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Economic Review Federal Reserve Bank of Cleveland January 1980 1 Current Developments in the Regulation of International Banking 1 16 The Local Labor-Market Response to a Plant Shutdown The Economic Review is published quarterly by the Research Department of the Federal Reserve Bank of Cleveland, Post Office Box 6387, Cleveland, OH 44101. Free subscriptions and additional copies in reasonable quantities are available upon request. Material in the Economic Review may be reprinted provided the source is credited. Please provide the bank's Research Department with copies of reprinted materials. Current Developments in the Regulation of International Banking Gerald H. Anderson IN T R O D U C T IO N International banking has grown dram atically in the 1970s. Expanded operations by foreign banks in the United States and by U.S. banks abroad have prom pted reviews and revisions o f federal regulation o f this im p o rta n t a ctivity. A fte r b rie fly describing the growth o f international banking, this article examines the three major current developments th a t are changing or may change U.S. regulation o f international banking and shape its evolution in the 1980s. Foremost among these developments is the International Banking A c t o f 1978 (IB A ), which makes many regulation changes, delegates to various government units the a u th o rity to make additional changes, and directs the study o f still other possible legis lative changes. The other tw o developments th a t may bring change to U.S. regulation o f in te r national banking include the recently extensive foreign efforts to purchase U.S. banks and the New Y o rk Clearing House Association proposal to perm it special International Banking Facilities in the United States. Growth of International Banking International banking is growing in tw o senses: the volume o f banking services th a t fa cil itate international trade and investment is growing as international commerce grows, and banks are establishing more offices outside th e ir homelands. Some banking offices are established abroad to serve on-site the foreign affiliates o f m ultinational firm s w ith w hich banks have domestic relationships. A d d itio n a lly , banks establish offices abroad to acquire new customers and to diversify bank sources o f funds and earnings. U.S. offices o f foreign banks and foreign offices o f U.S. banks have increased th e ir numbers and assets dram atically in the 1970s (see charts 1 and 2). In November 1972, when such data were firs t collected by the Federal Reserve System, 104 offices o f foreign banks, including 79 agencies, b ra n ch e s, and in v e s tm e n t c o m p a n ie s and 25 subsidiary banks, were operating in the United States (see de fin ition s in box A ). Together, these offices had to ta l assets o f $24 b illio n . By July 1979, 328 offices were operating w ith total assets o f $137 b illio n , o f w hich $28 b illio n was commercial and industrial loans to parties in the United States and $12 b illio n was commercial and industrial loans to parties in foreign countries. This $40 b illio n to ta l is more than 15 percent o f the $259 b illio n o f commercial and industrial loans o f all (domestic and foreign) commercial banks in the United States. Foreign operations o f U.S. banks have also grown rapidly. From end-1971 to end-1978, foreign branches o f Federal Reserve member banks increased in number fro m 577 to 761 and assets expanded fro m $55 b illio n to $258 b illio n . Economic Review January 1980 1 Chart 2 Number of U.S. Offices of Foreign Banks Reporting to Federal Reserve System Chart 1 Assets of U.S. Offices of Foreign Banks Reporting to Federal Reserve System Billions o f dollars '72 '73 '74 '75 '76 '77 '78 '79 '72 '73 '74 '75 '76 '77 '78 '79 NOTE: Except fo r 1979, data represent year-end figures. Representative offices (see box A ) are another rapidly growing facet o f international banking presence. Foreign banks have increased the number o f th e ir representative offices in the U nited States from 126 in 1972 to 238 in 1978. In the same period, U.S. banks enlarged their number o f representative offices abroad fro m 173 to 2 8 8 .1 The F ourth Federal Reserve D is tric t has shared in the grow th o f international banking and has several international banking facilities. Foreign banks m aintain three branches and fo u r representative offices in the D is tric t w hile banks headquartered in the D istrict have fourteen foreign branches, fourteen foreign representative offices, and seven Edge C orporations (see box B). Regulatory Initiatives 1. Representative o ffice data are based on surveys by the Am erican Banker, reported in the issues o f February 28, 1973, July 31, 1973, and March 23, 1979. 