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2008: The Year the Good Times Ended?


As the new year begins, recent reports suggest that economic prospects for 2008 look rather bleak, but that fiscal prospects, at least in the short run, look manageable. The city projects a yawning $6.5 billion budget gap for fiscal year 2011. But mayors and city councils tend not to worry that far into the future. In the shorter term, while the city anticipates a decline in revenues, money from last year's budget surplus and Mayor Michael Bloomberg's October directives calling for immediate cutbacks in city spending seem to provide a cushion.

The economic slowdown and its effect on city coffers are likely to rule out any major new spending initiatives in the mayor's preliminary budget for next year, which will be released shortly. The city's capital budget, though, continues to climb. The economic uncertainly also raises questions about whether city can continue to cut its property tax rates and still maintain services.

Feeling Wall Street's Pain

The city's reliance on tax revenues from Wall Street bonuses and profits explains the glum forecasts for 2009 and beyond. "The ongoing turmoil in the credit and housing markets will have serious implications for the city's economy.... The greatest risks ... are a sustained downturn on Wall Street and a housing-induced recession," according to the state deputy comptroller's December report on the city's October budget modification.

While the city's forecasters do not anticipate a recession, in October they project a slowing economy and a decline in job growth from 62,200 new jobs in calendar year 2006 to only 12,100 in calendar 2008. The city does not, however, anticipate a recession.

The city comptroller's December report on the city's economy and finances notes that "the unfolding sub-prime mortgage debacle and its collateral effects on credit marketsâ threaten both the national and local economies. The resulting financial losses and layoffs, however, are likely to fall disproportionately on New York firms and workers.

The mortgage crisis has already had a significant impact on Wall Street profits. As a result, the earnings of the city's financial firms are likely to be down significantly from 2006 levels -- along with the associated bonuses, which last year reached a record $34 billion."

The state Financial Control Board's December report notes that worries about the city's financial services industry led the city in its October modification to reduce projections of revenues from sources other than the property tax by $576 million in the current budget year, including a reduction of $207 million in the personal income tax and $256 million in property transfer and mortgage recording taxes.

The city also cut back its estimates of non-property tax revenues for fiscal years 2009, 2010 and 2011 by $1.1 billion, $1.2 billion, and $1.5 billion, respectively.

The control board sees an additional concern: inflation. The city projects that inflation will drop from 3.2 percent in 2006 to less than 2 percent a year from 2009 to 2011. The board, though, points to higher gasoline, other energy and food prices that make it "difficult to see how an acceleration of inflation could be avoided without a recession."

Endangered Tax Cuts?

All of this could affect taxes. Will the city continue its program to cut property tax cuts? The cuts -- a 7 percent reduction in the property tax rate (costing about $750 million) and a $400 rebate for residential homeowners (costing $250 million) -- are built into each of the next three years of the city's financial plan, contributing to the projected deficits. The mayor has said that maintaining the cut wills depend on economic and fiscal conditions.

The importance of the tax-cut question is highlighted by the state deputy comptroller's report. It pointed out that the city will spend $3.3 billion more this fiscal year than it will take in in revenue. It will bridge the gap, though, with funds from last year's budget surplus. That money is paying for the $1.3 billion in tax cuts and $2 billion in new expenditures this fiscal year.

Since the projected budget gap for 2009, which the preliminary budget will have to fill, has grown from $1.55 billion to $2.7 billion since June, the extension of tax cuts as well as new expenditure cuts should become part of next year's budget discussion.

Not only will the mayor and council have to review the arguments for continuing the property tax rate cut and rebate, but they will also have to push the state legislature to keep the current city sales tax rate at 4 percent. The city sales tax rate falls to 3 percent in July with the demise of the Municipal Assistance Corp.

MAC was created in 1975 by the state to create a bonding entity that raised the money to bail the city out of its near-bankruptcy. As part of that state legislation, the city sales tax was raised from 3 percent to 4 percent to assure the payment of debt service on the MAC bonds. Those bonds have now been paid off.

The city's financial plan assumes the sales tax will remain at 4 percent, but the state will have to pass legislation authorizing that rate. Well over $1 billion in city sales tax revenue is at stake.

