citizens of New York
City, either individual or corporate citizens.
There will be speculation on the side, but I wTould presume it will
be small.
Mr. WEINTRAUB. There is a difficult question here. If you come
up with some sort of rescue plan which makes whole the present
holders or investors in New York City securities and puts the entire
burden of the plan, the entire cost on the residents of New York who
are not holders of the securities and on the employees of the city of
New York, you are going to run into a difficulty that way.
I t seems there has to be a share go here. I t seems to me to be healthy
from a standpoint of correcting from future imprudent investment
decisions that don't pay enough attention to ratings and risks.
Mr. PETERSEN. If they hold them to maturity, they will have to pay
capital gains. So there is a little more Federal revenue for you.
State of New York has a capital gains, too. They will get back a
little bit. Otherwise, it's a dilemma.
Mr. WEINTRAUB. Presumably when they bought the security, they
understood what the yield to maturity was.
Mr. PETERSEN. On the presumption they would be paid.
The CHAIRMAN. Mr. Weintraub has a good point. It is true; you
can understand how the employees and taxpayers of the city, if we
pose an additional tax, as Chairman Burns proposes or we continue
to hold down wage increases and prevent rehiring, which would be
necessary—I frankly do not see what you can do about it. I don't
think that in order to do justice and prevent anybody from making
a buck out of this thing, we precipitate what most people would construe as a default, and I think that would be a copout.




308

Mr. FULLERTON. If you permit a unit of Government to pay less
than par for its matured debt, I will have difficulty selling bonds in
the future. The next guy says, " I don't want to take a chance on you."
Mr. WEINTRAUB. Let's suppose we construct a new State agency
called MAC 2, for want of a better word. We let MAC 2 issue securities in exchange for New York securities as they mature. These
securities would have a Federal loan guarantee on them.
These securities could be issued to pay the same—to pay the same
yield that treasuries of comparable maturities do, say less half a
percent. That would be the penalty.
On their face they would be dollar for dollar, but their present
value, if anyone went to sell in the after market, would be somewhat less.
Mr. FULLERTON. Would you force the present holder to turn in his
securities ?
Mr. WEINTRAUB. We would give him the option as they mature.
He could do it or take his chance on the city paying him.
Mr. FULLERTON. If the city doesn't pay him, he steps into court and
says, "Hey, city, you owe me money."
Mr. WEINTRAUB. What is the judgment he could get.
Mr. FULLERTON. I believe the constitution of the State of New York
says that first money will go to the debt service, even before operation.
That may not be practical.
Mr. WEINTRAUB. I have been told by a lawyer in New York who
is dean of university law school is all that wyould happen in the case
of those holding full faith credit securities of New York was they
would get a judgment and the judgment would attach that part of
city-owned property not being used for public purpose. That amounts
to nothing.
I n this case it would be an offer they could not refuse.
Mr. PETERSEN. This is a general obligation.
Mr. WEINTRAUB. This would be full faith and credit notes. You are
not in default if the person has taken the MAC 2 security.
Mr. PETERSEN. If you presume to get the city of New York back in
the bond market by the year 2000, I would not suggest that move.
Mr. FULLERTON. The minute they do not pay off 100 cents on the
dollar when the bond matures, they are out.
Mr. WEINTRAUB. H O W long did it take Detroit to get back into the
bond market after they defaulted ?
Mr. FULLERTON. They did finally pay off 100 cents on the dollar.
Mr. WEINTRAUB. When they paid off 100 cents on the dollar, did
they pay it with the interest that was lost in the interim period?
Mr. FULLERTON. I would assume they had to.
Mr. PETERSEN. I think they did in almost every case. Out of the
securities that went into default during the depression, the final loss
in municipal bonds was $200 million or 1 percent of all the debt outstanding. That is, the securities that actually went into default and
remained unpaid. That was infinitesimal. Most of them paid interest
on the interest.
The CHAIRMAN. Gentlemen, thank you very, very much for most
useful testimony. You've given me a great deal of information that
I didn't have before. You have made a helpful recommendation.




309
Your organization is nonpartisan, I'm sure. I t probably has less
interest than any of the witnesses who appear. The witnesses who
appear generally—a number are disinterested, but the Governor has
a deep interest and bankers a deep interest. Nevertheless, it's a position that reflects what they represent and have responsibility for, and
the Secretary of the Treasury has a particular interest in a sense.
You gentlemen, I think, come before us, it's true, concerned with
the prospects for your cities. That, in a sense, represents all of the
citizens of our country. All of us live in some kind of a municipality
or county or State which may have to raise money.
Thank you very, very much. You have been helpful.
We stand in recess until a week from tomorrow, Saturday, October 18.
[Whereupon, at 3:55 p.m., the hearing was recessed to reconvene
on October 18,1975.]
[The following additional material was received for the record:]




370

MUNICIPAL FINANCE
OFFICERS ASSOCIATION
SUITE 303
1730 RHODE ISLAND AVENUE. NV:
WASHINGTON. D C 20036
202 466-2014

October 17, 1975

Mr. Kenneth A. McLean
Committee on Banking, Housing and Urban Affairs
5300 Kirksen Building
Washington, D.C. 20510
Dear Ken:
Enclosed are some items that you requested after our testimony
of last Friday.
The Final Report on Planning For Research and Improving Municipal
Credit Information and Credit Quality has served as the basis for the
larger-scale project we are now undertaking for the National Science
Foundation. (I referred to the report in our testimony and you are free
to include it in the record if you wish.)
It has been underway only a short period of time, but we hope to
have interim reports shortly.
Sincerely,

JP:dq
Enclosure




371
FINAL

R E P O R T

PLANNING FOR RESEARCH ON IMPROVING MUNICIPAL CREDIT
INFORMATION AND MUNICIPAL CREDIT QUALITY

JOHN PETERSEN
Co-investigator, Municipal Finance Officers Association
and
RONALD FORBES
Co-investigator, State University of New York at Albany

CONTENTS
Page
I.
II,
III.

PURPOSE AND CONDUCT OF THE STUDY

1

AN AGENDA FOR RESEARCH TO IMPROVE MUNICIPAL CREDIT
INFORMATION AND CREDIT QUALITY
REVIEW AND CRITIQUE OF THE PLANNING PROJECTS

5
22

APPENDIX
Proceedings of the user/researcher seminar

National Science Foundation
Grant No. GI-44097




November 30, 1974

372
I.

PURPOSE AND CONDUCT OF THE STUDY

INTRODUCTION
This report is organized into three sections. This first section
discusses the purpose and conduct of the planning study.

The second

section presents an agenda for research in the area of municipal
credit information and quality and serves as a summary of the planning
period's conclusions.

Section three presents a detailed review of the

individual project reports and the comment received upon them, as well
as conclusions by the coinvestigators.
Appended to this final report are proceedings of the user/researcher seminar. The individual project reports, publications, and
other materials under the project have been distributed and are available
upon request.

PURPOSE OF THE PLANNING PROJECT
The growth of capital outlays by State and local governments has
engendered increased demands for funds from the capital markets. While
vast amounts of capital have been raised, market participants and observers
have noted that risk premiums paid by many borrowers have been inordinately
high relative to the actual level of defaults.

Contributing factors to

this are a lack of adequate and reliable information about borrowers and
their projects, and, collaterally, a lack of knowledge on the part of
borrowers as to the criteria and information used in judging creditworthiness.

While the market has expanded the need for an efficient information

system, the existing exchange of information has developed in an ad hoc
manner.
The need to achieve improved information and analysis is ever more
evident and critical as the market for State and local obligations becomes




373
-2increasingly complex in the nature of financing arrangements.

In part,

this arises from the efforts of governmental borrowers to improve their
creditworthiness and to lower their cost of capital through new borrowing
techniques.
Several proposals have been made that would attempt to improve either
the information about creditworthiness or the substance of the credit itself.
Typically, such proposals usually are formulated to cope only with certain
specific symptoms of the overall problem; they often reflect confusion over
the appropriate components of credit quality, its measurement and how needed
information can best be obtained and disseminated.

