(FORTUNE Magazine) – Dear Milton, Happy New Year, where you are at least, I hope. In New York City everything's going to pot again. The schools are falling down, the hospitals are falling down, Wall Street is falling down, the sewers are blowing up. My son wants to buy an apartment, but who can afford to now? He's living in a luxury converted welfare hotel. Then there's the crack and the smack and AIDS and the people sleeping in the Citibank. They open the door and ask for a quarter, finally some courtesy. Other than that there's a new mayor -- I'm not saying it's good or it's bad, it just is -- and he says he's going to be tough on crime. Now six people have to be shot instead of three before it counts as a shooting spree. So how's Pensacola? Harry

THE BITTER forbearance with which New Yorkers view their hometown is beginning to wear thin again. Every decade or so a confluence of events, some local, others from beyond the city's borders, threatens New York City with decay and upheaval. The social and economic problems brewing in the city -- crime, illiteracy, and homelessness; drug abuse and AIDS; the high costs of living and doing business; crumbling public facilities -- will test it more severely than at any time since the mid-1970s, when fiscal mismanagement and the loss of 600,000 jobs pushed New York toward bankruptcy. Back then, facing economic ruin, New York was both smart and lucky. Smart, because it put in place extraordinarily effective financial controls that balanced the budget and won back entree to the credit markets. Lucky, because just as the city reached bottom, Act II of the restructuring of its economy began, with service jobs taking up the slack of manufacturers that left; the financial industry, just 12% of the employment base in 1977, added one-third of the 300,000 new private-sector jobs gained since those bleak days. New York appears to be running out of luck now. Social problems that did not even exist in the 1970s have invaded the city's consciousness and placed new burdens on spending. A series of abhorrent and violent incidents have inflamed both fear of crime and racial tensions, never far below the surface in New York. Companies needing to cut costs are eyeing other locales, as are individuals squeezed by high prices. And the financial industries that propelled New York through the 1980s seem to have lost their motive force. City tax revenues may not grow this year. The combined effect of its maladies has raised an old question: Is New York in danger of losing its spot as the world's preeminent business center? The short answer, which will surprise the prophets of demise, is no. Strong forces still compel businesses to stay in New York. Talented people still go there. Opportunities for growth still exist. The local government is not going bust. And, in the eyes of the dean of New York economists, the city has not lost its capacity for surprise. ''I caution those who question New York City's capacity for comeback,'' says Samuel M. Ehrenhalt, for ten years the regional commissioner of the Federal Bureau of Labor Statistics. ''People who have done so in the past have ended up with egg all over their faces.'' That said, not even the most chauvinistic New Yorkers would deny their city is hurting. Of all the items on the wrong side of the ledger, crime grabs the biggest headlines. Per capita rates of murder and robbery have risen by less than 5% in the past decade, but several high-visibility crimes -- the assault on a jogger in Central Park, murders of young blacks by white youths in Bensonhurst and Howard Beach, the Bernhard Goetz subway shootings -- create the perception that New York has become dramatically more unsafe. Certainly the environment of the city has changed, as drugs, crime, and homelessness reach into even affluent neighborhoods. Says Rosemary Scanlon, chief economist of the Port Authority of New York and New Jersey: ''Our public space has been / taken over by the poorest of the poor in a way not seen since the Depression. I don't discount the effect it has on the way we feel about ourselves.'' As bad as crime and racial tensions and homelessness are, people in the private sector and in city government argue that other aspects of urban life are more serious threats to the economy. Says Karen N. Gerard, a former deputy mayor for economic development and now vice president with relocation consultants Moran Stahl & Boyer: ''People like to say quality of life is the reason they leave, because the city can't bargain over that. But the bottom line is cost and quality of labor.'' Financier Felix Rohatyn of Lazard Freres agrees: ''Safety is clearly an issue, but it is not on top of the list. The cost of doing business, taxes, and schools are.'' WHY ARE COSTS so high? Poverty is one cause, particularly since New York State, unlike most other states, asks cities to share welfare costs. In 1987 the bill to New York City -- nearly one-quarter of whose residents live below the federal poverty level -- was about $1 billion. Afflictions like AIDS and crack cocaine are sundering lives and costing additional billions. Last year AIDS alone cost over $700 million, with the city government's share about 25%. As a result, companies in New York face strange species of taxes found nowhere else on earth, such as the 6% levy assessed on their rent. And their employees pay some of the steepest state and city taxes in the nation. To some extent New York is also a victim of the success of its high-paying businesses, whose employees have bid up the price of living space. As recently as 1982 the