Gotham Needs Wall Street; Does Wall Street Need Gotham?
Nicole Gelinas

New York’s leaders don’t understand how precarious the city’s prosperity is.

Wall Street has always been good to New York, the nation’s capital of capital. But the city faces two significant challenges it hasn’t yet begun to acknowledge. One, the stunning market growth of the eighties and nineties—and Gotham’s attendant growth in well-paying jobs, tax revenues, and public-sector spending—may well have been an anomaly that won’t be repeated for decades. Two, even when Wall Street does well, its prosperity won’t benefit New York City to the extent that it once did. Just as New York grows more dependent on Wall Street, Wall Street grows less dependent on New York.

Over the past half-century, New York’s reliance on Wall Street as a source of tax revenues and private employment has become ever greater. Formerly, Wall Street was just one of the three legs of Gotham’s sturdy private-sector economy, along with its bustling port and thriving manufacturing industry. But after World War II, the city’s port became obsolete, and its manufacturers drove off down the interstate highways toward cheaper regions. Even so, though the securities industry didn’t directly employ more than 100,000 New Yorkers until the early 1980s, the steady growth of both its workforce and its workers’ wealth kept the city’s economy afloat.

In 1958, when New York manufacturing still flourished, Wall Street jobs accounted for just 1.21 percent of total city employment. A decade later, as New York’s other private sectors withered, Wall Street jobs constituted 2.6 percent of Gotham’s total. By 1983, Wall Street accounted for 3.5 percent of jobs; by 1993, 4.8 percent. Today, despite massive losses in securities-industry employment after 2000, Wall Street accounts for 4.7 percent of the city’s jobs. If one considers just private-sector employment, the figures are higher still, rising from some 1.4 percent of the city’s private jobs in 1958 to about 5.6 percent today. (And many of the city’s new private-sector jobs, including those in health care and education, are taxpayer-supported, so they are wealth consumers, not wealth creators, like Wall Street jobs.)

While 5 percent of city employment may not sound like much, each Wall Street job generates a disproportionate share of city income—and that share continues to grow as the rest of New York’s private economy stagnates. In 1969, the Federal Reserve Bank of New York has noted, the securities industry was directly responsible for 4.5 percent of city earnings. Today, that figure is about 20 percent, and due to New York’s steeply progressive tax rates, the industry’s share of personal-income and corporate-income taxes is even higher. And Wall Street is increasingly the source of new jobs and income growth. In the 1980s, Wall Street, with its single-digit share of overall employment, produced 17 percent of new jobs in the city and 23 percent of income growth; in the 1990s, it was responsible for 21 percent of new jobs and for 56 percent of income growth.

Each Wall Street worker creates at least two jobs in the city and one more job in the greater region today: lawyers, accountants, financial-data providers, PR mavens, waiters, BMW salesmen, and the like. New York employs more than 900,000 people in information services, professional services, and general financial services, many of whom are inextricably tied to Wall Street. (The Street also creates more jobs in the city’s public sector, through its absurdly high city and state tax contributions.) Theorists can posit that New York is becoming a city based on media, entertainment, tourism, and real estate—but the fact remains that it is lost without Wall Street. As Harvard economics prof Edward Glaeser notes: “[T]he city’s future appears to be linked to a continuing ability to hold that industry.”

But the extraordinary growth in the stock market throughout the eighties and nineties allowed an already free-spending New York to grow complacent about its primary source of taxes and private-sector jobs.

Between 1982 and 2000, the U.S. was riding a long-term bull market: despite short-term cyclical downturns, stock prices grew robustly and steadily. During these years, the S&P 500 index and the Dow Jones Industrial Average grew sevenfold after inflation, or about 60 percent more each year than the expected long-term average. The NASDAQ grew more than 11-fold after inflation between its creation in 1984 and its peak in 2000.

Wall Street’s run-up sprang in part from America’s preeminence in the world in an era of globalization, and from technology and productivity advances. But there was another cause, too: the baby boomers, 78 million strong, created a demographic bubble in the markets. America experienced its bulge-bracket generation’s peak productive years in earning, spending, and investing. Middle-class investing, as measured by assets flowing into stock mutual-fund assets, grew from about $100 billion in 1982 to $4 trillion by 2000.