As a result, there is

no guidance in selecting the most efficient strategies to follow in this area
and the alternative strategies themselves have been subject to little in the
way of orderly and comparative analysis.
ORGANIZATION OF THE PLANNING PROJECT
Because of the inherent complexity of these questions and the diversity
of the factors that' must be considered, there was established a planning
period to develop specific projects and priorities for subsequent research.
In that five-month period, the two coinvestigators worked with a coordinate
team of researchers, public officials, and market practitioners to investigate and appraise the current state of knowledge and to identify the
more fruitful avenues of subsequent study and implementation.
The overall topic of credit information and quality was subdivided
into the following project areas:
A) An examination of the hypotheses relevant for defining the analytical
framework to be used in the measurement of credit quality.
B) A description and evaluation of existing credit information systems,
particularly as they are (or, are not) provided by various Statesponsored and private information and debt advisory services.




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-3-

C) A survey and appraisal of the needs and uses of credit
information and analysis by market participants, and how
such information influences the investment behavior of these
groups.
D) A comprehensive analysis of the wide range of governmental
and private programs and techniques that are designed to
enhance the creditworthiness and/or the marketability of
State and local debt obligations.
An organizational meeting of the investigators and selected advisors
was convened at the outset of the project in early July to establish
immediate research approaches and priorities.

At that time responsibilities

in each research area were assigned to one or more investigators. In late
September and early October, draft reports were submitted in the respective
areas.

These reports formed the basis of workbook materials that were

distributed to participants in mid-October prior to a seminar on the subject
that was held the end of the month.
USER/RESEARCHER SEMINAR
At the seminar, held October 31, 1974 in Washington, B.C., the research
projects

were subjected to a comprehensive examination by a discussion

group of 51 participants representing 45 different institutions and
agencies.

The participants were purposely selected to represent the

broadest possible array of interests.

It included representatives of State

and local government, bond investment and trading institutions, the major
regulatory bodies, governmental accounting and law firms, credit rating
agencies, and academicians.

(The seminar proceedings and list of partici-

pants are included in the Appendix).




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_4-

The seminar had two major objectives:
(1) To elicit substantive criticism of the planning reports of
the proposed research, both by professional researchers
and practitioners; and
(2) To assist in the development of recommendations and
priorities for subsequent research.
To insure a maximum of meaningful debate and to evenly distribute
critical attention, a number of discussants were preselected to comment
on the project areas, with blocks of time allocated for general group
discussion.

In addition to the seminar presentations, several participants

contributed extensive written comment. The more substantive communications
are included in the Appendix and proved of great value in developing the
research agenda„




376
-5II.
e

AN AGENDA FOR RESEARCH TO IMPROVE MUNICIPAL CREDIT
INFORMATION AND CREDIT QUALITY

A.

Improving Credit Information

Municipal Credit Information involves the process by which those
who need to know the financial status of a governmental debtor discover what they need to know.

Interest in such information is shared

by both the creditor and lender, since defects in the process can be
costly to either or both or, for that matter, to others with related
interests.
The need to know takes on many variations.

The investor

supplied

with adequate information can make a better appraisal of what he faces
and thus should charge less to uncertainty given his risk-return
objective. The borrower government is better equipped to plan and take
steps to mitigate its weaknesses and to enhance its strengths. The citizen
or regulator is in a better position to judge the effectiveness and
prudence of government or investor.
1. NEED FOR RESEARCH
The reports and extensive comment in this planning report note
several reasons that substantiate the need for research to improve
municipal information practices.
Protection of the Market Function
The recent focus on regulation of the municipal securities industry,
stemming from many concerns, has brought an immediacy to the question
of information practices. A substantial impact of such regulation
will be to generate a demand - already felt in

its

anticipation -

for more information in a standard and timely format to protect both




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-6-

investor and issuer and to accommodate an orderly and safe market.
It is essential that governmental reporting - often late, haphazard,
and incomplete - be attuned to supplying legitimate needs at a
reasonable cost.
Changes in Investor Groups and Needs
The dramatic growth in the municipal securities market has introduced new elements of investor interest that are unfamiliar with the
market. Most prominent is the individual investor who lacks sophistication in these instruments.

Furthermore, there is ample evidence

that swelling supplies of municipal securities may face restricted
demand from the conventional sources, forcing State and local governments to increasingly seek out new investors. Correspondingly, they
must be able to discern and satisfy the information needs of newcomers.
Changing Fiscal and Economic Environment
Collateral developments with the burgeoning of municipal credit
demand are important shifts in the character of governmental finance
and the economic climate in general. The more obvious trends in
the former have been toward greater reliance on intergovernmental payments, more progressive and volatile revenue sources, and - in the
bond markets - more exotic debt financing devices.

In terms of the

national economy, the historic rise in interest rates and other prices,
juxtaposed with flagging real growth and output, presents untested
waters for State and local fiscal systems.

Investors, in particular,

are concerned not only about the repercussions in terms of ability to
meet debt service but, also, the implications of inflation for potential demand for bonds, which is an additional element of risk.




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-7-

Continuing Inadequacies of Information Supplied to Traditional
Investors and their Agents
Both pilot survey results and expert testimonials have verified
the needs of present investors, underwriters, and analysts for
more and more useful information.

By his very nature, the creditor

must charge a premium for ignorance as an added risk. Furthermore,
timely and adequate information is taken as an indication of good
management and attentiveness to investor needs, for which investors
pay a premium.

Complete absence of the information is not always the

problem; rather, it is a lack of responsibility and mechanism to get
it to the right place on time.
Improvements in Analysis in Part Depend on Better Information
Not only does the lack of information hinder the implementation of
present measures of quality, it impedes the development of improved
techniques. Changes in the financing of government and new forms of
organizing the supply of services continually alter the concept of
credit quality and invite changes in the techniques by which it is
measured.

However, the state of financial reporting is such as to

hinder the kind of extensive comparative analysis that the market
needs to function efficiently.

For purposes of economy, the market

tends to rely on traditional forms of analysis and to delegate much
of credit judgment to two private firms, whose opinions it fervently
follows.

Still, all participants admit that the present summary and

symbolic judgments, while adequate in many respects, leave considerable
room for more refined analysis, both by the agencies and individual
investors.




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-8-

2. MAJOR RESEARCH QUESTIONS
Research in the area of municipal credit information must start
with a careful examination of the present system, its shortcomings and
how these might be met most efficiently.

Specifically, the major

questions are:
What Types of Additional Information are Needed?
Putting together a list of the desired information is a complex
job that must start with assessing the needs and uses of the various
customer groups. The key group is the investor, since it is he that
determines day-to-day in the market place the relative prices placed
upon debt. Much, if not most, of the information the investor receives
is through specialized agents - rating agencies, other professional
analysts, and dealers - and their opinions and experiences are useful.
Pilot surveys have indicated that investors and their agents do have
opinions on informational deficiencies and needs, although such direct
surveys must be carefully controlled to avoid bias in response. Also,
it must be noted that investors' needs depend on their peculiar portfolio requirements. Closely akin, and evidently important in the
municipal market, are the explicit (or implicit) perceptions of the
regulatory agencies as to information needs and allowable risks.
An added dimension are legal requirements. These are based on more
paternalistic notions of investor protection and on the realities of
complex markets, where the overall health of the market may be undermined by the excesses or omissions of a few.
Meeting these requirements, in what is an emerging area of law,
calls for an additional line of study based on both the conventions
of the existing municipal market and the precedents of other securities
markets. Practitioners all agree to the top priority of this work.




380
-9Additionally, there is need to elicit the needs of users with
an eye toward potential improvements in the way in which such
information is used.
Although one should not typify credit analysis as a hotbed of
revolutionary thinking, the view of experts is that techniques have
lagged behind the development of public finance and the market. One
objective of research into improved information items (and systems)
should be to foster, or at least allow, a broader and deeper development of credit analysis. Thus, information gathered should reflect
the needs of improved analysis. While this presents problems because
of obvious disagreements as to how one should ideally measure quality,
the pilot research and discussion did identify a strong affinity for
development of the cash-flow motif, as we shall discuss below.
Participants also showed a distinct preference for an early-warning
set of summary indicators, that would provide at least a base-line
of comparability, and that could be reported quickly.
Some of the problems are simply ones of faulty distribution.