Expense Budget Trends

The monitors highlight several interesting trends regarding city spending. Expenditures grew an average of 10 percent a year in 2004 and 2005 and 8.6 percent a year in 2006 and in 2007, according to the state deputy comptroller. (The rate for the latter two years includes $2.5 billion that was placed in a reserve fund, the Retiree Health Benefits Trust Fund.) This was well above the rate of inflation.

In 2008 the same report projects an increase of 5.6 percent in spending, and, from 2009 to 2011, an increase of 4.8 percent annually. This is lower than in the earlier years but still more than twice the projected inflation rate.

The expenditures are dominated by so-called non-discretionary spending: debt service, Medicaid, pensions and other benefits for city employees. These are expenses the mayor has little or no control over because of debt obligations, labor contract agreements, and federal/state mandates.

In fact, non-discretionary expenditures account for most of the expenditure growth. And, most importantly, their share of all expenditures has been growing rapidly. In FY 2003, 37 percent of city-funded expenditures were non-discretionary; in 2011 an estimated 49 percent will be non-discretionary. Growth in debt service is a big part of this increase, up 26 percent between 2008 and 2011, to $6.1 billion in 2011.

Where the Growth Is

The big increase in the capital budget may eventually define Bloomberg's fiscal legacy. As the state deputy comptroller notes, city-funded capital budget commitments will increase by 71 percent this fiscal year alone, to an all-time high of $8.3 billion. For the next four years, city-funded capital commitments will total $27.1 billion.

The rapidly growing capital budget means more new schools, more mass transit, more affordable housing, more environmental protection, etc. But, as the city comptroller's December report shows, the debt service that pays for the capital budget is part of the city's operating budget and will eat up an increasing percentage of city revenues -- from 11.8 percent in 2007 to 15.4 percent in 2011. That means there will be less funding available for discretionary services, such as education, housing, libraries, parks, and youth, senior, health and other social services.

In his October modification, the mayor began planning his first cutbacks in expenditures, by setting a hiring freeze in most agencies and asking all city agencies to find 2.5 percent in cuts this fiscal year and 5 percent next year. That would save $500 million and $1 billion, respectively.

We will soon see if these actions, in response to the bleak revenue prospects, keep the current financial plan manageable. If it does not, the city may have to revisit its long-term commitment to tax cuts and its very ambitious capital program.

Glenn Pasanen, who teaches political science at Lehman College, has been in charge of Gotham Gazette's finance topic page since 2001. 

Could Wall Street's Woes Be Good for New York?


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 for 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 polled by the Wall Street Journalrecently 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 mortgages.

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 – 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 increasing 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, lamentsthe 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 worriedthat 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 – 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 – 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 workers.

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.

After the "Financial Emergency"


Why would the mayor of New York City welcome the extension of a state finance law that dictates a state takeover of city finances if the city has a year-end deficit of $100 million or more?

Generally mayors would not want to see state government usurp one of their most important powers. But at a panel discussion last month sponsored by the Center for New York City Affairs at the New School and the Independent Budget Office. Mayor Michael Bloomberg’s budget director, Mark Page, indicated the administration would be happy to see the existing law survive after its July 1, 2008 expiration date because it “had served a very useful function."

The Financial Emergency Act was enacted in 1975 to resolve the severe city budget crisis. It has permitted the mayor to roll over multi-billion-dollar budget surpluses into the next fiscal year. One speaker at the panel discussion, former state budget director Dall Forsythe, characterized this process as a “synthetic rainy day fund” controlled by the mayor.

The mayor apparently wants to protect his discretionary budget powers. If the law was amended rather than simply extended, it could limit mayoral fiscal discretion by requiring that City Council’s approval for any plan to roll over funds for the following year’s expenses.

It would thus create, as one panelist, former City Council staff member John Banks, said, a “more robust debate” between the mayor and the council on budget matters and likely give new fiscal power to the City Council. The council’s speaker, Christine Quinn, has proposed just such a “rain day fund.” So far there seems to be only weak political support for Quinn’s proposal.

WHAT IS AT STAKE

The Independent Budget Office, in a background paper, “July 1, 2008: An Opportunity for a New Framework,” set out several issues that could be addressed in a revision of the Financial Emergency Act.

