The Streets Were Paved with Gold (19 page)

In New York, budget balancing was seen as a game—an annual rite of spring. And the best and the brightest people played the game. City Hall has probably never had a desk occupied by a more brilliant man than Edward Hamilton. Governor Rockefeller was so taken by his brilliance that after one Albany negotiation he enthusiastically offered him the post of state budget director. Hamilton said no. After serving fourteen months as city budget director, he was elevated in late 1971 to the position of first deputy mayor. Hamilton, however, had one glaring defect. “He was very sensitive to the charge that he wasn’t known as a ‘political animal,’ ” says a former colleague, “so he tried to swing more.”

The first deputy’s office had recently been occupied by skilled politicians, and Hamilton was determined to prove to Lindsay that he was not just a numbers man, that he was flexible, sensitive, could help his boss out of a political jam. So he became a pol, though he wasn’t treated like one. Because of an instinctive bias against people who work in political campaigns—and because of Hamilton’s brains and glittering academic background—the press and good government groups paraded this thirty-one-year-old “expert” as if he were an astronaut. Naturally, it went unnoticed that when it came to budget tricks, Hamilton was no boy scout. Like just about everyone else, he conformed—proved he was one of the boys.

The game went on because there was little opposition. But also because there were no rules. If New York followed standard accounting procedures and retained an outside auditor, as most corporations do, perhaps the game would have been played with an umpire. “The city’s accounting ‘principles’ were virtually incomprehensible,” said the SEC. Yet there was a method to this madness. In May 1976, Comptroller Goldin explained it before the Annual Conference of Municipal Finance Officers: “There was a
broad feeling, I believe, that even though the City’s accounting and budgeting had been revealed as a kind of Rube Goldberg conception—a system which defied understanding or control—it was better to leave it alone as long as it churned out enough money to meet the bills and pay the debts.”

While the game was divorced from rules, it was not divorced from the political ethos of the time. The public was demanding, expecting, more. In truth, it would have been difficult, even if New York had enjoyed strong leadership, to have cut the city’s budget. The sixties saw Mayor Wagner pledge a local war on poverty. President Kennedy promised Camelot. President Johnson promised both guns and butter. Mayor Lindsay promised Fun City. Martin Luther King had a dream. The Great Society was going to transform slums into Scarsdales, Vietnam into Ohio. Public expectations rose. Cities seethed with rage when the inflated promises of the Great Society and New Frontier were not met, and City Hall tried to step into the breach. The sixties were a decade of optimism. People recognized few limits to what could be done. It naturally followed that the limits of a budget or bond market went largely unrecognized. Beame and Goldin’s SEC brief inadvertently makes this point: “If blame for the resulting fiscal effects is to be cast at all, then it is clear that the lion’s share must go to the Governors, to the State Legislatures and to their policy of encouraging borrowing—a policy which implements
the decision to place needed social services ahead of fiscal conservatism.
” [italics added] Since “fiscal conservatism” was presumed to be at odds with the public good, it follows that lies, gimmicks, high interest rates, whatever, were necessary to escape this dreaded evil.

New York got away with it because—like national governments—it printed money. And it printed money because the investment community permitted it. Looking at the period just prior to the spring of 1975, the SEC staff report concluded that the banks and other underwriters of city securities had “knowledge of the crisis and the City’s related problems” and did not disclose these, thus failing “to fulfill their responsibilities to the investing public.” Cited were some of the largest and most powerful banks in America—Chase Manhattan, First National City, Morgan Guaranty Trust
Company of New York, Manufacturers Hanover Trust Company, Chemical Bank and the underwriting firm of Merrill Lynch Pierce Fenner & Smith. The SEC also charged the two major bond-rating agencies—Moody’s Investor Services and Standard & Poor’s—with having “failed, in a number of respects, to make either diligent inquiry which called for further investigation, or to adjust their ratings of the City’s securities based on known data in a manner consistent with standards upon which prior ratings had been based.” Also named were the blue-chip law firms retained as bond counsel—Hawkins, Delafield & Wood, White & Case, Wood Dawson Love & Sabatine, Sykes, Galloway & Dikeman—which “should have conducted additional investigation” and disclosed “material facts” to the public before allowing the sales to proceed.

