Even though stock indices may have rebounded from their late November lows,
the market remains volatile, and the economic outlook has taken a decided turn
the worse. A credit crunch has emerged on Wall Street with the sudden aversion
among banks to lend because of the uncertain value of collateral when almost
everything is tainted by years of sub-prime mania. The Federal Reserve took unprecedented
actions last week out of fear that the credit squeeze will lead to a serious
slowdown, possibly a recession over next few months. Leading economic forecasters
by the Wall Street Journal
recently put the chances of a recession at
38 percent. In the financial press, “toxic” has become the adjective
of choice in describing many of the once-revered “creative” financial
instruments linked in one fashion or another to sub-prime mortgages, the high-interest
loans financial institutions gave to those who could not qualify for more conventional
Wall Street’s implosion justifiably has produced much hand-wringing among
budget makers in City Hall and Albany regarding tax revenues. It seems clear
by now that the dot-com bubble was no fluke. The Wall Street resurgence and boom
since 2003 was largely inflated by real estate and sub-prime lending and spending.
Can Wall Street do well only by doing things imprudently -- and on a gigantic
scale at that?
Wall Street’s booms are certainly good for the city and state’s tax
revenues (the busts certainly aren’t), but are the booms good for the broader
economy? Might there be a silver lining in Wall Street’s comeuppance?
The Boom and New York
In many respects, the Wall Street boom of this decade was not that good for the
New York economy or for the nation.
Wall Street is often referred to, aptly, as the main engine of the New York City
economy. When it revs up, it becomes turbo-charged, generating high incomes and
tax revenues. Yet it also belches out the urban equivalent of diesel exhaust,
affecting the quality of life for everyone else. Soaring Wall Street incomes
helped fuel the demand for luxury housing, pushing up housing prices throughout
the five boroughs and pushing out many middle-class people in the process.
Wall Street’s aggressive lending and marketing practices were as responsible
as anything for the sub-prime debacle. The reverberations of collapse have been
felt in New York City neighborhoods far from the financial district. Thousands
of Residents moderate-income
New Yorkers, many of them once worthy of more conventional credit, have suffered
from the implosion of the sub-prime bubble.
Steering the Economy â€“ But Where?
Wall Street has taken center stage on the national economic scene. The trajectories
for the last two economic cycles have been determined largely by Wall Street’s
bubble machine. First it was the dot.com and telecommunications bubble, then
the real estate and sub-prime bubble. While the Federal Reserve and government “regulators” deserve
a big helping of responsibility for not minding the money store, Wall Street’s
financial innovations helped pave the way for a debt-induced spending spree since
2001 with mortgage debt
four times as fast as wage and salary income. Easy money and mountains
of unsustainable debt won out over a real policy debate about how to revitalize
the productive economy in a more sustainable manner.
A dynamic financial sector is vital to a competitive, world-class economy. The
ability to raise capital and move it across sectors in response to ever-shifting
market conditions is essential to robust economic growth. New York City-based
Wall Street investment banks have taken over many of the functions historically
performed by commercial banks. Mergers, like the one between J.P. Morgan and
Chase, have created gigantic financial institutions that amass large pools of
capital and provide a wide range of loans, equity investments and other means
for corporate finance to grease the wheels of commerce in the nuts and bolts
economy producing goods and services.
The financial clout of New York-based Wall Street investment banks over the national
economy today rivals the situation in the late 19th and early 20th centuries,
before the advent of the Federal Reserve Bank and national regulatory bodies
like the Securities and Exchange Commission.
In a well-functioning economic system, the financial sector helps facilitate
business activity in the nuts and bolts economy. Wall Street’s role is
to help make the economic pie larger. What has happened, however, is that New
York investment banks have become the tail wagging the dog. Wall Street’s
focus has been on financial innovation in the service of more and more short-term
fees, regardless of their economic value or consequence. This has bred an undue
tendency toward speculation, with the prices of stocks and other securities pushed
higher and higher, drawing in unsuspecting investors.