2 Federal Reserve Bank o f Cleveland Three facets o f this international banking growth have led to three regulatory initiatives. First, the rapidly increasing importance o f foreign Box A Organizational Forms Foreign banks use several organizational form s fo r th e ir operations in the U nited States, w ith subsidiary banks, branches and agencies as the most im p o rta n t. O ther organizational form s are representative offices and New Y o rk investment companies. Edge A c t C orporations, long used by U.S. banks fo r international banking, may now be form ed in the U nited States by foreign banks. A subsidiary bank is legally separate fro m the foreign bank which owns its stock, and the subsidiary bank has its own state or national charter. The foreign parent may create, de novo, the subsidiary bank, or may purchase an existing bank. The subsidiary bank has a fu ll range o f banking powers, such as accepting deposits and making loans. The m axim um loan a subsidiary bank may make to any one customer is subject to regulatory lim its based on the bank's own capital. A branch is an integral part o f the foreign bank th a t establishes it, and has fu ll banking powers.1 The m axim um loan a branch can make to any one customer is subject to regulatory lim its based on the parent bank's capital. The agency form o f organization can make commercial and industrial loans and finance in te r national transactions; it can accept credit balances2 but cannot accept deposits, sell certificates o f deposit, or perform trust functions. An agency obtains most o f its funds by borrowing in U.S. money markets and from banking affiliates abroad. Agencies are n o t subject to regulatory lim its on the size o f a loan to any one borrower. New Y o rk State permits an additional form know n as an investment company to engage in most banking functions. These may accept credit balances but may n o t accept deposits. The representative office is the least pow erful but the most prevalent organizational fo rm . It acts as a liaison w ith existing customers o f the foreign head o ffice , establishes contact w ith potential customers, and performs public relations functions, much as a loan production office represents a domestic bank out-of-state.3 It cannot accept deposits, make loans, or perform tru st functions. Because its activities are lim ited, the representative office is essentially unregulated and is the easiest organizational form to establish. Foreign banks sometimes use a U.S. representative office as a prelim inary step to establishing a banking office. The Edge Act Corporation is authorized by the Edge A c t, passed in 1919 and named fo r Senator Edge o f New Jersey. The Edge A c t permits domestic banks to establish these subsidiaries, w hich need n o t be in the same state as the parent bank. The International Banking A c t o f 1978 permits foreign banks also to establish Edge A c t Corporations. Edge A c t Corporations are o f tw o types: investment and banking. An investment Edge C orporation functions as a holding company through which its parent bank can make equity investments abroad. A banking Edge C orporation is one th a t "is o rd in a rily engaged in the business o f accepting deposits in the U nited States fro m n o n a ffilia te d "4 individuals or organizations. A banking Edge C orporation is perm itted to engage in a fu ll range o f international banking activities, but its transactions w ith U.S. residents are restricted to those trans actions that are closely related to its international business. 1. As explained in the te x t, the IBA restricts the kinds o f deposits th a t can be accepted at branches outside the "hom e state." 2. A credit balance is an account to which the proceeds o f loans or collections can be credited. A lthough it can be transferred to th ird parties by d ra ft, it differs fro m a demand deposit in th a t it should n o t be used fo r ordinary business transaction purposes. 3. For more in fo rm a tio n see Gerald H. A n d e rson ,"L o an Production Offices and Representative O ffices," Econom ic C om m entary, Federal Reserve Bank o f Cleveland, O ctober 31, 1977. 