The underwriters were as important to New York’s Ponzi scheme as public officials. All governments or businesses rely on banks. They go to the bond market to finance their long-term or capital budget needs. They go to the note market to meet shortterm cash needs because expenditures usually must be made before revenues are received (i.e., taxes or intergovernmental aid usually don’t arrive when expenditures must be made).

It is the underwriter’s or creditor’s responsibility to check that the debtor has, or is likely to have, sufficient resources to repay the loan. When revenues don’t match yearly expenditures, a default—and usually a declaration of bankruptcy—results.

But New York City defied the rules followed by most governments, businesses and individuals. When its income chronically did not match its spending, the financial community printed more money. Soon the city was borrowing not to retire principal on old debt but to repay interest. The city’s total debt and interest costs were rising. Imagine a family earning $22,000 a year but spending $25,000. To close this gap, the parents visit the local bank to ask for a loan. The bank officer asks for collateral and proof that the loan can be repaid. The parents fib and certify that their combined earnings are $35,000. The bank fails to check and grants the loan. The family fails to cut back on their food, rent and other spending. Their income remains fixed, while their expenditures rise. Pretty soon, they realize a choice must be made between paying the food bill or paying back the loan. They don’t make that choice. Instead, they visit another bank in search of still another loan, pledging as collateral a summer home that doesn’t exist.

Carry this analogy out and you have a fair approximation of
what happened to New York. With one difference. In the case of most loans, banks will check to certify that the person or business is credit-worthy, has sufficient collateral. That didn’t happen with New York City loans. The obvious question is, Why?

One reason is that the banks had a good thing. They were earning handsome underwriting fees and high rates of interest. The interest on all municipal securities is tax-free. And financial institutions and wealthy individuals were the sole suppliers. It’s also true that the banks were taxed and regulated by government, and one is less likely to question the word of a would-be borrower who happens to have a gun in his hand. Besides, the banks—and the market in general—probably suffered from the same optimism as city officials. They didn’t check the arithmetic. After all, not many believed that a city like New York—the financial capital of the world, the Big Apple—could default or go bankrupt.

There is no question that the financial community should have known the city’s true financial condition. But did they know? The SEC was certain they did. “Long before October 1974,” declared their chapter on the role of the underwriters, “the financial community realized that the City’s fundamental problem was the insufficiency of revenues to meet expenses, resulting in a chronic and ever-increasing budget gap. The financial community had also come to understand the consequences of using short-term debt issues to close its budget gap and questionable budgetary practices to conceal the gap.”

Among the evidence produced by the SEC: a November 8, 1974, memorandum to Alfred Brittain, III, chairman of Bankers Trust. The internal document revealed that in the previous fiscal year the city had an “excess of expenditures over revenues by nearly $2 billion, with less than half of the difference to be made up eventually by planned state and federal payments.” The memo noted that expense items consumed 53 percent of the city’s capital budget and that in the first half of 1974 New York City accounted for an alarming 27 percent of all the nation’s tax-exempt short-term borrowing. Yet Bankers Trust and the other underwriters continued to extend credit to New York. The SEC also observed that on December 13, 1974, Comptroller Goldin, with the approval of the banking community, permitted the lowering of note sales from denominations of $25,000 to $10,000—spreading the risk to smaller investors.

For these reasons, the SEC staff report charged underwriters
with a failure to make full disclosure to investors. Though their report covered only the brief period from late 1974 to mid-1975, they said: “The underwriters continued to offer and sell City notes to the public as safe and secure investments without disclosure of significant risks.” Between October 1974 and March 1975, the underwriters marketed $4 billion of city notes. Instead of sharing their private concerns about the city, said the SEC, the banks “reached out for the smaller investor”—thus “shifting the risk for financing the City from the City’s major banks and large institutional investors to individual investors.”