Wall Street wealth, of course, buoyed Gotham’s payrolls, with the city’s securities-industry employment doubling to about 200,000 workers at the bull market’s peak. It also buoyed New York City tax revenues—and spending. City outlays grew more than 50 percent after inflation during the long climb upward, propelled by social-services spending (welfare before the mid-1990s, and Medicaid after that), even as Gotham’s population grew by about 12 percent and its number of overall private-sector jobs grew by only 11 percent (including the growth in the securities industry).

But city leaders neglected to remember one thing during the market’s relentless upward march: it wouldn’t last forever. In fact, the modern history of the stock market is one of long periods of growth (interrupted sometimes by short downturns) followed by long periods of stagnation. Between 1969 and 1982, the S&P 500 actually fell by 64 percent after inflation.

Of course, in the seventies, unlike now, the nation faced persistent double-digit inflation. But today it faces a new set of problems, from increased competition for global talent and investment from India and China, to the continued failure to reform trillions of dollars in looming Social Security and Medicare liabilities before the baby-boom generation begins to retire six years hence. The generation that lifted the markets in the eighties and nineties could put a drag on them over the next several decades.

This is a New York challenge as well as a national one, since Gotham has built its economy and its budget on a finite market trend. And city officials have not faced up to the real possibility that the long capital-markets party with its headquarters in New York may be over for a long time to come. Mayor Bloomberg, for example, has hiked taxes to fund spending increases of nearly 15 percent after inflation during his first term. He continues to budget as if a long-term bull market will resume any minute now after a five-year break.

Just as bad, Wall Street’s wild gains throughout the eighties and nineties masked another trend. Even as New York’s securities-industry employment has grown, and even as New York has become increasingly dependent on Wall Street’s success for its own jobs and tax revenues, Gotham has steadily lost its share of national securities-industry jobs. This loss stems from permanent changes in the structure of the national securities industry that predate 9/11 by decades—changes that the city hasn’t yet confronted.

Over the 30 years before the 1987 stock-market crash, the city’s share of national securities-industry jobs steadily eroded by a little less than 1 percent a year. In 1958, New York boasted 43.2 percent of the nation’s securities-industry jobs; by 1986, it had only 35.7 percent. After the ’87 crash, as Wall Street sought to cut costs aggressively during a short downturn, this migration of securities-industry jobs became markedly less gradual. Since then, the annual rate of attrition in Gotham’s share has tripled to nearly 3 percent (although industry experts believe that it has stabilized for now). Gotham currently boasts only 22 percent of the nation’s Wall Street jobs—and the roughly 170,000 workers employed in the industry in the city today (about 30,000 industry jobs vanished after the tech bubble burst and after 9/11) surpass only modestly the 163,000 employed just before the ’87 crash.

As George Monahan of the Securities Industry Association wrote shortly before 9/11: “It should be sobering to New York governing officials that from the stock market crash in 1987 until May of this year [2001], New York has gained a net of only 28,300 [industry] jobs vs. 287,800 in the other 49 states. In other words, less than 10 percent of industry job growth occurred in New York—a startlingly low figure.”

But why? For a vivid insight into the changes wracking Wall Street, just look at the lesson playing out at the august New York Stock Exchange, the symbolic pillar of the industry and of New York’s preeminence within it.

Much like New York City, the NYSE, for most of its 213-year history, didn’t have to worry about the competition. Like Gotham, it derived its strength from its role as a central meeting place, and one industry can have only so many central meeting places. The NYSE was a not-for-profit entity where for-profit players could come together to do business for those who couldn’t be there and who didn’t have the information they needed to trade at the best possible price anyway.

But today, information is everywhere—and as for trading, much of the activity that once was done on the floor of an exchange is done over a computer network now. Says Ed Nicoll, CEO of institutional-brokerage firm Instinet (and, through Instinet’s Inet electronic trading network, a NYSE competitor): technological advances over the past 30 years, and particularly over the past decade, “help to solve the problem that the NYSE was created to solve in the first place.”

