Amid the proud and shiny signs of New York’s continuing prosperity, it is hard to recall that in 1975, not much more than three decades ago, this great city could not meet its weekly payroll and seemed destined to go broke. A few collective memories linger from those dark days, especially the classic New York Daily News headline “Ford to City: ‘Drop Dead'”, and the city’s gratitude to investment banker Felix Rohatyn, who helped establish a financing vehicle called the Municipal Assistance Corporation to sell its own “Big MAC” bonds when the markets were having none of the City’s paper. But the behind-the-scenes story of New York City’s close brush with financial ruin is one that has never been fully told. The purpose of this little memoir is to get one portion of it in print for the first time, a portion that may be of special interest to those interested in the uses of the law.
The time was late Fall of ’75. By that point the City had exhausted all its available credit facilities; the banks refused to lend another cent; the lead underwriter of the City’s bonds pulled back a contemplated offering when it began to doubt their repayment. Appeal was made to Washington, D.C., but the Republican administration of Gerald (“Drop Dead”) Ford, and its allies in Congress, still aggrieved over the Democrat-led driving of Richard Nixon from office, refused to give any aid to the Democrat-run city except on terms even the conservative business leadership in the City deemed unacceptable, including federal loan guaranties that would have enabled the City to borrow from conventional sources.
As for me, I had left my New York practice a little over a year before to take a job at the Internal Revenue Service as assistant commissioner in charge of pensions and exempt organizations. There, at my office at the Service’s national headquarters in Washington, I received a call late on a Wednesday afternoon from a well-known lawyer representing the City, Carr Ferguson, who later went on to become Assistant Attorney General for taxes.
Ferguson told me that the City had a payroll to meet that Friday and lacked the funds to do so fully. He wanted to meet at once to explore the possibility of the City’s borrowing from its municipal pension funds for police, firefighters and teachers. The request was directed to me because it was my job to apply the regulations meant to uphold the interests of pension beneficiaries like those in the municipal plans.
The only thing that surprised me about the call was that it hadn’t come sooner. As a New Yorker temporarily in Washington, I had followed the newspaper accounts of the City’s deepening plight, and I had half suspected for months that the City would end by turning to its own pension funds as lenders of last resort. This put me in a difficult position as the IRS official with authority to sign off on such a loan. Naturally I wanted to help save the city
I loved, but at the same time I was sworn to uphold, rather than to compromise, the best interests of the workers enrolled in the plans. I could not allow any personal feelings towards the City to color my actions. With all this in mind, I had half hoped the City wouldn’t come knocking on my door. But it had.
I agreed at once to a meeting in my office 8 a.m. the following morning with whomever from the City Carr deemed useful to be present. He speculated his contingent would include the Mayor, Abe Beame, City Comptroller Harrison Goldin, and labor leader Victor Gotbaum, who headed the City employees’ union. I told him I would assemble a team to meet with his group.
Approval for such a loan was going to be no easy or automatic matter. Federal pension law –then much as now – barred employers, including cities and states, from borrowing from their employee pension plans except under strict constraints affecting security, interest and repayment, that would adequately protect the workers’ pensions; and it was first necessary to get the acquiescence of the IRS, as the federal government’s sole regulator of municipal pensions. Although the best-known federal pension law, ERISA, had no application to government employers, the IRS had developed rules on loans from pension plans to “interested parties” and similar transactions years previously; and a quick search of those rules following the phone call disclosed that what slight authority there was neither prohibited nor authorized loans to a government in extremity by its own employees’ pension plans. Any misstep would be very likely to come under scrutiny in the national press, which was headquartered in New York.
I recall a very restless night, as I contemplated the forthcoming meeting with the City representatives the next morning, and rehearsed in my own mind the possible options that were open to us. I presumed that we would be faced with a request for a ruling approving the loans without penalty to the plans, its trustees, and possibly the City itself, and of course without adverse impact on the employees (non-repayment of funds was only one of the
dangers; another was the possible loss of tax exemption of the trusts and tax qualification of the plans, which might have a heavy impact on the plan participants). The sparse learning on the subject that I and my technical advisers had been able to scan provided no guidance on how such a sanction-free transaction might be crafted. We were essentially steering into an uncharted sea without a compass. The specific federal and state legislation that was later that year enacted specifically as part of the City rescue package to relieve the parties in interest in
the NYC matter from the sanctions of the prohibited transaction rules, and to insulate the trustees from recourse for making arguably improvident loans, did not come into place – indeed, was not even in contemplation – until months after that Friday meeting at the IRS. (Permit me to add as an aside at this point that, but for the actions we took that day, the later rescue package would have taken a very different shape, with the City then mired in a
doubtless unavoidable bankruptcy.)