4. Federal Reserve Regulation K, Section 211.2 (d). Economic Review January 1980 3 Box B International Banking Offices—Fourth Federal Reserve District FOURTH D IS TR IC T BRANCHES OF FOREIGN BANKS Branch Location Parent Bank Algemene Bank Nederland, Amsterdam Barclays Bank International Ltd., London Lloyds Bank International L td ., London Pittsburgh Pittsburgh Pittsburgh FOURTH D IS TR IC T REPR ESENTA TIVE OFFICES OF FOREIGN BANKS Representative Office Location Parent Bank Bank o f Nova Scotia, T o ro n to Bayerische Vereinsbank (U nion Bank o f Bavaria), Munich T o ro n to D om inion Bank, T o ro n to Royal Bank o f Canada, Montreal Cleveland Cleveland Pittsburgh Pittsburgh FOREIGN BRANCHES OF FO URTH D IS TR IC T BANKS Foreign Branch Location Parent Bank A m eriT rust Company (Cleveland) Central National Bank o f Cleveland Equibank, N. A . (Pittsburgh) H untington National Bank o f Columbus Mellon Bank, N. A. (Pittsburgh) National C ity Bank (Cleveland) Pittsburgh National Bank Society National Bank o f Cleveland Union Commerce Bank (Cleveland) Winters National Bank and T rust Co. (Dayton) banks' activity in the U nited States necessitated an updating o f federal regulation o f th a t a ctiv ity ; Congress responded to this need w ith the I BA. Second, foreign banks have been making recent substantial efforts to purchase co n tro l o f existing banks in the United States, rather than growing by opening new branches, agencies, or newly chartered subsidiary banks—the past pre dom inant methods o f growth. In response, some public officials are urging a review o f federal 4 Federal Reserve Bank o f Cleveland Nassau, Bahamas Nassau, Bahamas Nassau, Bahamas Grand Cayman, Cayman Islands London, England F ra n k fu rt, West Germany T o k y o , Japan Grand Cayman, Cayman Islands Nassau, Bahamas Nassau, Bahamas Paris, France Nassau, Bahamas Nassau, Bahamas Grand Cayman, Cayman Islands policy tow ard foreign purchases o f U.S. banks. T h ird , rapid grow th in international banking a c tivity outside the U nited States has led the New Y o rk Clearing House Association to propose changes in Federal Reserve regulations th a t w ould enable International Banking Facilities to attract Eurodollar banking business to the United States. This article examines the three regulatory initiatives th a t are like ly to shape the grow th o f international banking in the 1980s. Box B Continued FOREIGN R EPRESENTATIVE OFFICES OF FO URTH D IS TR IC T BANKS Representative Office Location Parent Bank Central National Bank Equibank, N. A. Mellon Bank, N. A. National C ity Bank Pittsburgh National Bank Union Commerce Bank Paris, France Mexico C ity, Mexico London, England Hong Kong Mexico C ity, Mexico Manila, Philippines Hong Kong Melbourne, Australia Rio de Janeiro, Brazil London, England Sao Paulo, Brazil Singapore Sidney, Australia London, England EDGE ACT CORPORATIONS OF FO URTH D IS TR IC T BANKS Banking Edge Corporations Central Cleveland International Bank, New Y ork Mellon Bank International, New Y ork Investment Edge Corporations Cleveland Trust International C orporation, Cleveland1 Mellon International Finance C orporation, Cleveland National C ity Cleveland International C orporation, Cleveland Pittsburgh International Finance C orporation, Cleveland Society International Corporation, Cleveland NOTE: In addition, many Fourth D istrict banks engage in foreign lending, trade financing, and other foreign services from th e ir main offices. 1. A p p lication has been made to change name to A m eriTrust International C orporation. IN T E R N A T IO N A L B A N K IN G A C T OF 1978 Because o f the rapid growth and inadequate regulation o f foreign banking in the U nited States, the Board o f Governors o f the Federal Reserve System has given considerable attention to foreign banking in the U nited States in the 1970s. The Board began collecting data on foreign bank operations in 1972 and proposed to Congress the Foreign Bank A c t o f 1974. A fte r considerable debate, a much-revised version o f th a t proposal, which is intended to provide adequate supervision and regulation o f foreign-owned banking offices and to remedy some o f the inequities o f the previous regulatory system, was enacted as the International Banking A c t o f 1978 (IB A ). Previous Regulation Previous regulation o f foreign bank op erations in the U nited States had been both Economic Review January 1980 5 inadequate and inequitable. A major weakness was th a t foreign banks were not subject to exam ination, regulation, or supervision by federal agencies. While a state could regulate and supervise the activities o f a banking office w ith in its ju ris dictio n , no coordinated oversight o f a m ultistate banking organization's entire operation existed. In addition, since most U.S. offices o f foreign banks were not required to hold reserves at Federal Reserve Banks, the Federal Reserve's a b ility to conduct m onetary policy was p o te n