One of the most positive trends of the past few years has been an emphasis on creating a culture of entrepreneurship in New York City and State. Until the last few years of the Bloomberg Administration economic development had meant bribing existing large companies, companies that were shrinking over time and threatening to move away, to promise to keep some jobs in New York. Bribing them with tax breaks and subsidies. New York had played this losing hand for years. More recently encouraging people to start new businesses, and at the very least not throwing obstacles in their path, has been the policy. Here as elsewhere the trend has been to latch on to whatever is trendy – new and social media, information technology, biotech, artisanal food products, artisanal alcohol, Greek Yogurt – and ignore everything else. But at least there has been some sense that economic development means encouraging and providing an environment for acts of creation, not just taxing the suckers and transferring money to existing business and unions that are failing in the marketplace but contributing to political campaigns.
With the Democrats back in charge of City Hall I feared that economic development would revert to the bad old days. After all, Bill DeBlasio is yet another ambitious politician who will require campaign cash for his next move, and businesses that do not exist yet do not make campaign contributions. Moreover entrepreneurs have not been part of the Democratic Party coalition since the New Deal, which favored existing large corporations, and entrepreneurs have generally been seen by Democrats as a source of revenues and a foil to be demonized, while existing companies are seen as a source of jobs. The good news, according to some recent reports, is the DeBlasio Administration is apparently unwilling to get in a tax break bidding war with New Jersey over large existing financial businesses threatening to leave the state. http://www.capitalnewyork.com/article/real-estate/2014/05/8545812/de-blasio-deputy-says-city-wont-try-top-christies-tax-subsidies It would be better news, however, if the DeBlasio Administration (and Cuomo Administration) would double down on Bloomberg’s late term policy of encouragement for new companies. Particularly those in a decidedly non-trendy sector: banking.
Before moving on to the specifics, some background on economic development. In the late 1970s a man named David Birch used data from Dunn and Bradstreet on business openings and closings to conclude that most of the new jobs are created by small businesses (actually small individual establishments, which could be part of larger companies). http://www.brevolutionconsulting.com/articles/david-l-birchs-contributions-to-entrepreneurship-and-small-business-research/
This was later debunked by those who found that much of the small business “job creation” was mere turnover, as when one restaurant closes and is replaced by another restaurant in the same spot with the same number of jobs. Meanwhile, at any given point most people work for large organizations in the public and private sectors.
This was then re-debunked by those who found that it isn’t just small businesses that turn over. Large enterprises start, grow, shrink, decline and disappear through merger or bankruptcy at a fairly rapid pace as well.
Back when I was at City Planning I asked Jay Mooney at the New York State Department of Labor to do a series of data runs, using unemployment insurance tax data and repeating Birch’s method, to analyze business turnover. I found that New York City needed 25,000 new business establishments per year just to replace those that closed, and New York State needed 60,000. One third of the jobs in New York’s private sector were in establishments that hadn’t existed five years earlier. That is the normal rate of job and business turnover, and it is massive. Particularly compared with the careers of private sector workers, who are now expected to work 40 or more years.
But beyond establishment openings and closings, huge numbers of jobs were gained and lost in existing businesses that were expanding (including those that had opened not much earlier) and contracting (including those that might later close). This was true across sectors, and turnover was nearly as great among large establishments as among small ones. The conclusion: with existing businesses declining and closing all the time, prosperity depends on businesses that not only start but also grow into large ones.
Now consider what has happened over the decades in New York’s most important sector: finance. From a large number of generally well-respected companies, New York’s money center banking industry has, for the most part, shrunk down to a handful of oligopolistic, much-despised firms. Those “too big to fail.” Among New York City’s top 25 employers today, according to Crain’s New York Business, are Bank of America, Bank of New York Mellon, Citigroup, JP Morgan Chase, and Morgan Stanley. Goldman Sachs is another large firm. For how much longer? We have certainly had the shrinkage side of business turnover in finance over the decades. Among the city’s large employers listed in a 1957 economic development report in my possession are Bankers Trust, Chemical Bank, the Hanover Bank, Irving Trust, Manufacturers Trust, and Merrill Lynch Pierce, Fenner & Beane. All no longer independent firms. Also gone are Lehman Brothers, Drexel Burnham Lambert, Bear Stearns, Smith Barney, Kidder Peabody, generally merged into other institutions (with the combined bank employing far fewer than the individual firms had separately) but sometimes bankrupt. As for the remaining firms, in a business where trust is paramount the question most people have about New York’s leading companies is why their top executives aren’t in jail.