So my responsibilities weighed heavily on my head as I entered what was to become a 20-hour non-stop session in my conference room beginning at 8 the following morning and continuing into the early hours Friday morning. There were 15 or 16 of us assembled for our solemn business, roughly equally divided between IRS and City people. It immediately became apparent that the Mayor, a man of short stature but large repute, was not there, nor were either of the other two promised City celebrities. But there was no shortage of experts from among the City’s budget, bond, tax, actuarial and legal ranks. I viewed that as a good augury of our ability to address efficiently the very technical matters to be explored, free of the political, and emotional, and, let me say, other atmospherics that the Mayor et al. could be expected to bring to the discussions.
And so began our deliberations. The usual opening banter quickly gave way to a discussion by the City people of the current state of their borrowing ability (more accurately inability), a run-down of the employee pension plans they hoped to tap, and the amounts of immediate funds they were looking for. Then it was my turn to speak, and, just for the record, I stated most generally the prerequisites we would require as a condition to any action we might take, principally relating to adequate security, a reasonable rate of interest, and a suitably near-term maturity. The immediate cash shortfall required to fully cover that week’s payroll was on the order of $500,000, just chump change for the City, imposing no peril for the pension plans’ abilities to satisfy their liabilities to participants. But no matter; it had to be done right, as god gave us to see the right.
“Let’s start with what is obviously the most problematic issue, the security you are able to deliver,” I posited. “What have you got that isn’t already pledged away? Can you dedicate a segment of the tax revenues to repayment of the loans?” It seemed a straightforward enough question, one that could be answered objectively by the fiscal experts in the room. Proving, I guess, that things are seldom what they seem, I did not get anything like an objective answer. There were some musings, speculations, hypotheses –- guesses, to be honest. My people and I were frankly startled at the apparent lack of preparation of the City’s people for such a core inquiry. We probed and prodded for the next three hours, to no avail. It was getting close to noon, and we were farther from a solution than I had thought us to be at the very start of the morning.
In some frustration – perhaps more disappointment at getting no help from the City in reaching a satisfactory resolution – I said, “Let’s try another tack.” I then proposed that we each try to compose in the rest of the day rough drafts of what we in the Service will require and what the City can deliver in the way of security, and then try to mesh our lists on which to predicate the ruling they were seeking. “Of course”, I acknowledged, “this doesn’t get the payroll paid tomorrow”; but, I added, “I will give you a letter of intent to issue such a ruling forthwith, if your banks, on the strength of that letter of intent, will agree to give you bridge financing today to cover the Friday payroll.”
Not surprisingly, the City folks liked the proposal; and it was agreed they’d immediately put in calls to their bankers, and we would resume our meeting as soon as we had their verdicts. To the readers who are at this moment wondering on what authority I could issue such a “letter of intent”, I must admit there is no such authority anywhere in the thick, multi-volume IRS Manual. There are all manner of procedures for the full panoply of issuances by the Service from full-tilt regulations down to press releases; but nowhere will you find reference to a letter of intent. It just blurted out of me. Had I thought about it for more than a nanosecond, I would almost certainly not have proposed it. But the City folks were out the door racing for the phones, and there was no putting it back into the box.
Less than an hour later they were back in the conference room, and the banks had agreed. So we all then bent to our tasks of composing and meshing our lists. Fifteen hours later, by dawn’s very early light (and electrical supplementation), I signed that letter of intent, and our meeting was adjourned. In case you’re wondering, I never had to issue the private letter ruling promised by the letter of intent. The City did come back approximately two weeks later for an authorization to borrow an additional sum, and, with increasing discomfort and a warning that there would be no more such dispensations from us, we did permit that second loan. But by this time, thanks to a softening of some important hearts in Washington (most importantly that of the President), the City got its federal guaranties, and a lot more of the pieces then fell into place, enabling the City to return to more conventional borrowing (including significant purchases of the Big MACs by the very same municipal pension funds!).
Oh yes, there is a little more to the story. A retired City high school teacher, whose pension, if I remember, was about $4000, sued me and the other government officials (even the President, if memory serves), as well as the plan trustees and banks, for putting his pension in jeopardy by our actions. His suit was thrown out of court as to us officials. We were just “doing our duty”, opined the court. That’s what I thought too. I imagine the unretired City
teachers and other municipal employees whose very jobs, let alone their pensions, were in jeopardy thought so.
Alvin D. Lurie was the first Assistant Commissioner of Internal Revenue charged with administering employee plans and exempt organizations following enactment of ERISA, and is a practicing tax lawyer in New York. He has written frequently on pensions. Al Lurie is Special Counsel to the SBCA.