tia lly weakened. Previous regulations also gave several com petitive advantages to foreign bank offices in the United States. First, since most U.S. offices o f foreign banks were n o t legally subject to the reserve requirements th a t the Federal Reserve imposes on its major com petitors (the large national and state member banks located in major financial centers), the foreign banks had a signi fican t cost advantage. Second, w hile U.S. law prevented and still prevents interstate branching by domestic banks, no federal restrictions prevented foreign banks from establishing agencies and branches in more than one state; in fact, at yearend 1978, 65 foreign banks had branches and/or agencies in more than one state. Interstate branch ing enhances a bank's a b ility to serve its m u lti state customers, and U.S. banks were thus at a disadvantage. T h ird , a foreign bank th a t had only agencies and branches in the U nited States could also have equity in a U.S. securities firm ; at least 20 foreign banks do. In contrast, securities activ ities o f domestic banks have been lim ited by the Glass-Steagall A c t since 1934. Moreover, foreign banks w ith only branches and agencies in the United States were not subject to the Bank Holding Company A ct. Thus, they could engage in U.S. nonbanking activities forbidden to domestic banks and bank holding companies. On the other hand, foreign banks faced some restrictions th a t lim ited th e ir a b ility to compete in certain markets. They were not per m itted to establish Edge A c t subsidiaries (see box A ), their branches and agencies could not obtain Federal Deposit Insurance Corporation (FDIC) insurance fo r deposits and credit balances, nor could they appoint foreigners as directors o f national banks. 6 Federal Reserve Bank o f Cleveland Underlying Principles A prim ary principle underlying the IB A is national treatm ent, w hich means th a t all banks in the U nited States, or w ith in a state, ought to have the same banking powers and restrictions, regardless o f whether the bank is foreign- or domestic-owned. Some people had advocated the principle o f re cip ro city rather than th a t o f national treatm ent. Under re ciprocity, the United States w ould have granted to a foreign bank the same banking powers as the foreign government allowed a U.S. bank operating in the foreign country. T hat w ould have resulted in d iffe re n t powers fo r banks fro m d iffe re n t countries, a situation th a t w ould have been d iffic u lt to adm in ister. A fu rth e r underlying principle o f the new law is co ntinuation o f the dual banking system, in w hich any bank in the United States, whether domestic or foreign, has a choice o f being chartered and regulated by either a state or national a uthor ity . F inally, the IB A recognizes the potential inequity o f changing the rules after a firm has established its operations and, accordingly, exempts from some provisions o f the law those banking offices operating or planned before the b ill became law. Major Provisions The IB A makes im p o rta n t changes in U.S. banking law in the matters o f federal licensing and chartering, m ultistate banking, regulation and supervision, nonbanking activities, deposit insur ance, and Edge A c t Corporations. A d d itio n a lly , the IB A directs the Federal Reserve System and other federal authorities to develop regulations designed to attain specified objectives and to make studies and recommendations relevant to other specified aspects o f U.S. banking law. 1. Federal Licensing and Chartering. Prior to enactment o f the IBA, foreign agencies and branches operating in the U nited States did so w ith state licenses and were regulated by state law. The IB A perm its these offices to obtain either a state or federal license. Thus, a foreign bank can now establish a federal agency or branch in any state except (1) those in which it operates a statelicensed agency or branch and (2) those states in w hich laws p ro h ib it foreign banking agencies or branches. A foreign bank cannot operate both a federal branch and a federal agency in the same state. A foreign bank w ith a federal agency or federal branch in a state may establish additional agencies or branches in th a t state, subject to the restrictions on branching th a t w ould apply to a national bank in the same location. A foreign-owned subsidiary bank has always had the choice o f obtaining its charter from state or national authorities. The IBA liberalizes this national charter option by perm itting the U.S. C om ptroller o f the Currency to waive the re quirem ent th a t only U.S. citizens can be directors o f a foreign-owned subsidiary bank; now, o nly the m a jority o f its directors must be U.S. citizens. 