In March 1975, three major banks refused to market New York City’s bonds. Leading to months of crisis when the City faced bankruptcy, culminating with bankers effectively taking over New York’s finances.
This astonishing story, rarely told, is the beginning of the modern world and the current political and financial structures.
A boom in the 60s and early 70s was interrupted by geopolitics as mainly Arab nations instituted an oil embargo over the Arab-Israel war that was ongoing in 1973.
The embargo was effective in as far as oil prices rose from $3 to $12 in the west and considerably more in US.
Two years prior, in 1971, America made an historic decision by pulling out of the Bretton Woods system, established after the second world war, whereby the dollar was pegged to gold with other currencies pegged to the dollar.
Following the oil shock, interest rates were cut to keep recession at bay. Without a gold base, however, the result was stagflation whereby inflation rose to some 20% and unemployment rose to 12%.
The economic crisis led to a fiscal crisis in many cities across America, most acutely in New York City. Here is a congressional report describing why borrowing is an integral part of city finances, and we quote at some length:
“New York, like almost all State and local governments has borrowed to finance capital construction projects.
Financing of capital improvements through long-term borrowing serves to stretch out the payments for capital construction over the life of the improvements requiring all citizens who benefit from the facility to pay a portion of its costs.
Like some other governments, New York has also used short-term bond anticipation notes to fund capital construction. These notes are usually issued when long-term funding is not available at reasonable prices, but are later converted to long-term bonds when market conditions improve.
If New York were unable to borrow for capital construction purposes, its capital improvement program would have to be gradually terminated causing a deterioration in the city’s capital stock.”
In other words, instead of paying upfront for the building of say a hospital or a bridge, they take out a loan or issue bonds which then they pay back in installments.
The recession, however, had lowered tax incomes with a deficit of $700 million out of $12 billion starting to build up.
Banks, therefore, refused to market the bonds, denying the public the opportunity to itself evaluate whether they wish to purchase the debt or otherwise.
That’s because the banks here act as an intermediary. They’re effectively buying all the debt, and then sell it to the public on the market. If they think the public wouldn’t buy it, then they would not provide a market.
Banks also buy themselves some of this debt which benefits from tax-free interest rates. New York banks held about a billion dollars of New York City debt.
As crunch times were biting, they were concerned the debt won’t be paid back, refusing to lend to the City which now was facing bankruptcy.
Between March and May 1975, the New York State effectively borrowed on behalf of the City $800 million dollars.
On May 13th 1975, a meeting between the then president Gerald R. Ford, and the then New York Mayor Abraham Beame and Governor Hugh Carey was held.
The brief and the then drafted speech is now public. Ford refused to provide assistance, stating: “The taxpayer, on whom the whole pyramid stands, can only carry so much. It is fruitless to promise him more than he is willing to pay for.”
A corporation was set-up to market the bonds in a roundabout way. The Municipal Assistance Corporation (M.A.C) pledged the city’s sale tax and stock transfer tax for the bonds, but bankers were still not happy. Thus:
“The State Legislature was deeply concerned that the City would be unable to meet its debt service obligations and thus be foreclosed from seeking funds in the public markets.
In an attempt to bring the City’s finances under strict control and assure continuity of government operations, the Legislature enacted the New York State Financial Emergency Act for the City of New York (Emergency Act).
The Emergency Act provides for a State Emergency Financial Control Board which wields review power over City operations and control over City funds to ensure that payment of debt service obligations receives highest priority.”
The effects of this decision to impose harsh austerity on the then world’s wealthiest city is described by a New York Time’s article written at the time:
“In March the banks refused, for the first time in anybody’s memory, to bid on a city note issue, and, as Mr. Goldin and the Mayor were forced to cancel the sale and negotiate terms for private sales and to agree to high interest rates, the city’s predicament began.
Recurring announcements by Mr. Beame that he would lay off more and more city workers, that he would cut city services and demand future economies were greeted without cheer by the banking and investing communities. In May and June the Mayor was forced to agree to the state’s creating the Municipal Assistance Corporation: the agency through which bond issues on behalf of the city would be sold.
Further economies were demanded and agreed to by Mr.Beame, even as he publicly denounced the banks for attempting, he said, to usurp the power of the city’s elected officials.
Then a wage freeze was demanded. The Mayor said he could not unilaterally impose freeze, could not reverse agreedon labor contracts. But he did impose a freeze.
He said that he would not accept the management level inserted into the city’s budgetary process, something he called a ‘shadow government.’ But he did, and installed the Metropolitan Life insurance Company’s chief executive officer and one of the brokers of, the M.A.C. legislation, Richard it Shinn, as its head…
A ceiling on the budget was demanded by both M.A.C. and the bankers. Mr. Beame said it was impractical and impossible, but he agreed to it.
A freeze on taxes was demanded. Mr. Beame said he could not commit the city to that, but he did.”
Felix Rohatyn, “a senior partner of Lazard Frères & Co., the huge investment banking firm,” was made finance director of M.A.C. The Financial Control Board was likewise full of bankers like Rohatyn.
They were effectively now running New York, with NYT quoting individuals from the time stating banks were discriminating against women and minorities in their lending and “have not been contributing to the bottom line of society.” They say:
“Victor Gotbaum, chairman of New York’s Municipal Labor Committee, has laid much of the blame for the city’s crisis at the doorstep of the First National City Bank of New York. He charged that the bank was ‘the No. 1 enemy’ in the crisis and denounced Walter Wriston, the bank’s chairman, as ‘venal.’
Calling for the bank to lend money to the city at reduced interest rates and to use its influence in trying to get the Federal Reserve Board to come to the city’s aid. Mr. Gotbaum [said]
‘First National City Bank has orchestrated pressure on the financial community, in the media, in Albany and Washington to force Mayor Beame to reduce the minimum services now available in this city and to fire municipal employes.’
The Mayor himself, in his own denunciation, urged Congress to open an inquiry into what he called a ‘whispering campaign’ by the big banks ‘to denigrate our fiscal integrity,’ following the refusal of the banks to advance $1‐billion last summer in short‐term notes needed to meet current expenses.”
Before we proceed to the blockchain part, and ethereum based tokenization in particular, there is an interesting book excerpt on the role of FED in such situations.
The book starts off with the failure to bailout New York City and arrives at more recent times when a number of investment banks became chartered banks in a roundabout way to access FED money. AIG, likewise, received $180 billion from the FED.
Such assistance, however, was refused to New York City which could not benefit from the bankers’ tricks of effectively printing money out of thin air.
Yet now with blockchain technology, and with ethereum’s smart contracts, anyone can access global markets by issuing a token.
Had it been today, for example, New York City could have issued tokenized bonds, baked by sale taxes. Of course whether people would have wanted to buy them is a different question, but such judgment would have been disbursed to the many, who may have even seen buying such bonds as a civil duty, rather than limited to three gatekeeping banks who arguably were the immediate cause of the near bankruptcy due to their failure to market the bonds.
States, cities, or even nations, need not throw away the current methods of bond sales and jump into the unknown. They can, instead, continue to offer the paper promises while also giving a digital token as a substitute claim for the same thing.
In this way they can transition more gradually, more incrementally, to an open global market controlled by the many, not the few.
It is the case, thus, that governments and the elected can benefit greatly from blockchain technology for at the very least it offers them an alternative, and thus offers banks competition. So limiting, if not eliminating, situations which may effectively amount to blackmail.
Or situations where bankers usurp democracy and take over the running of a state at great cost to social cohesion and at a great cost to the social contract. For blockchain tech now offers the option of accessing open markets where no one individual can bankrupt a city or a nation.