New York City’s financial sector is in the same situation as Michigan’s auto industry a couple of decades back. From a substantial number of innovative firms it had shrunk down to a “Big Three” oligopoly in which everyone was overpaid and products were poor. Meanwhile in Japan you had ten hungry, growing, innovating, efficient companies looking to expand. For years the “Big Three” relied one their political muscle rather than technology and innovation to keep cashing in, getting the Congress to enact voluntary import limits, limit demands for fuel efficiency, and bail out failing firms. But in the end it was not enough. After putting all its eggs in three baskets metro Detroit, indeed all of Michigan, has spent most of the past 13 years in the equivalent of a Great Depression.
Fortunately for New York City’s workers the financial sector doesn’t provide nearly as many jobs in as it once did, thanks to office automation and back office relocation to places such as Florida and India. The middle class “back office” “pink collar” jobs were largely wiped out from 1990 to 2000. Even among those jobs that remain in the metro area, many are now located in New Jersey, and even among those located in Manhattan, many are held by residents of the suburbs. So it is easier than one might think for Mayor DeBlasio to turn down request for tax subsidies. That isn’t his voters’ jobs.
But with many of the remaining financial workers paid like Saudi royals, the New York City and New York State tax bases remain heavily dependent on Wall Street. Indeed, 14 out of 25 of New York City’s largest employers are either public or non-taxable non-profit entities. If the city and state were to lose the financial sector, it would be a fiscal disaster.
Today it is easy to see New York City’s overpaid financial sector as a big fat target for potential competitors, with our remaining “Big Six” likely to eventually go through the same wrenching downsizing and Detroit’s “Big Three.” While desperate, backward-looking New Jersey seeks to poach the city’s jobs in existing “too big to fail” companies with tax breaks and subsidies, more innovative places are seeking to nurture their replacements. Silicon Valley firms are looking to “disrupt” finance and wipe out the incumbent firms in New York, generally choosing to operate outside the regulated financial sector with its capital requirements and consumer protections. (Which can lead to disaster, as the Mt. Gox “Bitcoin” failure and any number of “shadow banking” failures in the Great Recession show).
Which raises the question: given the public relations disaster suffered by existing financial institutions over the past five years, where are the new banks? Not new one-storefront credit unions, or savings and loans that can provide individuals with checking accounts and auto loans. Where are the new, major money center banks, the kind that can handle the transactional needs of huge businesses, mid-sized banks, governments, and large non-profit organizations, float their bonds for investments in plant and equipment, act as primary dealers in the U.S. Treasury and other key financial markets, provide loans to manage their cash flow, and manage and invest huge pension funds and other cash on hand?
Surely, I thought a few years ago, a few new ones would arise since the old ones were widely discredited. A new major bank would not have the hidden losses from past deals sitting on its books. It would not have a past history of ripping off its customers and shareholders, and face of future of ongoing regulatory penalties over past misdeeds. Its employees would not have become dependent on excessive pay packages, to maintain the lifestyle to which they had become accustomed and pay the debts they had run up expecting the gravy train to continue forever. Excessive pay packages that could never be supported by the old fashioned business of old fashioned honest banking, and can seldom be gained except at someone else’s expense. Moreover, a new bank’s information and customer account system could be built entirely new from scratch with the cyber-crime threats of today in mind, rather than rely on an older legacy system like the ones existing banks have to defend. The safety of the information system is to today’s electronic banks with their electronic money what massive safes and stone edifices were to banks 100 years ago – security blankets for nervous customers.
Surely such an organization, staffed by those willing to accept a solid middle- or upper-middle class income in exchange for being able to sleep at night (and the possibility of building wealth with shareholders as the firm grew, which worked out well for Warren Buffett, Steve Jobs et al), would sweep all before it. Expecting such opportunities to arrive, I even suggested finance as a good career opportunity for my children. Those with more reasonable expectations and a modicum of integrity would be in a position to cut the discredited organizations and their overpaid workers off at the knees.
Well, my children are not interested in going into finance. Very few members of their generation who consider themselves to be good people will even consider it. And there are no new major banks occupy all that empty office space downtown and provide options for companies, workers, shareholders and consumers. And no new major accounting firms, even as the “Big Ten” has shrunk to a much smaller number of ethically challenged organizations. And no new major bond rating firms, despite the disgrace of those that already exist. Why? Will these incumbent firms use their political and market power to control things for another decade or so, and then by swept away by a wave of new organizations from outside New York (even outside the United States), taking the city’s tax base with them?
