Would the auto industry, and would we all, be better off if Ford, General Motors and Chrysler were allowed to go bankrupt?
The possibility became more real last night, as the Senate rejected the bailout proposal endorsed by President Bush and Congressional Democrats. A case study from 30 years ago--one with remarkable resonance for the global financial crises of today--suggests the risks ahead.
If you are of a certain age, you remember the headline: “Ford to City: Drop Dead.” It was from the New York Daily News in October of 1975 after President Gerald R. Ford (not the Ford automobile company) gave a speech rejecting New York City’s request for federal loans to avert a default on city debt. Ford’s speech pleased many at home, but the possibility of a default on billions of dollars in debt sent tremors beyond American shores. The overseas reaction was perhaps the first signof financial globalization and its perils, now grimly familiar in the meltdown of 2008.
Who can be sure that if the Big Three auto makers go down, it won’t be like Lehman Brothers earlier this year, with surprising impacts around the world and at home?
New York City debt, to borrow a phrase from today, was a toxic asset. But such debt represented an estimated 20 percent of the equity of the biggest commercial banks on Wall Street. A default threatened Chase Manhattan Bank, Morgan Guaranty Trust, Citibank and other giants with a major blow to their solvency.
Shortly after giving his speech, just before Thanksgiving, President Ford traveled to Rambouillet, an 18th century chateau outside Paris for the world’s first economic summit, summoned by President Valery Giscard d’Estaing to deal with the worldwide downturn. Arthur Burns, chairman of the Federal Reserve, attending the Rambouillet summit with Ford, asked both Giscard and Chancellor Helmut Schmidt of Germany what they thought if the city that served as the capital of global finance went bankrupt.
“The answer was loud and clear,” recalls Felix G. Rohatyn, the investment banker who helped engineer the New York City rescue, and who later served as an ambassador to France under President Clinton. “The European leaders felt that a bankruptcy of New York City was unthinkable.”
Rohatyn, who heard about this conversation from key participants on both sides of the Atlantic, says that Giscard and Schmidt told Burns that a New York City bankruptcy would be seen as a bankruptcy of America itself, causing a run on the dollar and extreme difficulties for leading American financial institutions.
Soon after Rambouillet, the Ford administration softened its opposition to helping New York City. While it was popular, then as now, to bash Gotham, mayors and governors around the country were uneasy about interest rates going up on their own borrowings, and even some southerners worried about welfare recipients packing their bags and going to other states. (In 1976, Ford lost New York State in his close contest with Jimmy Carter for the White House.)
In addition, by late 1975, some in Ford’s inner circle, as well as some at Burns’s Federal Reserve – including Paul Volcker, then president of the New York Fed and now the new chair of President-elect Barack Obama’s outside advisers, the Economic Recovery Board -- were beginning to argue that New York City had done a lot to get its finances in shape and was deserving of help, especially since the risk of bankruptcy was becoming increasingly clear.
There was also the chaos factor. I covered the city fiscal crisis for The New York Times as a City Hall reporter in my 20’s. What I remember vividly is that no one could guess the consequences of bankruptcy throughout the American financial system. For one thing, no one knew for sure who owned all that debt and what institutions in the chainwould be at risk. Many individuals whose incomes had gone up with the hyper-inflation in the 1970’s had alsopurchased New York City bonds and notes because of their tax-exempt status.
There was talk then, as there is now with Detroit, of a “cram down” solution in which a bankruptcy judge would force various parties to accept sacrifices. But in 1975 the experts wondered where a bankruptcy judge would hold court to hear the competing claims of New York City’s stakeholders – its untold numbers of creditors, municipal workers and taxpayers. Yankee Stadium? And would they have to reserve Shea Stadium just for the lawyers?
By December Ford signed the New York Emergency Finance Act of 1975, providing the city with $2.3 billion of short-term financing. The measure gave New York City three years to balance its budget and restructure its debt. It was a long way from the time when a White House whose press secretary, Ron Nessen, compared New York to “a wayward daughter hooked on heroin” who would be better off going “cold turkey to break the habit.” The “habit,” of course, was excessive government profligacy and liberalism. As in Detroit today, the city’s labor unions, with generous contracts wrested over the years from a city that had experienced strikes by police, teachers and sanitation workers, were considered a major culprit.
New York City was surely profligate, and its unions were surely powerful, just as the United Automobile Workers has been. But like Detroit, the city was also a victim of a global financial downturn, reflected in the urgency of the meeting in Rambouillet. In the early 1970’s, more than 100 Wall Street firms collapsed in a bear market brought on by speculative bubbles in technology, corporate mergers and so-called growth stocks. The Yom Kippur War in 1973 and a global oil price spike and American gasoline prices did not help the situation.
In the end, as part of the Federal bailout, all the stakeholders in New York City paid a price. The price was fashioned and negotiated under the leadership of Gov. Hugh Carey, Rohatyn, Peter Goldmark, the state budget director, and Republican legislative leaders. But it was bank leaders like David Rockefeller and Walter Wriston who agreed to write-downs and restructuring of their New York City debt holdings. The State Legislature enacted tax increases, an increase of tuition at City University and a “moratorium” on payment of the principal in more than $2 billion in debt. The city had to install a new accounting and budget system in which leading business figures participated. And the unions not only had to invest more than $3 billion in pension funds to finance the city’s recovery plan; they had to agree to a reduction of 60,000 workers, from attrition and layoffs, or 20 percent of the city’s work force. They also went along with a three-year wage freeze.
Even today you can argue that what New York City went through was a virtual bankruptcy and a “cram down” of sacrifices. The “moratorium” on the debt principal was the equivalent of the default everyone tried to avoid.
But what was avoided was something unknown. I wouldn’t argue today that banks around the world would be threatened by a bankruptcy of the American auto industry. Indeed, some European leaders are warning that a federal rescue of Detroit would be seen as “protectionist,” necessitating retaliatory trade steps in Europe. There is another crucial difference between a city and car companies. While going through a painful contraction, New York City got away with delivering fewer services to its customers. The auto industry would have to make cars that Americans still wanted to buy.
But who can be sure that if the Big Three auto makers go down, it won’t be like Lehman Brothers earlier this year, with surprising impacts around the world and at home? Would a default of the auto companies lead to collapses of countless suppliers and businesses around the country, or to Michigan and other states, or to financial institutions connected to them?
In his 1980 book on the city’s fiscal crisis, “The Cost of Good Intentions,” the author Charles R. Morris – who more recently warned of a global meltdown because of subprime mortgages – was fascinated by the subject of why everyone in middle of the crisis had difficulty understanding what was happening around them. “Maybe we were dumb,” Beame’s deputy mayor, James Cavanagh, famously stated after the city’s brush with financial ruin, “but nobody else seems to have understood what was happening either.”
Then as now, an aphorism from Felix Rohatyn would seem to apply. Never place a bet that you can’t afford to lose.