cost of housing in the region was about the same as the national median; now it is twice as high. Construction costs are around 15% more than they are just across the Hudson River in New Jersey. The quality -- and quantity -- of labor is another critical issue for business. New York's public school system, once a model of excellence and still able to cultivate more Westinghouse science finalists than any other city's, is failing in its bread-and-butter job of turning out a literate, work-ready labor force. Belying the city's reputation for workaholism, the proportion of New Yorkers working or looking for work is well below the norm: roughly 55%, vs. 66% for the U.S. as a whole. Only 25% of local 16- to 19- year-olds are in the labor force -- less than half the national average of 55%. ''The school system has underperformed, not just in New York City but * around the country,'' says American Express Chief Executive James D. Robinson III. ''Education is the No. 1 priority on the business agenda.'' The decrepit state of the schools' physical plant does not inspire much love of learning. Nearly all of the system's 983 schools need work. The backlog of repair requests has reached 33,000. ''High schools used to be built on a monumental basis,'' says Richard C. Wade, professor of urban history at the City University of New York Graduate Center. ''They were airy and light, and when a kid came in he knew he was someplace. Now, if he lives in a slum, he may find his school a worse place to be than home.'' The city has just begun a $4.3 billion five-year capital improvement plan for the schools. Wade thinks it may need to spend twice that amount. SOME DESPERATELY needed leadership has arrived in the person of new schools chancellor Joseph Fernandez, whom the city imported from Miami. He faces a stultifying central bureaucracy and corrupt local school boards that Felix Rohatyn says waste up to $500 million a year on worthless patronage jobs. Fernandez knows that quick and forceful action is essential. On his third day in office he suspended a principal for incompetence, unheard of in a city where principals have lifetime tenure in one building. He also asked 300 headquarters staff to resign. Rohatyn calls him the best thing to happen to the city in 20 years. Fernandez will try to keep more children in school and off the streets. As it is, the number of high school students who drop out before graduating fell from 32.5% in 1984 to 26.8% three years later, in part because of special counseling programs in the 43 high schools with the worst attendance records. Says Robinson of American Express, which helps train high school students for work in the financial and travel industries: ''The problems with the schools are not going to be solved overnight, but they can be dealt with very effectively and dramatically in the short range.'' One innovation that is catching on: training centers in high schools to help students learn what employers expect of them in the workplace. Sponsored by the Board of Education and the New York City Partnership, a group of local business and civic leaders, the centers began operating in six schools in 1988; they are now in 16, and a bill is before the City Council to expand the program to all of New York's 122 high schools by 1993. What, in the meantime, is keeping jobs in New York? After all, the schools did not go bad yesterday. ''If the city economy depended on the Board of Education, it would have failed 25 years ago,'' says Raymond D. Horton, president of the nonprofit Citizens Budget Commission and a professor of business at Columbia University. Some businesses simply have no place else to go. For example, financial companies that move their back offices from the city usually keep them within a 50-mile radius; the short leash allows face- to-face contact between the back-office director and headquarters. But the unemployment rate in the New York suburbs -- including those in nearby Connecticut and New Jersey -- is down to 3%, half the city's rate. Chase Manhattan recently decided to move to Brooklyn instead of New Jersey, in part because nearly 50% of its clerical staff is from that borough and might resist a long commute. Scanlon of the Port Authority says, ''Back-office moves from the city to the suburbs are probably over.'' Nor is a mass exodus of front-office service jobs likely, despite sophisticated telecommunications. ''Stockbrokers feel uncomfortable anytime they're away from the Street,'' says George Sternlieb, professor of urban planning at Rutgers University. ''A few adventurers may take advantage of faxes and modems. But the center of the pork chop is still New York City.'' The city continues to lose manufacturing jobs; even in the two years after the crash, it lost more jobs in industry than on Wall Street -- 21,000 vs. 15,000. Since 1970 the number of FORTUNE 500 headquarters has fallen sharply, from 118 to 48. But ironically, industry left -- and continues to leave -- less because New York is in decline than because service companies find it such a good place to do business: Bankers, brokers, and lawyers have bid up the average price of midtown Manhattan office space to $40 per square foot vs., say, $20 in Pittsburgh. As John F. Powers, managing director of the real estate brokerage Edward S. Gordon Co., says, ''Part of the incentive for the FORTUNE 500 companies to leave was the demand for their space.'' Counting the FORTUNE Service 500, 110 of the U.S.'s largest corporations have headquarters in New York. The city doesn't have the monopoly on banking and dealmaking that it