The Day New York Defaulted

Decades of reckless budgeting drove away the city’s tax base. In 1975, bond markets effectively ruled the city bankrupt.

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Commentary

In November 1974, New York Times film critic Vincent Canby wrote that the city had become “a metaphor for what looks like the last days of American civilization.”

“It is run by fools,” he wrote. “Its citizens are at the mercy of its criminals who, often as not, are protected by an unholy alliance of civil libertarians and crooked cops. The air is foul. The traffic is impossible. Services are diminishing and the morale is such that ordering a cup of coffee in a diner can turn into a request for a fat lip.”

The following year, New York City ran out of money.

Spending

New York City’s descent occurred as city government spending surged.

Since 1965, its operating budget had more than tripled, with expenditures rising at an average of 12 percent annually. Treasury Secretary William E. Simon reported: “From 1963 to 1973, per capita municipal expenses of other large US cities increased, on the average, 2.2 times. During the same period, New York’s expenses increased about 3.5 times—a 50 percent greater rate.”

As a result, “New York was spending in excess of three times more per capita than any city with a population of more than 1 million.” New York’s “level of spending on welfare (public assistance and Medicaid), higher education, and hospitals was virtually unique,” author Charles R. Morris wrote.

“On a per capita basis, only Washington DC, which doubles as a state government, exceeds New York City’s rate of spending in these areas, and no other government comes close to the New York City level,” Morris wrote.

New York City’s spending level was $584 per capita, compared with $105 in Detroit, $234 in Los Angeles, $89 in Chicago, and $76 in Philadelphia. The average grant paid to recipients of Aid to Dependent Children—$351 a month—was the highest in the country, with the second-, third-, and fourth-ranked states paying $340, $295, and $289, respectively.

The city’s wage bill was another strain. While city workers were not lavishly paid relative to other cities, there were many more of them. New York employed 49 people per 1,000 residents, Simon noted. Across other major cities, the figure was between 30 and 32 employees per 1,000 residents.

Taxes and Revenues

Aside from federal and state grants, the city government had only two sources of funding for these expenses: taxing and borrowing. Regarding the former, there was ever less to tax.

Between 1966 and 1973, writes author Kim Phillips-Fein, “the city raised income taxes multiple times, while property taxes climbed, and business taxes were extended to cover a variety of small businesses and partnerships.”

As a result, Gotham’s taxes became much higher than those in other U.S. cities. Rather than pay, many businesses and individuals simply left. Johnny Carson took “The Tonight Show” to California in 1972. Pepsi and Shell also departed.

“Parts of the garment industry, large bakeries, and food processors and breweries left the city,” Simon wrote, “and by 1969 they had taken about 140,000 jobs with them. The flight accelerated at a frightening pace ... between December 1974 and December 1975 alone ... 143,000 jobs disappeared. A cautious estimate suggests that between 1970 and 1977, some 400,000 jobs vanished.”

Between 1970 and 1980, the city’s population fell by 10 percent; it was literally decimated. It was easy to see why. As taxes climbed, so did the number of murders, by 248 percent between 1960 and 1973.

“By 1975,” Morris wrote, “the city had 41 percent of the state’s population, but 68 percent of its welfare recipients, and with 44 percent of the state’s personal income, the city had to pay 73 percent of the local welfare costs.”

“A ‘city’ of businesses and taxpayers as large as San Francisco has packed its bags and left New York,” New York magazine reported in 1976. “We have conducted a noble experiment in local socialism and income redistribution,” Ken Auletta noted in October, “one clear result of which has been to redistribute much of our tax base and many jobs out of the city.”

As a result of the disappearance of its tax base, the city’s revenues were rising at a rate of just 5 percent annually.

Borrowing

The city covered the shortfall by borrowing short-term to finance current spending.

“By the early 1970s, [New York City] regularly accounted for about 25 percent of all outstanding short-term state and local paper in the country,” Morris wrote, and by the end of 1974, it was selling $600 million of bonds every month, many backed by anticipated revenues that didn’t materialize.

In November, outstanding short-term debt totaled $5.3 billion, up $1.9 billion since June, a fourfold increase in four years. By the end of 1974, New York City accounted for more than 40 percent of short-term tax-exempt borrowing in the United States.

“By 1974, per capita debt in New York City was $1,767,” Daniel Patrick Moynihan noted, “while in Chicago it was $427.”

This avalanche of bonds drove prices down and yields up. In November, city notes, which went for 4 percent in the late 1960s, were going for 8.34 percent. In December, the rate rose to 9.48 percent. In February, it emerged that the city did not have the tax receipts legally required to secure a $260 million bond issue, and Bankers Trust and Chase Manhattan refused to underwrite it. On March 13 and 20, the city offered $912 million of short-term, tax-free notes at up to 8 percent, an effective yield three times greater, on a tax equivalent basis, than that available in a savings bank.

Weeks later, more than half remained unsold.

The Crash

New York City had reached the end of the fiscal road.

With federal and state funds and via a Municipal Assistance Corporation, the city refinanced its debts, and the state government took effective control of its finances. In effect, the city had defaulted.

Many of the problems New York City faced in the 1960s and 1970s were not unique. Cities across the United States struggled with suburbanization and cuts to federal aid, and those in the Northeast with a migration of businesses to the South and West. But only New York City went bust. As Phillips-Fein writes in her Pulitzer Finalist book “Fear City: New York’s Fiscal Crisis and the Rise of Austerity Politics,” “the scope of the city’s public sector brought [those problems] to the fore.”

New York City’s bankruptcy might not seem to offer any lessons above the state level. The federal government can print whatever money is necessary to finance its operations: It need never default in the “hard” terms of failing to pay its bills because it has the option to default in “soft” terms by paying them with money that is worth less. Ultimately, however, default is default.

New York City’s bankruptcy stands as an example of what happens when a government persistently spends more than it collects and throws itself at the mercy of the bond markets to keep itself going.

As New Yorkers ponder a re-run of what Morris called “the liberal experiment” of 1960 to 1975, or what Auletta termed its “noble experiment in local socialism and income redistribution,” it is an example they would do well to remember. So would the rest of us.

From the American Institute for Economic Research