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F o r r e l e a s e on d e liv e r y

S ta tem en t b y

A r th u r F . B u rn s

C h a ir m a n , B o a r d o f G o v e r n o r s o f th e F e d e r a l R e s e r v e S y s te m

b e f o r e the

J oin t E c o n o m ic C o m m itte e

O c t o b e r 8, 1975

I a m h e r e to jo in you in d is c u s s in g the e c o n o m ic and
fin a n c ia l p r o b le m s p o s e d b y th e fin a n c ia l c r i s i s o f N ew Y o r k
C ity .
T h e d iffic u lt ie s n ow fa c in g N ew Y o r k s t e m f r o m the
e r o s io n o f its fin a n c ia l p o s it io n o v e r the p a st d e c a d e .

D u rin g

th is p e r io d the e x p e n d itu r e s b y the C it y 's g o v e r n m e n t g r e w
r a p id ly w h ile r e v e n u e s f a ile d to k e e p p a c e .

T o c l o s e th e gap

b e tw e e n its r e v e n u e s and e x p e n d it u r e s , th e C ity r e l i e d in c r e a s in g ly
on b o r r o w e d fu n d s.

N ot o n ly c a p it a l e x p e n d it u r e s , but a ls o the

m ou n tin g d e fic it s on c u r r e n t o p e r a t io n s , w e r e fin a n c e d in this
fa s h io n .

B y the end o f 1974, N ew Y o r k C it y ’ s ou tsta n d in g d ebt

a m ou n ted to o v e r $13 b illio n , m u c h o f w h ich w a s in the f o r m o f
s h o r t - t e r m n o te s - - that i s , o b lig a t io n s m a tu r in g in a y e a r o r
le s s .
I n v e s t o r s m a y le a r n s lo w ly , but th e ir in n o c e n c e d o e s
n ot la s t f o r e v e r .

A s p o o r m a n a g e m e n t o f N ew Y o r k fin a n c e s

p e r s is t e d , at f i r s t a fe w but in t im e m o r e and m o r e in v e s t o r s
b e c a m e c o n c e r n e d abou t the C it y 's fin a n c ia l c o n d itio n .

D u rin g

the p a s t w in te r and s p r in g the C ity b e g a n to e x p e r ie n c e v e r y
s e r io u s d iffic u lt ie s in r o llin g o v e r its d ebt - - t o sa y nothing o f
ad d in g to its ou tsta n d in g in d e b te d n e s s .




-2-

U n fo r tu n a te ly , th e C ity f a ile d to ta k e c l e a r - c u t r e m e d ia l
m e a s u r e s , and t h e r e w a s s o m e l o o s e ta lk a b ou t an in v e s t o r
c o n s p ir a c y a g a in s t th e C ity .
q u ite s im p le .

T h e b a s ic f a c t s , o f c o u r s e , w e r e

F i r s t , c o m m e r c i a l b a n k e r s , b e in g a w a r e o f t h e ir

r e s p o n s ib ilit y f o r o th e r p e o p le 's m o n e y , fe lt th e y m a y a lr e a d y
h a v e a p p r o a c h e d - - i f n o t e x c e e d e d - - th e lim it s o f p r u d e n c e
in th e ir h o ld in g s o f N ew Y o r k C ity s e c u r i t i e s .

S e c o n d , the

m a n y th ou sa n d s o f in d iv id u a ls w h o in v e s t on t h e ir ow n a c c o u n t
lik e w is e f o c u s e d on s a fe t y ; th e y w e r e n o lo n g e r m u c h te m p te d
b y p r o m is e s o f an e x c e p t io n a lly h ig h y ie ld .

I n v e s t o r c o n fid e n c e

in the C it y 's fin a n c e s thus d w in d le d , w h ile its n e e d to pay c u r r e n t
b i l l s and to r e fin a n c e m a tu r in g o b lig a t io n s b e c a m e m o r e p r e s s in g .
O n ce th is s ta g e w a s r e a c h e d , th e p o s s ib ilit y o f d e fa u lt on th e
C it y 's o b lig a t io n s b e c a m e v e r y r e a l , and it w a s s o a d v e r t is e d
a lm o s t d a ily in ou r n a t io n 's n e w s p a p e r s .
T h e fin a n c ia l c r i s i s c o n fr o n tin g the n a t io n 's la r g e s t c ity
p r o m p te d the g o v e r n m e n t o f N ew Y o r k S tate to o f f e r fin a n c ia l
and m a n a g e r ia l a s s is t a n c e .

