One Step Back from the Brink

New York City may be saved from officially defaulting after all. By the end of last week, the Federal Government had softened its stand against helping the city, and seemed in a mood to approve some $2.5 billion in loan guarantees or other assistance. The shift came after state and city officials had put together a program of new taxes, budget cuts, debt deferrals and bank and pension-fund loans to tide New York over the next three years until its budget is balanced. Said Treasury Secretary William Simon: "They are finally taking the tough steps that they have been saying for the past eight months realistically could not be taken."

On the surface, President Ford did not seem especially mollified. He said he would await action by the New York State legislature before he came to a final decision. "Until they have acted, there is absolutely no change in my position," he declared at a press conference in Atlanta before he left for the international economic summit. Said Press Secretary Ronald Nessen: "The President is not backing away--quite the opposite. After trying in every way to scare this Government into a bailout, they have finally come up with a plan."

The fact is that New York's "scare tactics" had some effect. A nationwide publicity blitz orchestrated by New York's Democratic Governor Hugh Carey turned the country at least part way around on the issue. New Yorkers hammered away at the theme that if the city fell into default, others would soon accompany it. Yonkers, N.Y., teetered on the brink of default last week, only to be rescued at the last moment by a $25 million infusion of bank loans and state aid. Massachusetts, too, seemed headed for default until it managed to balance its $3 billion budget by slashing social services and raising taxes.

Administration insistence that a New York default would have only a minimal impact on the U.S. economy began to carry less weight. Each time Federal Reserve Board Chairman Arthur Burns was asked about the effect of default on money markets, he sounded a bit more anxious. A Federal Reserve report released last week indicated that 546 U.S. banks (out of 14,000) held New York State and New York City securities in an amount equal to at least 20% of their capital. Carey said that Burns pronounced the new rescue program "interesting."

Buoyed by Washington's reaction, Carey convened a special session of the state legislature. "The President is a reasonable man, and we have presented a reasonable plan," said Carey. "We are prepared to move from verbiage to vows." But the legislators, balking at the tax hikes, were reluctant to take the vows. The plan called for an $867 million increase in state and $200 million in city taxes. A boost in the state income tax was contemplated as well as a jump in the sales tax in the city to an onerous 10%, which would be the highest in the nation. As opposition mounted, Carey let it be known that he might scale down the tax increases and instead cut $500 million from welfare and Medicaid. Over the weekend, he continued to negotiate the final shape of the package with Senate Majority Leader Warren Anderson, an upstate Republican.

The most controversial feature of the program--a debt moratorium--was passed by the legislature. Private holders of $1.6 billion in short-term city securities will be asked to exchange them for long-term bonds issued by the Municipal Assistance Corp.; the bonds will pay 8% to 9% interest and mature in ten to 15 years. Noteholders who refuse to make the swap will not be able to redeem their present securities until June 30, 1978; they will continue to draw interest but at a reduced rate.

Carey insisted on calling the provision a moratorium, not a default. To others, it was a difference in name only.

The Governor pointed out that there was a precedent for such action in the moratoriums on mortgage payments enacted during the Depression. These were subsequently upheld by the U.S. Supreme Court. But the deferral of payments may trigger lawsuits by noteholders.

The other part of the rescue package involves further loans from city and state banks and retirement funds. Banks are asked to roll over $500 million in city notes, and city pension funds would renew a similar amount. The pension funds would also buy another $2.5 billion in city securities over the next three years. Finally, city and state banks and pension funds would give up $2.4 billion in three-year MAC bonds yielding 12% interest in exchange for ten-year securities paying 6%. Once this is all done, the Federal Government would bridge the remaining gap with some form of assistance.

A symbolic blow for fiscal discipline was struck last week when Deputy Mayor James Cavanagh was forced out of office. Long identified with New York's budget gimmickry, Cavanagh had been under pressure from the city's financial overseers. To demonstrate the city's determination to cut spending, Mayor Beame ordered the elimination of another 8,374 jobs last week for an estimated saving of $200 million. The cumulative cutbacks would reduce the number of full-time city employees from some 300,000 before the fiscal crisis began to a little more than 250,000.

To date, Beame has made his sharpest reductions in the departments that can least afford them: police, fire, sanitation. The latest cuts, however, will fall heavily on the department of social services, which is often accused of inefficiency; last year many millions of dollars in welfare checks were misplaced, lost or stolen. Meanwhile, the city's biggest bureaucracy, the board of education, tried to fend off cutbacks. Ordered by Beame to pare $39 million from its budget, the board offered to reduce school sports programs or subsidized transportation for handicapped students. Said City Budget Director Melvin Lechner: "The board is still playing games."

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