105. "Relief For the Cities: A Bond Swap" The New York Times, (November 13, 1977).
New York City keeps deferring its return to fund-raising from the private sector through the sale of new bonds, and continues to rely ever more on Washington handouts and allotments. Currently more than 15 percent of the city’s labor force is being paid with Federal monies. Indeed, bond-rating experts suggest that it would take New York a decade before it could sell bonds on a continuing basis. The reason usually given for the city’s inability to float new bonds or notes is that they will find no buyers.
That dilemma became painfully clear last week when the city was forced to abort its plans to sell up to $450 million in short term notes. The proposed offering, the first since the fiscal crisis erupted in 1975, was abruptly canceled when Moody’s Investors Service, a leading bond rating agency, pinned the lowest possible investment grade on the notes.
What is really at issue is the ability to sell city bonds at tolerable interest rates. If the city were to pay, say 20 percent interest, it could probably sell quite a few bonds and notes. After all, even the securities of bankrupt corporations find buyers– when the interest rate is sufficiently attractive. The trouble is that such high interest payments alone would eat up all of the funds the city could raise in this way in less than five years– and the city would still be obligated to return the full measure of the capital to investors and continue to pay interest until the bonds were redeemed.
In short, the problem for New York City and other financially troubled municipalities– for example, Yonkers, Detroit, Jersey City, Boston, Newark and Cleveland– is not whether they can sell bonds, but how much interest they must pay. Indeed a major source of the current burden on city finances is the high interest rates it must pay for notes and bonds it sold in the past: 9.5 percent (tax exempt) for notes issued in 1975. New York City must pay hundreds of millions of dollars in interest each year just to service its massive debt burden.
There is a way to reduce substantially this burden, a step that will enable the city to issue new bonds at a reasonable interest rate, a device that will simultaneously help other troubled municipalities, an approach that involves no Federal outlays.
The essence of the idea is for the Federal Government to offer municipalities in financial trouble a municipal improvement bond (“M.I.B”) seal. A municipality would be able to offer holders of selected categories of existing bonds an opportunity to exchange these for new bonds– issued by the same municipality– but carrying the Federal Government’s M.I.B. seal.
The seal would signify that in case a municipality declares bankruptcy the Federal Government would cover the interest payments as well as redeem the bonds at maturity. That is, it would turn the municipality’s bonds carrying the seal into an investment as secure as the Federal bonds backed up by the full authority and financial resources of the Federal Government.
Bond holders would be allowed a limited time period, say 90 days, in which to decide whether to hold onto their high-risk, high-yield bonds, or to exchange them for the new, lower-risk, lower- interest M.I.B.’s. In exchange for the M.I.B. seal, a participating municipality would agree to set aside revenues of certain municipal taxes (say, on cigarettes) to cover the interest payments on the bonds and their eventual redemption and to undertake agreed-upon reform measures to improve its financial condition.
In short, the swap would be one in which the participating municipalities would offer to exchange, for every $1,000 of outstanding bonds, $1,000 of new M.I.B.’s, yielding roughly the same interest rate at top-rated tax exempt bonds at the time of issuance. In November 1977 that would have been something over 4 percent, compared to 9 percent for the most recently issued New York City bonds.
It should be noted that offering bond holders an opportunity to swap their bonds for bonds that have different features is common in the private sector. In recent months such swaps have been offered to the bond holders of United Airlines, Chase Manhattan Realty Fund and scores of others. True, these swaps often have different purposes and hence differ in detail, but swaps are nevertheless routinely offered– and accepted– by bond holders.
For the swap to work, we suggest that it would need an additional feature: the total amount of municipal bonds backed by the suggested Federal seal must be limited in some way. Otherwise the availability of this Federal bail-out mechanism might constitute an invitation to irresponsible municipal management. One way to make the aid available without making it automatic, and hence one an irresponsible municipality could not count on, would be for a board to be set up to control the issuance of such seals. The board would review each case and establish whether the municipality deliberately ran itself down to qualify for the aid, or got into financial trouble in some deserving way.
Or, more simply, by setting a specific (say, $5 billion) ceiling on the amount of M.I.B.’s to be issued at any time, so that new M.I.B.’s would be available only as old ones mature or are otherwise redeemed. In this way, the currently troubled municipalities could be assisted without providing a blank check to future ones, or even to those now helped if they were to get in trouble again in the future.
Still another possibility would be to require specific reform initiatives by the municipalities granted this form of aid. Such reforms might include avoiding excessive fringe benefits, reducing the municipality’s labor force or collecting local taxes on a proper level.
Municipalities might also be required to set aside a small proportion, say 1 percent, of the huge sums they save by paying the lower interest rates that the M.I.B. would bring about. This apportionment would be paid into the M.I.B. account to cover the costs of administering the program, and would serve as a fund to be used by the Federal Government in case a municipality declares bankruptcy.
Certain questions naturally arise. For example, the present bonds or notes yield, say, 9.5 percent (tax exempt). You offer a bond that yields, say, 4.5 percent (tax exempt). Why would anyone swap? The answer lies in the difference in risks involved. The current high-yield bonds entail a high risk and low ratings by the services that specialize in evaluating the quality of bonds for investors. The new bonds would be rated AAA, the highest rating, as Federally guaranteed bonds typically are. Investors typically treat bonds of high risk and high interest rates as equivalent to low-risk, low-interest rate issues.
Well, why would they swap if the value offered is about the same? This is the reason the opportunity to swap would be limited in duration, say to 90 days. After that, all those who seek lower risk will lose the opportunity to swap. (The same procedure is followed by corporations. While occasionally a swap offer is extended by one more month, it is rarely if ever open forever). Also, by setting the new rate somewhat higher, say at 5 percent, the new bonds would in effect offer a premium to those who do swap, again a procedure commonly used by corporations that offer bond swaps.
It could also be suggested that the scheme is nothing more than a thinly veiled attempt to help New York City. While it is true that New York would be a major beneficiary, it is certainly neither the only municipality in need of help nor the only one standing to benefit. Indeed, the scheme does attempt to get away from favors to New York City only in order to make it politically more attractive to the Treasury, the President and the Congress, which tend to shy away from doing special things for any city.
How does the scheme compare to other ones, such as increased loans or grants to New York City? To favor the bond swap is not to oppose these other avenues. If one must choose among them, it should be noted that the multi-million-dollar savings for New York City under this approach would be achieved without any actual outlay on the part of the Federal Government.
Federal laws may require setting aside 25 percent of the value of all bonds guaranteed by the seal as a kind of insurance against bankruptcy and as a discipline against excessive issuance of such guarantees. But those funds would not be considered expenditures and would be set aside once for all the years the bonds are to be in effect. Outright grants would involve increased expenditures for the nation’s taxpayers and allotments to New York City not available to most other places. Loans would add to the interest payments with which New York is burdened, while the suggested swap would reduce them.
True, the bond swap we favor would not end all of New York City’s financial problems. But it might well allow New York to return to borrowing from the private sector and thus open the door to more normal financial existence.