Infor-

mation items now created often do not get to people who could use them.
This occurs because the responsibility has not been affixed or an
existing information simply is not attuned to credit needs, although
the added cost of making it so would be small. Thus a study of transforming existing data into that needed by the credit-oriented users,
stressing national comparabilities, and how to get it to them would be
most worthwhile.

The current convening of the National Committee on

Intergovernmental Accounting offers great opportunity for the development of better standards in this respect.




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-10-

Last, it should be noted that the kind of information to be
collected should serve the needs of various State and local government regulatory or advisory bodies.

Progress in this area has been

slow, but the potential for State correctives to ailing local fiscal
situations and the State's general interest in local debt dealings
are obviously positive factors in appraisals of credit quality.
In summary, the kind of data to be collected should depend on
intended user group's needs, both present and potential.

the

Survey work

should be supplemented with actual analysis of the data to test their
adequacy.

Sentiment seems to be for fashioning simpler systems,

with maximum application, and concentration on cash-flow analysis.
As noted, the practical uses of credit-related information act as
a constraint on the amount of data required and there seems to be
great uncertainty over the advantages of developing big data systems
for the purpose of credit analysis. More work is needed to demonstate in detail how such information can be used and, in the absence
of clearly decisive empirical tests, demonstrations will have greatest
impact if they start with information items upon whose value there is
reasonable consensus.
How Should the Information be Collected and Disseminated?
In addition to the types and amounts of information needed, the
management, locus, and financing of the system need to be determined.
Just as the adequacy of information varies greatly, so do the systems
devised for its transmission.

The most widespread and influential

system at work now is provided by the private rating agencies, whose
quality ratings are important in the primary market and hold sway in
the secondary market. However, existing ratings do not serve all the
needs of investors and analysts. By the agencies' own admission,

60-832 O - 75 - 25




382
-iithey likewise would benefit by a better system to supply information. Moreover, many borrowers do not pay the fee to be rated and
they are not covered by the system (about 30 per cent of borrowers,
accounting for 5 to 10 per cent of the dollar volume of borrowing).
Initial opinion affirms that the most logical place to start
analysis of collection and dissemination problems is at the State
level, where a pilot project has already gathered much data.

Some

States have relatively well developed (and well recognized) information systems and all States have the legal powers to improve or
develop such systems. From the aspect of researchable experience,
there is a wide variation for the analyst to study and evaluate.
The initial observations on a national information system are mixed.
While there is desire for improved collection and dissemination of
data to serve a national market, there seems to be more profit in
strengthening the State's capacity first. The fundamental technical
problem at either level appears to be one of comparability, timeliness,
and enforcement of reporting. A first step should be assessing the
feasibility of these attributes on a State or regional basis, before
plunging into a national system.

On the other hand, many items of

analytical interest are collected nationally and these and their
sources need to be catalogued and pitched toward bond market needs.
Last, research on the locus of reporting systems should be aware of
the informational roles that, even in improved State and regional
systems, will still reside with the local borrower.

These are of

primary importance in the new issuances of debt and, along with other
elements of bond sales, seem to require specialized forms of technical
support that are frequently missing at the local level.




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-12
How Should the Improved System be Financed?
A difficult problem in research into information systems will be
the imposing budget constraint based on tangible cost and benefits.
Fragmentary evidence of such systems in the private and public sector
indicates that there are benefits (that, certainly, is the opinion of
professionals) that most likely could be shared between issuer and
investor.

Furthermore, cognizance must be taken of the safety and

insurance aspects in terms of the long-term costs that may be extracted if investors lack confidence in the market, or regulation to
protect them engenders increased and formal requirements,or legal
developments create large loss exposures which relate to information
and which might be catastrophic in their consequences.
Research should be initially directed toward enumerating those
informational areas where improvements may be rapid and economical.
A first and relatively costless endeavor will be the creation of more
widely observed standards of reporting, disclosure, and due diligence
in bond sales. More elaborate information systems in State, regional
or national depositories will need to be justified and perhaps can be.
But to be practical, this depends on better agreement on the data items
most needed and full and timely reporting of financial data from issuers.
Detailed comparison of existing systems is the best first step.
3. METHODOLOGY
Examples of the methodology required to satisfactorily answer the
above research questions are extensively given in the background papers.
But certain observations are in order.
The nature of the research area is such as to require an interdisciplinary
approach with heavy doses of practitioner input. The problems in the




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-13-

information area are only partially technological and, in many ways,
reflect strong institutional and conventional barriers to change.
Information problems are not new, although their consequences are
taking new dimensions, and the credit system has learned to live with
them, though at a cost. Only by direct involvement of those responsible for, and knowledgeable in, the various operations, can the analysis
be both technically correct and convincing to those who will implement improvements.
Information cost constraints are fundamental to this applied research. While the capital markets operate by many conventions that
seem to be less than ideal, its professionals are typically quite good
with figures.

Improvements need to be shown to be economically feasible

as well as operationally possible and who ends up paying for them may
appear to be an overriding consideration.

But, the experience of both

private and public systems demonstrates that market participants will
pay for some improvements, either directly through subscription to
services or indirectly with better bids on bonds.

In either event, it is

doubtful if dollar costs bulk large for feasible systems. Moreover,
the substantial risks of ignorance or illegality justify an insurance
element here and participants will pay the premium to mitigate the
possibilities of loss due to information lapses.




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-14-

B. Improving Credit Quality
Credit quality can be narrowly defined as the likelihood an obligor
will meet his debt obligations in full and on time. Obviously many
factors can influence this likelihood and, in an operational sense,
the definition is most closely observed in efforts to determine the
availability of cash to meet a particular debt service payment. Factors
which market participants believe contribute to that happy event strengthen
credit quality; factors thought to detract from it, weaken quality.
Credit quality is not static. While it is usually thought of in
terms of intrinsic fiscal and economic strength, its impact can be altered
or offset by changes in the nature of the financial arrangement or the
obligation.

Thus, it seems appropriate to include such marketability

factors as well in this analysis.

In discussing the needs for and design

of research in the area, we shall not rigorously distinguish between the
quality and marketability aspects.
1. NEED FOR RESEARCH
Both borrowers and lenders have an active interest in credit quality
for many of the reasons discussed already under their information needs.
But certain specific research needs arise in the area of improving the
quality of credit.
Influence on Borrowing Costs and Rates of Return
Quality is fundamentally important to governmental borrowers because
it is a major determinant of their cost of borrowing and, in some
cases, their ability to borrow, absolutely.

Depending on a host of

conditions, quality factors normally can account from 10 to 25 per
cent of the cost of borrowing in terms of interest rate differentials.




386
-15Our

interest is heightened because governments can take policy

actions which influence the quality of their obligations.

It is

for this reason that borrowers find it worthwhile to discover what
factors are held by analysts and investors in determining quality
(and why public officials become upset if they disagree with these
factors or cannot discover them).

Investors obviously hold quality

dear and base portfolio decisions on risk/return calculations that
depend heavily on perceptions of quality.
Efficiency in Financing
Given the fact that credit quality can be altered or offset by
various policy actions, it is important to know both what these policies
may be and what their cost are.

Such costs may be direct but, also,

they may appear as constraints on other forms of expenditure or as
potential weaknesses in other areas of fiscal responsibility.

But

unless one attempts their measurement, one has an inadequate basis
for rejection or acceptance.

On the other hand, improvements in

quality or marketability may be relatively costless for the benefits
received.

Efficient decision-making requires, therefore, knowledge

of both costs and benefits in this area.
Financial Soundness of System
At base, credit quality is important to both investor and debtor
because it gauges the financial strength of the system, the assurdness of repayment. While post-World War II conditions have brought
only isolated tests of quality, both those experiences and the widespread collapses of the depression era have demonstrated the monumental, protracted costs of actual failure or even widespread suspicion




387
-16-

of its likelihood.

Accurate estimates of credit quality, there-

fore, tell us much about the stability and resilency of both the
State and local sector and those capital markets which tend to and
depend upon it.
2. MAJOR RESEARCH QUESTIONS
Research in credit quality forms a difficult area for a variety of
reasons.

