Clusters

Every area of the country wishes to decrease the unemployment rate and increase wages.  Companies are always looking to cut costs and do this partially through tax incentives from governmental agencies.  However, as often happens when cities and states compete with each other is a race to the bottom in order to attract these new jobs.  If communities would work in conjunction rather than competing with each other, all areas would be better off (in a sort of prisoner’s dilemma).  Perhaps the best way to attract jobs to an area is to make them want to come to the area without tax incentives; this would be by creating a cluster industry.

Industry clusters are derived from David Ricardo’s theory of comparative advantage in 1817, and developed formally into business clusters by Michael Porter in 1990.  The basis of these theories is that specialization in a narrower aspect of the economy leads to economies of scale and higher levels of efficiency.  Silicon Valley, Wall Street, and Detroit were symbols of efficiency in their respective fields and were able to develop their products at more efficiency than other areas that did not have the geographic relationships.  However, as is the case with Detroit, stagnation and lack of innovation can reduce the efficiencies gained by the cluster and send portions to other areas.

Clusters can be based around many different aspects by attracting a workforce to the area to engage in the type of production, research, or supplier.  The separation and specialization of the area further attracts more firms to the area and raises the chicken or egg question in regards to Silicon Valley – did the technology boom occur there because the people were there or the firms were there?  The likely answer is that there were feedback effects that brought more workers to the area which brought more firms, which brought more workers, etc.  Technology firms did not need tax incentives to locate to Silicon Valley, but rather were pulled by the amenities (workers, infrastructure, etc.) available. 

A wise strategy for a community looking to increase the number of jobs would be to determine which industries or activities have the greatest competitive advantage and leverage them.  In the early stages, there may be a necessity for tax incentives, but if properly implemented, the cluster should provide more jobs and higher wages for every community.

America's Best Banks

Last week Forbes released their "Best and Worst Banks of 2011."  The entire rankings can be found here:

http://www.forbes.com/sites/kurtbadenhausen/2011/12/13/full-list-americas-best-and-worst-banks/

This report gauged the financial health of the top 100 banks.  Financial health of banks is something that is typically not viewed a whole lot during boom times in the economy, but following a financial crisis of the depth we have seen, it becomes a big issue.  Each of the banks were evaluated on the amount of non-performing loans (NPL) on their books, leverage ratio, and reserves to non-performers.  The healthiest banks are those who did not take huge risks during the bubble phase of the housing crisis, and therefore did not see the large returns on investment in 2004/05, but were not exposed to catastrophic mortgage failures.

Rank	Company	Total assets ($bil)	Return on avg equity	NPLs/total loans	Reserves/ NPLs*	Tier 1 ratio	Leverage ratio
1	Prosperity Bancshares	$10	9.30%	0.10%	1030%	15.50%	7.70%
2	Bank of Hawaii	13	15.7	0.8	317	17.6	7
3	First Republic Bank	27	15.2	0.1	191	13.8	9
4	Community Bank System	7	10.7	0.5	246	13.8	8.2
5	Signature Bank	14	13.5	1	124	17.3	9.8
6	East West Bancorp	22	10.5	1.4	111	14.6	9.3
7	Commerce Bancshares	21	12.3	1	203	14.6	9.7
8	SVB Financial Group	19	11.2	0.6	210	13.4	8
9	First Citizens BancShares	21	11	1.7	104	15.5	9.8
10	Cullen/Frost Bankers	20	10.1	1.5	94	14.6	8.8

Source: Forbes

What should be immediately evident when looking at the rankings on Forbes list is that the top performers did not have the highest returns to equity with the least healthy banks actually having the highest returns to equity.  However, there is a dark side to higher returns, increased risk.  The best banks are those that focus on the long run and manage risk as best they can.  All too often, however, a manager will get caught up in chasing the  highest returns and subject their firm to unacceptable risk.  The top bank on the list - Prosperity Bancshares - apparently was not caught in the chase, did their due diligence, and are not carrying bad loans.  This can be seen by the highest reserve to NPL ratio on the list of 1030%.  Their return to equity and leverage ratio are also some of the lowest of the top 100 banks.

Banking in the long run is always won by the tortoise who steadily accumulates.  However, the structure of our current financial system seemingly encourages hare-like activity to achieve the highest gains as quickly as possible (see: AIG, MF Global, Long Term Capital, Savings and Loans, Indy Mac, etc.)

Disclaimer: The founder of Prosperity Bank is a family friend.

Green Affordable Housing

The combination of affordable housing an energy efficiency are essential in the development of city’s housing plans.  This story discusses Washington DC placing PV panels on rooftops of affordable housing buildings.  This is a great integrated project as poorer households tend to spend a larger portion of their income on utilities than richer families.  Cities have the ability finance the higher initial investment in solar power that will pay off in the long run with lower utility bills.  This effectively lowers the cost of living for households in search of affordable housing.