2. Multistate Banking. A foreign bank w ith offices in more than one state must designate a home state and may n ot operate a subsidiary bank outside th a t home state. Federal agencies and branches, however, may be established outside the home state where expressly perm itted by specific states. State agencies and branches may be estab lished outside the home state where approved by the regulatory a u th o rity o f specific non-home states. However, the deposit-taking powers o f federal and state branches outside the home state are lim ited to accepting on ly those deposits th a t an Edge A c t Corporation could accept.2 Agencies, o f course, cannot accept any deposits. The restric tions on deposit taking and location o f branches, agencies and subsidiary banks do not apply to offices established or fo r w hich permission to operate had been sought on or before July 27, 1978. 3. Regulation and Supervision. Federal agencies and branches are required by the IB A to maintain reserves w ith a Federal Reserve Bank. The Federal Reserve Board may subject state agencies and branches to the same requirements as federal agencies and branches after consulting w ith , and in cooperation w ith , state bank regulators. Those branches and agencies th a t are required to maintain reserves w ith a Federal Reserve Bank w ill be eligible to use the Reserve Bank's discount w indow . A lthough the IB A does n o t specifically say so, the U.S. Senate report on the bill makes clear that branches and agencies m aintaining reserves are also eligible to use the Reserve Bank's clearing fa cilitie s.3 The IBA also perm its the Federal Reserve Board to examine branches and agencies, although, insofar as possible, the Board must use the exam ination reports prepared by such other supervisory authorities as the C om ptroller o f the Currency, FDIC, and state bank supervisors. Thus, the Board's examining a u th o rity under IBA now gives the Federal Reserve a to o l w ith w hich to conduct a consolidated review o f a foreign bank's m ultistate banking netw ork. 4. Nonbanking Activities. The IB A makes a foreign bank subject to the Bank H olding Company A c t if it has a branch or agency in the United States, thus p ro h ib itin g such a foreign bank from engaging in nonbanking activities in the United States. However, some "g ra n d fa th e r" provisions soften this p ro h ib itio n . Nonbanking activities undertaken by September 17, 1978, the date the IBA was enacted, may be retained u n til December 31, 1985. A fte r December 31, 1985, those non banking activities undertaken by Ju ly 26, 1978, may be continued unless the Board o f Governors determines th a t te rm ination o f permission fo r those activities "is necessary to prevent undue concentration o f resources, decreased or unfair co m p e titio n , co n flicts o f interest, or unsound banking practices" (IB A , Section 8c). If permission is term inated, the company w ill be allowed tw o years to divest the n o n b a n k in g activity. A fo re ig n bank is n o t p rohibited, however, fro m owning shares o f a foreign company th a t is prin cip a lly engaged in business outside the U nited States. 5. FDIC Insurance. The IB A provides th a t a branch o f a foreign bank may obtain deposit insurance fro m the Federal Deposit Insurance C orporation. A branch th a t accepts domestic retail deposits (usually, deposits smaller than $100,000) must obtain deposit insurance if it is a federal branch or if it is a state branch in a state th a t 2. Deposit-taking powers o f Edge Corporations are discussed on pp. 8-9. 3. R eport o f the Com m ittee on Banking, Housing and Urban A ffa irs, U.S. Senate, to accompany HR 10899, August 1978, p. 13. Economic Review January 1980 7 requires banks to be insured. However, before a branch can become insured, its parent bank must pledge assets or provide a surety bond to FDIC. This requirem ent is intended to protect the FDIC against the extra risk "entailed in insuring the domestic deposits o f a foreign bank whose activities, assets, and personnel are in large part outside the ju risd ictio n o f the United States" (IB A , Section 6c7b). 