While the concepts of quality and what constitutes it are ad-

mitted on all sides to be difficult, the market to operate efficiently
and economically, has adopted many simplifications and conventions that
cause controversy.

Research, therefore, is torn between determining the

best way to satisfy existing perceptions of quality - as ill-defined as
they may seem - or questioning those perceptions and testing their adequacy.
In the absence of conclusive evidence to show superiority, as discussed
below, the tension will continue. Applied research, to have an impact and
to foster improvement, necessarily will march the middle ground to accommodate
immediate needs and to generate support for understanding and change.
What is Credit Quality?
Research must start with formulating a target for improvement and
this necessarily implies a notion of credit quality and its measurement.
The pilot efforts reported below studied three approaches to defining
quality; namely, the development of logical-conceptual models, relating
factors to an ability to pay; surveys of practitioners to determine
their perceptions of quality; and examining actual market performance,
attempting to empirically relate candidate quality factors to interest
differentials.

These approaches should not be mutually exclusive nor

any method, definitive.




388
-17-

The most salient point learned in the planning period is that
practitioners are generally more concerned with actual market performance than embarking on tests of its rationality.
Top priority in research calls for the development and testing of
improved analytical models of credit quality based on projected cashflow adequacy and the types of data needed for such measures. Not all
data are quantitative, since legal and administrative factors are held
important. Such a system necessarily would be multi-dimensional. As
noted in the above section on information, a summary list of early-warning
indicators of financial distress - explicitly and consistently built on a
cash adequacy framework - might have greatest influence on present
analysis. A thorough-going comparison - on a case study basis - with
alternative measures, is an essential element of this work.

Work on this

question should be carefully checked with practitioners for both its
validity or acceptability.

But existing conventions should not have veto

power; concepts can be changed as conditions warrant.
Investor Behavior Toward Quality
As previously indicated, the perception of quality as opposed to its
actual substance is potentially a target variable for research.

If it

can be shown in the light of actual performance or logical possibilities
that investors, through lack of information or faulty convention,do not
maximize return for a given actual risk, then the benefits of quality
improvement will come from its better recognition.

On a policy level

this involves the regulatory agencies that now depend heavily on existing
estimations without the benefit of examinations of their accuracy.




389
-18Realizing that credit quality is only but one risk element to the
investor, this research area lays a heavy burden on a deep understanding on investor objectives and portfolio behavior as well as
the historical performance of the market.
While the investor orientation is an important feature of potentially
improving both information flows and market acceptance of bonds, there
are many difficulties in mounting a major study of investor behavior
in this area. The crux of the problem would seem to be the need to
originate much market and portfolio data not now available. The absence
of secondary market trading data makes a direct empirical estimate of the
marketability factor in investment decisions an historic task.

By the

same token, studies of realized return on defaulted securities, while
of potential value, seem also to lack available data. The costs of
developing such data sets would be great and deserving of a project on
their own.. Obviously without such extended risk/return studies,
critiques of the rationality of either regulatory or investor constraints
and behavior are, at best, difficult to substantiate.
Many of these aggregative problems can be avoided by concentration
on a direct survey of investors, foregoing the costs (and losing the
advantages) of studying objective data on market performance.
survey work —

Such

which has resulted in some promising preliminary results —

will require careful attention to questionnaire design and procedure.
However, to maintain focus in the overall agenda, interest in the
investors behavior as regards to quality is necessarily more directed
toward what it can tell us about opportunities to better meet perceived
and demonstrated needs than evaluations of the rationality of that
behavior per se.




390
-19-

Policies to Improve Credit Quality and Marketability
Research in this area extends throughout the range of government
decision-making and organization down to the mechanical features of
bond design and sale. Obviously the studies of the determinants of
quality vis-a-vis financial management and legal arrangements and
their impact on the market will be suggestive of many changes that
can be adopted to enhance quality and lower cost. Many candidates
have been identified in the planning phase, but quantification or
ranking of their benefits and, it must be stressed, costs needs to
be done. The outcome needs to be a matrix, designed for application
under numerous constraints, of fiscal and management variables that
are controllable. This logically flows with the development of credit
models noted above and their empirical testing for market impact.
All levels of government are candidates for alteration in financing
arrangements that bear upon credit quality and financing costs.
A top priority must be placed on the analysis of forms of credit
assistance - ranging from guarantees through shifting of functional
responsibilities among governmental entities. These are increasing in
number and complexity and present an assortment of often practical but
sometimes costly alternatives to borrowers. The linkage to improved
analysis of credit, as well as a research objective in itself, needs to
be stressed.

A prime example is the importance of earmarked State

revenues.
Preliminary work demonstrates that the costs and benefits of credit
assistance techniques are estimatable and of great significance to all




391
-20-

market participants.

Surveys of investor behavior can be used to

gain insight into observed performance and primary market data can
be used to achieve quantification of the sundry techniques.
Studies of instrument design (marketability features) possess
strong possibilities for improved matching of investor needs by
borrowers and a clarification of the costs of certain features.
Again, the backbone appears to be in the use of available primary
market data in determinant analysis (to properly isolate a host of
modifying factors), supplemented by survey and interview work aimed
at major investor groups (and their agents).

A time series study of

bond sale timing factors, while in need of more specific development
as a proposal, also holds promise for influencing policy and behavior.
Growth-related aspects are only part of the overall capital financing question, but they do represent a traditionally important source
of demand for credit and possess special problems because infrastructure
expenditures frequently precede the wealth and activity that will
repay the debt. Moreover, the current focus on land-use and controlled
growth introduces a special and immediate need to develop the capitalrelated aspects of such policies.
Focus on improvements in creditworthiness and market acceptance by
changes in basic demands for capital and the division of capital costs
between various private and public entities is important.

It repre-

sents a natural complement to the study of how a government may better
finance debt that it elects to place within its sphere and the immediate
need for which is taken as given.




392
-21-

3. METHODOLOGY
The nature of the research dictates, as in the case of information
systems to which it is intimately related, the need for an interdisciplinary approach, founded on an extensive involvement of practitioners.
Data requirements are such that many questions can be studied and techniques
employed in concert and there are numerous opportunities for crossverification of findings.
A top priority requirement is the availability and use of statistical data on new issues, and, fortunately, those data are at hand.

Equally

important is the design and broad use of surveys of investor's preferences,
work upon which is well underway, although the problems of appropriate
sampling procedures remain to be met.
opment of governmental

Equally important is the devel-

fiscal, and related data for purposes of organizing

and analyzing the suggested forms of improved credit analysis, a task
that ties closely to the information work previously prescribed.

The

field of opportunity is so large and complex that efficiency dictates
extensive case studies and rudimentary applications prior to any fullblown data collection and analysis efforts.




393
-22-

III. REVIEW AND CRITIQUE ON THE PLANNING PROJECTS
The planning project set for itself two prescriptive goals for the
design of future research:

improving the nature and flow of information

related to municipal credit and improving the nature of such obligations
through either enhancing the creditworthiness or the marketing of the
instrument itself.
In the planning phase, it was thought best to take the broadest possible
view, since improvements are dependent on the behavior of a large number of
market participants and will be achieved only after the modification of
complex (and often esoteric) processes that match up borrower and lender.
For example, the process of exchanging information related to municipal
credit is extremely diffuse in terms of data origination and, today, is
heavily reliant on the summary opinions of two private credit rating agencies,
who themselves have difficulty in getting timely and usable data. Thus a
major existing flow of information is the published ratings themselves.
However, the lack of available data and the dominance of published ratings
have led to what is acknowledged by many to be a lack of development in the
area of municipal credit analysis. This is coupled with continuing controversy
as to how such analysis should be performed and criticism of the agencies,
in particular, for failure to be more explicit in how they grade municipal
securities. At the outset, therefore, one is faced with the twin tasks of
better serving the existing needs for information and of recognizing
that improvements in investor uses of information and its analysis may alter
those needs.