once did. But globalism, that 1980s buzzword, should play to New York's strengths in the 1990s. ''Globalization doesn't necessarily mean a shift of money to London and Tokyo,'' says Karen Gerard. ''It means the world has a larger need for financial institutions. New York can afford to assume a smaller share of the pie if the pie is growing.'' Most large foreign banks already have New York outposts, and they are poised for growth. They came, first, to follow customers from home. ''In a global market, if you can't serve your multinational customers in all the major cities of the world, they won't need you even in their home country,'' says Clarence Hill, an economist at Deutsche Bank AG. The foreign banks are now looking for other ways to make money, such as real estate finance and personal banking, and they are hiring more people. Deutsche Bank, for example, added 100 people to its New York commercial banking operations, raising the total to 350. ''Information creates power,'' says Hill, ''and New York is the information center of the world.'' AS AN INTERNATIONAL center, New York actually has some cost advantages. Office space in London is twice as expensive as in Manhattan, and in Tokyo four times as much. London has more foreign banks than New York -- about 450 vs. 250 -- because regulations there permit commingling of commercial and investment banking. For the past two years the Federal Reserve Board has been chipping away at restrictions of the Glass-Steagall Act, which forbids universal banking in the U.S., and many in the business believe the act's demise is inevitable. Should this happen, Hill believes, New York's stature in international banking will grow at London's expense. Foreign banks could enter the mutual fund business, insurance, and other lines, encouraging more U.S. hiring. ''Without a doubt we would hire in New York,'' says Hill. ''This is where the know-how is.'' New York has a flair for rebirth partly because it has always been a magnet for immigrants. The newest crop is extraordinarily diverse, mostly from the Caribbean, Latin America, and Asia, but with no country accounting for more than 15% of the total. Many of the immigrants are skilled, trained as doctors and nurses, engineers and programmers. Others have put new twists on old trades, such as the Korean greengrocers whose lush displays of fresh vegetables quickly attracted customers from supermarkets. The immigrants create a virtuous circle, with high rates of employment giving them buying power, leading to resurgence of commercial areas, leading to jobs. And their arrival has boosted the city's population, which grew by at least 300,000 in the 1980s. In fact, the city grew faster than the suburbs for the first decade since the 1920s. ''A larger population usually means a more buoyant economy,'' says Roger Waldinger, a City College sociology professor, ''and the immigrants have entrepreneurial drive and energy.'' New York relies on brainpower from other proving grounds. ''What the Nile mud is to Egypt,'' says Sternlieb of Rutgers, ''the graduation ceremonies at all the schools in the country are to New York.'' In recent years business schools at Harvard, Chicago, and other elite universities have sent fewer MBAs to New York: 20% of Chicago's class last year, down from 27% in 1986; 22% of Harvard's class, vs. 32% in 1986. The trend is disturbing, but placement officers blame the decline on a slower financial industry, not aversion to the city's mean streets. Says Jeanne Husain, placement director of the University of Chicago's business school: ''Very few people who are interested in finance will refuse to go to New York City.'' For the first time in nearly a decade, New Yorkers are concerned about the municipal budget; still, the tabloids proclaiming the city broke are overwrought. ''There's been way too much loose talk about a budget crisis,'' says Raymond Horton of the Citizens Budget Commission. Because revenues are lower than expected and costs higher, the city will have to vault a $1 billion budget gap in the fiscal year starting this July. ''In a $30 billion enterprise,'' Horton argues, ''that's not a Herculean endeavor.'' Intact, for the time being, is the city's capital budget: $22 billion over the next four years to rebuild hospitals, schools, waterworks, bridges, housing. The city may have to cut spending if income falls too much, since tax revenues must pay the debt service. But New York will not suffer the calamitous neglect of the 1970s, when it lost access to credit markets and the capital budget fell to $50 million a year. People like Horton worry less about a budget crisis than about the city's ability to spend efficiently and improve productivity. New York, for example, increased its police force by 4,200 from 1983 to 1987 but assigned fewer than 1,000 of the recruits to law enforcement; the rest went behind desks. Here are some spending suggestions from the Citizens Budget Commission and others: -- HOMELESSNESS. Allocate more money for housing allowances, less for new city-owned shelters. Says New York University professor Emanuel Tobier: ''Judging by the city's track record of managing buildings taken over for tax arrears, which is awful, I question how the new shelters will be run.'' After New York raised emergency housing payments to individuals and families in 1988, Tobier says, fewer people entered the shelter system, and private landlords in low-income neighborhoods got rent money that helped keep their buildings going. -- HEALTH CARE. Build fewer hospitals and more facilities for what Charles Brecher, research