S ta rtin g in A p r il, th e S tate put at

th e C it y 's d is p o s a l s u b s ta n tia l su m s that w e r e n o t s c h e d u le d f o r
p a y m en t u n til s o m e m on th s la t e r .

T h en , a ro u n d m id -J u n e , th e

S tate le g is la t u r e c r e a t e d a n ew a g e n c y - - th e M u n ic ip a l A s s i s t a n c e







C o r p o r a t io n (M A C ).

T h is a g e n c y w a s e m p o w e r e d to s e ll up

to $ 3 b illio n o f its d ebt o b lig a t io n s , w h ich w e r e to b e b a c k e d
b y c e r t a in ta x r e v e n u e s that o t h e r w is e w o u ld h a v e g on e to the
C ity , and then to m a k e the p r o c e e d s o f its b o r r o w in g a v a ila b le
to the C ity .

A r m e d w ith su ch b r o a d a u th o r ity , M A C sou g h t to

w rin g s o m e c la r it y out o f the C it y 1s ta n g le d fin a n c e s and to h e lp
d e v e lo p a b u d g e ta r y p la n that c o u ld le a d the C ity b a c k to a
b a la n c e d b u d g e t.
T h e s e m e a s u r e s , h o w e v e r , p r o v e d in s u ffic ie n t to r e s t o r e
in v e s t o r c o n fid e n c e in the C it y 1s fin a n c ia l m a n a g e m e n t 9 and
e v e n the n ew s e c u r it ie s is s u e d b y M A C s o o n c a m e u n d er a c lo u d .
T o w a r d o f f im m in e n t d e fa u lt b y the C ity o f N ew Y o r k , the State
a d op ted f i r m e r m e a s u r e s on S e p te m b e r 9.

F ir s t o f a ll, c o n t r o l

o f the C it y 's fin a n c e s w a s tu rn ed o v e r to a S ta te -d o m in a te d
E m e r g e n c y F in a n c ia l C o n tr o l B o a r d .

S e c o n d , the p o w e r o f

M A C to is s u e d ebt s e c u r it ie s w a s e n la r g e d .

T h ir d , the State

sou gh t to a r r a n g e a d d itio n a l fin a n c in g o f $2, 3 b illio n f o r the
C ity , o f w h ich $750 m illio n in lo a n s w a s to foe p r o v id e d b y the
S tate.

T h is fin a n c ia l p la n w a s d e s ig n e d to tid e the C ity o v e r

until e a r ly D e c e m b e r , and it w a s h o p e d that b y that tim e the
n e w ly o r g a n iz e d C o n tr o l B o a r d w ou ld h a v e in b e in g a s u ffic ie n t ly

-4-

s tr o n g p r o g r a m o f b u d g e ta ry r e s t r a in t s to e n a b le th e C ity to
r e s u m e th e s a le o f its s e c u r it ie s to the in v e s tin g p u b lic .
B u t w h en in v e s t o r c o n fid e n c e is o n c e sh a k en , it can
r a r e l y b e r e s t o r e d q u ic k ly o r e a s ily .

T h e n ew fin a n c ia l plan

fa ile d to e l i c i t e n th u s ia s m on the p a r t o f in v e s t o r s .

In g e n e r a l,

th e fin a n c ia l co m m u n ity r e m a in e d s k e p t ic a l abou t th e C it y 's
a b ilit y to a v e r t d efa u lt and r e b u ild its fin a n c ia l s tr e n g th .

The

c o n c e r n o f m a r k e t p a r tic ip a n ts w a s h e ig h te n e d b y a ju d ic ia l
r u lin g on. S e p te m b e r 29 that b r o u g h t in to q u e s tio n a p o r tio n o f
the fin a n c ia l a id p a c k a g e , n a m e ly , th e p u r c h a s e o f M A C b on d s
b y th e State p e n s io n fu n d s.

B e y o n d that, the r e c e n t in te rtw in in g

o f th e S t a t e 's fin a n c e s w ith the C it y 's fin a n c e s h a s t r o u b le d m a n y
in v e s t o r s and d a m a g e d the S ta te 's c r e d it sta n d in g.

