While waiting for some new data and a Supreme Court decision, we’ll interrupt the series of posts on making adjustments to the pillaging of our existing institutions to report some good news: New York City is getting better at allowing people to create new ones. People who have started their own business have told me the most important factor in their success is not the ability to create to good product or service, but the ability to sell it. Customers were the scarcest resource even before the global crisis of demand created by the end of the U.S. consumer debt binge. And metropolitan New York, combining a large population, above average incomes, and a large and diverse potential business client base, has lots of potential customers. Many of which can be reached in person in a small area in or near Manhattan. Combine that with a large and talented workforce and global connections, and I think the song “New York, New York” had it exactly backward. This is, or ought to be, a fertile ground for the new.
While New York as a place is hospitable to entrepreneurs, however, New York as a political culture has traditionally been hostile. To New York’s Democratic establishment the only good business is an existing business, preferably a large corporation that that makes campaign contributions. This bias has come out in a variety of ways, from tax breaks and subsidies to big companies, to complex and obsolete regulations that are only enforced against those who don’t play ball, to calls for commercial rent control. Wall Street may have both the Democrats and the Republicans in their pocket, but in the past New York’s Democratic politicians have shown zero interest in new businesses, and have generally preferred to preside over subsidized decline. A few years ago I had wondered why Mayor Bloomberg, coming into politics from the outside as someone who have founded a large company himself, hadn’t done more promote New York as a place to “take your shot.” But I’m pleased to report there has been a change large enough for someone like myself, on the outside, to notice it. But I have a question. Where is the attempt to encourage new banks?
First, let me clear up a couple of misconceptions, driven by falsehoods that turned out to be politically convenient or popular. Small businesses do not create the most jobs. That presumption was created by research on new business openings, which found that many new businesses that open are small. That research was debunked by a finding that the new small businesses are often just replacements for other small businesses that closed, a matter of churn and not growth. And many small businesses are just the local affiliates of larger enterprises. Most Americans work for large organizations.
This research, however, was re-debunked by a finding that it isn’t just small businesses that spring into being and disappear. Large ones do as well. Just ask the tens of thousands of people who once worked at JP Morgan, Chase, Manufacturers Hanover, Chemical Bank, Bear Stears, and Washington Mutual. A much smaller number of people now work in what is left of these organizations: JP Morgan Chase. I got the New York State Department of Labor to do a data run for me when I worked at City Planning, and it found that one-third of all jobs are in business establishments that did not exist five years prior, and New York needs 20,000-plus new establishments every year just to break even.
Most jobs are, in fact, created by firms that start small and grow into big ones. Most jobs are lost in firms that start big and then collapse or merge into small ones or out of existence entirely. Most new businesses will not survive, let alone get past the founding phase and expand. As a community, we would ideally be supportive and appreciative of those who try to create one, whether they succeed or fail, with the winners providing jobs for the losers and the rest of us. And the winners, ideally, would be grateful to those who provided the environment that allowed that success to occur. But that isn’t the way it has generally worked here.
As I read and write about regional economies around the country, moreover, I notice that local officials tend to pay attention to, and subsidize, one trendy sector at a time. Smokestack chasing gave way to silicon chip chasing. In the 2000s, places with no history of or infrastructure for biotechnology decided that hey, they want to be bio-tech centers too! Memphis, home of advanced science with perhaps the least educated labor force in the United States? The joke in Metro Washington was that Maryland got life, with a large life science complex, and Northern Virginia got death, with many defense contractors. Then Northern Virginia decided it wanted life too, but it hasn’t worked despite an educated labor force (albeit one that has trouble gathering in one place due to traffic hell that makes the BQE seem empty).
New York has not been immune. Flipping over to Channel 25, I get the feeling that the City of New York wants everyone to start a local restaurant/food company or an information technology/new media company. These sectors have been growing. But there are other sectors as well.
Take Finance, now the most subsidized sector in the history of the United States. All those subsidies go to the increasingly small number of increasingly large and increasingly reviled firms. These firms are increasingly vulnerable, and as its finance sector shrinks New York City may find itself with no financial sector at all.
In fact, were I writing about economic development in Pennsylvania rather than New York, I would suggest that state pass some really tough financial regulations for financial institutions headquartered there. And then start an advertizing campaign: “Pennsylvania; our financial companies won’t rip you off.” Back in New York, the city’s large financial institutions would likely point to the economies of scale they have achieved as they consolidated. Irish potato farmers would likely have made the same claim about relying on a single variety of potato in 1844.
On the operations side, there is no doubt that running a bank is a tremendous challenge, with the need to keep transaction costs to a minimum and, it seems, every math major in the former Soviet Union seeking to break into computer systems and suck the customer money out of their checking and savings accounts. I read one report from a computer security expert that said that if business customers knew how vulnerable most banks were, they’d only bank at the largest. On the other hand, if New York wants to be IT central for media, how about the fact that it is already IT central for finance? Surely the expertise to create a new bank is available here.