Indeed, over the past ten years, the NYSE has begun to lose its primacy in the capital markets, as technological, regulatory, and competitive pressures have trumped habit and history. Even as the NYSE has updated its own technology to compete, the exchange’s market share of trading in its own listed stocks fell to less than 75 percent last October, down from between 80 and 90 percent in recent years.

Institutional clients that buy and sell securities—such as mutual funds, hedge funds, large banks, and investment firms—now have another choice, in the form of upstart electronic stock-trading networks called Electronic Communications Networks (like Inet and its competitors). Technology, helped along by changing regulations, ignited the growth in ECNs.

While large customers have long had limited options to buy and sell securities electronically rather than through human brokers and specialists, many didn’t see the point of doing so until the 1987 crash—when they found that many institutional brokers simply didn’t answer their phones. They then began to rely more on early electronic trading networks, but regulations lagged far behind emerging technology. The result was that institutional investors built what Nicoll calls a “secret market,” where only they could see the prices, and they took advantage of price discrepancies between that market and the public market.

Not surprisingly, regulators didn’t like this when they figured it out in the 1990s—and new regulations decreed that electronic markets had to be open to all traders. As a result, a generation of competing ECNs cropped up. New firms like Archipelago (“Arca”) and Island (now Inet) invested in trading networks that throughout the late 1990s and early 2000s put intense competitive pressures on the old public markets like the NYSE, as well as on traditional brokers and traders.

With few exceptions, computers can match buy and sell orders faster and better than humans can. Major firms have adapted to the new technology (and lower costs) quickly, sending as much as 50 percent of eligible orders today to ECNs rather than to the NYSE. Computers, and those who run them, don’t need to be located in Manhattan.

The NYSE stood to lose much if it failed to evolve. It had one option available to it that’s not available to New York City: buying a piece of the competition. Its members have approved a merger with one of those upstart electronic trading firms, Chicago-based Archipelago, to give clients a wider choice of where and how to trade stocks. Because the NYSE needs money to grow, it soon will become a publicly held, for-profit company beholden to shareholders.

What will happen to the 1,000 NYSE employees and the 3,000 people who work on the exchange floor for other firms? The NYSE posits that its merger will increase business for stock-specialist firms by allowing them to diversify into trading products that couldn’t be traded on the old NYSE, such as unlisted stocks, derivatives, and exchange-traded funds. We’ll see—but right now, the traditional specialist firms that operate on the NYSE floor are under pressure. The shares of Labranche & Co., for instance, are down more than 70 percent in five years; one analyst who covers the company, Michael T. Vinciquerra of Raymond James (who, by the way, works in Atlanta, not New York), says that he’s not sure how specialist firms will find a way to share in the benefits of the NYSE merger, since much of the projected post-merger trading-volume increases at the NYSE will probably go through electronic channels.

For with the NYSE’s evolution will come yet more automation. “We have to automate more of what [NYSE floor workers] are doing, and we have to eliminate a lot of the keystrokes. We need to give the specialists more time to focus on where they really do add value, which is dealing with order imbalances, dealing with blocks or large pieces of stocks and dealing with unusual events,” NYSE president John Thain said in November. Investment bank Bear Stearns, which owns a major specialist firm that does business on the floor, says that it expects to compete in a “more efficient and more automated . . . business” there.

One harbinger of employment prospects for some who work at the NYSE: when Instinet bought an Arca rival (the Island ECN) in 2002, the combined firm’s electronic trading unit had 1,075 employees. Thanks to technological advances and other cost savings, the company now has 82 highly paid employees (all in Jersey City), even as trading volume continues to rise. Indeed, it hasn’t taken the NYSE long to start compressing its own jobs to cut costs: even before officially merging with Arca, it announced a layoff of 60 middle-income staffers, including many floor workers who routed paperwork through the NYSE’s trading stations. This move shouldn’t come as a surprise—for major investment firms have bought stakes in regional stock exchanges such as Philadelphia’s in recent months, just to send the NYSE a message ahead of its merger: keep cutting trading costs for us, or we’ll do it for you.

