Financial markets recoiled in horror in July when the Bureau of Economic Analysis announced that the US economy had dropped by a third. Gross domestic product shrank at an annualized rate of 32.9 percent in the second quarter of 2020 vs the same period in 2019. GDP was down 9.5 percent compared to the first quarter of this year.

The good news is that U.S. economic activity is already showing signs of recovery in some sectors. Estimates of U.S. retail and food services sales for June 2020, adjusted for seasonal variation, were $524.3 billion, an increase of 7.5 percent (± 0.5 percent) from the previous month, and 1.1 percent (± 0.7 percent) above June 2019.

But the bad news is that unemployment remains in double-digits. Sectors such as commercial real estate and the fiscal affairs of states and major cities, are in growing distress. While the states tend to focus on sales and income taxes for the bulk of their revenue, the cities and localities depend upon property taxes and local levies to support their budgets. But today the largest U.S. cities remain locked down.

Consider the case of New York State and New York City (NYC). For New York State, income tax collections are running nearly 50 percent below last year while all categories of revenue for the state are down 42 percent vs last year. Democrat Governor Andrew Cuomo has so far refused to take any significant action to cut back state expenses in front of the November 2020 general election. Suffice to say that no state better exemplifies the corrupt relationship between public sector unions and elected officials who set their salaries than does New York.

Ironically, Governor Cuomo is in a political battle with NYC Mayor Bill de Blasio, who wants to borrow in the short-term debt markets to cover the city’s $9 billion budget shortfall. Falling such a venture, de Blasio will need to layoff tens of thousands of unionized teachers, police and public sector workers before the end of the year. But such short-term expedients will not last, nor will they reverse the long-term damage being done to the NYC by its leftward political lurch.

“Ever since 1975 New York City has been haunted by the fiscal crisis that beset it beginning that year,” writes Kim Phillips-Fein in The New York Review of Books. “Images of battered, graffiti-decked subways and the Daily News cover photo of President Gerald Ford, appearing to tell the Big Apple to ‘drop dead,’ are familiar parts of its political iconography. After Andrew Cuomo was first elected governor in 2010, he gave out copies of a biography of Hugh Carey (New York’s governor at the time of the crisis) to his staffers and labor leaders – as though to signal his willingness to stand up to the interest groups often blamed for the near-bankruptcy.”

NYC had a fiscal problem last year, before COVID-19 exploded onto the scene. The business community stopped going to Albany to lobby members of the legislature long ago, leaving the fiscal discussion in the hands of public sector unions, state legislators and, of course, Governor Cuomo. But with the state staring at a $50 billion revenue hole, the discussion is becoming increasingly acrimonious.

The political process in NYC is a similar charade. In June, the progressive city council approved a $88 billion budget that seemingly assumes that Washington will come to the rescue, but it is unlikely that the federal government will or even can come to the rescue of all of the states and cities with significant cash shortfalls.

In the infantile-socialist milieu that is New York politics, Andrew Cuomo is the adult in the room. The anti-business, neo-Marxist rhetoric of Alexandria Ocasio Cortez is pretty typical of the views of the younger Democrats in NYC and increasingly in Albany too. These politicians see business as the enemy and view wealthy New Yorkers as a resource that can be taxed to fill the city’s fiscal gap.

The trouble, of course, is that wealthy people and also businesses can and are leaving in New York and in growing numbers. The signs of financial distress that are resulting as individuals and businesses decide to leave Gotham are visible in the monthly cash reports that are published by the state and NYC.

The radical left in New York wants to cut back on police protection and increase social spending, a recipe for financial disaster and public anarchy. Five of AOC’s Democratic Socialist of American (DSA) backed candidates won their races in the June 23 New York state primary, creating a block of explicitly socialist officials.

New York Assemblyman Walter Mosley (D-Brooklyn) lost his reelection bid to a 31-year-old primary challenger, a nurse named Phara Souffrant Forrest, who was backed by the DSA. In an interview with Jewish Insider last month, Mosley said there was nothing he could have done to win a race that was influenced by a wave of anti-establishment sentiment. Mosley expressed concern that the newly elected DSA-aligned lawmakers will not just try to push their anti-business agenda in Albany, but also influence other statewide lawmakers and future candidates.

In an ominous sign of things to come, Governor Cuomo last month quietly nominated three close associates to fill vacancies on the seven-member Financial Control Board. Former Secretary to the Governor Steve Cohen, former City Comptroller Bill Thompson, and current Secretary of State Rossana Rosado were all confirmed by the state Senate last month.

The Financial Control Board is controlled by the governor and has the legal power to manage the finances of New York City. During the city’s fiscal crisis in the 1970s, the Board closely monitored the city’s finances for close to ten years. The Cuomo-dominated board can be empowered to greatly limit the NYC city council’s ability to make fiscal decisions.

The challenges facing NYC are numerous and growing. First and foremost, the city’s ability to generate sales taxes for the state, much of which is reallocated back to NYC, has been crippled. The performing arts, tourism and other public activities are prohibited under New York’s draconian approach to managing the COVID-19 pandemic. Vast expanses of the city that was roaring with activity at the start of 2020 are now quiet. Hotels, restaurants and other public conveniences are closed or operating at reduced levels.

The COVID-19 pandemic has also greatly damaged the physical assets of New York, the office buildings and apartments that comprise a huge part of the city’s tax revenue base. As vacancy grows in commercial and residential buildings, the rental offerings are falling in a Darwinian battle for fewer and fewer tenants. The fact that the Democrat controlled legislature in Albany passed punitive rent control laws last year is now coming back to haunt Cuomo and de Blasio. NYC faces the prospect of buildings being abandoned, something that has not been seen since the 1970s.

As rental rates fall, the value of New York commercial and residential assets will also decline. The owners will start a process of reassessing the value of real estate, which will have the effect of shrinking the city’s tax base further. As landlords are forced to reduce apartment rental rates, the value of these building will fall. Banks that hold mortgages on these buildings will be forced to re-underwrite the credit, in some cases demanding cash from the borrower to roll a loan.

Fixing the structural damage done to big cities by COVID-19 and the upsurge of socialist political figures in New York will take many, many years. The fact that the large cities and states most visibly in extremis financially are blue states that lean to the Democrats in national elections adds to the stakes in November. Simply stated, without a victory by Senator Joseph Biden in November the most obnoxiously socialist blue states such as New York, Illinois and California are facing growing financial constraint.

But regardless of who wins the White House, the fiscal situation facing big cities and the states which house them will require immediate attention and hundreds of billions in emergency “loans” – new debt that is unlikely to be repaid. And the federal government cannot subsidize cities and states indefinitely.

In New York, restructuring bad debt connected with moribund urban businesses and real estate will be the primary task for years to come. Local politicians in New York must eventually start to consider how their actions help or hinder this process. Should Donald Trump win re-election in November, then look for the blue states to suffer severe public sector layoffs and the very real prospect of economic depression, and possibly even a municipal bankruptcy.

Christopher Whalen is an investment banker and chairman of Whalen Global Advisors LLC. He is the author of three books, including Ford Men: From Inspiration to Enterprise (2017) and Inflated: How Money and Debt Built the American Dream (2010). He edits The Institutional Risk Analyst, and appears regularly on such media outlets as CNBC, Bloomberg, Fox News, and Business News Network. Follow him on Twitter @rcwhalen.