Oct. 31 (Bloomberg) -- New York state and city each predicted widening budget shortfalls as Wall Street profits plunge and the real estate market cools.

Mayor Michael Bloomberg yesterday ordered department heads to freeze hiring and cut spending this year and next in anticipation of less revenue. State financial officials reduced their estimates for personal tax collections, while state Budget Director Paul Francis said he plans to hold spending to no more than the growth in personal income.

``People are starting to get real,'' said Charles Brecher, research director for the Citizens Budget Commission, a non- profit, business-funded fiscal monitoring group. ``We don't know where the economy is going, but what's interesting is the directional change, and facing up to the fact that times are going to get tougher.''

Securities industry profits account for almost 9 percent of tax revenue for New York City and about 20 percent for the state, according to a report released yesterday by state Comptroller Thomas DiNapoli. While comprising 5 percent of the city's employment, financial firms generate about 23 percent of its personal income. Every Wall Street job produces two more in the city economy, said Rae Rosen, a senior economist with the Federal Reserve Bank of New York.

City Budget Director Mark Page wrote in a memorandum to department heads yesterday that New York's budget shortfall would reach $2.7 billion in fiscal 2009, $1.15 billion more than he projected in July at the start of the current fiscal year. For 2010, he estimated a $4.8 billion gap, $1.4 billion more than the administration had anticipated. The $6.5 billion deficit now expected for fiscal 2011 is $2.1 billion more than previously calculated.

Getting Real

Bloomberg yesterday ordered agency heads to stop hiring except for positions paid for by the federal or state government, or jobs with an immediate impact upon public health and safety. He also called for budget cuts of 2.5 percent this year and 5 percent next year for a savings of $1.5 billion.

Housing prices in the New York City metropolitan area may start to drop beginning in the current quarter and continue falling 1 percent to 7 percent per quarter through 2008, Mark Zandi, co-founder of Moody's Economy.com, an economic forecasting agency and unit of Moody's Corp. in New York, said last month.

``This slowing of the national economy and the local real estate market has a direct impact on the amount of the city's tax receipts,'' Page wrote in the memorandum distributed by the mayor's office. ``Credit tightening and hedge fund losses are expected to cut into the profits of the financial services sector of the city's economy, further eroding our revenues.''

State Gap

New York state faces a budget gap of $4.3 billion next year, up from $3.6 billion estimated three months ago, the Division of Budget said yesterday. Officials reduced their estimates for personal tax collections by $500 million in the current year and $650 million in the year beginning April 1 because of Wall Street declines.

Earnings at the seven largest financial firms based in New York City fell almost 65 percent in the third quarter compared with last year, according to DiNapoli's report.

All except Goldman Sachs Group Inc. announced third-quarter profits lower than last year. Merrill Lynch & Co. reported a $2.24 billion loss, while Morgan Stanley, Citigroup Inc., Lehman Brothers Holdings Inc., JPMorgan Chase & Co. and Bear Stearns Cos. all said earnings fell from a year earlier.

``Anybody that questions whether or not the economic engine of Wall Street is going to continue to help the city and state budgets just has to read the papers,'' Bloomberg said at a Manhattan news conference last week. The mayor is founder and majority owner of Bloomberg News parent Bloomberg LP.

2007 Bonuses

As for bonuses, which totaled a record $23.9 billion last year, ``the decline may be modest'' because the industry experienced a strong first half in 2007, DiNapoli said.

``The fourth quarter will determine the outcome for the year and set the stage for 2008,'' the comptroller said.

As recently as June 15, the mayor and City Council gathered in City Hall's rotunda to hail what they called a ``good times'' budget with a $4.4 billion surplus, a property-tax cut and record amounts for cultural organizations and libraries. Even then, the mayor warned ``the good times won't last forever.''

The city, which faced a $5 billion budget gap five years ago in the recession that worsened after the Sept. 11 terrorist attacks, benefited from a booming real estate market and surging Wall Street profits that resulted in rising revenue and helped New York win its highest debt ratings.

Shrinking Spreads

The risk premium, or spread, investors demand to buy New York City's 10-year bonds instead of top-rated municipal securities has shrunk by more than 60 basis points in the past five years to about 30 basis points, according to data compiled by Bloomberg. A basis point is 00.01 percentage point.

Bloomberg's decision to set aside some of the surplus to prepay city debt and create a trust to fund future retiree health expenses, combined with the financial industry's strong first half, may cushion the blow for this year, said Rosen at the New York Fed.

``The problem is we don't know whether the current downturn is a one-quarter phenomenon or a multiple-quarter impact,'' she said.

To contact the reporter on this story: Henry Goldman in New York at hgoldman@bloomberg.net

Last Updated: October 31, 2007 00:12 EDT