394
-23-

It is necessary to acknowledge a tension between the positive (what
is) and normative (what should be) aspects of the study:
(1) How can information flows, credit quality and marketability
be improved while accepting the current concepts of what constitutes
best credit practice and analysis, actual market performance, and
various institutional constraints; versus
(2) How might information flows, quality and marketability be improved
were the concepts of quality, its analysis, and its bearing on market
performance and constraints themselves to be changed.
At the risk of letting everything vary at once, the planning project
adopted an initial strategy of proposing studies both to identify existing
concepts and practices and to propose research that might modify the existing
concepts and perceptions as to what constitutes credit quality, how it might
better be measured, and whether or not certain institutional constraints
and behavior were optimal in view of such revised concepts and actual
experience in the market.
The obvious drawback to this approach is a diffuseness in and competition
for attention; but in a planning phase this seems to be more than offset
by the advantages of examining a number of candidate techniques and strategies
of research, with a minimum of j priori constraint.
i
The first two reports deal specifically with an examination of the
concept of credit quality and how it might best be measured.

The particular

stress is upon what constitutes and how one might best anticipate payments
difficulty on the part of governmental borrowers. The following report
proposes research to evaluate the mechanics and contents of the existing
credit information network, particularly as it is provided by State or




395
-24-

privately sponsored advisory services. The adequacy of both credit quality
concepts and information concepts will depend ultimately upon how well they
meet the needs and uses of bond market participants, especially investors.
The next two reports, therefore, relate specifically to analyses of how such
concepts and information influence

investor behavior.

The studies proposed

carry both positive and normative elements since investor and regulatory
perceptions of quality might be subject to modification if more is known
about actual performance.
The last two reports deal with a range of governmental and private
programs and debt marketing techniques that might enhance the creditworthiness or marketability of State and local obligations.

The first report

focuses on various credit assistance programs and ways of better designing
the debt instrument itself to improve its salability.

The second of these

dwells on alternative growth and land-use policies as they relate to fiscal
capacity and market appraisals of credit quality.
The projects in each major area are next reviewed briefly, followed
by a critique and conclusions.




396
-25A. Credit Definition and Measurement

1. SUMMARY OF REPORTS
"CONCEPTUALIZING AND MEASURING GOVERNMENT CREDIT QUALITY"
(Roy W. Bahl and Michael J. Wasylenko)
Research Statement
There is need to develop an analytical framework to relate
explicitly various economic, fiscal, and debt characteristics to
the comparative measurement of credit quality. This requires the
selection and development of comparative data sets to demonstrate
the operation of such a system.

A system of credit classification

must be developed out of a clear definition of the object being
measured.

Here, that definition is credit risk as the probability

of default.

In view of the sparseness of default experience, the

set of relationships will depend heavily on conceptual (or theoretical)
analysis of the possible behavior of key characteristics in periods of
economic or fiscal adversity.
Research Plan
Governmental credit quality is to be systematically related to
economic base, fiscal, and debt characteristics. Most data and
analysis will involve governmental borrowers in the SMSA's, with
certain items to be estimated for cities in excess of 25,000. A
variety of data sources are to be used.
a. Economic Base
The project will describe and measure various dimensions of economic
base and the types of instability to which they may be subject at the
local level, either due to local or national economic fluctuations.
This will depend on economic diversity in particular units and the




397
-26-

sensitivity of components and the aggregate to national or
regional changes in economic activity.

Interpretation must be

geared to dependency and responsiveness of local revenue systems
to the base.
b. Fiscal Base
Relative exposure to default depends on a complex of expenditure
and revenue characteristics of the borrowers, for which summary
measures shall be attempted.

Included are projection and comparison

of levels of public service demand versus the overall level of
economic activity and resources; the adequacy and stability of
available revenues under various fiscal systems, including degrees
of flexibility in use of revenues and the degree of concentration in
the tax base; the importance and trends in intergovernmental revenue
assistance; and changes in functional responsibility among levels of
government.
c. Debt Factors
Given the economic base and revenue characteristics, relative debt
burden depends heavily on forms of measuring debt and a variety of
other economic and legal constraints that may alter debt bearing
capacity.

Relationship of debt burden to possible changes in debt

capacity is the final link in measuring exposure to default risk.
Policy Implications
A recurring complaint in municipal credit analysis has been a lack
of disclosure of the factors used to judge credit, especially by the
rating agencies. The project would demonstrate a rigorous and
explicit method of relating measurable characteristics into an
empirical-comparative data system.

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O - 75 - 26




The system, in turn, could lend

398
-27itself to a quantitative rating technique using a multidimensional
scale or single scale (with assignments of weights to various
factors).

"CASH FLOW AS A MEASUREMENT OF RISK"
(Philip M. Dearborn)
Problem Statement
The ultimate test of credit quality is the degree of likelihood
that a borrower will have cash available to pay debt service when
due.

The key element is immediate cash availability since less liquid

remedies can be costly and protracted.
Research Statement
Most financial emergencies can be averted with sound management
and adequate cash revenues. However, unexpected external "shocks"
to the normal patterns of cash flows can precipitate financial crises.
Thus, methods of analyzing payments performance must also consider
the ability of governmental units to respond to these unexpected events.
This discussion suggests three general fiscal and administrative
characteristics that should be evaluated in considering risk of default:
(1) Immediate cash availability to meet initial crisis period until
correctives can be instituted.
(2) Degree of compulsion on local officials to diagnose and take
corrective action.
(3) Available methods for taking remedial action.
It is suggested that each of these characteristics has gradations
in practice that are subject to measurement and its selective importance can be weighted in terms of protection from default.
Under each characteristic

several techniques are described and

tentatively classified as to their relationship to cash flow adequacy




399
-28-

and perceived risk.
Policy Implications
Models of creditworthiness should incorporate and collect data
on these cash-related factors. No final proposal is developed for
an empirical investigation of the prevalence and behavior of these
factors or for a specific way in which they might be used in a credit
rating system.

However, the conceptual development lends itself to

a surveying of practices that should correlate to degrees of protection against both emergency and protracted deficiencies in debt payments.

2. CRITIQUE
Mr. Bahl's report raised many important issues that have been debated
in a less organized fashion. Essentially, it argued for a crisp definition
of credit quality to be consistently applied in the development of formal
indicators by which quality can be measured.

While arguing that the particular

choice of factors and weights in achieving a credit rating may be largely
a matter of judgment and logic, Bahl underscored the need for a concrete
and fully explicit model that all participants could know (if not necessarily
agree with) and, presumably, could manipulate and rework to suit their
particular needs.
The principal focus of the Bahl endeavor was upon the longer-term
aspects of fiscal and economic base interdependence. Mr. Dearborn, on the
other hand, narrowed his focus to a central concern of cash availability:
the ultimate test of credit quality is the degree of likelihood that a
government will have cash available in the future to pay debt service
commitments when due. While longer-term structural difficulties may make
a government more susceptible to payments difficulty, it was clearly
Dearborn's feeling that fiscal management aspects predominate in potential
cash shortages. Thus, whatever the borrower's particular economic or




400
-29-

fiscal base, poor timing and mixture of receipts versus cash outlay
requirements can cause difficulty: essentially sound governments that
are poorly managed can have payments difficulty.
Dearborn's analysis, while not denying the importance of fundamentals
in determining the potential for cash difficulties, emphasizes the added
dimensions of financial management quality and legal requirements to
avert or solve such difficulties.
Appropriate Definition
Discussion and correspondence exhibited a mixture of opinion on
the appropriate definition of credit quality and the degree of
accuracy by which it could be measured.

Starting with areas of agree-

ment, consensus did arise that, in terms of credit risk, an essential,
if not the central target variable should be cash adequacy to avoid
payments shortfalls. At the same time, it was generally felt necessary
also to relate cash needs versus availability to the longer-term
economic and fiscal base characteristics. Mr. Rubinfeld asked that
the short and long-term factors be linked by analysts as two means
by which default might occur. Mr. Breen indicated that these factors
are distinguished, at least in the Fitch system,

Mr. Hempel stated that

factors with longer lead times should be used in the forecast of cash
adequacy than those given in the Dearborn outline. Nonetheless,
practitioners were obviously impressed by the scheme Dearborn had devised.
Measurement Problems
Basic disagreements arose over the possibility or desirability of
analysts (a) making explicit comparisons among credits, (b) the proper
interpretation of various credit measurements, and (c) the formal
development of multi-dimensional, quantifiable rating systems. Mr. Breen,
for example, argued that such systems of measurement were too inflexible




401
-30-

and that although the letter grades produced by the rating agencies
might be used as summary comparative measures of credit quality,
that the verbal rationale provided was in fact the heart of
appraisal. This hesitancy to embrace formally quantified creditrating systems was evidently shared by Messrs. Tinsley, Moak, and
Steinkamp. Mr. Bahl and Mr. Rubinfeld argued that only by attempting
as explicit a measurement as possible could one know on what grounds
a specific rating was based.