T h u s, th e

s t r e s s e s and s tr a in s that d e v e lo p e d in the m u n ic ip a l s e c u r it ie s
m a r k e t o v e r the s u m m e r m on th s h a v e b e c o m e m o r e a cu te in
re ce n t days.
S in c e the s u m m e r , and to an in c r e a s in g d e g r e e in r e c e n t
w e e k s , the p a r tic ip a n ts in the m u n ic ip a l m a r k e t - - that i s ,
in v e s tm e n t b a n k e r s , s e c u r it ie s d e a le r s , and u ltim a te in v e s t o r s - h a v e b e e n a ttem p tin g to r e d u c e t h e ir e x p o s u r e to the r i s k o f l o s s .
T h is h a s a f fe c t e d n ot o n ly s e c u r it ie s b e a r in g a N ew Y o r k n a m e ,







-5-

but a ls o is s u e s o f s o m e o t h e r State an d l o c a l g o v e r n m e n t s .
T h u s , m a n y s e c u r it ie s d e a le r s h a v e sou g h t to c u t b a c k on th e ir
in v e n t o r y o f m u n ic ip a l s e c u r i t i e s , and th ey h a v e o fte n fou n d
it n e c e s s a r y to o f f e r b on d s f o r s a le at p r i c e s c o n s id e r a b ly
b e lo w th e ir p u r c h a s e p r i c e .

U n d e r w r it e r s o f m u n ic ip a l is s u e s

h a v e g e n e r a lly s c a le d b a c k on th e ir p a r t ic ip a t io n in n ew o f f e r in g s ,
t h e r e b y p r o t e c t in g th e ir c a p it a l in an u n c e r ta in and v o la t ile
m a rk et.

S o m e u n d e r w r it e r s h a v e g o n e s o fa r a s to w ith d r a w

e n t ir e ly f r o m b id d in g s y n d ic a t e s .

A n d in v e s t o r s - - the u ltim a te

b u y e r s o f m u n ic ip a ls - - h ave b e e n ten d in g to s h ift to h ig h e r q u a lity m u n ic ip a l s e c u r it ie s o r to c a t e g o r ie s o f in v e s tm e n t
ju d g e d to b e l e s s h a z a r d o u s .
T r a d in g in the m a r k e t f o r o u tsta n d in g t a x -e x e m p t b on d s
has t h e r e fo r e s lo w e d a p p r e c ia b ly and the s p r e a d b e tw e e n b id
and a s k e d q u ota tion s has w id e n e d .

T h e s e d e v e lo p m e n t s a r e

c h a r a c t e r i s t i c o f a p e r io d w h en in v e s t o r c o n fid e n c e h as b e e n
sh a k en , and th ey a r e in d ic a t iv e o f a w e a k e n e d m a r k e t .
T h e r e c e n t b e h a v io r o f in v e s t o r s and d e a le r s has r e s u lt e d
in a r i s e o f the y ie ld s on m u n ic ip a l s e c u r it ie s to the h ig h e s t le v e l
e v e r e x p e r ie n c e d in the t a x -e x e m p t m a r k e t .

Y ie ld s f o r e v e n the

h ig h e s t - r a t e d b o r r o w e r s h a v e r is e n o v e r the p a s t fe w m o n th s .

S o m e o f th is in c r e a s e h as b e e n a s s o c ia t e d w ith the u p w a rd d r ift
o f o p e n -m a r k e t in t e r e s t r a t e s s in c e m i d - y e a r .

In a d d itio n ,

m u n ic ip a l y ie ld s h a v e b e e n u n d er u p w a rd p r e s s u r e b e c a u s e o f
the h e a v y v o lu m e o f new t a x -e x e m p t is s u e s flo w in g to m a r k e t .
T h e m a r k e t f o r t a x -e x e m p t s e c u r it ie s is m o r e c o n c e n t r a t e d ,
an d t h e r e f o r e s m a lle r , than f o r ta x a b le b o n d s .

H e n c e , w h en

u n u su a lly la r g e am ou n ts o f su ch s e c u r it ie s h a v e to b e p la c e d ,
la r g e r y ie ld a d ju s tm e n ts r e la t iv e to ta x a b le m a r k e t s a r e lik e ly
to o c c u r .

N e v e r t h e le s s , u n til the la s t tw o w e e k s , I w o u ld ju d g e

that th e y ie ld s on the h ig h e s t - r a t e d m u n ic ip a l is s u e s h a v e n ot
b e e n out o f lin e w ith th o s e a v a ila b le on c o r p o r a t e b o n d s o f
c o m p a r a b le q u a lity .
In c h o o s in g a m on g t a x -e x e m p t s e c u r i t i e s , h o w e v e r ,
in v e s t o r s h a v e b e c o m e in c r e a s in g ly s e l e c t i v e .

T h e d iff e r e n c e s

in y ie ld s , c o m p a r in g l o w e r - r a t e d b o n d s w ith h ig h e r -r a t e d i s s u e s ,
h a v e in c r e a s e d c o n s id e r a b ly s in c e la s t s p r in g and h a v e b e c o m e
u n u su a lly la r g e .