6. Edge Act Revisions. The IB A eliminates the requirem ent th a t directors o f Edge Corporations be U.S. citizens and perm its foreign banks to own a m a jo rity interest in Edge Corporations. The IB A removes the requirem ent th a t an Edge C orpo ration's borrowings be no greater than ten times its capital stock and surplus. In addition, the reserve requirem ent fo r deposits at Edge C orporations is changed fro m a m inim um o f 10 percent to the same reserve requirements th a t apply to member banks. Additional Objectives In several matters, the IB A specifies objec tives rather than rules. The objectives are to be achieved through suitable regulations, which the Federal Reserve and other federal regulatory agencies are mandated to develop by certain dates (see box C). Some o f the mandates include: 1. Edge Corporations. One purpose o f the IB A is to perm it Edge Corporations to compete effec tively w ith foreign banks in the U nited States and abroad, to provide a means o f financing trade, especially exports, and to stim ulate com petition throughout the U nited States in the provision o f international banking and financing services. To this end the IB A directed the Federal Reserve Board to revise its regulation concerning Edge C orporations, w ith the revised regulation effective June 14, 1979. One feature o f the June 14 regulation pertains to Edge C orporation branches. The form er regulation perm itted a bank to organize Edge Corporations in more than one location, such as in d iffe re n t states, b u t each office had to be separately incorporated. The new regulation, however, perm its a bank to establish one Edge 8 Federal Reserve Bank o f Cleveland Corporation and then establish branches o f th a t Edge Corporation across state lines. This provides a simpler adm inistrative and organizational struc ture. In addition, it permits expansion o f the lending powers o f the various Edge offices by com bining th e ir capital. Since an Edge C orporation has a lending lim it o f 10 percent o f capital and surplus to any one customer, the lending lim it o f an Edge C orporation w ith branches w ill be larger than the individual lending lim its o f several sep arately incorporated Edge offices. C urrently, a few large banks have Edge C orporations in several cities.4 The new regulation also increases the per m itted leverage on an Edge C orporation's capital, compared to the situation p rio r to the IBA. The previous regulation required th a t an Edge C orpo ration's to ta l liabilities be no greater than ten times its capital stock and surplus. The new regulation requires an Edge C orporation engaged in banking to have capital and surplus o f n o t less than 7 percent o f risk assets on a consolidated basis. In effect, this means risk assets could be 14.3 times greater than capital plus surplus, in contrast to the form er requirem ent th a t to ta l assets be no more than 11 times greater. Since total assets is a broader category than risk assets, the increase in perm itted leverage is even greater than these ratios suggest. The new regulation also gives an Edge Corporation greater latitude fo r lending. Previously, an Edge C orporation was perm itted to provide financing o n ly fo r shipm ent and storage o f e xp o rt goods; now, however, an Edge C orporation may also finance the production o f e xp o rt goods. A n o th e r proposal, still under consider ation by the Board, w ould fu rth e r enhance the powers o f an Edge C orporation to serve its cus tomers. The regulation issued on June 14 lim its an Edge Corporation to providing financing and related services fo r o n ly those transactions th a t are specifically related to international trade. The 4. C itibank o f New Y o rk cu rre n tly has the most w ith six, located in M iam i, Chicago, Houston, Los Angeles, San Francisco, and W ilm ington, Delaware. The Bank o f America has five Edge Corporations, and C ontinental, First Chicago, Manufacturers Hanover, and Morgan Guaranty each have fo u r Edge Corporations. proposal w ould perm it an Edge C orporation to provide any kind o f banking service, including accepting deposits, to a corporation whose p rin cipal business is international commerce. A corpo ration w ould be considered to have international commerce as its principal business if tw o -th ird s o f its sales or tw o-thirds o f its purchases were in te r national in character. For customers who do not meet this test, the Edge C orporation w ould still be lim ited to providing services only fo r transactions th a t are specifically related to international commerce. When the Board issued its new regu lation fo r Edge C orporations on June 14, 1979, it deferred action on this proposal and announced th a t after fu rth e r study it w ill publish a revised version o f the proposal fo r fu rth e r public comm ent. A nothe r issue not yet resolved is whether Edge C orporations should be perm itted to become members o f the Federal Reserve System; this is currently