In doing this, the banks were charged with another breach: ridding their portfolios of city securities and dumping these on an unsuspecting market. The SEC concluded, “Certain of the underwriters were in the process of reducing or eliminating their holdings of the notes. Moreover, certain underwriters determined not to purchase additional city notes for their own accounts and for their fiduciary accounts.” This charge has been made more dramatically by others. In the early stages of the city’s fiscal crisis, municipal labor leader Victor Gotbaum led a delegation picketing in front of Citibank and carrying placards that charged the banks with precipitating the crisis by “dumping” massive amounts of city paper. In their book
The Abuse of Power
, Jack Newfield and Paul Dubrul claim that between the summer of 1974 and March 1975 “the big New York City banks as well as other major banks across the nation, quietly dumped approximately $2.3 billion in New York City securities.” Therefore, they concluded: “It is our judgment that the banks … are largely to blame for the last year and a half of pain in New York.” Others have made similar charges, citing as evidence the SEC staff report.

A close reading of the SEC report, however, shows they never used the word “dumping.” Nor does the SEC make a case for massive disinvestment in city paper. Instead, the SEC charges that of the six major city banks, all but Chemical Bank “followed a policy of trying to reduce or eliminate their own holdings in city notes.…” The word “dumping” implies a massive disinvestment. In fact, the SEC report revealed that: between September 30, 1974, and April 30, 1975, Bankers Trust reduced its city note holdings from $118.7 million to $58 million; Chase Manhattan, from $165 to $58 million; Manufacturers Hanover Trust, from $180 to $163 million. Citibank actually increased its “total position” in city notes from $24 to $30 million but purchased no new securities for its
investment account. Figures for Morgan Guaranty were incomplete, but the SEC said it “made no additional purchases of City Notes for its investment account.” Chemical increased its investment account from $187 to $224 million. On the basis of this evidence, add and subtract and you’ll find that in the critical months leading up to the fiscal crisis the six large city banks “dumped” a total of just $141 million—a figure later confirmed by a series of phone calls to the SEC. Thus the six banks “dumped” not $2.3 billion but a relatively modest $141 million. Which suggests that the banks’ and financial community’s failure to make full disclosure to investors is a more serious charge.

The 800-page SEC staff report was published thirteen days before the 1977 Democratic mayoral primary, striking Abe Beame with the force of a bazooka. The charges dominated the news. Stunned and shaking with rage, Beame counterattacked, denouncing the report as “a shameless, vicious political document” and claiming, “The record shows that I was leading, and not misleading, the City during this period.” In a vain attempt to rescue his candidacy, the Mayor took to the streets. An outside organization, he said, had “injected itself into the political campaign at the eleventh hour with malicious abandon.” Clearly, the SEC had, as Beame complained, “rushed to judgment.” An inquiry begun eighteen months before need not have been released days prior to an important primary.

But the report’s timing was the least of Beame’s complaints.
Why pick on me?
was the attitude adopted by Beame and Goldin, the two city officials singled out in the report. Didn’t the Governor and the state legislature approve most of these so-called “gimmicks”? Didn’t the City Council and Board of Estimate? And didn’t the banks make the loans? Hadn’t this practice been going on for some time, not just the brief period studied by the SEC? Everyone was guilty, not just them. This view was echoed in the city’s first legal brief, submitted nine months before the SEC staff report appeared, and was intended to refute the anticipated SEC judgment: “The staff’s criticism, therefore, cannot be leveled at the City or its officials. It must rather be aimed (if at all) at the very touchstones of our democratic political process.” The city’s second brief, following the SEC report, reminded the federal agency of the state’s role: “If,
with the benefit of hindsight, the means adopted to finance these services appear to have been unwise, the fault does not lie with the City or with its officials alone.”

Why pick on Beame and Goldin and a narrow time period? “The answer is simple,” says William D. Moran, Administrator of the SEC’s New York Regional Office and the person who supervised the staff report. “We didn’t have unlimited manpower. We took what appeared to be the most critical period—November 1974 to March 1975. To go back to the Lindsay and Wagner period—we’d still be working on it!” Adds an important SEC official, “I’m confident that Wagner and Lindsay engaged in the same kind of shenanigans.”