Creating solar panels is still not enough, however, to create sustainable affordable housing.  Solar is considered "active" heating where machinery brings hot or cold air to change the temperature, where much of the new green building incorporates "passive" heating, which sets the home up to use less energy by using heavy insulation and positioning windows to take advantage of heat from the sun.  Affordable housing complexes, like Sheridan Station in DC, that take advantage of passive heating and solar energy create not only a lower burden on lower income families, but is also good for our environment.

image via Sheridan Station

Poverty Figures Questioned

Last week I wrote about the 1 of 2 households in poverty figure.  This post from Slate questions the figures, cites census analysts saying that the low-income households actually are closer to 1/3, which is what the census shows.  As the Slate article reports:


"It's not exactly clear where the mistake came from -- or, for that matter if the original reports got their math wrong -- but the Census officials speculated to the NBC station that it was a case of reporters misunderstanding the data."


But what interests me is that the news story spread to over 300 different news outlets.  It appears as though one outlet got the information wrong and then others took the report as fact.

1 in 2 households in poverty?

There have been numerous reports today over the fact that nearly 50% of the country is classified as being in poverty or low-income.
http://news.yahoo.com/census-shows-1-2-people-poor-low-income-054325860.html

That number seemed surprisingly high and after a fact finding mission found that the number appears to be grossly overstated.  Low-Income people are classified by those whose incomes are less than 200% of the poverty line.  The 2010 American Community Survey (ACS) 5-year estimates run by the Census Bureau report the total of all living under the poverty line being 40,917,513, which is 13.8% of the United States population, while those under 200% of poverty at 94,693,417, which is 31.9%.  This figure of low-income is significantly lower than the 50% figure from the Associated Press.

It is unknown where these figures are derived from, but the hundreds of news reports show the same figures.  Is this one of those circumstances where journalists write an article without fact checking?  To be sure 94 million people is still a sizable chunk of the population and something that does need to be addressed.  Imagine being one of the nearly eighteen million people living on less than $5,000 per year.

All Individuals below:
50 percent of poverty level	17,762,160
100 percent of poverty level	40,917,513
125 percent of poverty level	54,155,678
150 percent of poverty level	67,790,487
185 percent of poverty level	86,708,847
200 percent of poverty level	94,693,417
Total Population	296,141,149

Source: U.S. Census and Wikstrom Economics

MF Global

                MF Global has been in the news recently for their bankruptcy and the misallocation of customer funds.  The majority of media outlets report that the failure was the result of failed bets on Euro Zone debt.  However, that does not appear to be the case as many of those bets were profitable.  Well then, how exactly did MF Global go bankrupt if most of their bets were profitable?  The simple answer is that they were overleveraged with regards to their trades. 

                The way the majority of broker-dealers leverage their trading is not only through margin accounts, but is through a process called re-hypothecation.  Re-hypothecation occurs when a broker-dealer receives collateral on a loan and then uses that collateral as collateral for a loan of their own.  In the absence of a “haircut” (http://en.wikipedia.org/wiki/Haircut_(finance)) this initial collateral can multiply almost infinitely.  If this concept is confusing, that’s because it is; essentially this works in the same way as banks would with a reserve requirement of zero and no FDIC insurance.  The United States does place a limit on the amount of times an asset can be re-hypothecated, but MF Global found a loop-hole in the UK financial system where they were able to re-hypothecate assets with no limit, thereby leveraging to the hilt.

                There are positives and negatives to leverage; it is possible to greatly increase returns on investment, but can also multiply losses.  MF Global was so leveraged that their Euro Zone bets were profitable, but the slightest hiccup caused a run on their assets.  The high levels of leverage MF Global was exposed to did not leave much capital to be able to face margin calls.  As with any financial firm who encounters trouble, contagion spreads and all their creditors demand more collateral so they are not left holding the bag.  This was the end result of the MF Global debacle: they may have had some profitable trades on Euro Zone debt, but were sufficiently overleveraged and illiquid that they were not able to meet their repayment requirements.

                Now keep in mind, this says nothing about the missing customer funds, which appeared to be used in their speculative bets.  

2012: The Year of Cooperatives

The International Labor Office (ILO) created this video in response the United Nations General Assembly proclaiming 2012 to be the year of cooperatives.

http://www.youtube.com/watch?v=KALLFDpuHUE

Cooperatives are a great way of promoting and enhancing the standards of living of millions of people around the world.  Cooperatives are owned by the customers and employees and secure the livelihoods of nearly a quarter of the world's population.  The great thing about them is that it allows control of the company to not be lodged purely with a CEO or board of directors, but rather with the backbone of the company (the workers) and the customers.  The active involvement of the community creates an environment conducive to creating jobs, empowering people, and alleviating poverty, especially during times of crisis.

More information on the ILO and cooperatives can be found at:
http://www.ilo.org/global/topics/employment-promotion/cooperatives/lang--en/index.htm