The NYSE’s historic merger isn’t the beginning of a trend but just one milepost in an ongoing one. Over 30 years, a diverse array of highly profitable business lines on Wall Street, from stock brokerage to stock trading to debt and equity underwriting, have been ground down to razor-thin margins by technology, competition, and regulation. What’s left are just a few spectacularly profitable business lines and many low-margin businesses—and an industry that can no longer afford armies of support employees in expensive New York City.

As Brad Hintz, a securities-industry analyst at Sanford Bernstein, has found, one standard measure of performance, a company’s return on its equity (ROE), has declined steadily and steeply throughout the securities industry over the past 25 years, from about 50 percent in 1980 to 20 percent in the mid-nineties to the high teens today. “These declines stem from troubling and persistent secular trends that will not solve themselves anytime soon,” Hintz notes.

How much have returns on some business lines shrunk? Retail stock commissions per share have fallen 73 percent since 1980, while costs for large institutional traders have fallen by 60 percent, from about 10 cents in the 1980s to about 4 cents last year. Since 1992, the average fee for underwriting debt has fallen 30 percent, and is down 16 percent on underwriting initial public stock offerings (IPOs).

The inexorable squeeze on Wall Street’s profits really began over 40 years ago, with the advent of mutual funds. In the 1950s and sixties, computing advances allowed money managers to construct well-diversified stock portfolios on a mass scale and market them to retail investors. Compared with stock commissions, fees on these new mutual funds seemed cheap—and lots of individual investors, including affluent middle-class ones who might otherwise have relied on high-priced brokers, flocked to the funds in the 1960s. Mutual funds, in turn, used (and are still using) their institutional heft to drive their own trading costs down, cutting into that slice of Wall Street profits. Today, mutual-fund managers in turn find themselves squeezed by, among other things, even cheaper index funds, which give middle-class clients access to the broad markets without forcing them to pay high fees to fund the high salaries of mutual-fund managers.

Mutual funds and other large institutional investors (including pension funds) gradually helped to drive down trading costs until the ECNs took over—steadily shrinking a relatively stable source of industry profits and of New York jobs. But even as this shrinkage was occurring, regulators detonated Wall Street’s “Big Bang” in 1975, abolishing fixed (and high) commissions on individual-customer stock trades. The regulators thus introduced discount stock trading to the average investor as a new form of competition to full-service (and expensive) mainstays like Merrill Lynch. While the discount brokerage industry has strong ties to New York, its major firms, including industry leader Charles Schwab of San Francisco and Ameritrade of Omaha, are more often than not headquartered elsewhere, just as the mutual-fund industry (growing out of a pooled Harvard faculty investment fund in the 1890s) is headquartered in Boston.

One seemingly innocuous change that took place in 2001 has further squeezed margins for institutional traders: the regulators’ move toward decimalization of the equity markets. Previously, stocks were traded in increments of one-eighth; today, they’re traded in increments of one-hundredth, reducing the minimum spread—a major source of profit—on a trade.

New York securities firms face additional pressures from globalization and from changing regulations, as European and Asian banks seek to do more U.S. investment-banking business and as commercial banks, once barred from the investment side of the industry, have joined up to throw money around.

When profit margins began to shrink, Wall Street’s leaders reasoned that they had better shrink some of their costs, too, and—particularly after the ’87 crash—they moved to cut staffing costs aggressively and permanently. As one Wall Street titan reportedly put it in the late eighties, “Any job that doesn’t have to be here, shouldn’t be.” Supercharging the cost cutting was new, cheap communications technology that made possible the wholesale automation and decentralization of a large swath of New York’s middle-class Wall Street jobs.