While a new bank would face the challenge of convincing customers of its operational competence and security, it would not face the challenge of convincing them that it is solvent. Many believe that there are large possible or even certain losses hiding on (or off) the books of every financial institution that was active during the 30-year U.S. debt binge. More trouble may be coming from abroad. Where could companies put the money need to meet payroll, and people put the money to pay the rent? In this environment, perhaps starting from zero isn’t the worst situation.
Then there is the trust deficit. Like many people, I have a significant amount of long-term (ie. retirement) savings earning zero percent right now. Might it make sense to use some of that money to partially back a set of entrepreneurs in the hopes that one of them might hit? Certainly. But the problem is, I don’t have personal expertise in that regard. And with regard to those who might have that expertise, and are in the business of investing funds for others, I don’t trust any of them. None at all.
Whatever money I give the existing financial institutions, I’ll assume the goal is to translate my savings into their bonuses while leaving everyone on both sides of any transaction with as little as possible. I’d say about the only people still handing their money over to theses pirates are public employee pension funds. Not because they’ll deliver good returns. But because they’ll promise good returns, thus allowing lies about the impact of all those retroactive pension deals to be perpetuated a little more.
In addition to past losses and a loss of trust, existing financial institutions are burdened by excess pay to employees who have enough political power within them to keep it, even if they do not deserve it. Pay so high there is no possibility of truly earning it while doing “Gods work” of allocating capital. Pay that can only be gained through the redistribution of economic well being, not its creation.
Let’s say you are a banker working up to a $10 million book of business in 100 small to medium sized loans averaging $100,000 each. Doing “Gods Work” is a lot of work. First, you’d have to identify and recruit firms that could both use the money well and pay it back. Next, you’d have to closely monitor how the money was used. If it was used to finance inventory, was the inventory received? If it was used to finance the fit up of an office, store or factory, is the money being paid out in proportion to the work done, to stay on budget? Is the business plan sound? Are sales meeting expectations? And if not, should a loss be admitted or should more money be put in? A banker doing Gods Work would have to be constantly keeping tabs on those 100 customers, reviewing their financials, helping deal with their problems, and getting new customers.
And how much could the banker doing “God’s Work” earn? Let’s say the average interest rate was eight percent. On that $10 million in loans that would mean $800,000 in potential income, minus loan losses, to pay the people whose money the bank was investing, all the transactional costs of serving the loans, the profits for the bank’s share holders and, last of all, the pay of the bank loan officer. That loan officer might earn, what, $60,000 per year, working up to the low six figures, perhaps as much as $300,000 if some of their customers become major companies? No one on Wall Street now is willing to do all that work and settle for that pay. So they don’t do God’s work. They pillage customers for fees or gamble in “heads I win, tails the government bails us out” casino bets. Existing financial companies want to keep making those bets to finance their bonus pool.
Those working in existing money center banks expect to make too much money to be willing to do actual banking. But a brand new organization, overseen by a set of directors with the right motivations, could put in place a set of pay guidelines that our existing financial institutions would require a revolution to duplicate. It could attract financial professionals who were willing to earn somewhat less in exchange for not being expected to rip anyone off. A brand new organization would not need to trade against its customers’ interests to get enough revenues to funds is bonus pool, and could really put a “Volker rule” in effect. Start something new and all the bad history, past deals, connections, favors and office politics are irrelevant.
All that would be needed are customers. But as it happens, two of the biggest customers out there are New York City and New York State. A “checking account” customers, they run, what?, $180 billion per year through their budgets. As investors, their pension plans had over $300 billion under management in FY 2010. As money users, the City and State of New York and related entities were $210 billion in debt in FY 2008, and sadly that number keeps going up.
New York City and state are big customers, and they need to use big banks. Could they use a new big bank? Could a new big bank or two be created?
As it happens, Mayor Bloomberg has a bit of a conflict of interest when it comes to steering city financial business away from existing big banks to any possible new ones. Those existing big banks might decide that they don’t need those Bloomberg Terminals on their employee’s desks anymore after all (even if they really do). But the State of New York and the Mayor’s replacement will have no such personal constraints. They could be open to proposals. They could provide the economies of scale needed for new financial institutions to get started, new institutions New York will have to have if it is to continue to have a financial sector.
Our ever shrinking financial sector aside, however, I’m glad to see the city’s traditional hostility to new business is waning, at least for the moment. What I would ask is that civic leaders refrain from thinking themselves as being capable of doing what the financial sector no longer can, and picking winners. New businesses can come from any line of work, not just trendy ones such as organic food or bio-tech or new media.
Looking back to see which industries have been concentrated in New York in the past, the one word that best described the city’s role is “miscellaneous.” As in niche activities whose markets were too small and specialized to support a single establishment in a small place, and required the very largest market to get established. As in Miscellaneous Manufacturing Not Elsewhere Classified, Miscellaneous Publishing, Miscellaneous Goods Wholesaling, Miscellaneous Professional Services, Miscellaneous Financial Services, etc. New York has been the capital of the specialized, unique, new, and odd. And still can be, because if you need to come up with a few people to work with and a few more to sell to, this is the best place to do it.