director of the Citizens Budget Commission, calls alternative care. Brecher says city hospitals are overcrowded because 11% to 12% of their beds are occupied by people who don't need to be there, such as abandoned infants and the elderly. He maintains that these people could be cared for more cheaply outside hospitals. -- DRUG TREATMENT. The city uses prisons to house inmates who could be better -- and more cheaply -- rehabilitated in drug treatment centers. ''Live-in 24- hour-a-day treatment centers are much less expensive than prisons,'' says Horton. ''If someone's an addict or an alcoholic, and not a rapist or a murderer, he shouldn't be in jail.'' BUSINESS LEADERS have done very little to attack these problems. That's partly because, as Rohatyn puts it, ''there is no such thing as the business community in New York. There are several business communities, and all have different interests. The chief executives do not all live here. And the city and state political structure has not always been hospitable to the notion of working with the business community.'' Even so, individuals could do more to help. The city's big wheels have often volunteered their time and money on projects in the public interest -- a report on how to manage government more effectively, a new wing for a museum, a skating rink in Central Park. But, says Brecher of the Citizens Budget Commission, ''not a lot of people are stepping forward to sponsor facilities for troubled youths.'' New Yorkers could also do more to promote their city. Karen Gerard notes that even in cities as large as Atlanta and Denver, companies and local government have learned to cooperate. ''Our clients want to go to a town to meet employers and learn about economic development programs in the region,'' she says. ''Those cities can bring it together.'' New York has, at least, taken some first steps. Last year Mayor Edward Koch and deputy mayor for economic development Stanley E. Grayson took the city's first-ever dog-and- pony show to Chicago and Los Angeles, visiting banks and professional service firms that might be looking to expand eastward. Grayson says response was good, even though none of the targeted companies -- which he declines to identify -- has made a move yet. To help lure prospects, David N. Dinkins, New York's first black mayor, should call on satisfied local business people. They do exist. Some, because of the specialized nature of their businesses, are even satisfied with the Board of Education. ''The New York schools give us good semiskilled people,'' says Bernard L. Schwartz, chief executive of Loral, a $1.5-billion-a-year defense electronics company with plants around the country. His flagship factory in the South Bronx is the most profitable of all his plants. True, Loral is in a niche market and tends to hire graduates of New York's vocational high schools. But testimonials like Schwartz's are too good to pass up. Since winning the election last fall -- barely -- Dinkins has struck a fiscally prudent pose. He quickly scaled back some of his most expensive campaign proposals, such as treatment on demand for drug addicts. Dinkins is hardly the first politician who promised more than he could deliver, but his actions helped calm the financial community, which worries that city labor unions have the mayor in their collective pocket. Castigated for being too gentlemanly to handle the brawling metropolis, Dinkins made a gutsy appointment, reaching beyond the pale -- that is, to Houston -- for a new police commissioner despite objections from many New York politicos, Ed Koch and Governor Mario Cuomo included. The uneasy relationship between the city and the hinterlands has long been New York's bane and its salvation. In a 1939 issue devoted entirely to New York City, FORTUNE wrote: ''The discovery of huge resources in the West, occurring at the very moment when economic and political pressures in Europe were driving emigrants to this country, created ideas for the exploitation of the continent; ideas in the heads of the great American entrepreneurs, the gamblers, the speculators, and the investment houses; ideas for vast schemes and enterprises to change the face of the earth. These ideas were not necessarily generated in New York. But they exploded in New York because New York had the immigrants and New York had the credit. In one spectacular, breathless human lifetime New York exploded from a marketplace for goods to a marketplace for ideas; basically capitalistic ideas, but also ideas of every kind and shape that a new, expanding, optimistic, liberty-loving, profit- hungry continent could use. The fact is that New York cannot be intelligently discussed as a city, because it is not just a city. It is the heart of the U.S. economy.'' It still is, 15 years after President Gerald Ford spurned New York's request for money, prompting the New York Daily News to run that memorable headline FORD TO CITY: DROP DEAD. ''The bulk of learned opinion said New York was dead,'' recalls Sternlieb. ''The only question was how to bury it.'' Outsiders often dismiss New York as too rich, too profligate, too different. But because some people -- and companies -- really like it, and others need to be there, the economic circumstances that bind enterprise to New York are not likely to change soon, despite the hardships that always seem about to upset the apple cart. ''Are you from the city?'' asks Stanley Grayson, the former deputy mayor. ''Aren't there days when you say, 'I can't take it anymore'? There are for me. But then I ask myself, Where else will I go?''