Where were most of the new jobs in the industry created over the past two decades, then, if not in New York? (Some jobs have just vanished to automation, just as bank tellers have fallen victim to the ATM.) A decade ago, the industry solidified itself firmly in the New York region. Many jobs went to New Jersey—lured by generous tax breaks. The Garden State’s securities industry nearly tripled between 1990 and 2001 (and continues to grow faster than New York’s after 9/11). Just in the past decade, Citigroup Global Markets, Goldman Sachs, Instinet, JPMorgan Chase, Knight Equity Markets, Lazard Frères, Lehman Brothers, Merrill Lynch, Morgan Stanley, SG Americas, and TDWaterhouse Securities have created 11,000 jobs in northern New Jersey. Meanwhile, back across the river in lower Manhattan, developers have carved 15,000 new apartments out of old office space.

During the current recovery, though, investment firms are ranging further afield. JPMorgan Chase announced in early December that it would create 4,500 new securities-industry jobs in Bangalore, India, by 2007, joining UBS (with 500 jobs there) and Goldman Sachs (with 750). Twenty-five years ago, most of those jobs would have been created in New York; 15 years ago, perhaps half of them would have, with the rest going to places like New Jersey and Florida.

Wall Street’s first cost-cutting target was its back office. New York viewed this job loss with a certain fatalism; despite efforts in the late eighties and early nineties to use subsidies to trap low- and middle-income securities jobs at outer-borough campus sites like Brooklyn’s Metrotech, city officials have long seemed resigned to the fact that Gotham is too expensive for rational corporate executives to house support-level employees there.

But for the past decade, Gotham’s securities-industry employment losses have been, “in large part, highly paid, highly skilled, former New York City jobs,” as the Securities Industry Association puts it. Morgan Stanley and Jefferies, for example, have high-level trading operations in Westchester County and northern New Jersey, respectively, staffed by employees who earn mid-six figures and more. Nor are the jobs that JPMorgan Chase is creating in India simple telephone call–center jobs worth $7 or $8 an hour in the U.S.; employees there will do support work for high-level derivatives and structured-finance products. Bear Stearns proudly notes that it has hired workers in cheaper overseas labor markets to put together complex presentations for its investment bankers, and that it plans on hiring more such workers to do analysis for its banking teams. As technology and competition squeeze more and more once-lucrative product lines, and as ever-more-sophisticated jobs can be automated or moved away from centralized locations, Wall Street will have to cut costs more deeply and more creatively.

Even Wall Street’s army of securities analysts is shrinking. “In-house research departments are historically expensive to maintain,” notes the SIA’s Kyle Brandon. “Some firms have stressed lowering their costs by cutting staff . . . and outsourcing routine number-crunching tasks to services located in India and other low-cost locales.” A New York–based start-up, Copal Partners, has begun hiring analysts in New Delhi to support Wall Street investment bankers. Copal has 175 analysts there, and hopes to have 400 within a year. This is marginal job growth, but much of it formerly would have occurred in New York City.

What’s left on New York’s Wall Street, then, are the highest-level, highest-paid stars—the top people in the traditional investment-management firms and investment banks, the mergers-and-acquisitions and leveraged-buyout princes, and a crop of new high earners as well. So in Manhattan, the securities industry has fewer workers, each of whom earns more money—because the workers left in the city are mostly only the ones whose productivity can justify the high cost of being here. “New York has become a high-end boutique for Wall Street,” notes Manhattan College finance prof Charles Geisst, who wrote a book on the history and current state of Wall Street. Wall Street firms today look for individuals with “courage, imagination, and education,” said one industry veteran—not for legions of entry-level junior bankers, traders, clerks, and secretaries.

The proof that only the most productive jobs remain in Manhattan is in the numbers: New York, with only one-fifth of the nation’s securities-industry jobs today, has kept a full half of national securities-industry compensation. Even at the top, Wall Street is becoming increasingly frugal with its hiring: Bear Stearns notes that its ratio of junior bankers to senior bankers used to be about seven to one; today, it is four to one.