In analyzing the financial market ills leading up to the 1929 stock market crash,
economics great John Maynard Keynes wrote: “Speculators may do no harm
as bubbles on a steady stream of enterprise. But the position is serious when
enterprise becomes the bubble on a whirlpool of speculation.”
More recently, John Bogle, founder and former chief executive of Vanguard mutual
funds, laments the rising share of the economic
pie going to the finance sector. Bogle notes that 25 years ago the finance sector
accounted for 6 percent of the profits of the Standard & Poor’s 500
large corporations. Prior to the recent market meltdown, the finance sector took
about one-third of corporate profits. Bogle estimates that hedge funds, mutual
funds, investment banks and the like “siphoned about $500 billion from
shareholder returns” in 2006.
Readjusting the Economy and Wall Street’s Role in It
It is not at all clear how long it will take for Wall Street to right itself.
Barely a year ago, Mayor Michael Bloomberg, Senator Charles Schumer and some
other prominent New Yorkers
worried that Wall Street was somehow losing competitive ground to London, Shanghai
and other global financial centers. They blamed government securities regulations
enacted in the wake of the Enron collapse. Now, it is more likely that there
will be calls to effectively regulate Wall Street so that the bubble-making machine
is de-activated in favor of a return to making money the old-fashioned way. The
problem was not that Wall Street was regulated too much but that it was not regulated
in the right way. Financial “innovation” run amok turned out to be
the real threat, not London or Shanghai. Those market centers also are plagued
by bubble tendencies and are in similar need of effective oversight.
As Wall Street regroups from its current woes, city economic policy-makers might
want to consider a different set of priorities. In City Hall, the focus could
be on really diversifying the city’s economy and using mega-development
projects to make the city more livable and more likely to produce good, middle-income
paying jobs. For the past few years, City Hall’s main real estate development
goal has been ever more space for huge financial trading floors â€“ a fixation
that is no more sustainable than the latest financial bubble. The big challenge
is to make sure that the jobs created in developments induced by city actions
pay decent wages and offer career opportunities that lead to the middle class.
New York will not have a middle class if it doesn’t have middle-class jobs.
In Albany, the state is still groping for an economic strategy responsive to
the needs of New Yorkers. While some observers are eager to write it off, manufacturing
still employs over a half-million workers in New York and remains the economic
backbone of many upstate communities. Several manufacturing industries, including
but not limited to ones deemed “high tech,” are highly productive
upstate. It is myopic to think that high value-added manufacturing â€“ microelectronics,
optics, ceramics, biotechnology, instrumentation -- will entirely desert the
U.S. or New York, with its world-class technical universities, advanced technology
research base and highly skilled manufacturing workforce. The state should identify
the strong performers among manufacturing firms, work to make them even more
competitive and ensure that they can retain and develop more highly skilled manufacturing
The state desperately needs to overhaul its economic programs across the board,
from Empire Zones to Industrial Development Agencies, to transform them from
giveaways and cronyism to strategic interventions addressing the failure of markets
to invest sufficiently in further advancing New York’s human capital assets
through skill training and research and development.
Both City Hall and Albany should also seriously pursue the many opportunities
now unfolding to develop green jobs promoting energy conservation and the production
of green building materials and other environmentally friendly manufactured products.
Economic sustainability is as desirable a goal as environmental sustainability.
Our current economy is anything but that. In the long run, the state and city
tax base will be more sustainable with an economy geared to providing ample opportunities
for more good-paying jobs as opposed to our current highly polarized, Wall Street-dominated
economic structure. With a strengthened and expanded middle class, New York will
have stronger and more vibrant communities.
James Parrott is deputy director and chief economist
of the Fiscal Policy Institute (www.fiscalpolicy.org). He has been studying and writing about the New York economy since
he landed in New York City a quarter century ago.Â
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