The Streets Were Paved with Gold - Ken Auletta [64]
The Financial Community
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