It was 37 years ago this month that New York City’s fiscal crisis made history.
A warning shot across the bow came in March 1975, with a default on bond anticipation notes by the Urban Development Corp. Although the UDC was not a part of city government, the projects it financed were in the city’s limits.
Rumors circulated that New York was in a cash crisis that could only be solved by more borrowing. The city had already borrowed about $4 billion, revenues were falling short because of the ’72-74 recession, and the Big Apple was still running out of cash.
On April 4, 1975, Standard & Poor’s suspended the city’s A rating, citing inadequate information to make even an educated guess about its true financial position and cash flow for the coming months.
Like a recession, this crisis had a starting point and an end date. Some say that S&P’s rating suspension was the official start of the crisis. It was punctuated month’s later by the infamous Daily News headline, “Ford to City: Drop Dead.”
Most would observe that the end came in the spring of 1981, when New York obtained its first investment-grade rating in nearly six years and could finally borrow money without federal guarantees or the assistance of the Municipal Assistance Corp., known as MAC.
It took a year or more to ascertain what the city’s true financial position was. Accounting gimmickry allowed the city to run 15 consecutive years of deficits. The city had $6 billion of short-term debt coming due within a year or less on an annual budget of about $15 billion.
There were fears that a New York City bankruptcy could roil international financial markets; indeed, some of the city’s major banks had 20% of their capital tied up in city notes and bonds. In 1975, the Big Apple was truly America’s version of Greece today.
Members of the National Federation of Municipal Analysts can thank New York’s financial crisis for their career. The sins of the city provided the fodder that reshaped municipal credit analysis in the modern era. New York in 1975 was the definition of Murphy’s Law: Whatever could go wrong, did go wrong, and at the worst possible time.
The forensic financial analysis required to determine how New York could arrive at the brink of bankruptcy taught new lessons still in use today:
• Cash-flow analysis
• Financial accounting and reporting
• Debt and budgetary management
• Long-term economic and tax-base analysis
• Intergovernmental relations
• Pension funding analysis
The city’s accounting chicanery led to the push for application of Generally Accepted Accounting Principles in the late 1970s and early ’80s, which resulted in near-universal application of standardized financial reporting of state and local books. New York’s MAC and its Emergency Financial Control Board provided models that were later emulated by Philadelphia, Washington, D.C., and the Chicago Board of Education, and will serve as a historical resource as Detroit tries to avert bankruptcy.
Bond insurance in 1975 was a novelty. Few, if any, New York City bonds were insured before the crash. The city’s financial crisis didn’t automatically jump-start the bond insurance industry — the real growth came after the Washington Public Power Supply System defaulted, and Ambac paid on defaulted debt in 1982. New York’s crisis provided fertilizer for this budding industry, which eventually resulted in 50% of new-issue volume being backed by bond insurance.
The city’s crisis pointed out the glaring lack of independent credit analysis in the muni market. After being criticized for upgrading the city just prior to its near-bankruptcy, rating agencies realized that they had to beef up their staffs. In 1975, I was hired as the 10th municipal analyst at Standard & Poor’s. By 1985, 10 years after the crisis, S&P’s muni department had grown to 135 analysts and support staff.
The 1970s crisis also resulted in the first real push for improved financial disclosure. Official statements more than tripled in size. It was a slow and torturous path that eventually led to the Municipal Securities Rulemaking Board’s online Electronic Municipal Market Access system known as EMMA, which tracks secondary market disclosure. New York’s crisis started that ball rolling, too.
Finally, the crisis opened up the “black box” of bond ratings. In 1979, S&P made the strategic decision to memorialize its rating procedures. The most important decision was to take those written standards and criteria and disseminate them widely, for free, to any interested parties.
S&P believed that by opening its process and standards to the financial community, it would rebuild its reputation and solidify its franchise. This legacy of opening the black box is still very much in operation, with recent legislation requiring public dissemination of rating criteria and standards, and any revisions that may be contemplated in those standards.
New York’s financial crisis was a deep, dark cloud that some might argue was the worst financial meltdown in the history of the municipal bond market. But the lessons learned, and the legacies that were spawned, are clearly a bright silver lining that continues to influence all of the more than 1,000 members of the NFMA.
