Just because someone cames up with a really bad solution doesn’t mean he didn’t identify a legitimate problem. At the core of Marx’s economic thought is the identification of a “contradiction” in capitalism: each individual business can maximize its own profits by cutting its workers’ pay, but business in general has to turn around and sell products and services to those same workers in order to make money. The result, Marx asserted, there would be a series of increasingly dire crises and depressions, a theory that looked pretty good in 1932. But capitalism is an adaptable economic system. For the past decade or more, businesses have been able to make rising profits, and top executives have been able to capture a rising share of national income, by selling more and more to those who have less and less. This has been possible for three reasons. First, thus far health insurance and pensions, which affect well being in the future when one is sick or retired, have been cut more than cash, which is spent today. Second, Americans have gone deeper and deeper into debt, increasing spending today but cutting it tomorrow. And third, people in the rest of the world have been willing to lend Americans the money they need to spend more than they earn. But the wheels may be about to come off this system, and New York City and State had better be ready for the fiscal consequences.
While rising credit card debts stoked the economy in the 1990s, since 2000 soaring housing prices, with more and more money borrowed against home values, have supported spending. But those home values have soared beyond the level people can afford, and have now started to collapse in much of the country. It isn’t just those who bought at peak prices who are going under. It is also those who bought years ago, but then took out second, third and fourth mortgages as the purported value of their homes rose and spent the proceeds. And it isn’t just “sub-prime” mortgages to less well off people with bad credit histories that are going into default. It is people whose credit WAS good but have now borrowed more than they can afford to pay back, under terms that kept payments low in the short run but jacked them up in the long run. The reason the stock market has started to wobble is the realization that “sub-prime” is the tip of the iceberg.
That’s because it isn’t just home prices that got inflated beyond the ability of income to support the debt. Commercial properties have the same issue. A huge portfolio of office buildings formerly owned by Equity Office Properties, which had gradually accumulated them for years, has sold twice or three times in just one year. They were purchased collectively by private equity firm Blackstone, then sold off to other large companies, some of which are alos selling them, all at higher and higher prices. Every time these properties, worth billions of dollars, sell, New York City, New York State and the MTA collect massive real estate transfer taxes, ever more massive because the prices have gone up and up. Other buildings and portfolios of buildings have sold as well, with record sales in 2006 nearly surpassed in just the first few months of 2007. But all this has been make possible by investors willing to lend money at low interest rates without asking too many questions about whether or not the money will be able to be paid back.
And what about stock prices? The ratio of prices to earnings is pretty high, given that the earnings themselves are pretty high, but stock prices have been staying high because it is believed private equity firms might come along and buy the companies at a higher price. Those firms have only been able to buy companies due to, guess what, cheap debt – lenders accepting low interest rates and assuming there won’t be any losses. The private equity firms know the companies can’t afford to pay those debts and provide a decent return, but they expect to be able to sell to some greater fool later on. This has been going on for half a decade.
It may go on a little longer. But it may have ended this week. Suddenly, investors are seeing the sub-prime defaults, and realizing they are going to lose money on bonds backed by those mortgages. Suddenly, they are unwilling to lend money at low interest rates to people, commercial buildings and buyouts if the money cannot be paid back. The whole debt securitization process, according to market participants, has just stopped dead. Nothing is moving, according to one of the most respected commentators.
There are two potential outcomes here. The bad scenario is a global financial disaster and recession like that of the 1970s, if not the 1930s. The second is that the U.S. economy, instead of being a powerhouse that pulls along the rest of the world, will become anemic but be pulled along by places like China and India.
The latter could happen, and it would be good in a global sense if it did. But that would cause American prices to rise, and the American standard of living to fall, in any event. There wouldn’t be any more free money lent to us by poor countries, because they would have to finance their own growth (shouldn’t the rich have been lending to the poor all along)? And there wouldn’t be any more cheap energy, because they would be competing for a share of the supply.
These are national problems, and are probably worse elsewhere. But much of the additional tax revenue – corporate, personal income, and real estate transfer – that has generated all these New York State and local govenrment surpluses over the years has come from deals based on cheap debt that cannot be repaid. The securtization of bad debt has pumped up corporate profits and bonuses on Wall Street for example.
Well, financial stocks are getting killed, and financial firms are reporting lower profits, because of mortgages that aren’t being paid. Debt these firms had expected to dump on the suckers, the suckers suddenly won’t take. Several buyout deals have collapsed this week, with large financial firms stuck with the debt. The real estate press reports several large commercial real estate transactions have collapsed, because no one is sure of financing. Wall Street profits may turn in to Wall Street losses soon. And those losses can be rolled forward, meaning no Wall Street tax revenues in the early years of a recovery either.
It may be now. Or it may be someday. But bonus-based personal income tax revenues, corporate income tax revenues, and real estate transfer tax revenues are going to regress to the mean relative to the base income that is earned here, perhaps falling below the mean along the way. At the same time as interest rates on new debt rises. At the same time that governments are forced to admit that their pension funds are under-funded, and to pay more in.
What will this mean for taxes? What will this mean for services? And what about the 2010 to 2014 MTA Capital Plan? Governor Spitzer had better not run for re-election while saying that “due to circumstances beyond our control we have to cut back on normal replacement projects and cancel system expansion projects” again. Because the circumstances are not beyond his control, if he is willing to demand that no matter what past losers – New York City’s children, New York State’s future (debt, infrastructure, defered pension payments), and New York City’s taxpayers without lots of special deals will not be sacrificed again.
“Easy is what we have had,” the Governor said. Then he proposed a budget that was mostly easy, thanks to all the revenues coming in, but contained some tough choices. He got fought like crazy on those few tough choices. Spitzer is going to have to choose between the privileges of the winners and the needs of the losers. Very soon he will not have enough free and easy money for both. And if he chooses the right way, that is a far more important fight than the burning issue of Joe Bruno’s helicopter rides. The world isn’t going to come to an end, but the era of easy money probably will. It may have already happened.