A Moral Issue

During the turbulent days following the assassination of Martin Luther King Jr. in April 1968, the New York State Urban Development Corporation was born. At the urging of then Governor Nelson Rockefeller, the state legislature established an agency to rebuild ghettos in New York by financing low-cost housing and civic and commercial projects.

The legislature gave the U.D.C. broad and controversial powers, such as the right to initiate projects over the objections of local communities and the authority to raise up to $2 billion by selling tax-exempt bonds. Rather than seek approval for the U.D.C. 's financing from a testy electorate, Rockefeller seized on a financing expedient developed in the early 1960s by a successful Wall Street bond lawyer named John N. Mitchell:

the state legislature backed the bonds with a morally--but not legally --binding commitment to make good the debt if ever the U.D.C. failed.

Last week the unthinkable happened: the U.D.C. found itself unable to pay off $104. 5 million in one-year bond-anticipation notes. It was one of the big gest defaults by a public agency since the 1930s, and it posed a severe test of the value of the so-called moral-obligation bonds that the U.D.C. and other agencies have issued in recent years. The default posed the possibility that the agency could be besieged by a rush of lawsuits filed by creditors demanding immediate payment of its entire $1.1 billion in out standing bonded debt. Conceivably, such a siege could transform the U.D.C. 's problem from an embarrassing financial stumble into the largest municipal default in U.S. history.

The U.D.C. has been a prodigious builder. In just seven years it has completed or started housing for 33,000 families, as well as numerous civic and commercial projects and three "new towns," one of which lies half-built on an island in the middle of Manhattan's East River. The agency's troubles began last summer when it postponed a sale of $100 million in short-term notes because it felt that interest rates (then around 9%) were too high. By last September, when the U.D.C. finally sold $225 million in bonds, it had to pay a painful 9.4% for its cash, which was all the more distressing because only half of the agency's projects had begun to generate revenue.

Close Look. Around this time, many institutional buyers began to worry about the U.D.C. 's heavy borrowing. They prefer to limit their investment to 10% of any particular security and also seek geographical diversity; the U.D.C. and New York City together have accounted for about 30% of all tax-exempt bonds sold in the U.S. over the past few years. As money grew tight, investors began to look more closely ' at the U.D.C. 's unconventional moral-obligation bonds, which are tied not to specific projects but to the highly uncertain fortunes of the agency as a whole. Meanwhile, the U.D.C. 's welcome on Wall Street was wearing thinner by the month as a result of friction between Ed ward J. Logue, the agency's former president, and the New York banking community, where Logue was considered to be "arrogant." When the bankers would ask questions about the U.D.C. 's in come, says Jackson R.E. Phillips, director of municipal bond research at Moody's Investors Service, agency officers would blithely reply that "they had the state's backing and didn't need to provide cash-flow projections."

New York's new Governor, Democrat Hugh L. Carey, brought in Richard Ravitch, a wealthy construction executive, to run the U.D.C. last month after Logue resigned. Carey last week sped a bill through the state legislature creating another public agency whose mission is to bail out the U.D.C. by buying mortgages on its uncompleted projects. The rescue effort will be costly: more than $392 million will be needed by the agency to complete the U.D.C. 's current projects.

The U.D.C. episode will cast a pall over the municipal bond market. The doubts raised by the U.D.C. crunch could have especially grave repercussions for the more than $6.3 billion of outstanding moral-obligation bonds is sued by similar public agencies in 30 states. Following the default, U.D.C. bond prices fell rapidly; some bonds sold for half their face value, and by week's end most other outstanding issues had fallen by more than $100 per $1,000 bond.

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