On Sunday, the New York Times’s Gretchen Morgenson proposed giving American mortgage borrowers and their lenders the same kind of financial bailout that New York City got 33 years ago. On its face, the idea seems simple and elegant. But Morgenson forgets the steep price that New York paid for its bailout: a near-complete surrender of its fiscal autonomy for decades. Do Americans and American banks want to pay the same price today—and if they do, who would supervise them as closely as New York’s independent fiscal overseers have supervised the city since the 1970s?

Morgenson’s analogy isn’t bad, up to a point. To fund ever-higher social spending, New York City started to borrow heavily in the mid-sixties, and by 1975 it was paying nearly $2 billion a year in interest costs on that debt—nearly 15 percent of its total budget. Similarly, many Americans today have borrowed far more than they can afford to pay back. New York made a habit of relying on short-term debt, backed by the next year’s tax revenues, to fund its regular gaps. Likewise, Americans over the past half-decade have repeatedly refinanced their houses, whose values were increasing every year, to fund their own annual budget gaps.

Neither practice was sustainable, and both eventually came to a crashing halt. The banks soon panicked and stopped giving New York new short-term debt, leaving it without cash in 1975. A few decades later, the banks and their mortgage investors panicked again, refusing to lend new money for mortgages and refinancings as real-estate prices started to fall. Many home borrowers find themselves in foreclosure, or at least in straitened financial circumstances.

In 1975, as New York City began running out of cash to maintain public services and pay its bondholders, the state government, along with the city’s banks, real-estate titans, good-government groups, and elite citizens, cobbled together a solution: use the state’s better credit standing, as well as the city’s tax revenues, to refinance much of New York’s unsustainable debt so that the city could recover without eliminating vital services. A few months later, Washington abandoned its position that a bailout would only discourage the city from getting its house in order—FORD TO CITY: DROP DEAD had been the infamous Daily News headline—and got on board with some guaranteed financing of its own. “It worked,” writes Morgenson. “A few years later, the budget was balanced and New York was back on its feet. . . . There was a will to do what was necessary in 1975 that is missing today.”

According to Morgenson, what’s necessary today is a similar bailout—though with a $300 billion federal guarantee, it would be far larger. She points approvingly to a House bill that would allow more than a million homeowners to refinance their private-sector mortgages and receive federal guarantees. In return for this gift, the lenders would cut the outstanding debt on each house, probably by an average of around 15 percent.

But Morgenson’s story is incomplete. After New York got its bailout, it didn’t return, chastened, to running its own finances. In fact, it was never again allowed to have full control over them. In 1975, the state set up a board and a special financial-oversight office to watch the city’s budgets and borrowing closely. Since then, the city’s elected officials have had to appear before the board annually and present audited financial statements, as well as clear evidence that the budget is balanced without resort to gimmicks like short-term debt (which is now sharply curtailed). And until last year, the board retained its right to seize day-to-day management of the city’s budget if it determined that such action was necessary. (State legislation to renew this provision is pending.)

Bondholders, too, have more control over the city’s finances than they used to. In order to reassure bondholders worried that the city might default on its debt, the 1975 bailout initiated a practice in which many of New York’s tax revenues go from the state, which collects them, right into special trusts before the city ever sees them. Those trusts give the investors in certain bonds their regular payments and only then disburse the balance to the city.

Elected officials rightly insisted on all these strictures. Without them, the city—and other municipal governments—would have been tempted to get in trouble again, knowing that the feds would ride to the rescue. A large-scale bailout for homeowners is a terrible idea for lots of reasons, and one of them is the same hazard: that homeowners and especially home lenders would feel emboldened the next time around unless the bailout came with tight strings attached. Would home borrowers feel comfortable with their employers’ depositing much of their paychecks into a special trust—and with receiving the balance of the money only when their mortgage lenders were satisfied? Would they enjoy appearing before a government committee every year to prove that their household budgets were balanced, knowing that the committee could seize control of their finances if the lines didn’t meet? And would the borrowers and their fee-hungry lenders pledge never to turn to credit cards again—a pledge that Gotham now sticks to, more or less?

Faced with such terms, many if not most homeowners would choose to take advantage of an option that New York never practically had: defaulting on an onerous obligation and then starting over. People and institutions who go through foreclosure will still pay a price, of course: the borrowers likely won’t be able to secure new debt on good terms for five to seven years, and the lenders will lose money. But as New York City’s example proves, no option is painless, and in the present case, foreclosure would hurt borrowers and lenders a lot less than a seventies-style rescue would.


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