What a difference a few decades makes. In the mid-seventies, New York Citys looming bankruptcy was a horror that the state, feds, and city ultimately avoided. Last week, Detroit declared bankruptcy because Michigan thought it was the best choice available—and Washington stayed out of it. The Motor Citys default should spur New Yorks bondholders, public-sector workers, and residents to take a fresh look at our own financial burdens.
In spring 1975, New York City couldnt pay its bills. It had long covered over its deficits with short-term borrowing, and the banks, growing nervous, shut off the tab. The city turned to Albany for help; Albany went to Washington to request a federal bailout. Republican president Gerald Ford first vowed that he wouldnt help the insolvent city, provoking the famous New York Daily News headline: FORD TO CITY: DROP DEAD. But Ford came through in the fall, after several months of negotiations. Why the about-face? Ford feared a global financial panic. Treasury secretary Bill Simon said default would be awful. Federal Reserve chairman Arthur Burns told Ford that Europes leaders considered bankruptcy unthinkable. The city got its bailout and repaid its debt—or, rather, refinanced it. We still owe $2.1 billion from that era.
Today, theres no chance that Detroit will pay all or even most of the $18 billion it owes to bondholders and public-sector retirees. It killed one sacred cow when it included $530 million in general-obligation bonds as unsecured debt, preparing to offer bondholders seven cents on the dollar. It killed another when city officials said that pensioners will have to take a hit of up to 30 percent of expected income, if it turns out that the citys past pension contributions indeed fall $3.5 billion short of covering future payments. As for the $5.7 billion Detroit owes public workers for retiree health care, the plan is for retirees to try Obamacare.
Back in the seventies, the specter of bankruptcy prophesied urban death. New York could never recover from such a cataclysm, many believed. Now, Detroit is pushing bankruptcy as the catalyst for a turnaround, telling locals that City Hall can do everything from fixing street lights to hiring police with the money that taxpayers save by stiffing creditors. Detroit should stand as a warning: New Yorks bondholders and public-sector workers can never look upon their city as too big to fail again. As Mark Kaufman, co-chair of the municipal reform and innovation practice at the McKenna Long & Aldridge law firm, points out, Detroit highlights a critical question that other cities must grapple with: What does general-obligation debt really mean? What does full faith and credit mean? Its not worth a candle if you have a city that cant meet that obligation.
If New Yorks bondholders, public-sector workers, and retirees apply this sobering thought to their own city, they could help fix things before its too late. New York, after all, is doing well compared with many other cities. The time to act is now. But act New York must: the citys obligations dwarf even Detroits. Consider the $5.7 billion Detroit owes for retiree health care. New York owes $88.2 billion—or $20 billion more than Detroit when adjusted for population—and the city has no money squirreled away for this purpose. Or consider pensions: New York owed pensioners $69.9 billion more than it set aside as of last years annual report. Adjusted for population, thats $28 billion more than Detroit owes. New Yorks bondholder debt stands at $77.3 billion, about $34 billion less than Detroit when adjusted for the population difference. That means theres still time, but bondholders should remember that Detroit kept borrowing until it was too late to maintain the illusion that the city could afford its retirement benefits. Now both creditors and pensioners will suffer.
New York should heed another stark indicator. Detroit cant balance its annual budget because it must spend one-third of its revenues on health, retirement benefits, and debt. New Yorks budget has run an operating deficit six of the past seven years (with the shortfalls covered by pre-2008 surpluses). These deficits exist because New York also spent a third of the budget on health, retirement benefits, and debt.
Of course, New Yorkers can comfort themselves that they live in a rich city, where the median household income of about $51,270 (thanks to Manhattan) is nearly twice Detroits. Still, cities have ups and downs. Detroit lost the auto industry. And New York, half a decade after Lehman Brothers collapsed, is still missing more than 30,000 jobs from its premier industry, finance. The sectors employment ranks remain down 7.5 percent. Thats important, because finance provides 28.9 percent of New Yorks income from wages, and the city needs the taxes on those wages to keep services up, lest the worlds financial elites decamp—with their cash.
It would be one thing if the city were working on fiscal reforms. Instead, city unions have sued—successfully, so far—to protest a city audit of their health-care plans to root out basic fraud. Union leaders have balked at the Bloomberg administrations mild requests that workers pay for some of their health-care premiums. And last week, city comptroller John Liu was crowing about the citys pension funds great quarter—as if that doesnt owe mostly to the Feds interest-rate policy, which has conjured another speculative frenzy.
New York is banking on continued good luck. Detroit shows what happens when luck runs out.