Despite differences on how to measure

and weight credit components, it was agreed that better cash flow
indicators need to be developed,

Messrs. Breen, Moak, and Goss

stressed the importance of various income and outlay flow factors as
opposed to the traditional stock measures.
Cost of Data
George Hempel stressed the difficulty of empirically proving the
superiority of models, or their components, in view of the lack of
default experience. Much comment was received on the practical as
opposed to conceptual problems of definitions and measurement. The
cost and availability of data were frequently cited as impediments
to implementing more formal quantitative models. It was felt by
Mr. Dearborn that efforts to improve credit quality measurement should
start with the minimum of information required to indicate potential
trouble spots. The point was stressed that costs of data collection —
in view of the absence of agreement beyond certain fundamental factors —
needed to be carefully weighed against possible benefits. An important
aspect, too, was the timeliness of such information.
A suggested area of special concern for the credit quality aspects
of the project was that of the impacts of inflation on both the fiscal
performance of governments and investor preferences (Messrs. Gies and
Tinsley).




402
-31-

Other Risks Besides Default
A final issue relating to the definition and measurement of credit
risk revolved around the importance of default risk relative to other
risks in determining the cost of capital to borrowers and the risk/return
calculations of investors. The point was frequently made that default risk
may be the risk fundamental to published ratings, but that interest cost
differentials are determined by investors, ultimately, who face a larger
complex of market risks (Messrs. Tracy, Petersen, Zarin).

In this regard,

Mr. Solari stressed that ratings play a role beyond that which the
agencies envisage for them because the investors do use them as a
comparative measure beyond the one dimension of default risk for which
the agencies state that they are intended.

This added dimension relates

to investor perceptions of various other risks and their impact on market
behavior.

(This is the subject of research discussed below in Section "C").

3. CONCLUSION
The contrast struck in the Bahl and Dearborn papers

was most useful

in eliciting strong responses from both academics and practitioners, which
helped to focus on areas of initial agreement. The emphasis on cash
availability to meet debt service in timely fashion (as opposed to more
subjective and multi-dimensional targets) evidently vindicated the cashflow operating hypotheses set forth in the planning proposal. While discussion did suggest inadequacy of certain traditional credit measures, it
also lent importance to certain managerial and legal aspects that have
been traditional concerns for professional analysts and rating agencies,
but that defy quantitative specifications.
On the other hand, the complexities of the area, the lack of agreement
on (and development of) analytical techniques, the limitations of data,




403
-32-

and the inability to empirically test competing concepts, all seem to
lead to the conclusion that complex and elegant models would not be
enthusiastically received.

In particular, the farther the proposed

analysis moved from the operating "cash-register" of a government's
accounts, the greater was the disagreement over relevant factors (and
the more likely the charges of being excessively academic). However,
economic base and demographic factors are held to be important in conventional analysis because, even with the cash-flow variable as a target
for credit quality, the longer term forecasts needed for credit quality
estimates require the tracking of basic factors into their impact on
the governments' capital needs and cash needs.
Emphasis on research in this area should be toward developing measures
of projected cash adequacy and the types of data needed to support such
measures. This would suggest case studies of financial management and
the host of fiscal factors that influence liquidity in a variety of governments. As a practical matter, the formal development of a summary list of
"early-warning" indicators, explicitly built on a cash adequacy framework,
might have the greatest impact on present analysis. Research in this area
will be of most use if it works toward stressing consensus items among
practitioners and, in the process of achieving rigor and consistency, reinforces or erases competing factors from the framework.




404
-33-

B*
1.

Collection and Dissemination of Credit-Related Information

SUMMARY OF REPORT
"COLLECTION AND DISSEMINATION OF CREDIT-RELATED INFORMATION"
(John E. Petersen)

Research Statement
There is a need to evaluate the quantity and quality of information
relating to credit quality and financing practices.

Such information,

along with various collateral services to investors and borrowers, is now
collected and disseminated through a variety of private and public mechanisms with greatly varying degrees of comprehensiveness, availability and
comparability.

The existing information system should be analyzed in terms

of its providing data to meet investor needs and/or to achieve improved
levels of analysis.

Furthermore, the various techniques and components

of the current system need to be compared to alternative information
systems, including the collection and dissemination of data at the national
level.

Research Plan
Research will concentrate initially on a thorough inventory of the
present network of information sources, primarily at the State and Federal
level, through use of surveys and interview techniques.
information services is already in progress.

A survey of State

The resulting listing

of information sources and practices will be analyzed for cost, completeness,
comparability and other qualities on a State-by-State basis.

In addition,

the existence of State requirements for reporting and disclosure purposes
and the provision of other debt-related technical services will be
collected and compared.




This will include an extensive survey and

405
-34-

appraisal of information furnished in debt offerings and post-sale reporting.
In conjunction with other projects, a second phase of research
will correlate (1) alternative measures of credit quality and (2) user
(investor and borrower) information needs and uses with existing and
potentially available data.

This should permit evaluation of the feasi-

bility and cost-effectiveness both of current practices or of modified
collection and dissemination systems.

Also, there will be an analysis

of developing legal and regulatory requirements as they bear upon the
informational process.

Policy Implications
In addition to providing a comprehensive description of existing
sources of data, the project, in conjunction with companion studies, will
evaluate the relative effectiveness of the various methods of collecting and
dissemination of credit-related information and technical assistance.
Such evaluation should lead to identification of best practices and
standards, and suggest improvements in information systems to meet a
variety of needs with greater efficiency.

CRITIQUE
Comment on the preliminary and proposed study of credit-related
information systems was- uniformly favorable, as an area in need of research
and operational improvement.

It was noted through conference opinion

and pilot studies that both the contents of various financial reports
and documents and the process by which they are collected and disseminated




406
-35-

to the market are both of great importance and in need of substantial
improvements.

It should be stressed, too, that this project forms a bridge

with other areas of study that focus on improved definitions of and
measurement of credit quality, better meeting investor needs, and enhancing
the methods of marketing state and local securities.

The following prin-

ciple issues and points were raised in communications and conferences:

Disclosure and Investor Protection
Perhaps the most salient theme that did emerge from this discussion
was the growing awareness of an increasingly urgent need for substantial
improvements in the standards for disclosure practices on new issues.
Commissioner John Evans of the Securities and Exchange Commission, and
Richard Goss and Robert Doty, highlighted the growing concern by the
courts, Federal officials, and others that adequate financial reporting
i even more essential in light of proposed regulation and well-publicized
s
examples of fraudulent activity already within the context of existing
securities law.

As summarized by Philip Dearborn, "MFOA should develop

standards and guidelines for disclosure of information before some
financial officers get caught in serious lawsuits and before the SEC or
other Federal agencies usurp their responsibility".

Messrs. Moak and

Schimmel, among others, noted that such an effort would provide benefits
to all issuers, but would be especially helpful to smaller municipalities,
which pay the least heed to sophisticated market requirements.
As noted by James Marling and Michael Zarin, the attainment of
substantive improvements in disclosure and reporting practices calls
for a careful analysis of the costs of inadequate reporting, as part of
the process of education of issuers as to the importance of accurate and




407
-36timely credit information.

Mr. Grossman stated that the greatest contri-

bution the proposed project could make to the rating agencies would be
to devise ways to improve financial reporting practices.

Reporting and Advisory Mechanisms
The focus on reporting practices widened to several considerations
of how improvements should be made.

In the first instance, some repre-

sentatives of the investment community suggested that direct credit
information was most important at the time of issue and that the burden
of monitoring such information on a post-issuance basis would be
extremely costly and better left to, say, the rating agencies.

