The Streets Were Paved with Gold - Ken Auletta [65]
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