Wall Street, being Wall Street, still finds ways to make good money, even if it can’t make as much simply by processing trades, underwriting debt, and giving advice to clients. To generate their outsize profits, though, even the most elite firms—the ones that still create jobs in New York—often bet more of their own capital than they once did. Investment banks today “make much of their money by taking risks,” says Salomon Brothers veteran Richard J. Schmeelk, now a partner at private-equity firm CAI Managers & Co.

Such risk taking increasingly occurs even in traditional investment banking. Say that a major corporation in the business of building and operating power plants hires Morgan Stanley, for a large fee, to underwrite a bond to finance the construction of a new plant. In return for the fee, the company might also expect Morgan to take on some of the venture’s risk. It may, for example, expect Morgan to agree to purchase some of the power generated from the company’s plant on a long-term basis, which Morgan will then sell off through its vast commodities-trading operations.

Twenty years ago, Morgan likely would have earned the same fee for the much safer and less complex task of merely underwriting the bond. Back then, it only had to assess the credit quality of the power company and perhaps the long-term outlook for power sales in the new plant’s area. Today, it must also try to forecast the movement of power prices during a given time frame.

Wall Street firms long have had cowboy teams that thrived on much greater risk taking than their comparatively staid colleagues in research, underwriting, and advice proffering. But as margins on those more traditional products grow thinner, investment banks must depend to a much greater extent on the money generated from risk-taking ventures.

Industry leader Goldman Sachs’s recent profit trends bear out this point. In 1998, income from activities that included trading on, and investing, the firm’s own capital—relatively risky compared with offering advice to merger clients—produced only about 28 percent of net revenues; money from more traditional investment banking and asset management generated the rest. By 2000, trading and principal investments accounted for nearly 40 percent of Goldman’s net revenues, as well as 48 percent of pre-tax profits. In 2004, these activities produced nearly 65 percent of net revenues and 75 percent of pre-tax profits. As Goldman notes: “We have been committing increasing amounts of capital in many of our businesses and generally maintain large trading, specialist, and investment positions.”

One measure of the investment banks’ increased appetite for risk: the average “value at risk” across the industry—that is, the amount of money each bank estimates it would lose in a given time period in a given loss scenario—is up 17 percent over the past year. And even this is not an adequate measure, because banks derive their value-at-risk figures in part from simulating what future losses would look like based on past events, like generals who are always fighting the last war.

As part of their new embrace of risk, major investment banks over the past several years have focused on devising and trading ever more exotic products, as opposed to plain-vanilla stocks and bonds. Through a credit derivative, for example, a bank can now “unbundle” the risks for a client who holds a certain investment.

Say that a client owns a General Motors bond and, though he likes the interest rate, is worried that GM will go bust and the bond will lose much of its value. Ten years ago, he would have had to sell the bond to assuage his worry; today, he can buy a type of derivative option that would allow him to collect at least a percentage of his loss in the event of a bankruptcy (if it occurs within a given time frame) from the institution or person who sold him the GM credit-derivative option, who is in turn betting that the price he received for the derivative option amply compensates him for the risk.

At Bear Stearns, volume at the firm’s credit-derivative desks is up 800 percent in two years, while employment on those desks is up 30 percent. Investment banks are beginning to offer similar credit derivatives that allow investors in a hedge fund (really just a lightly regulated pool of investors’ money aggressively managed by a private partnership) to purchase over a trading desk the option to collect cash if the fund performs poorly within a certain time frame.

It’s difficult to calculate the day-to-day value of such exotic products and the aggregate risk of an individual firm’s own holdings in them. The large investment banks say they’re not worried: they can handle the risk because they diversify their investment and trading portfolios well. If a credit derivative on one product becomes worthless (or worse) in the event of an oil shock, the theory goes, that same shock will simultaneously make a credit derivative on another product suddenly lucrative, balancing the loss. Trouble is, in times of severe shock, investors could lose confidence in all of these relatively new and opaque products, at least for a crucial few days.

Further, to earn above-average profits today, investment banks not only devote more of their own capital to exotic trading strategies and products; they also bet more of their own capital on longer-term outside investments whose value and risk are equally hard to determine. Some banks invest heavily in outside hedge funds and in other private-capital ventures. Bear Stearns recently noted that its investments in outside private-capital funds are becoming more important to its bottom line; Merrill Lynch chief Stan O’Neal said in December that Merrill would invest more money next year in external private-capital funds.