Post-

issuance credit information is also important, particularly for the rating
agencies, but these agencies stressed the great difficulties in collecting
such information on a timely basis, either directly or from intermediaries.
Both conference participants and the pilot survey results indicated
that, by-and-large, State agencies should provide increased debt-advisory
services (including information gathering).

Special benefits, again,

would accrue to the small issuers who now often receive limited or
amateurish advice on the technical aspects of debt marketing.

Uniform Reporting
A major block to improved analysis and improved investor information is the variety of reporting formats and accounting systems employed
in local governments.

Mr. Marling noted the difficulties experienced

by the State of Michigan when it adopted a uniform local government
accounting system.

While it was felt that accomplishing a national

uniformity in accounts was visionary, if not impossible, it was stressed




408
-37by Mr. Grossman that the project should try to establish some kind of
basis of comparison for different State fiscal reporting to serve as a
basis for a national reporting system.

Limiting Information Needs
Several comments were received on the importance of keeping the
information burden and costs to an economically defensible minimum.
The mood was,that barring a major and unforeseen novelty in analytical
requirements, primary stress should be placed on timely and complete
retrieval of that useable minimum of data most closely attuned to the
current or immediately foreseeable needs of analysts and investors.
Mr. Dearborn, in a communication, stressed the desirability of creating
a limited array of cash-focused items that would form the backbone of
the credit analysis of individual units.

Also noted was the need of

obtaining agreement on fundamental data sets fro™ analysts and investors
as a practical guide for prescriptions of contents and procedures.

3.

CONCLUSION
The central focus of the project, to study the process of collection
and dissemination of credit-related information (and the agencies and
materials involved in that process), is evidently especially pertinent.
This stems not only from meeting the traditional needs of investors,
but from meeting emerging legal responsibilities in the areas of investor
protection.

Preliminary survey results indicate a great variation in the

adequacy and timeliness of credit-related information provided by issuers.
After development of a reasonably complete description of available sources
and techniques, analysis should aim at methods of promoting the following:




409
-38-

standardization of document contents to permit more comparative
analysis; determination of the best locus for various types of information, given economic and institutional constraints; guidelines for
full disclosure of factors that materially influence investment value;
and the development of information items, now absent or ill-defined,
that may be needed for more sophisticated analysis.
The above objectives call for a strong user orientation and a
multi-disciplinary approach.

Improving the comparability of credit data

will need the support of those skilled in municipal accounting.
satisfying (and anticipating) various
legal scholarship.

Adequately

disclosure requirements will demand

The appraisal of information systems will call for

expertise in cre°dit analysis and information management and finance.
To have an impact, the policy prescriptions need not only be well-documented, but reflective of the various interest groups involved.

In

the normative phases of assessing adequacy and recommending improvements,
this study is heavily dependent upon the research to be performed in the
credit measurement and investor needs and uses areas. Furthermore,
the project should contain a strong implementation component.




410

C.
1.

INVESTOR NEEDS AND USES FOR MUNICIPAL CREDIT INFORMATION

SUMMARY OF REPORTS
"ASSESSING THE VALUE OF CREDIT INFORMATION"
(Ronald Forbes)
Research Statement
There has been an increasing concern that a lack of efficient information systems is contributing to imperfections in the municipal market.
This study is designed to evaluate the costs and benefits of developing
a more effective flow of credit information.

The relevant questions

that are explored include:
(1) Is there any perceived "need" for additional sources of
credit information?
(2) What specific costs can be associated with less than "full
disclosure"?
(3) What specific types of credit information are important?
(4) What is the appropriate delivery system for such credit
information?
(5) What are the operational, technical and economic parameters
associated with the development of a municipal credit data base
and analysis center?
Research Plan
An important part of the methodology for this research will be to
undertake a large-scale survey of major market participants.
will elicit

This survey

attitudinal measures of (1) the relative importance of

ratings versus direct credit information; (2) the perceived availability
of direct credit data; (3) the relative importance of specific types of
credit data; and (4) the relative importance of prospectus information




411
-40-

vis-a-vis ongoing reports.
The analysis will relate the extent of disclosure of specific
credit data to the perceived importance of that data to determine what
deficiencies may exist in current reporting practices.

It will also

be extended to determine whether the extent of disclosure affects the
terms of borrowing.

Preliminary analysis indicates that ratings and

numbers of bids received are related to the amount of information reported
in the prospectus for smaller issues.

Policy Implications
The results of this research program will be used to develop
recommendations on the scope and locus of any needed improvements
in the flow of information to the municipal bond market.

"EVALUATING THE MARKET PERFORMANCE OF MUNICIPAL BONDS"
(Thomas Gies and Timothy Nantell)
Research Statement
Interest rate differentials are established through a complex market
process that relates characteristics of issues and issuers to the characteristics of investors.

This discussion focuses on market risk-market

return characteristics of municipals.

It also relates the market

performance to the operating conventions and regulatory constraints
that affect commercial banks.
Portfolio practices of these institutions appear to place a heavy
reliance on ratings as surrogates for risk, with a consequent tendency
for bank demand to be segmented by rating grade.




This study outlines

412
-41-

a series of tests designed to determine whether the market performance
of municipals justifies the emphasis on agency ratings as determinants
of portfolio composition.
Research Plan
One methodology that will be used to evaluate the relationships
between operating factors and bond selection will be an extensive survey
of commercial banks. This survey will be national in scope and will
focus on developing an analysis of institutional perceptions of the effects
of regulatory constraints relative to the intended purpose of the
regulatory agencies. This methodology will be supplemented by several
studies of the secondary market behavior of municipals.

One specific

test will determine whether the variability in holding-period returns
is systematically related to rating class.

A second study will measure

the association between marketability (as measured by spreads in bid-ask
prices) and rating class. A third study will test the hypothesis that
realized yields for defaulted bonds are significantly understated if
holding periods terminate at time of default.
In addition, the study proposes to analyze the relationship
between yields on unrated bonds and the underlying economic characteristics of the bond issues. The analysis will measure the rating effect
by comparing yields on

unrated issues with yields on bonds from compar-

able issues, with ratings.

Policy Implications
The analysis of comparative market performance will have
implications for three policy areas:
(1) Have government regulatory agencies been over-conservative
in the risk rate assigned to municipal issues.




413
-42-

(2) Does actual risk/return performance, under reasonable
assumption, justify existing rate differentials among grades.
(3) Can ratings help municipal issuers achieve more efficient pricing
of their bonds relative to their intrinsic creditworthiness?

CRITIQUE
The logical relationship posed by the original proposal was that
improvements in the credit information system-- either its contents
or delivery mechanism -- must ultimately be geared to satisfying
the investing public (or their agents) since it is they who set the final
terms of borrowing.

Moreover, improvements in the creditworthiness and

marketability of debt would ultimately be judged by their ability
to better meet investor (or their agents) needs. This is so whether
or not the definition or methods of measurement of credit were in
need of (or capable of) being improved.

Thus, while the analysis of

investor needs and uses was contemplated as a separate study area, it
must be viewed as an integral part of the overall credit project .

The original proposal set forth essentially two paths to better
knowing investor needs and behavior vis-a-vis quality information: (1)
through use of survey techniques, to elicit directly from investors
(and other market participants) their present and desired use of credit
information and their opinions as to its impact on their investment
behavior and (2) through essentially statistical studies of observed
investment behavior of investors and the results of that behavior in
terms of realized risk/return experience.

The latter approach, as

developed in the planning phase, ambitiously envisaged the study of

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O - 75 - 27




414
-43-

credit risk as part of the overall risk/return portfolio decision of
investors.
The Forbes proposal relates to the receiving end of the creditinformation, and thus is a close companion to the collection and
dissemination system study (Petersen) discussed in the preceding
section, which approached the question from the standpoint of data
origination and distribution mechanisms.

As became obvious, the two

studies need to be integrated to be properly analyzed and the two projects
were, in effect, planned in tandem.

At the same time, efficiency

dictated that the Forbes and Gies-Nantell projects, both dealing with
investor attitudes and behavior and both employing survey techniques y
needed to be consistent and integrated in the same survey.