T h u s, the a v e r a g e y ie ld on M o o d y ’ s A - r a t e d

b on d s n ow e x c e e d s that on A a a -r a t e d b on d s b y m o r e than a fu ll
p e r c e n ta g e p oin t - - o r abou t th r e e t im e s the r is k d iffe r e n t ia l
r e q u ir e d b y in v e s t o r s d u rin g the p r e c e d in g s ix y e a r s .

T h u s,

th e in t e r e s t c o s t f o r l o w e r - r a t e d b o r r o w e r s c o m in g to m a r k e t
h a s r i s e n m a t e r ia lly .







-7-

T h e d e t e r io r a t io n o f the m a r k e t f o r m u n ic ip a ls o f l e s s
than the h ig h e s t q u a lity h as b e e n e s p e c ia lly p r o n o u n c e d f o r
o b lig a t io n s o f N ew Y o r k C ity , N ew Y o r k S tate, and c e r t a in o f
the State a g e n c ie s .

In the c a s e o f the State p r o p e r , in v e s t o r s

h a v e b e c o m e c o n c e r n e d that the r e s o u r c e s b e in g d iv e r t e d to
the C ity a r e d a m a g in g the fin a n c ia l p o s it io n o f the State i t s e l f .
S o m e o f the S t a t e ’ s a g e n c ie s that is s u e nm o r a l o b lig a t io n ’ 5
s e c u r it ie s r a th e r than " fu ll fa ith and c r e d i t ” o b lig a t io n s h a v e
b e e n u n a b le in r e c e n t m on th s to fin a n c e t h e m s e lv e s in the p u b lic
m a r k e t.

T h e r e n ow a p p e a r s to b e s o m e te n d e n c y on the p a r t

o f in v e s t o r s to u n d e r e s tim a t e the fin a n c ia l s tr e n g th o f th e s e
a g e n c ie s - - an attitu d e that s te m s at le a s t in p a r t f r o m the
t e m p o r a r y d e fa u lt e a r l i e r this y e a r b y the U rban D e v e lo p m e n t
C o r p o r a t io n .

T o a l e s s e r ex te n t, th e r e h as a ls o b e e n s o m e

r e lu c t a n c e b y in v e s t o r s to a c q u ir e the s e c u r it ie s o f s im ila r
a g e n c ie s in o th e r S ta te s.
D u rin g the p a s t w e e k o r s o , the im p a c t o f the m a r k e t 's
u n e a se has s p ille d o v e r to a w id e r ra n g e o f s e c u r i t i e s .

S ig n ific a n t

in c r e a s e s in y ie ld s h a v e o c c u r r e d in the c a s e o f s o m e ou tsta n d in g
b on d s o f g o v e r n m e n ta l un its that e n jo y a h ig h fin a n c ia l sta n d in g.
M o r e o v e r , a fe w is s u e r s h a v e n ot r e c e i v e d an y b id s f o r th e ir

-8-

b o n d s , o r h a v e r e je c t e d th e b id s r e c e i v e d b e c a u s e the in t e r e s t
co s t w as d eem ed e x c e s s iv e .

T h e s e d e v e lo p m e n ts r e f l e c t in ­

c r e a s in g c o n c e r n o v e r the c r i s i s o f N ew Y o r k C ity .
If the w e a k n e s s o f th e m a r k e t f o r m u n ic ip a ls w e r e to
p e r s i s t and s p r e a d fu r th e r , m a n y s o u n d ly ru n , c r e d it w o r t h y
c o m m u n itie s and p u b lic a g e n c ie s c o u ld h a v e g r e a t d iffic u lt y - o r s u ffe r e x c e s s i v e c o s t s - - i n r a is in g n e e d e d fu n d s.

H o ld e r s

o f m u n ic ip a l s e c u r i t i e s , a m on g w h ic h fin a n c ia l in s titu tio n s a r e
n u m e r o u s , w o u ld to s o m e d e g r e e b e a ffe c t e d , and s o m ig h t o t h e r s
l e s s d ir e c t ly in v o lv e d .

H e n c e , i f th e N ew Y o r k C ity c r i s i s r e m a in s

u n r e s o lv e d , and i f th e fa te o f N ew Y o r k S tate r e m a in s t ie d to th e
C it y 's , th e p r o c e s s o f e c o n o m ic r e c o v e r y now u n d er w a y in ou r
n a tion c o u ld b e in ju r e d .
U n til th is m o s t r e c e n t tu rn o f ev en ts - - w h ic h I t r u s t
w ill p r o v e to b e a t r a n s it o r y p h e n o m e n o n - - the m a r k e t f o r
m u n ic ip a l s e c u r i t i e s , tak en as a w h o le , fu n c tio n e d v e r y e f f e c ­
t iv e ly .

