"When the crunch comes in any city," Frank Raines observed, "you have to decide who gets paid, the bondholders or the cops. Washington decided to pay the cops. It sends a message to the people who make the credit ratings."
That summarizes Raines' analysis of the real significance of the changes the D.C. City Council made last week in Mayor Marion Barry's proposed budget for 1982. In Raines' view, the Council's amendments undermined the fundamental premise of Barry's overall financial plan for the city, which calls for paying off the city's debts and establishing its credit worthiness as a borrower in the commercial money markets.
Raines, a former member of President Carter's domestic policy staff who now works for the New York investment banking house of Lazard Freres, is Barry's chief financial adviser. He devised the long-range strategy with its emphasis on borrowing in private markets instead of from the U.S. Treasury, but he said he felt no "pride of ownership" in the plan and did not take personally the inroads the council made in it.
Raines is philosophical about the course he thinks the District of Columbia has chosen for itself. He would make more money if the city carried out his program and went into the private bond market, he said, but "if the city wants to reject this plan and give up any chance for fiscal independence and stay tied to Congress, it's all right with me."
In fact, neither the City Council nor Congress nor any other group actually has voted on Barry's comprehensive rescue plan as a package. But the budget for the 1982 fiscal year, which begins next Oct. 1, contained provisions for implementing critical pieces of the overall strategy. Those provisions called for putting money aside to finance the city's entry into the private borrowing market, but they did not survive the council's determination to find more money now for the immediate needs of payroll and services.
The District of Columbia always has done all its borrowing from the U.S. Treasury. That is true of both long-term capital project funds and short-term cash advances drawn to tide the city over fallow periods between tax collections. Therfore, unlike other cities that experience financial difficulty, notably New York and Cleveland, Washington does not owe any money to banks and never has issued any bonds.
According to Raines, city administrator Elijah Rogers and other city officials, that is the reason the city is able to keep functioning and meet its payrolls even though its liabilities exceed its assets. The Treasury is a tolerant lender; as long as the city can dip into it for needed cash it can continue to operate -- just as the Chrysler Corp continued to operate despite its losses when lenders were found to provide the needed funds.
For a variety of reasons, however, the mayor, Congress, and Lazard Freres want the city to end the Treasury tie and borrow commercially, as do all other American cities. That was the objective of Congress in creating a Financial Oversight Commission to impose a computerized accounting system that would bring order out of the chaos of the city's books, and it was the overriding goal of the financial plan that Barry proposed last July.
One reason is that the home rule charter presumes that the city will stop borrowing from the Treasury. The District of Columbia's authority to do so has been extended by Congress on a year-to-year basis because the city has not established itself as a creditworthy borrower. If Congress were to revoke that authority or if the White House were to curb it, the city could be left without any source of credit.
A more important reason is that it is very expensive to borrow long-term money from the Treasury. Municipal bonds, exempt from U.S. taxes, could be sold at interest rates several points below what the Treasury charges, saving millions of dollars on each loan. In addition, according to Raines, the cost of private borrowing is reduced further because all the funds are drawn at once and they can be invested by the city, earning some of the interest back, until they are actually expended. The Treasury does not permit the city to do that.
The long-range financial plan is aimed at facilitating the switch to private borrowing by balancing future budgets and paying off a cumulative deficit estimated at $409 million, to convince potential lenders that the city's fiscal house was in order and satisfy potential bond purchasers that their payments would have priority on the city's resources. The council, in its amendments to the budget, struck out three critical chunks of money earmarked for fulfilling those objectives, and transferrd the funds to current needs -- mostly salaries. In Raines' phrase, they chose to pay the cops, not the bondholders.
First, the council took $10 million out of "debt service" and gave it to the public school system. Debt service is money used to pay principal and interest on existing loans, in this case to the Treasury. Part of that $10 million represented payments that the Treasury was willing to defer to a subsequent year; but the city's auditors, Arthur Andersen & Co., insisted that potential private lenders would require that the city follow generally accepted accounting principles, which in their view meant foregoing that deferral.
Then the council took out $2 million that Barry wanted set aside to pay interest on any short-term loans that the city might have to make with private banks. Short-term loans from the Treasury are interest-free, but loans from banks would be subject to interest, and Barry wanted money available to pay it.
Councilman John A. Wilson, chairman of the Finance and Revenue Committee, argued that there was no reason to borrow and be charged interest when it was still possible to borrow interest free, and the council diverted the $2 million into salaries and Fire Department operations.
Then the Council diverted $20 million into salaries that Barry earmarked to begin paying off a special one-time loan from the Federal Financing Bank, an arm of the Treasury, that Barry wanted to make this year. While that loan would not be on the private market, Raines considered it essential to the city's hopes of subsequently going into the private market because it would be used to repay debts that any potential lenders would insist on having cleared up before they would buy the city's bonds.
That diversion also was inspired by Wilson. He argued that the proposed loan, which would require congressional aproval, is unlikely to be made and therefore there was no reason to set aside money to repay it. He also argued that it was foolish to submit a budget to Congress that contained no money for salary increases, which Barry's did not, when it was clear that negotiations with the city's labor unions would result in a settlement costing at least $50 million.
Wilson later said he would accept a compromise in which $10 million would be restored to the proposed debt payment fund and the other $10 million left in the pay raise kitty. Either way, he argued, the city is going to face the need for a massive tax increase, perhaps enough to raise $217 million in one year and is going to have to go back to Congress for a supplemental appropriation for more pay-raise money when a salary package is finally negotiated with the unions.
The Home Rule Charter specifies that the city should switch to private-market borrowing. The reason it has not happened in the five years of home rule so far is that the city's debt, budget policies and bookkeeping systems were so mismanaged, Congress decided, that nobody would lend to the city. So an extension of the Treasury connection was made necessary.
The proposals in Barry's budget that the council overrode were attempts to begin doing what Lazard Freres and Arthur Andersen said was necessary to effect the switchover. In their debate, the council members did not oppose the principle of making the change, but their votes reflected the skepticism many of them have voiced about whether the overall plan can be implemented.
Before the vote, Barry wrote to the council urging that the $20 million loan-repayment fund be kept intact. "It is tempting to use this $20 million to add to other opearating budgets," he said, "but I urge us not to yield to this temptation. Moreover, to do so would again violate my basic principles of beginning to solve our budget problems now and not wait until the crisis is upon us."