I’m not suggesting that New York City and New York State start subsidizing new financial companies instead of subsidizing large existing financial companies. Entrepreneurs don’t generally need tax breaks and subsidies in any event. And I’m not suggesting that New York City invest in new banks. According to the 2012 Comprehensive Report of the NYC Comptroller for New York City “in April of 2012, the Bureau of Economic Development was established with the mission of leveraging the authority and responsibilities of the Office of the Comptroller to create new and sustainable opportunities for the economic growth and development of the City of New York and its people. The Bureau is responsible for the administration of the Economically Targeted Investment (ETI) program.” Having politicians seeking campaign contributions decide which firms should receive public money sounds like an even worse idea that having Wall Street do it. http://comptroller.nyc.gov/wp-content/uploads/documents/CAFR2012.pdf
What entrepreneurs need, more than anything else, is customers. And New York City and New York State are major customers of the financial sector. In FY 2011, according to data from the Governments Division of the U.S. Census Bureau, http://www.census.gov/govs/local/ the State of New York, the City of New York, and other local governments in the state spent about $300 billion. That’s what the turnover in the government “checking accounts” in this state added up to. They issued $40 billion in long-term debt, and had $8 billion in short-term cash management debt at the end of the fiscal year. That’s the equivalent of a lot of auto loans, mortgages and credit cards. They had $477.5 billion in cash and security holdings, including $300 billion in pension funds. That’s the equivalent of a very large savings/investment account. All this money passing through thousands of individual accounts.
And which financial companies got all this business? In the case of New York City, I looked through the Comptroller’s report to try to find who was holding the city’s money. It wasn’t in there: I’m pretty sure it used be years (decades?) ago. But I’ll bet I know who it is. Bank of America, Bank of New York Mellon, Citigroup, JP Morgan Chase, Morgan Stanley, JP Morgan Chase, and Goldman Sachs. I did find out in the Comptroller’s report that the City of New York had entered into a bunch of swaps and derivatives deals with two big to fail financial companies, which had negative values in the FY 2012 report, one of which had the city owing Wells Fargo “infinity” in collateral in the event of a large NYC credit downgrade (p. 70). I guess we don’t have to worry about that, because we can surely trust then-Comptroller John Liu, who was seeking funds to run for Mayor at the time, to know what he was doing. Just like the officials of Jefferson County, Alabama. http://www.bloomberg.com/news/2011-11-09/jefferson-county-s-path-from-scandal-to-u-s-bankruptcy-filing-timeline.html
Doing business with a new major bank would carry risks, even if the bank was part of the transparent banking system and fully vetted by regulators. Including the risk that one day the payroll of a major agency such as the MTA or Health and Hospitals Corporation could disappear like Mt. Gox’s bitcoins, and this time with no federal bailout because New York’s taxpayers rather than the rich would be harmed. Indeed, the assumption that the large size of the firms in the financial oligopoly would allow them to make good if a hacker from Russia emptied out a company or government’s entire account is probably a big part of their comparative advantage. By continuing to do business with the few remaining financial companies large enough to handle their needs and cover that risk, however, New York City and State are putting their fiscal and economic future in a small number of increasingly tattered and tainted baskets. That too is a risk.
So how should the City and State of New York respond to banks threatening to leave New York, threatening to pull jobs out of New York, or actually doing so? How about encouraging their replacements? How about letting the best bankers know that if they want to stay in New York, are willing to work in a more reasonable environment for more reasonable pay (at least in the short run, until they can benefit from long-term growth), and might consider starting a new bank, there might be some city and state business that now goes to the “Big Six” there to be had by a new firm with certain characteristics? How about bringing up the possibility of starting a new bank with the wealthy people the Mayor and Governor respect outside of finance, with they meet regularly (at fundraisers)? How about asking if the remaining regional banks outside NYC are interested in creating a new money center bank on a cooperative basis to meet their needs?