D u rin g the th ird q u a r te r o f th is y e a r , e v e n as p r e s s u r e s

a s s o c ia t e d w ith the N ew Y o r k C ity p r o b le m in t e n s ifie d , n ew bon d
is s u e s a m o u n te d to abou t $ 9 . 5 b illio n .

T h is is b y fa r the la r g e s t

v o lu m e e v e r f o r a th ir d q u a r t e r , and it w o u ld h a v e b e e n a r e c o r d
e v e n in th e a b s e n c e o f th e $2. 4 b illio n o f M A C b on d s s o ld d u rin g
the p e r io d .







In s e e k in g w a y s to r e s o l v e N ew Y o r k C it y 's c r i s i s , the
s u g g e s tio n h a s o c c a s io n a lly b e e n a d v a n c e d th at the F e d e r a l
R e s e r v e m ig h t s e r v e as a s o u r c e o f e m e r g e n c y c r e d it .

No

f o r m a l a p p lic a t io n f o r su ch c r e d it w a s e v e r r e c e i v e d b y the
B o a r d o r th e F e d e r a l R e s e r v e Bank o f N ew Y o r k .

But I

w ant t o e x p la in w hy w e p r o b a b ly w o u ld h a v e d is a p p r o v e d su ch
an a p p lic a t io n h ad it b e e n m a d e .
A s th e u ltim a te s o u r c e o f fin a n c ia l liq u id ity in the
e c o n o m y , th e F e d e r a l R e s e r v e h a s c e r t a in p o w e r s to ex ten d
e m e r g e n c y c r e d it even to in s titu tio n s that a r e n o t m e m b e r s o f
the S y s te m .

But the u s e o f that a u th o r ity is tig h tly c i r c u m s c r i b e d .

T h e b a s i c p r o v is io n — c o n ta in e d in S e c tio n 13, p a r a g r a p h 13,
o f the F e d e r a l R e s e r v e A c t - - s ta te s th at e m e r g e n c y lo a n s w ith
m a t u r it ie s n o lo n g e r than 90 d a ys m a y b e m a d e b y the F e d e r a l
R e s e r v e B anks on the b a s is o f p r o m i s s o r y n o te s b a c k e d b y
T re a s u ry o r F e d e ra l agen cy s e c u r itie s .

T o q u a lify f o r c r e d it

a s s is t a n c e u n d er this p r o v is io n o f la w , a l o c a l g o v e r n m e n t w ou ld
h a v e to p o s s e s s s iz a b le am ou n ts o f u n e n c u m b e r e d F e d e r a l o b l i ­
g a tio n s .

T h is w o u ld b e an u n u su al s itu a tio n fo r any d is t r e s s e d

b o r r o w e r and it o b v io u s ly d o e s n o t a p p ly t o N ew Y o r k C ity .

-10-

T h e le n d in g a u th o r ity u n d er p a r a g r a p h 3 o f S e c tio n 13
o f th e F e d e r a l R e s e r v e A c t is b r o a d e r , p e r m it t in g th e B o a r d ,
in u n u su a l and e x ig e n t c ir c u m s t a n c e s , to a u t h o r iz e R e s e r v e
B an ks to m a k e lo a n s on the k in d s o f c o l l a t e r a l e lig ib le f o r d i s ­
count by m e m b e r ban ks.

Such p a p e r m a y n o t h a v e a m a tu r ity

o f m o r e than 9 0 d a ys and m u s t a f fo r d a d e q u a te s e c u r it y to th e
R e s e r v e Bank a g a in s t th e r i s k o f l o s s .

F u r t h e r m o r e , in v ie w

o f r e s t r ic t io n s o f la w and C o n g r e s s io n a l in ten t, c e r ta in c o n d itio n s
m u s t b e m e t in o r d e r to p e r m it th e e x te n s io n o f e m e r g e n c y c r e d it
u n d e r th is a u th o r ity .

A m o n g t h e s e c o n d itio n s is a r e q u ir e m e n t

th at an a p p lic a n t h a s ex h a u sted o th e r s o u r c e s o f funds b e f o r e
c o m in g to the F e d e r a l R e s e r v e , that th e b o r r o w e r is b a s i c a l l y
c r e d it w o r t h y and p o s s e s s e s a d eq u a te c o lla t e r a l, and that the

{

b o r r o w e r 's n e e d is s o l e l y f o r s h o r t - t e r m a c c o m m o d a t io n .