Wall Street’s seemingly permanent embrace of increased risk is in one way positive for New York. It is partly why firms like Goldman don’t move even their top workers to lower-cost areas to boost profits—which would be the death knell for New York’s economy. But Gotham continues to dodge that bullet because Wall Street’s elite echelons—those who deal as much in human capital as in financial capital to structure today’s ever more complicated deals—continue to thrive on urban density.

The Street elite makes money today by manufacturing ideas. Every quarter, someone must come up with a new scheme for an exotic derivative product before the competition does. Someone else then must figure out how to insulate the firm from the potential losses that the new product could precipitate. The industry thus needs top talent—not (as 30 years ago) the bottom quarter of the Yale class—and the competition for brainpower is fierce.

To fill these jobs, “outsourcing to India doesn’t work,” says Instinet’s Nicoll. To take just one field: “Everyone is tripping over each other to hire derivatives professionals. . . . The market is growing so quickly and the talent pool is relatively small. There is also competition for traders, with the hedge funds luring so many talented people away from the Street,” notes Investment Dealers’ Digest editor Jeff French.

This is good news for the New York region and for the city: Gotham can draw on a 16-million-strong labor pool of relatively well-educated people connected by relatively efficient public transportation, and it is a perpetual magnet for global talent. “The [financial] industry is able to evolve because of its intellectual capital,” says Rae Rosen, senior economist at the Federal Reserve Bank of New York. “If it moves, it won’t find that.” A firm that needs to beef up its derivatives or its commodities-trading desks can look across midtown and offer more money to lure a successful team from a competing firm. What Berkeley prof AnnaLee Saxenian has noted about a key ingredient of Silicon Valley’s innovation and success goes for Wall Street, too: high-level staffers can change jobs without uprooting their families or even altering their commutes. Any investment-banking firm that moved too far from Manhattan would lose ready access to this talent pool, dulling its competitive edge.

It would also lose the opportunity for everyday face-to-face interactions with clients. A client from Seattle who plans on hiring an investment bank to structure a complicated deal, for example, wants to fly to New York and walk from block to block along Sixth Avenue to meet with competing banks and then seal the deal over a fancy lunch. He’s not going to take a limo to New Jersey or a plane to Florida to meet with the one bank that has moved away. Wall Street also depends on New York’s dense network of talent in other fields—from lawyers to PR folks to event planners. Investment banks that are productive enough find that it still pays to stay in Manhattan.

Even so, the technology that has helped erode the profit base of the old Wall Street has created another crop of high-flying finance jobs that are not as wedded to New York City as traditional high-end investment banking continues to be. Computing technology, comparatively light regulation, low trading costs, and half a decade of record-low interest rates have fueled the creation of thousands of hedge funds, private-equity funds, asset-management firms, and the like. In just ten years, 2,080 hedge funds with assets of $76 billion have grown to 7,000, with nearly $1 trillion of assets.

Many hedge-fund managers are experienced researchers and bankers who, in a different era, would have spent their careers at a major Manhattan-based firm like Morgan Stanley. Now, an experienced asset manager doesn’t need the backing of a corporation; he can manage assets from anywhere—so New York does not have a lock on these jobs. Moreover, asset managers who do lead their operations at major investment houses aren’t wedded geographically to their firms, or, for that matter, to the city. Merrill Lynch isn’t going to fire a star investment manager just because he decides he’d rather work in Greenwich; the firm likely would help him find an office there and provide him with the technology he needs.

Same with top-flight traders. A Morgan Stanley group, at its own choice, now buys and sells contracts on oil, gas, electric power, and other commodities from a Westchester County office building. They don’t just trade commodities as a neutral agent for clients while assuming minimal risk for the firm. Morgan actually physically owns millions of barrels of oil and its own power plants, with all the risk that entails. According to the Wall Street Journal, Morgan controls about one-quarter of America’s home-heating-oil reserves and is an aggressive seller of its own electric-power supplies to wholesale clients around the nation; the firm also controls oil-storage barges around the world. The Westchester high fliers sometimes go as far as buying the rights from major oil producers to sell the companies’ oil even while it is still in the ground.

