By the 20th century, most of the institutions familiar to the municipal securities market were in place, but innovation in the market was just getting started. In part because the municipal market was resistant to manipulation – for example, you cannot sell bonds short -- and lightly regulated, its practitioners were among the most creative.
The bedrock of the market remained the “general obligation” bond, which was backed by the full taxing power of a municipality. These were the safest of bonds and state legislatures ensured that they stayed that way, often requiring referenda and competitive bidding for general obligation issues. Another type of issue, “revenue” bonds, were more flexible and less secure since they were repaid solely from the receipts of the project they funded, usually a toll bridge, waterworks or turnpike. Through the 20th century, revenue bonds became increasingly popular because they relieved city leaders from issuing referenda and provided investors with more certainty about the source of their proceeds.
The real innovation began during the Great Depression. Mississippi, in an effort to build up its manufacturing base, issued the first “industrial development” bonds. Similar to railroad bonds a century earlier, these bonds used public issues to finance private ventures, albeit those deemed by legislators to have an underlying public purpose. “IDBs” started slowly, but by 1960, some 17 states authorized their issuance. In the North, “authority” bonds emerged to fund urban renewal public housing projects. These local housing authorities were dwarfed by the Port Authority of New York and New Jersey and the Triborough Bridge Authority. With the latter, Robert Moses used the contractual protections of the bonds he issued to create a power base exempt from national, state, and local control for 40 years.
New York continued to be the locus of innovation into the 1960s. With Governor Nelson Rockefeller determined to continue building despite public rejection of his financing proposals, bond lawyer and future U.S. Attorney General and Watergate conspirator John Mitchell developed the “moral obligation” bond, acknowledging the state’s moral obligation to repay, despite having no legal duty to do so. By 1970, New York City had added “revenue anticipation” and “tax anticipation” notes to an increasingly questionable arsenal of instruments. But, with a default rate of less than one quarter of one percent, municipal securities seemed safe, and investors asked few questions. At the time, New York’s disclosure documents consisted of little more than notice of sale and a statement of the terms of issue.
But deindustrialization and urban decay had begun to erode New York’s tax base. Rent controls and tax moratoria carved out exemptions and growing union payrolls and pensions inflated city budgets. Banks had helped the city through a 1966 credit crunch but New York kept spending. As the economy slowed in the 1970s, the financial high wire act wore thin. In 1972, Moody’s and Standard and Poor’s cut New York City and State bond ratings. In 1974, the banks that underwrote the city’s debt were unable to sell a $50 million offering. In 1975, the city sold only half of a $900 million issue and a tax anticipation note offering was completely cancelled. 5
With the city’s financial spigot shut off, the state created a Municipal Assistance Corporation (MAC) to issue new bonds, established an emergency financial control board, and appealed to the federal government for help. Americans bristled at the thought of bailing out New York City with their tax dollars. Secretary of the Treasury William Simon, who had once worked at Salomon & Hutzler, advised President Gerald Ford to insist on “a responsible fiscal program.” 6 The resulting New York Daily News headline, “Ford to City: Drop Dead,” touched off a furor that convinced the administration to provide a $2.3 billion short term loan that stabilized the city. 7 Nevertheless, in November 1975, New York City went into technical default, offering bondholders MAC notes instead of cash.
This culmination of two centuries’ development in the bond market had been a remarkable episode. For a few months in the mid-1970s, the nation had been keenly interested—even passionate—about the formerly-staid and little-known business of municipal finance.
(5) See Better Financing for New York City, August 1966 ; New York City’s Debt Problem, July 1973; Papers from New York City Comptroller Harrison Goldin, 1975-1978; The City in Transition: Prospects and Policies for New York, June 1977.
(6) George J. Marlin and Joe Mysack, The Guide to Municipal Bonds: The History, The Industry, The Mechanics (New York, 1991), 8.
(7) President Ford had stated, “I can tell you, and tell you now, that I am prepared to veto any bill that has as its purpose a Federal bailout of New York City to prevent a default.” See October 29, 1975 Remarks of the President and Question and Answer Session, The National Press Club.
The virtual museum and archive is copyrighted by the SEC Historical Society. The Society reserves the right to restrict access to or use of the museum by any user at any time.
Users are prohibited from sharing or downloading any material for publication or commercial purposes without written permission from the Executive Director. Requests for permission must be submitted by email and specify the material requested and for what purpose.
Material used with the Society's permission should be credited to: www.sechistorical.org.