It was 1975 and New York City was running out of cash. Its excessive spending and lack of financial oversight created a $14 billion debt.
A request for a bailout from the federal government, headed by President Ford, didn’t happen, which sparked the famous New York Daily News headline “Ford to City: Drop Dead.”
The state of New York took action. That landmark process has become a primer for other entities to follow in keeping out of bankruptcy.
“It’s a well-regarded credit now,” municipal bond manager Tom Dalpiaz said; he’s senior vice president of Advisors Asset Management in Colorado. “New York’s budgetary process is very strong. They keep track of it, have projections and know when they are going to run into trouble.”
But before arriving at a disaster point, municipalities can employ a variety of strategies to stay solvent.
“You can only do what is sustainable and affordable and if you make promises you can’t keep, then the best thing you can do is correct that mistake as soon as possible,” said Chicago bankruptcy attorney James Spiotto. “You have to watch your budget.”
Before a municipality can file for Chapter 9, it has to be truly insolvent and not just looking for a way to get out of existing contracts and pensions.
Cities like Vallejo, Calif., and Central Falls, R.I., had minuscule budgets compared with their looming pension payments, and the contracts with city workers were excessive. Bankruptcy was the only option.
New York legislators created the Municipal Assistance Corp. in 1975. “The MAC demanded that the city institute a wage freeze, lay off employees, increase subway fares and begin charging tuition at city universities,” according to a report from the California Research Bureau.
“Despite a summer of labor unrest, these measures stuck and MAC was able to refinance some city debt, but the market was still resistant.” Next, the state created the Emergency Financial Control Board, which took control of the city’s finances.
“The state law creating the EFCB required the city to balance its budget within three years, change its accounting, and submit a three-year financial plan,” the report said.
“The Board had the power to review and reject the city’s financial plan, operating and capital budgets, contracts negotiated with the public employees’ unions, and all municipal borrowing.” Six years later, the Big Apple had a balanced budget and was able to sell long-term bonds.
Municipalities not lucky enough to have a MAC-style agency helping out have to scan other options in preventing bankruptcy. One of the most obvious is controlling labor costs.
Worker contracts and their pensions proved to be the undoing of both Vallejo and Central Falls and endanger numerous other municipalities, including San Diego and Los Angeles.
“To the extent that employee compensation costs are a problem, states have it within their power to change collective bargaining rules,” said E.J. McMahon, a senior fellow with the Manhattan Institute.
Raising taxes could stave off some filings, although the public doesn’t appear to have an appetite for that. But there are other things legislators can do.
According to a 2008 report from the American Bankruptcy Institute, legislators can pass a law requiring cities to set aside a certain amount of money every year as a “rainy day fund,” with a mandate that it cannot be spent until a time of need.
“Bankruptcy is like a boat overloaded with people in the water when a storm comes,” McMahon continued. “It’s that one wave that sinks them and they are all done.”
Tori Richards is an award-winning investigative reporter.
