New York City and Wall Street: Saved by Cheap Money So Far
Perhaps you heard about the drop in the stock market and the growing financial crisis in emerging markets last week. Basically U.S. businesses and the global economy are so addicted to Americans spending more than they can afford (which is to say more than businesses are paying them) that they can’t cope with the Federal Reserve raising interest rates to zero. Which in effect is what is happening by having the Fed taper off the latest round of “quantitative easing.”
The emerging markets are most affected thus far, but sooner or later Wall Street will be affected as well. Most New Yorkers won’t notice, because the NYC job base has been broadening and is less dependent on finance than 20 years ago. But the NYC and NY State tax base are more dependent on taxes on the undeserved profits in that industry, and the undeserved pay packages of those who work there. Which makes this Marketwatch.com article worth a read. “In a 2013 study, McKinsey Global Institute found that between 2007 and 2012, interest rate and QE policies resulted in a net transfer to U.S. financial companies of $150 billion from households, pension funds, insurers and foreign investors.” And the interest rate margin on cheap Federal Reserve money amounts to 60 to 130 percent of last year’s profits on the country’s biggest banks. “The analysis highlights how a focus on earnings changes without regard for true earnings potential can be misguided.”
What is happening is a replay of the early 1990s, when the Fed kept interest rates low relative to the money that could be earned on federal government bonds as a way to redistribute money to the banks and get them out of the hole caused by the commercial property bubble and bust of 1980s.
But then as now “this enhancement of current financial performance comes with significant risk. As banks become instruments of policy, holding greater levels of government securities, deterioration in sovereign quality or rising interest rates exposes them to the risk of large losses. A reversion to normal interest-rate conditions would also reverse other identified positive earnings effects.”
That’s what happened in the mid-1990s when the Fed decided the banks had profited enough and savers suffered enough and raised interest rates. The resulting collapse of financial profits in the mid-1990s intensified a fiscal crisis in New York City brought on by the recession that started with the stock market crash of 1987 six years earlier. That led to Mayor David Dinkins being turned out of office, and Mayor Rudy Giuliani inheriting a nearly bankrupt city.
Among those who saw it coming were then-representative Chuck Schumer, as noted in this New York Times article. “Signaling a dramatic turnaround for the banking industry from the gloomy forecasts of just 12 months ago, Federal regulators said today that 1992 would be the most profitable year ever for the nation's banks. As a consequence, they said, fewer institutions would fail in 1993 than had been expected, even though new regulations that go into effect next week require officials to seize weak, but solvent, institutions.” But Schumer was unimpressed, and was quoted as saying “the banks' heavy reliance on Treasury instruments reflected the fact that there were few other long-term investments strong enough for investing insured deposits. ‘Any idiot can make money by taking in money at 3 percent and lending it at 7 percent,’ Mr. Schumer said. ‘But anyone who looks at the last four quarters and thinks the banking industry is back on track is making a mistake.’"
The idiots realize that they have been in effect handed $billions, and are making adjustments according to another Marketwatch.com article. During the huge run-up in bank stocks, part of a broader stock market rally generated by the cheap money policy that has further enriched the rich, top bank executives had their cronies on the boards pay them variable compensation based on stock prices. They scored big when their “brilliant management” caused their stock prices to temporarily soar.
Now, however, they suddenly want their cronies to pay them in a way that is closer to a flat rate no matter what happens to the company stock price. “Like me, you were probably chagrined to see the pay of J.P. Morgan Chase & Co. Chairman and Chief Executive Jamie Dimon balloon in 2013 to $20 million, nearly double what he received in 2012. But Dimon’s pay day is even more outrageous than first considered. That’s because Dimon wasn’t awarded stock options or a riskier stock bonus called stock appreciation rights, or SARs. Instead, he was granted nothing but restricted stock. It was the first time in 10 years J.P. Morgan didn’t award stock options or SARs.”
Dimon is a smart man who knows the jig is up, according to the article. “The decision to pay Dimon entirely in restricted stock suggests that expectations at the bank are that the stock’s best days could be behind it, according to John Olagues, who not only brought this to my attention, but did some analysis on just how significant this switch in stock grants is.” Other financial executives are making the same switch. So are executives in other industries. Suddenly, they once again don’t want their pay to depend on how well shareholders do. And in their “bargaining” with the other top executives on their boards, they are agreeing to give each other exactly what they want. “This means that stock are going lower and not by an incidental amount.”
Which would mean, among other things, that those who run our public pension funds would need to come up with new and different lies to cover up the extent to which NYC public services will be devastated despite a high tax burden due to the retroactive pension increases of the past. Agreed to between public employee unions and politicians in deals reminiscent of the awarding of executive pay.
Perhaps the Wall Streeters will steal enough to keep the NYC and NY State tax revenues elevated, but that’s not the way to bet. Sooner or later out politicians will have to face the consequences of having made New York City’s public employees so much richer than everyone else, the Wall Streeters and other executives aside. Not in cash pay, which has to be paid up front, everyone can see, and might actually generate some kind of gratitude from the public employees themselves (and a little bit of compassion on their behalf for the serfs). But in more and richer years in retirement, which those employees don’t even count until they are gone – and which haven’t been paid for until years – decades – after the deals were cut.
The interest rate increases and austerity of the mid-1990s, while prolonging the “jobless recovery” that many thought would cost Bill Clinton his job, also laid the groundwork for the booming economy of the late 1990s. And we may hope that three to five years from now the city’s budget and the U.S. economy would be similarly in a real recovery.
But that isn’t the way to bet. We are in a lot more debt, collectively, now than we were then. We are in a lot bigger pension hole now than we were then. Many of us are facing retirement with much lower incomes much sooner now than was the case then. And the factors that for 40 years mitigated the impact of falling wages and rising inequality on consumer demand – rising labor force participation, reduced saving for retirement, and soaring public and private debt – are in the past. And we’ve only traveled a short way down the road we need to travel to get out of this mess. This isn’t a recession. It is the collapse of an unsustainable era that has been managed and deferred.