How Big a Blow to the Budget?

Even with federal aid and spending cuts, the city is facing big deficits

It took a quarter of a century, but New York City officials had pulled off a turnaround for the ages. From its 1975 brush with bankruptcy and descent into a national symbol of urban blight, the city became a model of clean municipal finance. Buoyed by bull market tax revenues, the city that once required a federal bailout was consistently balancing its budgets.

That was before September 11. Now, Mayor Rudolph Giuliani estimates the city will lose $1 billion in revenues this fiscal year--including a 20% decline in personal income taxes and more than 30% declines in hotel and real estate transfer taxes. Added costs for additional police overtime, downtown cleanup, and other services will soar into the billions. And big union contracts expire starting at the end of June.

The bottom line is that even with help from Washington, New York is staring at a budget deficit of $4 billion in the fiscal year beginning next July, more than 10% of current spending. Says Charles Brecher, research director at Citizens Budget Commission, a not-for-profit fiscal monitor: "You've got big spending pressures coming, and now revenues are going down. It doesn't look good."

To make matters worse, New York was still footing the bill for its last recovery effort. Officials more than doubled the city's debt since the last recession to fund what has become a never-ending effort to upgrade school buildings, roads, and other infrastructure neglected during the 1970s. Even before September 11, debt service was running at a high 15% of revenues, up from 11% in 1990, according to Fitch IBCA bond-rating service. Few would argue with the need for capital spending. But the city was using its boom-time revenues to cover annual operating expenses. That's like a household counting on work bonuses to pay the electricity bill.

CRUNCH TIME. Now those extra monies are vanishing. First it was the bust on Wall Street, then a stalling national economy--and now this. It all adds up to a crippling situation for the next mayor, who will be elected on Nov. 6. The winner will take over as resources dwindle and citizens voice demands for every penny. Worst case: The city has to scale back services, such as garbage pickup and aid to the homeless, or hike taxes, chasing away employers and tourists. "From our long-term rating point of view, the question is what people and business will do about staying in the city and reinvesting," says Fitch analyst Richard J. Raphael.

The immediate issue will be keeping the budget for the current fiscal year in balance. Under laws set up after the 1975 fiscal crisis, when investment banker Felix G. Rohatyn worked with Mayor Abraham D. Beame and others to skirt a financial meltdown, the city must end each year within $100 million of its budget or risk losing control to a state authority. As a practical matter, the budget--now $39 billion including federal and state funds--must be balanced to keep access to the capital markets. The city has balanced it for the past 20 years.

Now, officials will have to scramble to uphold that record. On Oct. 9, Mayor Rudolph Giuliani told a room packed with city and municipal-bond-market officials that city agencies would have to cut $1 billion from their spending plans. Uniformed services, such as police and fire, and the board of education are getting preference, having to cut their budgets by only 2.5%. Other agencies will have to cut 15%, and some are likely to offer severance packages to reduce payrolls. Those numbers assume that the federal government will reimburse the city for $11.4 billion in expenditures Giuliani says are directly related to the attack, such as $5 billion for emergency construction at the World Trade Center site, and $3.8 billion for police, fire, and health services. Congress has approved $20 billion in aid for New York, Virginia, and Pennsylvania.

The situation would have been even more dire had the city not estimated revenues conservatively last spring. Even then, Giuliani planned on profits plunging 75% in the securities industry, a major source of taxes. He was also expecting a 6% decline in corporate profits. "We've faced significantly worse" fiscal problems in the past, Giuliani says, including crunches in 1994-95 when Wall Street and the real estate market were still suffering from the bust at the end of '80s.

But things will get gloomier next July. That's because this year's budget is using up most of a $2.9 billion surplus left over from the roaring '90s. "Clearly the city is going to have a tougher time with next year's budget than they thought they would," says Colleen Woodell, credit analyst at Standard & Poor's. And Washington is already wary of an expanded commitment. Indeed, Governor George Pataki is going beyond Giuliani's reimbursement request and asking for $54 billion. Says Assistant Senate Minority Leader Don Nickles (R-Okla.): "We have a lot of money for New York in the pipeline right now. Let's see where that goes."

So far, all three major debt-rating services are sticking to their investment-grade opinions of city debt, figuring that regions hit by natural disasters tend to get a short-term boost from rebuilding. City bonds are in such demand that they are trading at yields only 0.15 percentage points above AAA-rated municipal debt, New York's lowest level in several decades, says Michael Roberge, a portfolio manager at MFS Investment Management. Much of the appeal is due to New York City's hard-won goodwill from investors for its relatively clean accounting.

SOUND MANAGEMENT? But if taxpayers begin to flee, New York could be caught in a downward spiral, making it hard for a city already awash in debt to borrow more. Indeed, debt has nearly tripled since 1990, from $11.8 billion to $33 billion as of December. In addition, $2.5 billion of debt is still outstanding from Municipal Assistance Corp., the entity created in the 1970s to give the city time to pay its bills. Add in capital lease obligations, and city indebtedness is $40 billion--or $4,800 per capita, the highest in the nation, according to the city comptroller.

Why did New York let its debt grow so during the fat years? Giuliani insists it was sound fiscal management, and that debt maturities were staggered so that just 26.5% comes due over the next five years. If the city had used its surplus to pay down debt, it would be short of cash now and "near bankruptcy," the mayor says. But critics say New York should have paid more of its rebuilding costs out of its annual budget. That makes sense, given the constant and intense wear and tear on city structures. Also, paying more along the way would have cut interest costs and left more leeway to borrow as a last resort.

Now, the city will likely have to scale back its capital plans. Victims may include desperately needed new classrooms, as well as subway-line extensions and parks. As the patriotic cheering for New York dies down, city officials will face the grim reality of having to do more with less.

By David Henry

With Steve Rosenbush in New York and Lorraine Woellert in Washington

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