It looks like the next round of congressional battles over restarting the economy will involve Federal aid to cities and states. While Speaker Pelosi and the Senate Majority leader, Mitch McConnell, battle over money for the states, Mayor de Blasio is pleading for $7.4 billion. This is by no means the first time the Big Apple has asked for a Federal bailout. The fiscal collapse of 1975 is the occasion that most commonly comes to mind.
It turns out, though, just over a century ago, a now-forgotten New York crisis ended up establishing a remarkable precedent in American finance. It was triggered by what we now call a “Black Swan” event — in the event, the outbreak of World War One. It was not preceded by a prolonged diplomatic or military crisis. Winston Churchill later recorded that, paradoxically, “the spring and summer of 1914 were marked in Europe by an exceptional tranquillity.”
Then, on June 28 a gunman at Sarajevo, assassinated the Austro-Hungarian archduke, Ferdinand. It took only five weeks for the world to become engulfed in what would be, at the time, the greatest military slaughter in history. And therein lies a point to dwell on amidst the Black Swan of the coronavirus pandemic.
In the America of 1914, the sudden conflict appeared to have the makings of a financial disaster. With our financial reputation still smarting from the Panic of 1907, Treasury Secretary William McAdoo, who (hat-tip to Jared Kushner) was President Woodrow Wilson’s son-in-law, was desperate to keep the dollar on the gold standard and maintain the country’s international financial standing.
The Europeans, especially the British, began pulling their gold out of America. Stymied by shipping restraints, they started bidding up the sterling, the world’s reserve currency. This plunged America into a liquidity crunch even worse than that of 1907. The eight month old Federal Reserve system was not yet functional.
McAdoo, as documented by NYU Professor William Silber, ad libbed brilliantly. He encouraged the New York Stock Exchange to suspend trading for more than four months to prevent Europeans from trying to redeem their American securities in gold. He invoked emergency currency provisions of the 1908 Aldrich-Vreeland Act, which permitted banks to issue national bank notes without the normal requirement that the currency be secured by America’s government bonds.
Into this volatile mix was thrust yet another crisis, care of, you guessed it, New York City. Even in those days, the metropolis was living beyond its means. Despite a local schedule of business and personal taxes higher than any incurred through the federal or state governments, the city was perennially short of cash. Total municipal debt at year end 1913 was more than $1 billion ($26 billion in today’s debased dollars). By contrast, the total debt of the Federal government in 1913 was only $2.9 billion.
As a chronic debtor, New York City was on the lookout for creative ways to lower its interest payments. In that fixed rate, gold-based era, it may have made a certain sense for the city to issue short term, revenue anticipation notes, denominated in sterling and francs, in the London and Paris money markets. These transactions represented an early form of interest rate swaps. Except that, with the war’s outbreak, the bottom fell out.
On August 19, the Comptroller’s Office announced that New York needed to rollover $82 million in pound and franc notes. The British and French wanted to cash out. The dollar crashed against the pound, threatening an additional outflow of gold.
The private sector came to McAdoo with a solution. As Professor Silber relates, bankers at J.P Morgan and Kuhn, Loeb formed a syndicate that raised $100 million in three year notes, more than enough to pay off the city’s current and near term obligations, including gold and sterling owed in Europe.
There was, though, a catch. To make the deal work, McAdoo agreed to permit the banks to accept New York City securities as collateral to cover their issuance of emergency currency. The banks were already lacking in sufficient reserves since the outbreak of the war, and elevating the status of New York paper could be seen as a risky precedent. The alternative was a New York default, and McAdoo gladly caved in the interest of America’s global credit rating.
The arrangement was widely applauded. In a September 6 commentary, the newspaper then carrying the flag of The New York Sun noted approvingly that “One thing the loan to the city does, involving the agreement to pay the full amount of the city’s foreign obligations in gold, if necessary, is to inform the world of the American intention to establish no moratorium here against American foreign debts.”
It goes without saying that this milestone bailout required no permanent change to the city’s budget and spending. Professor Silber points out that those extraordinary 1914 measures on behalf of New York marked the birth of the “too big to fail” doctrine in American finance. It’s a legacy we saw in 2008, and in the current crisis it gets messier by the day.
As part of it’s Covid-19 tool kit, the Federal Reserve has already pledged up to $500 billion in credit to state and local governments, with Treasury providing up to $35 billion to cover losses. Just today The Wall Street Journal reports that the Fed, prodded by lobbyists and Congress, will broaden the number of governments from which it will purchase debt from an original total of 75 to as many as 261, not all of whom are good credits. “Left unanswered,” notes The Journal “ are questions such as what role the central bank would play in a bankruptcy.”
What Congress will do in its next bailout bill is uncertain. It is certain, though, that New York and other municipal entities, in demanding emergency aid, will plead that “no one could have foreseen this.” Just like New York failed to foresee the assassination of the Archduke in 1914, and the Black Swan swooped down out of the sky.
Mr. Atkinson, a contributing editor of the Sun, covers the 20th Century.