It

d o e s n ot a p p e a r that N ew Y o r k C ity is now in a p o s it io n to m e e t
a ll t h e s e r e q u ir e m e n t s .

C e r t a in ly , its fin a n c e s w o u ld h a r d ly

p e r m it e a r ly r e p a y m e n t o f e m e r g e n c y b o r r o w in g s .
In a d d ition to the e m e r g e n c y len d in g p r o v is io n s in
S e c t io n 13 o f the F e d e r a l R e s e r v e A c t , th e R e s e r v e B anks h a v e
a u th o r ity u n d er S e c tio n 14(b) to p u r c h a s e s h o r t - t e r m o b lig a tio n s
o f S tate and l o c a l g o v e r n m e n ts is s u e d in a n tic ip a tio n of a s s u r e d







-11-

r e v e n u e s , s u b je c t to r e g u la tio n s b y the B o a r d .

L e g is la t iv e

h is t o r y in d ic a te s that th is a u th o r ity w a s d e s ig n e d to a s s i s t th e
F e d e r a l R e s e r v e B anks in m e e t in g th e ir o p e r a tin g e x p e n d it u r e s ,
and a ls o to e n a b le th e m to m a k e th e d is c o u n t r a t e e f fe c t iv e w h en
lit t le b o r r o w in g to o k p la c e at th e d is c o u n t w in d o w .

T h e r e is

n oth in g in the F e d e r a l R e s e r v e A c t o r its le g is la t iv e h is t o r y
to s u g g e s t that S e c t io n 14(b) c o n te m p la te d th e p u r c h a s e o f
m u n ic ip a l s e c u r it ie s as a m e a n s o f a id in g fin a n c ia lly d i s t r e s s e d
c o m m u n iti e s .
T h e C o n g r e s s , o f c o u r s e , c o u ld a m e n d th e F e d e r a l
R e s e r v e A c t s o as to r e la x the r e q u ir e m e n t s f o r exten d in g
F e d e r a l R e s e r v e c r e d it to fin a n c ia lly t r o u b le d g o v e r n m e n t a l
u n its .

But the B o a r d o f G o v e r n o r s w o u ld h a v e the g r a v e s t

d ou b ts abou t any su ch a c t io n .

If lo a n s w e r e to b e m a d e to

S tate o r l o c a l g o v e r n m e n t s , th e F e d e r a l R e s e r v e w o u ld h a v e
to in v o lv e i t s e l f in the a c t iv it ie s o f t h e s e g o v e r n m e n ta l u n its ,
in c lu d in g p a r t ic u la r ly th e ir e x p e n d itu r e b u d g e ts and the a d e q u a cy
o f t h e ir r e v e n u e s .

M o r e o v e r , s in c e n u m e r o u s d em an d s f o r

c r e d it m ig h t en s u e , the F e d e r a l R e s e r v e w o u ld h a v e to s e t
s ta n d a r d s o f e lig ib ilit y .

B e in g thus p la c e d in th e p o s itio n o f

h a v in g to a llo c a t e c r e d it ariiong g o v e r n m e n t a l u n its , the n a tio n 's
c e n t r a l bank w o u ld in e v ita b ly b e c o m e s u b je c t to in te n s e p o lit ic a l

-12-

p r e s s u r e s , and its a b ilit y to fu n c tio n c o n s t r u c t iv e ly in th e
m o n e t a r y a r e a w o u ld b e u n d e r m in e d .
T h e B o a r d fu lly r e c o g n i z e s that th e F e d e r a l R e s e r v e
S y s te m h a s th e r e s p o n s ib ilit y , s u b je c t o n ly to r e s t r i c t i o n s u n d er
e x is tin g la w s,, to s e r v e a s the n a t io n 's le n d e r o f la s t r e s o r t .
O v e r the y e a r s , w e h a v e t h e r e f o r e d e v e lo p e d c o n t in g e n c y plan s
t o d e a l w ith p o s s ib le e m e r g e n c y s itu a tio n s .

A s I p r e v io u s ly

in f o r m e d the C h a irm a n o f th is C o m m it t e e , o u r p lan s h a v e b e e n
a d a p ted r e c e n t ly to c o p e w ith the fin a n c ia l s tr a in s th at m ig h t b e
a s s o c ia t e d w ith the d efa u lt o f a m a jo r m u n ic ip a lit y .
In that even t, I a s s u r e y o u , the B o a r d is p r e p a r e d to a c t
p r o m p t ly .

