New York and the Financial Crisis
New York’s Financial and Economic Condition before, during and after the Financial Crisis
New York City is the largest regional economy in the US. It is also the world’s premier financial center. As the home to Wall Street, NASDAQ, and the New York Stock Exchange, it is at the top of the world’s stock market. The economy of New York accounts for the majority of economic activities in the United States. Manhattan takes the lead as the center of banking, communication, and finance. Most of the largest corporations have their headquarters in New York. The financial crisis of 2008 had the largest impact on New York, being the financial backbone of the United States. This paper analyzes the economic and financial situation of New York before, during, and after the financial crisis.
Before the Financial Crisis
New York had one of the most vigorous economies in the world before the financial crisis. The financial sector was firm and vibrant. New York’ Wall Street and NASDAQ have remained the world’s largest stock exchanges by the measure of market capitalization and trade volume. Financial services employ about 35% of the population of New York. Before 2008, the city’s financial services employed about 345,000 people (Fetai, 2013). New York was a major exporter of financial services within the US and globally.
The main factors behind the financial crisis included technological financial innovations, deregulations, and globalization. The stock market bubble, the housing market bubble, the imbalances in the current account and an increase in accounting scandals also significantly contributed to the financial crisis. The condition of activities in these sectors describes the financial condition of New York before the financial crisis.
The signs of a financial crisis began manifesting back in 2001, when the state experienced a short-lived recession. To avert a recession, the federal funds rate was lowered by about 5%. This created a sudden increase in cheap money. New York started to deplete foreign exchange reserves. The state experienced an increase in consumption beyond its production capacity. People were living beyond their means. The restless bankers had found money to profiteer from a population with the characteristics of meager income and few assets. The banks issued more home loans, the number of home buyers increased, and home prices escalated.
The abundance of cheap credit and an increase in home prices increased the attractiveness of investments in high-yielding mortgages. The federal government continued to lower interest rates and kept inflation low. The products in the financial market were selling at an extremely affordable rate without a down payment.
Financial innovations first began manifesting after banks relaxed borrowing rules. They repackaged loans by passing debts to a secondary institution through collateralized debt obligation. This gave rise to a secondary market for creation and distribution of collateralized debt obligations. In 2004, the securities exchange commission further relaxed the capital requirement for investment banks. The banks could then leverage up to about 40 times their initial investments. The condition further increased unsecured borrowing and excessive consumption.
Securitization was another condition in the financial market that preceded the financial crisis. The assets that sat on the balance sheets of the banks were repackaged into financial securities which were then sold off on the financial markets. This innovation freed capital in banks, enabling increased lending. For example, the US commercial paper increased from $500 billion in 2004 to $1.2 trillion in the early 2007 (Fetai, 2013). Securitization significantly increased subprime mortgage lending.
The three factors impacted the economy in different ways. First, the globalization dynamics complicated the Central Bank’s task to analyze the inflation process, leading to an overestimation of potential output. This means that New York realized strong but unsustainable growth before the crisis. Second, the imbalances led to a distortion of relative asset prices and caused the financial market to systematically underprice risk. Lastly, insufficiently regulated financial innovations created a whole class of assets, such as subprime mortgages, that had no underlying economic basis. The risk of financial stability increased and cash flows in the asset classes became extremely vulnerable to declining house prices.
During the Financial Crisis
The financial crisis had the greatest financial implication for New York since it is the financial capital of the United States. The interest rates started rising, pushing home ownership to a saturation point. At the beginning of 2005, the Fed began increasing rates drastically to 5.25%. The rates remained at that point until 2007.
The period before the recession had seen home-ownership hit 70%. At the end of 2005, home prices started to reduce. The home construction index in New York reduced to about 40%. Subprime borrowers also started to default loans since they could not withstand high-interest rates. At the start of 2007, subprime lenders began going bankrupt. By April 2007, two subprime lenders in New York had filed for bankruptcy. In the same month, the popular New Century Financial filed for bankruptcy. The news reports in 2007 indicated that hedge funds and financial firms owned over $1 trillion in securities that the failing subprime mortgages backed (Nahtigal, 2012). Seizure of assets from failing hedge funds began.
By September 2007, the subprime crisis became too overpowering for the New York financial market to solve. The problem had spread to other regions of the entire United States. The interbank market completely went under. A liquidity crisis took toll on the financial market. The effects called for the governments and central banks around the world to come together and prevent the worsening of the financial situation.
The crisis made the federal and state governments adopt conventional and nonconventional measures to find a solution to the problem. The central bank began providing liquidity support to financial institutions with the idea of reviving the interbank market. The federal bank started to cut discount rates and fund rates, but the crisis persisted. More organizations, such as Lehman brothers, filed for bankruptcy. JP Morgan acquired Stearns, while Bank of America bought Merrill Lynch (Mertzanis, 2013).
At the last quarter of 2008, the discount rate was reduced to 1.75% and federal funds rate decreased to 1% (Nahtigal, 2012). However, liquidity support and rate cuts could not stop the financial crisis. The US government created the National Economic Stabilization Act that established a corpus of $700 billion to facilitate the purchase of distressed assets such as mortgage-backed securities (Nahtigal, 2012).
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After the Crisis
After the financial crisis, New York lost more than 100,000 jobs (Fetai, 2013). Travel and tourism, media, entertainment, financial and professional services suffered the biggest losses. These sectors are the most significant contributors to the New York economy. The only sectors that had experienced growth after the financial crisis were health and education. However, these sectors depend on public resources.
The financial services of New York suffered the biggest impact of the financial crisis. Big companies that are the biggest taxpayers and employers suffered losses and some of them closed down. The businesses that survived had either received a bailout from the government or the government provided protection for them. The federal bank regulators swung into action to regulate bank capital. It was announced that banks should not give loans that are 30 times larger than bank reserves (Fetai, 2013). A credit crunch hit New York in which banks hung on to their cash and loans were unavailable. The economic recovery became a little more difficult. Though the government embarked on working on a variety of programs to revive banks and ensure businesses gets credit, the recovery could take time.
The traditional multimedia industry suffered the loss of customers and their advertising revenue dropped by about 25%. The main customers of this sector such as automobile makers and banks were adversely affected by the recession. Retail revenues in New York reduced by about 10% and high-end retailers experienced the greatest loss. Tourism visits dropped by 6% and hotel occupancy dropped by 5.5%. This had a net effect of falling off hotel revenue by 35% (Nahtigal, 2012). The small travel and tourism-related enterprises closed after consistently making losses.
Real estate was another big loser. The vacancy rate of class A offices increased to 12%, which was double the rate of the previous year. Residential sales fell by 50% from the previous year. Construction came to a halt. The multifamily apartments dropped below what the owners had paid for the buildings, forcing the organizations into receivership. This situation presented a serious threat to tenants. Philanthropic organizations that supported charitable institutions fell by 30% (Mertzanis, 2013). Institutions such as Apollo that sponsors charitable institutions went under.
Currently, the economy of New York is on the rise. Unemployment, which currently stands at 9.5%, is projected to fall. The federal government committed a trillion dollars in various stimulus and investment products to help the economy level off and improve. New York is now the biggest in tax collection among all other 50 states. The financial services generate about 25% of the economic output and tax revenues (Fetai, 2013).
The financial crisis had a far-reaching impact on the financial and economic conditions of New York. The main causes of the crisis included cheap and unsecured credit, speculative bubbles, and regulatory failures. The crisis caused a crash in the Wall Street, loss of homes, the collapse of businesses, and loss of employment. The confidence in the financial market does not recover quickly once shattered. However, New York has fully recovered and came out strong after the financial crisis.