DEAR Gov. Paterson: As you took office yester day, you referred to Wall Street’s continuing meltdown and noted that “our economy appears to be headed toward crisis,” adding that you’ll start meeting with government and business officials to “adjust the budget accordingly.” If you meant budget cuts, you should stick with this strategy, even as you face pressure from others in Albany.
It’s likely that you’ll hear from legislators and lobbyists who argue: We don’t know what’s going on yet with the fi- nancial world. One day the market’s up 400 points; another day it’s down 200. One day the talking heads are saying the crisis is over; the next day, a huge investment bank, Bear Stearns, is going under.
So why not stick with the status quo, they might say: Fund former Gov. Eliot Spitzer’s proposed spending increases despite a $4.5 billion deficit – whether through borrowing or a temporary tax hike or both – so as not to cause any angry lobbyists and their constituents to hold big rallies just as you want things to calm down. Then hope that Wall Street’s problems mysteriously go away, just as they mysteriously appeared.
But the risk of sticking with the status quo is far worse than the risk of cutting spending now. Why?
Forget subprime mortgages, credit crunches, derivatives and counterparties. You just have to remember one thing about the state budget as it relates to Wall Street: Assets create income. The state government gets its income – “revenue” – from New York’s private-sector assets.
The biggest concentration of those assets is in Gotham’s financial industry. The trillions Wall Street has loaned to homeowners, commercial builders, buyout companies and the like – those are assets, because Wall Street uses the profits from those loans to make new loans and employ tens of thousands of people. The value of the stock market is an asset.
But the biggest assets are the firms and workers themselves, those people who are constantly thinking up new financial-industry products to make new profits and send new tax revenues to Albany.
Right now, the value of all of these assets is plummeting. Banks have seen $150 billion in assets vanish because of the crisis that started in subprime mortgages. The market thinks many of those particular assets are worth almost nothing.
Just look at Bear Stearns. Last year, it was worth $20 billion, but today the Fed and J.P. Morgan, which wants to buy what’s left, think it’s worth just $250 million.
More pain is coming, because banks and their customers became so reckless with their lending and borrowing a few years back. Every time you hear the words “asset write-down” or “asset fire sale,” you don’t have to bother about the details. You just have to think that’s a little bit less money New York state will have to spend – not just this year but indefinitely.
That’s because as the banks see the value of today’s assets fall, they have less money to create new assets. They can’t invest in new people or products; they can’t even keep the old ones around.
Plus, the investors whom those banks need to replenish their assets are rethinking the value of the banks’ human capital – of New York state’s most lucrative human assets. They’re wondering: If these bankers screwed this up so badly, how much are they really worth? Is this industry worth any more of my money?
It may take the financial world a long time to win back the trust of its investors and customers. Until it does, New York’s asset base will suffer severely.
To see what that means for the state budget, think of Wall Street’s assets as a trust fund that supports spending, just as trust funds support some wealthy people. After a decade of good times, a wealthy person’s investment adviser might say: Based on the value of the assets in your trust fund, you’re a pretty rich guy. You can spend $5 million dollars a year and increase that spending every year, because these assets just keep growing, creating more income.
But what if those assets stop growing and even lose value? A responsible adviser would say: Look, you’re going to have to cut back, because these assets aren’t generating that much income right now. You’re not going to like it, but it’s better to cut back a little now – say, 5 percent – than to have to cut three times as much next year.
What if the person doesn’t listen? The answer to that is easy. To fuel too high spending, he’s going to have to sell off assets, because keeping those assets and watching them grow isn’t generating enough money anymore. By selling assets, he’s hurting future income. He can’t do this forever, however – and is only delaying pain.
It’s the same thing with New York.
Governor, if you choose to go along with what the Legislature might pressure you to do and try to borrow and tax your way out of this crunch, it’s just like selling off your good assets to generate income today at the expense of the future. Raising taxes on the wealthy, for example, will push some high-income New Yorkers – assets – away. Borrowing for operating expenses has another negative effect, because every dollar we borrow to plug a deficit is a dollar we didn’t invest in such infrastructure as roads and bridges, which are assets that help the private sector create income.
Gov. Paterson, the prudent thing to do is to start to cut spending now, to give the state’s private-sector assets a chance to recover.
If the state recovers quickly, the worst that could happen is that next year or the year after, you’ll have to fend off the same lobbyists who will be back around lobbying for yet higher spending. But if it doesn’t recover quickly, delaying action now will make it much harder later.
Nicole Gelinas is a contributing editor to City Journal. From city-journal.org.