T h e c o n tin g e n cy p lan c a lls fo r len d in g to c o m m e r c i a l

ban k s th r o u g h th e F e d e r a l R e s e r v e d is c o u n t w in d ow b e y o n d the
a m ou n ts r e q u ir e d b y n o r m a l d is c o u n tin g o p e r a t io n s .

C r e d it p r o ­

v id e d in th is m a n n e r w o u ld a s s i s t banks in m e e tin g th e ir t e m p o r a r y
liq u id ity n e e d s .

N ot o n ly th at, th e p r o c e e d s o f the s p e c i a l lo a n s

m a d e a t th e d is c o u n t w in d ow c o u ld a ls o b e u s e d b y the ban ks to
a s s i s t m u n ic ip a lit ie s , m u n ic ip a l s e c u r it ie s d e a le r s , and o th e r
c u s t o m e r s w h o a r e t e m p o r a r ily s h o r t o f c a s h b e c a u s e o f u n s e ttle d
c o n d itio n s in th e s e c u r it ie s m a r k e t s .

In a d d itio n , th e S y s te m

w o u ld , o f c o u r s e , b e r e a d y to u s e its b r o a d p o w e r to s t a b iliz e
m a r k e t s th r o u g h op en m a r k e t p u r c h a s e s o f T r e a s u r y o r A g e n c y
s e c u r itie s .







-13-

In the e v e n t th is c o n t in g e n c y p la n h as to b e a c t iv a t e d , the
B o a r d w ill m a k e funds a v a ila b le on w h a te v e r s c a l e is d e e m e d
n e c e s s a r y to a s s u r e an o r d e r l y fin a n c ia l e n v ir o n m e n t.

The

B o a r d r e c o g n iz e s that s iz a b le e x te n s io n s o f F e d e r a l R e s e r v e
c r e d i t w o u ld ru n the r is k o f le a d in g to a s u b s ta n tia lly la r g e r
e x p a n s io n o f ban k r e s e r v e s and the m o n e y su p p ly than is c o n ­
s is te n t w ith lo n g e r - r u n m o n e t a r y o b je c t i v e s .

C le a r ly , t h e r e f o r e ,

a n y s u c h e x p a n s io n m u s t b e o n ly t e m p o r a r y .

In t im e , an y

e x c e s s i v e g row th in bank r e s e r v e s w ou ld n eed to b e c o r r e c t e d
th rou gh o ffs e t tin g o p en m a r k e t o p e r a t io n s and th ro u g h r e p a y m e n t
o f bank b o r r o w in g f r o m the S y s te m .
T h e r e a r e a ls o c e r t a in s u p e r v is o r y and e x a m in a tio n
q u e s tio n s that m a y a r is e w ith r e s p e e t to ban ks in the e v e n t o f
a m a jo r m u n ic ip a l d e fa u lt.

In th is c o n n e c t io n , the B o a r d and

o th e r r e g u la t o r y a g e n c ie s h a v e p la n s to r e v i s e p r o c e d u r e s that
a p p ly to the v a lu a tio n o f d e fa u lte d s e c u r i t i e s , s o that a n y w r i t e ­
d ow n s m a y b e p o s tp o n e d u n til the m a r k e t has had a fe w m on th s
to s t a b iliz e and thus p r o v id e m o r e r e lia b le in d ic a tio n s o f th e ir
v a lu e .
E v e n s o , a d efa u lt m a y u lt im a t e ly r e q u ir e w r ite d o w n s that
c o u ld s e r i o u s l y im p a ir the c a p it a l o f s o m e b a n k s.

In that ev en t,

-14-

fche F e d e r a l D e p o s it In s u r a n c e C o r p o r a t io n has s ta tu to r y p o w e r s
to a s s i s t F e d e r a lly in s u r e d ban ks that m ig h t fin d th e ir c a p it a l
im p a ir e d b y a d e c lin e in the v a lu e o f s e c u r it ie s in th e ir p o r t f o l i o .
I u n d e r s ta n d that the C o r p o r a t io n is p r e p a r e d to im p le m e n t, w ith
a p p r o p r ia t e s a fe g u a r d s , its c o n t in g e n c y p la n s f o r d e a lin g w ith
in s u r e d banks that r e q u ir e a t e m p o r a r y in fu s io n o f s u p p le m e n ta l
c a p it a l f o r the a b o v e r e a s o n .
I think it e v id e n t f r o m the f a r -f lu n g scop e! o f ou r c o n ­
tin g e n c y p la n s that w e b e lie v e a d e fa u lt on d e b t o b lig a t io n s b y
N ew Y o r k C ity c o u ld p r o d u c e s e r io u s s tr a in s in s e c u r it ie s
m a rk e ts.