BOX: New York City population 1988 7,352,700 1980 7,071,639 1970 7,895,563

Foreign born 1990 30% 1980 24% 1970 18%

Population density per sq. Tokyo: 36,121 mile N.Y.C.: 24,387 London: 11,047

Private-sector jobs 1989 3,009,500 1980 2,784,900 1970 3,182,300

N.Y.C.per capita 1987 $18,191 income 1979 $9,942 1969 $4,908

U.S.per capita 1987 $15,484 income 1979 $9,033 1969 $3,808

FORTUNE 500 headquarters 1988 48 1980 81 1970 118

City budget fiscal year 1990 $26.6 billion 1980 $12.8 billion 1970 $6.6 billion To relate the tables on this and the following pages to inflation, it helps to know that $1 in 1970 bought as much as $2.04 in 1980 and $3.16 in 1990.

SOURCES: NEW YORK CITY DEPARTMENT OF CITY PLANNING; U.S. DEPARTMENT OF LABOR; NEW YORK CITY DEPARTMENT OF RECORDS AND INFORMATION SERVICES; EMBASSY OF JAPAN; BRITISH EMBASSY; NEW YORK STATE DEPARTMENT OF LABOR; U.S. DEPARTMENT OF COMMERCE

SOCIAL CONCERNS 1989 23,906 AIDS cases cumulative 1984 3,462 1979 0

Welfare cases 1989 366,783 1979 339,978 1969 273,020

Homeless 1989 70,000 1979 10,000

Homeless in 1989 23,000 city shelters 1979 1,000 per night

N.Y.C. poverty rate 1987 23.2% 1979 19.3%

U.S. poverty rate 1988 13.1% 1979 11.7%

SOURCES: NEW YORK CITY DEPARTMENT OF HEALTH; HUMAN RESOURCES ADMINISTRATION; NATIONAL COALITION FOR THE HOMELESS; U.S. DEPARTMENT OF COMMERCE; NEW YORK STATE EDUCATION DEPARTMENT; COMMUNITY SERVICE SOCIETY OF NEW YORK

EDUCATION Public school enrollment 1989 923,940 grades K-12 1979 960,242 1969 1,113,826

Private school enrollment 1989 269,749 grades K-12 1979 312,647 1969 447,566

High school dropout rate 1987 26.8% 1985 27.9% 1984 32.5%

SOURCES: NEW YORK CITY DEPARTMENT OF HEALTH; HUMAN RESOURCES ADMINISTRATION; NATIONAL COALITION FOR THE HOMELESS; U.S. DEPARTMENT OF COMMERCE; NEW YORK STATE EDUCATION DEPARTMENT; COMMUNITY SERVICE SOCIETY OF NEW YORK

REAL ESTATE Apartment buildings 1989 119,308 1979 123,490 1970 131,193

Park Ave. apartment 1989 $740,000 avg. price, 2 bdrm. 1980 $190,000

Office vacancy rate midtown 1989 11.4% 1981 2.4%

Office rent midtown, 1989 $39.62 per sq. ft. 1979 $20.16

Assessed value of real estate 1990 $70.1 billion 1979 $38.1 billion 1969 $34.3 billion

