Goldman Sachs CEO Lloyd Blankfein woke to a headache yesterday. One of his vice presidents chose to resign via the New York Times opinion page, saying that he no longer wanted to take unfair advantage of the firm’s customers. But the people who should go to bed worried tonight are New York Governor Andrew Cuomo and Mayor Michael Bloomberg: Goldman’s PR crisis is New York’s fiscal crisis.

Goldman veteran Greg Smith wrote that he was leaving the company after nearly 12 years because its culture was “as toxic and destructive” as he’d ever seen. He claimed that Goldman’s business model is to wring money from clients in three ways: sell them investment products that Goldman knows aren’t very good; sell them products that are decent but way overpriced; or trade securities so complicated that it’s impossible for customers to see if they’re getting a good deal. Smith concluded that he couldn’t “in good conscience” work at a firm that calls its clients “muppets” and thinks only of how “to make money off them.” Plus, he says, “this decline in the firm’s moral fiber represents the single most serious threat to its long-term survival.”

It’s hard to overstate what a bombshell Smith’s resignation is. The news pushed Goldman’s stock down more than 3 percent in one day. London’s tabloids splashed the story on their front pages. Disgruntled bankers don’t come forward all that often. They’re well-paid in part to be discreet, and, if they don’t like the work, to leave quietly.

Yet Smith’s revelations aren’t surprising or even unique to Goldman. In 2008, Wall Street’s business model—packaging up loans and selling them to investors while reaping high fees in the process—collapsed. For two decades, that business model had generated record profits. To replace those profits, investment firms have to take huge risks with stockholders’ money, an approach not nearly as popular as it once was. The firms and their beleaguered employees are tempted to take advantage of the customers and investors they’ve got left. In the last few years, Wall Street firms’ multiple settlements with regulators and private investors show that there’s a grain of truth, at least, to Smith’s complaints.

The problem isn’t bad Washington regulation. Sure, President Obama’s new regulations are terrible, and they’re certainly not helping matters. But Wall Street’s core dilemma goes far beyond that: just as Detroit once sold bad cars, Wall Street is selling bad—well, whatever it sells—and it doesn’t seem able to fix the problem.

Don’t cry for Goldman and its peers. The firm may recover from the Smith debacle by massaging its clients, as it did after Blankfein’s damaging testimony before Congress two years ago. It can insist that Smith wasn’t a top player at the firm, and maybe it can spread some dirt to undermine his credibility. And if it has to pull back from aggressive selling for a while, Goldman can shrink further, letting thousands more people “retire” in their thirties and forties. If the firm falters, so what? Companies, including storied ones, succeed and fail all the time. Industries shrink and often grow healthier in the process.

Cry for New York instead. Over the same years that Wall Street firms were tending to their “muppets,” the state and city budgets grew dangerously dependent on tax revenue from financial-industry profits. Only through tax revenues from Goldman, its competitors, and their employees has New York been able to balance its budgets.

The party ended five years ago, but New York City and State have just now gotten around to doing something to prepare for a smaller Wall Street. The city’s public-worker pension and health-care costs now total $15 billion annually. New York State, which controls the city’s pensions, finally achieved a measure of pension reform today—but it only applies to future workers, and Bloomberg still must negotiate with the unions on a better health-plan deal for taxpayers. New York has much more to do to put its fiscal house in order, and it needs to get started now. Otherwise, if Bloomberg and Cuomo hope to balance their budgets without the type of draconian cuts that could drive New Yorkers away from the city, they’ll need Greg Smith’s clients to keep on being muppets.