Moving Surpluses from Year to Year

The city is legally obligated to have a balanced budget. But what does that mean exactly? Does that mean that this year’s revenues must cover this year’s expenses — without any operating deficit or surplus? That would preclude operating surpluses or deficits – or multiyear roll-overs.

The roll-over, or roll, employed by the Bloomberg administration lets the city pre-pay bills for the following fiscal year. This gets around the current state law that says the city can’t end the year with a surplus. Use of this budget tactic gives the mayor a tremendous leg up in balancing the next year’s budget. The down side is that the city is using one-time carryover revenues to balance its budget; there’s no guarantee a similar surplus will be available in another year.

The method also presents a transparency problem for budget analysts and the general public. The way in which one-time surplus revenues are reported in budget documents obscures the actual balance between revenues and expenditures during any single fiscal year. Although a fiscal year may be “balanced” because of the carryover, the city could be spending more that year than it is collecting in revenues.

The state deputy comptrollerfor New York City in his reports on the city budget has adjusted for the use of carry-overs. In his December 2007 report, he found that in four of the most recent eight fiscal years, including 2008, current-year expenditures exceeded current-year revenues. In 2008, he estimates current-year expenditures will exceed current-year revenues by $3.3 billion.

The transparency problem has grown as the mayor has expanded the carry-over tactic, rolling 2007 surplus dollars not only into the current2008 fiscal year, but into 2009 and 2010 as well. In October, faced with a new budget gap that created by lower tax revenues and higher labor costs, Bloomberg took, nearly $300 million of the 2007 surplus that had been scheduled to balance the 2009 budget and used it to re-balance the 2008 budget. (Simple as pie, right?)

Should the city make the roll-overs more understandable, by establishing a rainy day fund with explicit rules for using the surplus funds? Would this require changes in city law, state law or the City Charter.

The State’s Job

Another issue involves the role of the state Financial Control Board. Should it review only city finances? Retain its current power to take over the city budget should the city have a year-end deficit of $100 million or more? Should the takeover trigger be higher than $100 million to reflect inflation and increased city spending?

In addition, the IBO notes that Speaker Quinn has proposed new reporting requirements for so-called “covered organizations,” quasi-public agencies that administer city services but are not under direct city control, such as the Health and Hospitals Corporation, New York City Transit, the New York City Housing Authority and the Battery Park City Authority. The IBO suggests requiring more disclosure by other “off-budget” organizations created by the city, such as the Economic Development Corporation, the mayor’s quasi-independent economic development office that worked under a $1.2 billion city contract in 2007; the Water Authority and the Hudson Yards Development Corporation, which oversees the development of the West Side of midtown Manhattan.

The Council’s Responsibility

The opportunities for a greater City Council role in city budgeting are rare. Structurally, the council is hamstrung in many ways. Its budget staff, for example, is dwarfed by the mayor’s Office of Management and Budget. The mayor’s budget office has a 2008 budget of nearly $32 million. The council’s equivalent office, its finance division, has a personnel budget of $2.95 million. OMB has a staff of 325, the council finance division, has 38 (up six from 2007).

Then there is the problem of term limits. One of the unrecognized consequences of restricting City Council members to two consecutive terms is that it discourages continuity in council budgeting expertise. In practice, the speaker gets only one term (it’s unlikely a first-term council member will get elected speaker) and so any finance division director the speaker appoints is likely to serve a maximum of four years. Furthermore, in recent years a number of top council finance staff has moved to OMB or other mayoral offices, which apparently offer more opportunities.

LOOKING TO THE FUTURE

In many respects, this might be a good time to have a broader debate about the Financial Emergency Act. There may be some tough decisions ahead, so why not try to have more information available and more actors engaged?

The administration’s October budget modification, for instance, has some sobering numbers. It projects a $6.5 billion deficit for 2011 (up by $2.1 billion since June), which, according to the state deputy comptroller, represents nearly 15 percent of city fund revenues and the second-largest gap at this point in a fiscal year since 1981.

That 2011 gap is nearly as big as the one the city faced in November 2002. In that case the mayor acted quickly and unilaterally. The next time the city faces such fiscal hard times, though, it might be good to have more information and a broader consensus in decision-making. A new law could help accomplish that.

Glenn Pasanen, who teaches political science at Lehman College, has been in charge of Gotham Gazette's finance topic page since 2001.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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