The top talent who do choose to stay in New York do so in large part for quality-of-life reasons; they enjoy living here and find it profitable to do so. For many of the industry’s wealthy leaders, New York’s cultural legacy—its museums, grand apartment buildings, parks, galleries, concert halls, and private schools, to name a few—continues to outweigh the city’s high costs. That’s why New York is home to six of the top ten hedge funds, and was home to three of the five largest start-up hedge funds last year.

But industry veterans who don’t mind commuting to the city to get their cultural fix instead of commuting to get to their jobs (as well as those cultural philistines who just don’t care) have the option to set up shop away from the city today; their technology is portable. That’s why Greenwich now rivals New York as a hedge-fund hub; morning commuter trains from Manhattan to Connecticut are just as crowded today as the trains going in the other direction.

New York City, like the NYSE, now must work hard to keep much of the business that it once took for granted. So what can the city do to keep Wall Street’s elite anchored in New York, and to infuse new energy into its economy, so that it is not as dangerously dependent on a single, volatile, and mobile industry?

New York’s high marginal state and city tax rates put the city at a greater disadvantage now than they did 20 years ago, because top earners aren’t stuck in New York. So New York can start with the obvious: cut marginal income taxes. Instead, New York has done the opposite, with personal-income and corporate tax revenues, largely derived from Wall Street, rising from 15 percent of Gotham’s tax revenues in 1970 to 34 percent today.

Moreover, New York City levies an extra tax on business ventures that are formed as partnerships, not as corporations. While this 4 percent unincorporated business tax does offer an exemption to investment partnerships, including hedge funds, structuring a company properly to ensure that it escapes the tax is complex. High tax rates keep entrepreneurial industries away, so New York becomes more dependent on Wall Street, even as Wall Street itself becomes more dependent on risk-taking activities for its own profits. Thus, even with fewer securities-industry jobs, New York is more vulnerable than ever to sudden shocks within the industry. Because its securities-industry workers are the best-paid in the business, Gotham is more dependent than ever on income from highly volatile Wall Street bonuses. Between 1987 and 1989, cuts in Wall Street bonuses slashed income-tax revenue by about $14 million, or half a percent of such revenues. Between 2000 and 2002, cuts in bonuses slashed income-tax revenue by $250 million, or 5.6 percent.

In addition, New York should encourage office development, starting with allowing developer Larry Silverstein to rebuild the World Trade Center. More real estate means cheaper real estate—and more start-up businesses. And Gotham should get the Number 7 subway extended to the Far West Side, to jump-start free-market development there. Meanwhile, the city needs to slash taxes on commercial real estate, along with its bizarre tax on commercial rents.

Wall Street’s evolution has another important implication for Gotham: New York has little room for error today on governance issues like crime, public order, and the quality and reliability of public transportation.

In the seventies, eighties, and early nineties, Wall Street firms and workers stuck it out in New York—and helped the city to recover from its fiscal and social problems—in large part because they had no choice. But many wealthy taxpayers who once would have had to weather incompetent government in Gotham will not have to do so the next time around. Even those bankers, managers, investors, and advisors who love the city and who thrive on urban density would have the option to move away if the intangible costs of doing business here—including crime and inconvenient transportation choices—began to outweigh the benefits. Density in specialized sectors of the finance industry can be created elsewhere: just look at Greenwich.

This means that events like December’s mass-transit strike could have a greater long-term effect on New York today than they would have had 25 years ago. More than a few Wall Street workers noted during the strike that they easily could work at home. If the threat of business interruption makes it too difficult for New York firms to accomplish their day-to-day business productively, those firms easily can station workers elsewhere.

New York always must remember: its top earners and its top firms are here only for as long as New York continues to be a profitable and pleasant environment for them.

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