This

integration, while recognized as necessary for the actual study,
was not accomplished on a pilot basis in the planning phase.

The Centrality of Investor Needs and Preferences
Comments received on the proposals to study the needs and uses of
credit information were enthusiastic about the focus on the investor.
In fact, it was repeatedly stressed (as noted in Section "A u above)
that the investor has a range of risks to consider beside that involved
in default, which in the aggregate may largely outweigh those involved in
issuer payments difficulty.

Therefore, the practical requirements of

credit information and investor needs for it surpassed those involved
in the measurement of the probability of default risk.

In this

context, Mr. Tracy pointed out that, from the standpoint of the investor,
the market performance of a bond after issue (perhaps in response to news
about financial condition or management) was equally important in
determining credit quality as was the probability of ultimate default.




415
-44Studies of Portfolio Behavior
While the view was favorable toward a focus on investor needs,
several comments were raised regarding the feasibility of the proposed
techniques of studying investor behavior.

First, Messrs. Tracy and

Hempel stated that portfolio practices vary greatly among institutions
and that, except for the largest banks, are often not formalized.

Second,

a myriad of factors such as tax-status, monetary conditions, and issue- or
issuer-related legal and fiscal characteristics will condition bank
behavior and need to be taken into account. Third, in terms of any study
of information requirements, careful attention must be paid to the cost
of supplying more data, since any survey of perceived informational benefits,
without recognizing associated cost increases, would be misleading.
Secondary Market Performance
Special problems, acknowledged by the investigators, arose in the
contemplated examination of the secondary market, primarily involving
the lack of data of actual bond trade prices and ask/bid price quotations.
Without such data series, estimates of post-issuance price behavior in
a controlled sample would be impossible without very expensive original
data collection.
Realized Return and Default Experience
Mr. Hempel, in particular, was sympathetic of deeper study of the
ultimate return on defaulted bonds. However, it was the opinion of him
and others that prior studies had exhausted the data from present sources.
A reworking of these data might be useful but appeared to be of marginal
benefit at present.




416
-45-

Impact and Efficacy of Regulating Constraints
Comment tended to shift focus on the two aspects of regulation
in the commercial bank area, capital adequacy formulas and the impact
of portfolio constraints placed upon investors by regulatory bodies.
First of all, in the absence of data on secondary market performance
and the ultimate pay-out on defaulted bonds, it would be difficult
empirically to support contentions of market (or total) risk versus
return.

Furthermore, it was noted by Messrs. Kaufman and Buser in their

comments that risk to the financial system -- as opposed to risk to an
individual investor -- required that insuring agencies adopt a different
standard of allowable risk than that permitted to individual investors.
Thus, what might be permissable to risk for one unit would not be
permissable in the aggregate to the system of units.

CONCLUSIONS
While the investor orientation is an important feature of potentially
improving both information flows and market acceptance of bonds,
there are many difficulties in mounting a major study of investor
behavior in this area. The crux of the problem would seem to be the
need to originate much market and portfolio data not now available.
The absence of secondary market trading data makes a direct empirical
estimate of the marketability factor in investment decisions an
historic task.

By the same token, studies of realized return on defaulted

securities, while of potential value, seem also to lack available
data.

The costs of developing such data sets would be great and requiring

of a project on their own. Obviously, without extensive risk/return
studies, critiques of the rationality of either regulatory or investor
constraints and behavior are, at best, difficult to substantiate.




417
-46-

Many of these aggregative problems can be avoided by concentration
on a direct survey of investors, foregoing the costs (and losing the
advantages) of studying objective data on market performance.

Such

survey work -- which has resulted in some promising preliminary
results -- will require careful attention to questionnaire design and
procedure.

The use of the limited market-wide portfolio and y/ield

data may be employed to validate and extrapolate the survey work.
Proper organization and interpretation of such research does
require a formal, testable statement of investor portfolio behavior.
This, unfortunately, was beyond the capability of tie planning project
to develop.

While such a necessarily conceptual statement -- in view

of the limited opportunities for empirical testing -- lacks "practical"
appeal to some, it nevertheless needs to be constructed prior to data
gathering or testing.

The study of unrated bonds -- to test certain hypotheses as to the
value of the ratings and as an insight into their effect on marketability-can most effectively be approached by statistical analysis of new issues
for which much necessary data are available.

Here, a determinant

analysis of new issues, reflecting variables posited or found important
to investors (as supplied by the information gleaned from a well-donesurvey document that is focused on credit-related aspects of portfolio
behavior), would appear the best approach.




418
-47D. Improving the Credit Quality and Marketability
of Municipal Obligations

SUMMARY OF REPORTS
"ASSESSING POLICIES TO IMPROVE THE QUALITY OF THE
CREDIT AND THE QUALITY OF THE BOND INSTRUMENT"
(Ronald Forbes, Arthur Hierl, Edward Renshaw)
Research Statement
Concern over relative borrowing costs has led to a number of
innovations in the municipal market. Many of these innovations
have focused on devices designed to reduce default risk, such as
the use of guarantees, insurance, and state backup provisions.
However, there are vast differences in the manner in which each
program attempts to improve creditworthiness and there is some
casual evidence of significant variations in the cost effectiveness
of these programs. To date, there has been no systematic evaluation
of the relative effectiveness of the alternative approaches to improve credit quality and the proposed research program is designed
to fill the gap.

Emphasis will be placed on developing estimates

of comparative borrowing costs for insurance and guarantee plans;
for policies designed to segment overall municipal debt by risk class
and for specific programs designed to assist school districts.
Another approach to credit assistance has focused on the development of a more efficient bond instrument.

To date, most programs

have emphasized the inefficiencies of small bond issues and have
attempted, through pooling arrangenents such as bond banks, to
"package" these securities into a more marketable form.




419
-48-

Research Plan
Four distinct projects will be carried out to evaluate specific
types of credit assistance.

One project will focus on bond insurance

and will analyze the relationships between the costs of insurance
and the present value of future benefits that result from guarantees
against default.
A second project will develop estimates of the weighted average
cost of capital for selected cities and states with a similar overall debt burden but with varying proportions of general obligation
debt outstanding.

The analysis will focus on the relationship between

the cost of capital and the mix of revenue-general obligation financing.
A third project will evaluate the relationship between the amount
and form of state school aid and the relative borrowing costs of school
districts.

The specific tests will be designed to estimate whether

revenue assistance has reduced the cost of school borrowing.
Using an extended data base on new municipal issues, a fourth project
will estimate the relationships among borrowing costs, the number of
bids and underwriting spreads and the size, rating and timing of new
issues.
Policy Implications
In addition to providing an evaluation of the relative efficiency
of alternative approaches to credit assistance, the results of these
studies will be directed toward the design of new policies. For
example, the interrelationships between optimum issue size and credit
quality may suggest the viability of new concepts such as the sale of
term bonds by communities, with debt retirements managed through a
state sinking fund.




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"LOCAL GOVERNMENT DEBT AND GROWTH MANAGEMENT"
(George Peterson)

Research Statement
Growth poses particular problems for debt financing because of
irregular, lumpy demands for capital funds, as communities experience
cycles in development.

Increases in debt

in turn translate

into

(1) increased tax rates and (2) enlarged supply (glut) of bonds. Both
erode market acceptance and prices of debt instruments. Additionally,
the composition of growth can be such as to cause fiscal inbalances
as expenditures outpace tax receipts.

Pressure of growth on capital

needs and market acceptability of local debt can be mitigated by the
following policies:
(1) Public Facility Ordinances:

Local restrictions on pace and place

of growth and the capital demands thereby generated.
(2) Fees and Exactions:

Making private sector (developers) absorb

costs of development directly (fees and dedications in new developments) .
(3) Fiscal Zoning:

Restriction on growth to those activities that

"pay their own way".
There is evidence that the market
to positive controls on growth.

and analysts

react favorably

This relates to the ability of government

to alter (or offset) changes in its underlying characteristics as they
reflect upon its fiscal capacity and/or market appraisals of its
creditworthiness.




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Research Plan
A large sample of local units will be taken to relate growth patterns
to