F o r a t im e , it c o u ld a ls o a d v e r s e ly a f fe c t m u n ic i­

p a lit ie s that n e e d to is s u e n ew d e b t.

T h e lik e is tr u e o f fin a n c ia l

in s titu tio n s that h o ld su ch s e c u r it ie s in s ig n ific a n t v o lu m e , and
a l s o o f in d iv id u a l in v e s t o r s w ho h av e p a r t o f th e ir lif e s a v in g s
at r i s k in t h e s e b o n d s .

I s t i l l b e lie v e that the d a m a g e s te m m in g

f r o m a p r o s p e c t iv e d e fa u lt b y N ew Y o r k C ity is lik e ly to b e s h o r t ­
liv e d .

In d eed , the p o s s ib ilit y o f su ch a d efa u lt h as a lr e a d y b e e n

d is c o u n te d to an a p p r e c ia b le d e g r e e b y the m a r k e t .

But I a m

a l s o a w a r e o f the u n c e r ta in ty that in h e r e n tly a tta c h e s to a
ju d g m e n t on this s c o r e ; and I r e c o g n iz e that a d e fa u lt, b e s id e s
b e in g a v e r y s e r io u s m a t t e r fo r the C ity and State o f N ew Y o r k ,
c o u ld h a v e t r o u b le s o m e c o n s e q u e n c e s f o r the n a tio n at la r g e .







-15-

T h e v e r y fa c t that this C o m m it t e e and o th e r c o m m it t e e s
o f the C o n g r e s s a r e h o ld in g h e a r in g s on N ew Y o r k C it y 's fin a n c e s
im p lie s that c o n c e r n is s p r e a d in g that a N ew Y o r k d e fa u lt m a y
in ju r e the e c o n o m ic r e c o v e r y n ow in p r o c e s s .

I h a v e s a id

en ou gh to in d ic a te that I f e e l this p o s s ib ilit y c a n no lo n g e r be
d is m is s e d lig h tly .

T h a t, h o w e v e r , d o e s not e a s e the ta sk that

the C o n g r e s s f a c e s in d e a lin g w ith the N ew Y o r k p r o b le m ; f o r
the p r e c i s e is s u e is w h eth er F e d e r a l fin a n c ia l a s s is t a n c e to
N ew Y o r k m a y n o t c a u s e n a tio n a l p r o b le m s o v e r the lo n g ru n
that o u tw e ig h any t e m p o r a r y n a tion a l a d v a n ta g e.
A s this m a tte r is d e b a te d b y the C o n g r e s s , the a d v e r s e
e f fe c t s o f a N ew Y o r k C ity d e fa u lt w ill u n d ou b ted ly r e c e i v e fu ll
a tte n tio n - - as th ey in d e e d s h ou ld .

I w ou ld o n ly u r g e that the

l o n g e r - r u n r is k s a ls o b e c o n s id e r e d th o r o u g h ly .

A p rogra m of

F e d e r a l a s s is t a n c e to the C ity m a y w e ll le a d to d e m a n d s f o r
s im ila r a s s is t a n c e f o r o th e r h a r d - p r e s s e d c o m m u n it ie s , e v e n
th o s e w h o s e d is t r e s s w as b r o u g h t on b y g r o s s n e g lig e n c e o r
m is m a n a g e m e n t.

S u b sta n tia l F e d e r a l c r e d it - - w h e th e r th rou g h

in s u r a n c e , g u a r a n te e s , o r d ir e c t lo a n s - - w ou ld c o m p e t e d i r e c t l y
w ith the a lr e a d y huge a m ou n ts o f F e d e r a l fin a n c in g n e e d s .

M ost

im p o r ta n t o f a ll, the p r o v is io n o f F e d e r a l c r e d it f o r l o c a l g o v e r n ­
m e n t w ill n e c e s s a r i l y in je c t a m a jo r F e d e r a l p r e s e n c e in l o c a l
sp e n d in g and ta xin g d e c is io n s .

It is h ig h ly im p o r t a n t, t h e r e f o r e , to r e c o g n i z e that the
is s u e o f a s s is t a n c e to N ew Y o r k C ity g o e s to the v e r y h e a r t o f
o u r e n t ir e F e d e r a l s y s t e m o f s e p a r a tio n o f p o w e r s - - a s y s t e m
that, d e s p ite e n o r m o u s e c o n o m ic and s o c i a l c h a n g e s , s t ill
p r e v a ils in o u r c o u n t r y .