Unfortunately, to the extent that New York City and State have been willing to take the risk of doing business with newer, growing firms, it hasn’t been with stolid, transparent, regulated banking entities with highly but not excessively paid staff. It has been with opaque, unregulated, illiquid hedge funds and private equity companies with executive and trader pay levels in excess of even the “Big Six.” In fact there is a bill in Albany right now, likely to be approved, to allow New York City’s pension funds to invest up to 35 percent of their total assets in these and other “alternative assets,” up from 25 percent today. Alternative assets are politically attractive because they “are often are harder to value and sell” and thus useful in covering up how deep in the holes pension funds are. http://www.moneynews.com/InvestingAnalysis/NYC-Pension-Hedge-Funds/2014/06/04/id/575239/
In general, however, in finance the City and State of New York just direct all their business and assistance to the large existing incumbent firms. As when the State Insurance Commissioner was prepared to allow AIG to take money out of its New York State property and casualty insurance subsidiary, putting New York policyholders at risk, to stay alive during the financial crisis – a deal that was superseded by the Federal Reserve bailout. See page 16 of this paper on the subject by the Society of Actuaries to see what they think of that. http://www.actuaries.asn.au/Library/Events/SUM/2013/FerrisAIGProducts.pdf
In exchange for that supreme act of being willing to sacrifice ordinary New Yorkers to save an existing large employer, AIG has recently told its employees in New York and New Jersey not to buy houses, because it will be eliminating 1,500 jobs and moving 4,000 others to “lower-cost cities” such as “Olathe, Kansas; Alpharetta, Georgia; Amarillo, Texas; Bogota, Colombia; Sofia, Bulgaria; the Philippines; and Malaysia.” Less than six years later. Large existing companies simply cannot be relied on to form the basis of a local economy long term. State and local governments need to understand that. http://www.crainsnewyork.com/article/20140529/ECONOMY/140529868/-dont-buy-homes-in-ny-area-aig-warns-workers
And how about the federal government? Not long ago the Federal Reserve announced that the problem of “Too Big To Fail” was not solved. http://www.cnbc.com/id/100612215 But nationalizing the large banks and breaking them up, which might have been on the table in 2008, is certainly off the table politically now. How about encouraging their replacements? Would it take years for a new entity to receive regulatory approval to engage in official banking? It didn’t take Goldman Sachs and Morgan Stanley that long back in 2008. And a little “creative destruction” would be a more politically palatable way to a more diversified and less concentrated financial sector, if the federal government were to decide that having more large financial institutions was in the economic interest of the United States.
As it happens, the Post Office is considering going into banking as a way to survive shrinking mail volumes. http://www.economist.com/news/finance-and-economics/21601026-americas-postal-service-ponders-foray-financial-services-put-your-money “Earlier this year its inspector-general released a white paper suggesting that post offices should begin offering financial services, such as cheque-cashing, small loans, bill payments, international money transfers and prepaid cards to which salaries or benefits could be transferred. The reasoning is simple: a lot of Americans have scant access to banks and a lot of post offices have too little to do. More than one-quarter of American households are unbanked or underbanked, meaning they either lack a current or savings account, or they have one but still use alternatives to banks such as cheque-cashers and payday lenders.” So they would go after the check cashing and payday lender industry. Fine. How about alternatives when the unbanked are ready to graduate to banking? Like leasing space in Post Offices for ATMs for new major banks?
In summary, the City of New York, the State of New York and perhaps the Federal Government should think very carefully about what kind of financial institutions they would like to do business with, and have the citizenry and other businesses, do business with. And what kind of company they would like to invest in. And rather than engage in a grinding, multi-decade, likely futile battle to try to force the “Big Six” to become those types of organizations, try to get other, untainted people to create them. Capitalism is a system of consumer sovereignty, and it is as a customer than people have the most power. That is the lever that could be used to perhaps avoid the eventual collapse of New York’s financial sector. And what would those rules be? In addition to limits on cash pay, the tying of any additional compensation to shareholder value over the very long term, a strict interpretation of the “Volker Rule” and treating customers as actual fiduciaries I have one more. Politicians looking to suck taxpayer money into today and risk disaster for people they don’t care about in a future they don’t care about are not “sophisticated investors.”
One More Note Here is an analyst on why AIG needs to move out of New York to lower cost areas with lower cost workers. “The single biggest weapon for managing a soft market is focus on fixed costs,” he said. “If you have high fixed costs, the temptation is to try and write dumb business to try and cover your cost base, and you’ll regret it later.” Dumb business, dirty business – that is what New York’s financial institutions need to pursue to earn the kind of salaries those who control them are used to. Honest banking is a tough job. Business has to be sought, nurtured, and checked up on constantly to make sure loans are repaid. If you are loaning against inventory that needs to be audited. If you are loaning against cash flow that needs to be audited. In exchange, you are making a fee that can’t be too large and getting paid in an interest rate that can’t be to high compared with the interest paid out. How many loans can be managed intensively with proper due diligence? And how much of an income could those loans provide, for the worker and the organization? A very good living — for those who form relationships with firms that do very well and build up a big book of business over a career. Those looking to get rich quick, however, aren’t going to be doing “God’s Work,” as the head of Goldman Sachs once described his firm’s role. They are going to be doing something else, desperately fighting for the last $200,000 in annual pay they have to have.