'Now Everyone Is Really Scared'

"We are running hard just to stay even, and that cannot go on indefinitely." So warned Investment Banker Felix Rohatyn last week as he and New York State officials desperately glued together yet another financial "solution" designed to keep New York City from defaulting on its myriad loans--for the time being.

The newest crisis was precipitated by the state court of appeals when it upset a key part of last month's "solution"--a complex scheme approved by the state legislature to raise $2.3 billion to support the city until December.

Among other things, the legislature had directed State Comptroller Arthur Levitt to invest $125 million from two state employees' pension funds in bonds is sued by the Municipal Assistance Corporation (Big Mac). In addition, the state was to try to borrow $750 million and then promptly lend it to Big Mac (TIME, Sept. 15).

Delicate Refusal. But two unions representing state employees went to court to prevent any of their $7.2 billion pension funds from being invested in the tottering city. The court ruled that the legislature did not have the authority to order Comptroller Levitt to buy the bonds. The court did not forbid him, however, from buying them if he wanted to. Despite pleas from Governor Hugh Carey and Mayor Abraham Beame, Levitt showed no such desire.

Rather delicately, he explained that al though the Big Mac bonds were a "sound security"--of which he had already bought $25 million--any further pur chases might "unbalance" the funds' portfolios. Other experts suggested that the fiscally conservative comptroller might well fear that buying more Big Mac bonds could eventually leave him open to accusations of irresponsibility.

Whatever the reason for his opposition, it helped cause another fiscal crisis for the city on the very next day.

The state had already issued $250 million in notes as part of its share of the bailout scheme. But some of the financiers who handled the deal had been stuck with an estimated $100 million in notes they could not sell. After Levitt's refusal to buy more Big Mac bonds, the bankers told MAC Chairman Rohatyn that they could not sell the remaining $500 million of the state's $750 million share at this time.

The twin setbacks sent Big Mac bond prices plunging as low as 75-c- on the dollar. Even worse, investors' lack of confidence spread to state securities that had no connection with the city's crisis. The state's housing finance agency was unable to refinance $69 million worth of securities and warned that it might have to default and stop work at dozens of housing, hospital and nursing-home construction projects. The city again seemed headed for default--this time on Oct. 17, when $450 million in debts came due--and officials feared that the state might be pulled down as well, even though it is in basically sound financial shape. Said one discouraged expert of the situation: "This is the first time I've felt we've had it." Added a city official: "In the past, the state had the credit, and the only question was whether it would be used. Now the state's credit is in danger, and everyone is really scared."

At the last minute, however, Carey and Levitt devised another temporary fix, by legerdemain. Although Levitt would not buy MAC bonds, he did agree to buy $250 million worth of the otherwise unsalable state notes, thus providing the state with money to lend to the city. In addition, Levitt said he might "conceivably" buy another $250 million worth of state notes, if they could not be sold to anyone else. That should enable the city to get through October and probably November.

Even so, the crises left the city's overall fiscal situation still worse than before. The supply of financial tricks to keep New York afloat is just about exhausted, and the state's credit has worsened. To officials' dismay, Moody's Investors Service last week lowered its rating on New York State general-obligation bonds, from A a to A 1, which could cost millions of dollars in higher interest. At the same time, Moody's knocked down its rating on New York City bonds by two grades, from A a to A l, a category in which bonds are "judged to have speculative elements."

Last Resort. In search of a permanent solution, Carey and Rohatyn journeyed to Washington again to lobby for help from Congress. At their request. Democratic Senator William Proxmire of Wisconsin scheduled hearings before his Senate banking committee this week on an array of bills to aid the city. Because of overwhelming congressional opposition to a direct subsidy, most attention has focused on one proposal that would authorize federal guarantees of state securities designed to help finance local governments. The proposed legislation would make the guarantees available only as a last resort.

Carey and Rohatyn were further encouraged by Federal Reserve Chairman Arthur Burns' warning before the House Budget Committee that the New York City financial crisis "could injure the recovery process now under way in our national economy." Burns would not elaborate on that statement, but it is a significant shift in his position and puts him at odds with Treasury Secretary William Simon and President Ford. Simon and Ford have consistently minimized the damage a default by New York might have on the ability of other cities and towns to sell bonds. Both also have firmly opposed federal help for the nation's largest city.

But time is running out. Rohatyn warned that without federal help, New York may have to default by December. That would ruin the city's credit, force a drastic cutback in services and probably cause an exodus of major corporations. Said he: "The flow of blood would be irreversible."

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