AND then there were two.
In six months, New York City has lost three of its five top-tier investment banks. Bear Stearns and Lehman Brothers are history, with Merrill Lynch (to avoid the same fate) swallowed up by out-of-state Bank of America at less than half of last year’s value. Morgan Stanley and Goldman Sachs are the last two standing.
It’s impossible to exaggerate the gravity of the plight of Wall Street and of the broader financial sector – as well as the grave situation facing New York City and state.
After the blows of the tech bubble’s bursting and 9/11, New York lost 40,000 of its roughly 200,000 highly paid Wall Street jobs. This time around, it seems safe to say that job losses will exceed that figure by tens of thousands.
Those losses will ripple throughout the local economy. From 2001 to 2003, Wall Street’s job losses were about one-sixth of the total lost in the city. If that ratio holds, total losses could top 300,000 – nearly a tenth of all New York City jobs.
And there’s no reason why the ratio wouldn’t hold, or be even higher. In the last half-decade, New York became only more dependent on Wall Street, with the financial sector responsible for more than a third of total wages and earnings in the city. We’ll be lucky if this round is merely a worse version of the last drop.
Despite their losses from the tech bubble’s burst, the banks, their big customers and their investors were all basically OK. The financial institutions had done what they were supposed to do: make calculated bets. Yes, those bets lost, but the banks’ investors and best customers, knew (or quickly realized that they should have known) that tech stocks were risky.
This time, the banks weren’t offering a risky proposition that promised a potentially huge return, as with tech stocks. Instead, they bet hundreds of billions on something that they convinced their clients, lenders and shareholders was a perfectly safe proposition that would result in a fairly modest return.
The no-lose investment was to put money in houses and other hard assets like commercial office buildings and toll roads. The banks said that they had magically “structured away” any risk through careful, statistics-based engineering.
But when the housing bubble burst, it all came crashing down: All of that careful and expensive risk engineering was a mirage. The bare fact is that the banks failed at their one job: measuring and allocating risk. It’s as if a supposedly safety-conscious auto-maker had made cars that exploded upon impact – what customer would go back?
In short, it’s not the losses that are the problem – it’s the future.
The investment-banking and financial-services industries now have to shrink and fix themselves – and it’s not likely to be a quick turnaround. (The federal government’s Herculean efforts to slow the descent over the past year bought only time, not a miracle.)
Talking about the half-trillion in losses so far, in fact, is useful only because it shows how so much of the past half-decade’s worth of profits was an illusion. Consider: In 2006, according to the state comptroller, Wall Street earned $21 billion. Since then, it’s lost $33 billion – or all of those profits and more.
And tens of billions that flowed from Wall Street into New York’s state and city budgets over those years were just as illusory as the profits from which they came. Now we’re going to have to give them back – meaning (most likely) far larger budget deficits than we’d been expecting.
In early summer, state analysts figured that Wall Street bonuses would be down 20 percent this year. Today, such a decline looks like a fairy tale: Banks that don’t exist can’t give out bonuses. (And the surviving banks know that most of their employees have nowhere else to go if they don’t like what’s on offer.)
The city’s projected shortfall for next year was $2.3 billion; that will likely grow – and the following year’s gap of $5 billion could rise by another billion or even more.
City officials are still too complacent that the housing and office markets will continue to provide stable, even growing, tax revenues. In fact, when there’s no rich investment banker to buy that house or work in that office, it’s worth less.
Mayor Bloomberg should make clear to the public that the answer can’t be small-scale budget cuts and emergency tax hikes while we wait for things to become great again. What worked six years ago won’t work now, because this industry’s recovery might be measured not in years but in half-decades.
New York needs to find new jobs to replace those that will be lost – something that will be hard enough without the city making it harder by adding to the burden on the private sector. That is, we can’t afford to be the stubborn landlord who won’t cut the rent when the market changes, and so gets stuck with an empty storefront.
Instead of trying to cut from the current baseline budget, the mayor and City Council should quietly, calmly start with a budget of zero – and figure out what spending is essential over the next three years to maintain quality of life and humane social services (while also continuing to pay our contractual obligations, like debt costs). If city employees don’t want layoffs, they can start negotiating for pay and benefit cuts. Otherwise, they’ll find there are few taxpayers left.
The era of the luxury city that can spend indiscriminately may be over.
Nicole Gelinas is a contributing editor at City Journal.nicole@city-journal.org