July 1, 2009 @ 4:24 pm
[Note: It’s a long and, we hope, an interesting story. Unavoidably, we have to tell it in bite-size installments. But if ever a story embodied George Santayana’s observation those who cannot remember the past are condemned to repeat it, this is it.]
In the first of four winning campaigns, Nelson Rockefeller was elected governor in 1958. He also won voter approval for a $100 million bond issue to build Mitchell-Lama housing. The bond issue had gone down to defeat in the Harriman administration under an avalanche of propaganda led by the Real Estate Board of New York.
REBNY had called the program “socialism,” but it was hard to pin that label on a Rockefeller. $100 million was just the ante. Nelson quickly became the most prolific builder, borrower and spender in the state’s history. Insiders called it Nelson’s Edifice Complex: Like Mike, Nelson generally got what he wanted without going to the voters.
When I was up in Albany, the story making the rounds was that when Meade Esposito, the Brooklyn county leader, admired a Picasso drawing hanging on the wall of Rockefeller’s office suite in midtown Manhattan, the governor got out of his chair, took it off the wall and handed it to him. Maybe it happened, maybe not; nobody seems to know for sure.1 The fact that folks in Albany believed it says something about Rockefeller’s singular grip on the state’s political and governmental machinery. Here’s how he scaled up the Mitchell-Lama program to multibillion dollar levels that eventually triggered New York City’s 1975 fiscal collapse.
Like many politicians, his signature mechanism for achieving a political objective was to establish a task force or blue-ribbon panel. In this case, it was the Task Force to Devise Measures for Significantly Increasing the Supply of Middle Income Housing. As is almost always the case, the governor knew going in what recommendations he wanted coming out. The task force recommended that the state leverage the $100 million bond proceeds into a $300 million fund.2 Banks, insurance companies and other institutions, or so the task force claimed, would lend two thirds of a project’s financing at 1 percent below market.3 The leveraging plan could finance about 21,000 units of moderate-income housing — triple what could otherwise be built. A state agency would oversee the construction and service the mortgages.
Rockefeller established the Limited-Profit Housing Mortgage Corporation, a pooling mechanism that enabled lenders to invest in the corporation’s mortgage-backed securities rather than in individual projects. This, it was claimed, would reduce risks. (Sound familiar?) Still, with only rental revenues backing the debt, the lenders wanted higher interest rates. But that would drive up costs and undermine the program’s purposes. Rockefeller was undeterred.
Until then, lawyers opined that the only way he could get lower interest rates would be to have the state issue bonds backed by its full faith and credit—general obligation bonds. That way bondholders wouldn’t have to rely solely on rents to pay down the debt; they could tap the general treasury. Lawyers said those bonds would need voter approval, which would be a tough sell.4
John Mitchell, a bond lawyer who went on to become Nixon’s attorney general, is credited with the concept of moral obligation financing.
[When] Nelson Rockefeller was elected the Governor of New York in 1958, the voters turned down all of the propositions that had to be voted [on] under the state constitution—for housing, mental health, etc. His director of housing was telling me about the state’s problems.
In order to keep the interest cost down and have a security that would be marketable, I transferred over to the Housing Finance Agency (HFA) a concept [of moral obligation bonds] that had been used temporarily in connection with school districts. I just took that and adapted it to the Housing Finance Agency and structured the mechanics of it. It went very, very well and the bonds were marketable, the interest rates were more than reasonable, and, of course, we took it from there.5
Legally, these moral obligation bonds weren’t state liabilities. Thus bondholders would have to look only to project revenues – rents or maintenance payments – for interest and repayment of principal. But written into the bond resolutions was a clause providing that if debt service reserves came up short, the agency that issued the bonds would have to present the shortfall to the governor and legislature who, in turn, would be “morally obligated” to appropriate the funds. If the lending institutions bought into the scheme—and remember this was Nelson Rockefeller whose brother David ran the family bank, not to mention all the other interconnected mega rich—the issuance of moral rather than general obligation bonds would keep interest low and finesse the constitutional requirement for voter approval.
The lawyers faced one last hurdle: federal law only allowed commercial banks to underwrite bonds backed by the state’s full faith and credit (i.e. general obligation bonds). Rockefeller’s lawyers argued that for purposes of federal law, the moral obligation bonds were really general obligation bonds, but for purposes of the state constitution, they weren’t. Thus, they claimed, the state could issue the bonds without voter approval and without violating the state constitution, and the banks could sell them without violating federal law. We are fond of saying that we have a government of laws not of men, but given a powerful chief executive; the lawyers will generally find a way. Think Alberto Gonzales, the “quaint” Geneva Conventions, and the torture memos.
The U.S. Controller of the Currency approved the bonds for investment and sale by the banks. State comptroller Arthur Levitt warned against this form of financing but he couldn’t stop it. In 1960, the governor authorized the New York State Housing Finance Agency (HFA) to lend $1 billion directly to Mitchell-Lama developers.6 The money would come from the sale of moral obligation bonds.
That’s when things really got interesting. John Mitchell’s concept enabled politicians around the country to borrow large sums without going to the voters; it was a license to print money.7 By 1975, thirty states had established public authorities to float billions of dollars in moral obligation debt.
There’s always a public purpose rationale, but for a program to survive and thrive, the real issues are: Who pays? How much? Who benefits? Who controls? Some answers were plainly visible from the wording of the Mitchell-Lama law; others were hidden even from the legislators who voted for it; still others emerged only years later. Some methods the insiders used to take the public money off the table were richly imagined, while others were run-of-the-mill corrupt practices. Similar schemes are still around. We’ll describe them next time.
(TO BE CONTINUED)
– Neil Fabricant
A friend who was in a position to know told me that Rockefeller had loaned the Picasso to Esposito; he didn’t know whether it had been returned.
Public Papers of Governor Nelson A. Rockefeller, pp. 841, 842.
The initial projects received the state loans at 4 percent for fifty years. The private financing would be at 5 percent for thirty years, or one half of 1 percent below the market rate.
To finance projects such as toll roads and bridges, where project revenues — the tolls — can be counted on to pay off the bondholders, tax-exempt revenue bonds that carry relatively low interest rates can be sold. The state needn’t pledge general tax revenues. For subsidized housing projects, however, where rental revenues are less certain than bridge tolls, bondholders want either higher interest rates to compensate for additional risk or general obligation bonds—that is, general revenues, the use of which require voter approval.
As cited in Edwin Rubenstein, “Cranking the Debt Machine,” City Journal (Winter 1992).
In 1971, Albany authorized New York City to establish the Housing Development Corporation, with the power to raise $700 million through bond sales.
For a good explanation of the different forms of state debt, see Charles R. Morris, The Cost of Good Intentions (New York: W.W. Norton, 1980), p. 199 et seq.
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