SOURCES: NEW YORK CITY DEPARTMENT OF BUILDINGS; CORCORAN GROUP; COLDWELL BANKER COMMERCIAL SERVICES; EDWARD S. GORDON CO.; NEW YORK CITY DEPARTMENT OF FINANCE; NEW YORK CITY POLICE DEPARTMENT

CRIME Homicides 1988 1,915 1979 1,752 1971 1,466

Robberies 1988 86,578 1979 82,572 1971 88,994

Burglaries 1988 128,626 1979 178,780 1971 181,331

Motor vehicle thefts 1988 119,659 1979 85,882 1971 85,735

Police officers 1988 27,483 1979 23,675 1971 31,370

SOURCES: NEW YORK CITY DEPARTMENT OF BUILDINGS; CORCORAN GROUP; COLDWELL BANKER COMMERCIAL SERVICES; EDWARD S. GORDON CO.; NEW YORK CITY DEPARTMENT OF FINANCE; NEW YORK CITY POLICE DEPARTMENT

ON THE TOWN Dinner at Lutece 1989 $60 without wine 1979 $35 1969 $25

Metropolitan Opera ticket 1989 $66.00 1979 $27.00 1969 $16.50

Cab fare 1990 $5.88 average ride, 2.9 mi. 1979 $3.33 1969 $1.52

Plaza Hotel double room 1989 $245 1979 $75 1969 $34

SOURCES: LUTECE; METROPOLITAN OPERA; NEW YORK CITY TAXI & LIMOUSINE COMMISSION; NEW YORK CONVENTION & VISITORS BUREAU; NEW YORK CITY DEPARTMENT OF SANITATION; NEW YORK CITY DEPARTMENT OF ENVIRONMENTAL PROTECTION; NEW YORK CITY LAW DEPARTMENT; METROPOLITAN TRANSPORTATION AUTHORITY; CHICAGO MAYOR'S OFFICE; NEW YORK CITY DEPARTMENT OF TRANSPORTATION; HOUSTON DEPARTMENT OF PUBLIC WORKS

ILL WINDS Garbage disposed in tons 1989 6,135,000 1979 6,605,000

Water main breaks 1989 609 1979 574 1969 415

Suits filed against N.Y.C 1989 9,510 personal injury 1979 9,874

N.Y.C. payout 1989 $138 million personal injury 1979 $29 million

SOURCES: LUTECE; METROPOLITAN OPERA; NEW YORK CITY TAXI & LIMOUSINE COMMISSION; NEW YORK CONVENTION & VISITORS BUREAU; NEW YORK CITY DEPARTMENT OF SANITATION; NEW YORK CITY DEPARTMENT OF ENVIRONMENTAL PROTECTION; NEW YORK CITY LAW DEPARTMENT; METROPOLITAN TRANSPORTATION AUTHORITY; CHICAGO MAYOR'S OFFICE; NEW YORK CITY DEPARTMENT OF TRANSPORTATION; HOUSTON DEPARTMENT OF PUBLIC WORKS

RAILS AND ROADS Subway ridership 1989 3,670,000 weekday average 1979 3,600,000 1969 4,550,000

Subway fare 1990 $1.15 1979 $0.50 1969 $0.20

Graffiti-free 1989 100% subway cars 1985 31% 1979 0%

Potholes filled 1988 Chicago 520,222 N.Y.C. 416,000 Houston 225,000

SOURCES: LUTECE; METROPOLITAN OPERA; NEW YORK CITY TAXI & LIMOUSINE COMMISSION; NEW YORK CONVENTION & VISITORS BUREAU; NEW YORK CITY DEPARTMENT OF & SANITATION; NEW YORK CITY DEPARTMENT OF ENVIRONMENTAL PROTECTION; NEW YORK CITY LAW DEPARTMENT; METROPOLITAN TRANSPORTATION AUTHORITY; CHICAGO MAYOR'S OFFICE; NEW YORK CITY DEPARTMENT OF TRANSPORTATION; HOUSTON DEPARTMENT OF PUBLIC WORKS