prohibited by federal law. Edge Corpo rations already must maintain the same required reserves at Federal Reserve Banks as member banks and can obtain the same Federal Reserve services as member banks, except fo r the privilege o f borrowing at the discount w indow . Thus, availability o f the discount w in d o w privilege w ould be the major additional advantage o f System membership. As required by the I BA, the Board o f Governors sent its recommendations on this m atter to Congress on June 13, 1979. The Board expressed no objection to legislation th a t w ould perm it Edge Corporations engaged in banking from applying fo r System membership, but it recommended legislation th a t w ould grant them access to the discount w in d o w w ith o u t membership. The new Edge Corporation regulation and fu ture decisions on the services th a t these corpo rations can provide and Federal Reserve member ship should be o f particular interest to foreign banks fo r tw o reasons. First, several foreign banks are reported to wish to establish Edge C orpor ations in the United States; naturally they need to know the potential powers of these corporations. Second, new U.S. branches o f foreign banks located outside the "hom e state" are subject to the same restrictions on sources o f deposits as Edge C orporations; they too must know what th e ir powers w ill be. 2. Federal Branches and Agencies. The I BA authorizes the U.S. C om ptroller o f the Currency to license, regulate, and supervise federal branches and federal agencies. On November 13, 1979, the co m p tro lle r issued final rules on these matters. In general, these rules are the same as w ould apply to a national bank in the same location. T w o aspects o f the com ptroller's rules may make federal branches more attractive than state branches in some states. First, some states w ill n ot license a branch o f a foreign bank whose home co u n try does n o t perm it branches o f U.S. banks. The com ptroller's rules, however, do not require reciprocity by the foreign bank's home government. If a state permits branching by any foreign banks, banks fro m any foreign nation, including those th a t do n o t reciprocate, w ill be eligible to obtain a license to operate a federal branch in th a t state. The c o m p tro lle r reasons th a t reciprocity require ments are incom patible w ith the national treatm ent principle o f the International Banking A ct. Second, the c o m p tro lle r has elected not to impose a maintenance o f assets rule at this tim e, while reserving the right to impose one in the futu re . Some states require branches o f foreign banks to m aintain assets in the state th a t exceed certain liabilities by a specified margin, such as eight percent. While this difference in treatm ent may give federal branches a com petitive edge over state branches, the co m p tro lle r believes th a t the capital equivalency deposits required by the com p tro lle r and the reserves required by the Federal Reserve System provide adequate protection to the banking system w ith o u t a maintenance o f assets rule. 3. Reserve Requirements and Interest Rate Ceilings. The Federal Reserve Board proposed on July 23, 1979, to impose reserve requirements and interest rate ceilings on state and federal branches and agencies o f foreign banks whose parent banks have w orldw ide assets o f at least $1 b illio n . The Board also proposed th a t branches and agencies holding reserves at a Federal Reserve Bank be eligible to borrow at th a t bank's discount w indow and obtain Reserve Bank services, including wire transfer, check clearing, securities safekeeping, and currency and coin supply. Having requested com ments on its proposals by September 24, 1979, the Economic Review January 1980 9 Box C Actions Required to Im plement the I BA A. Edge Act Corporations Board must issue proposed regulations by February 14, 1979. Board must issue final regulations by June 14, 1979. B. C. D. E. Board must recommend to Congress w hether Edge Corporations can jo in Federal Reserve System by June 14, 1979. Federal Branches and Agencies C om ptroller may issue regulations—no deadline. Interstate Banking Operations Offices operating on or before July 27, 1978, are grandfathered. Insurance of Deposits Branches requiring insurance must have it by September 17, 1979, or when opened. Authority of Federal Reserve System Board may specify reserve ratios fo r federal branches and agencies d iffe re n t from ratios fo r member banks—no deadline. Board may impose reserve and other requirements on state branches and agencies. Board must consult w ith state authorities and report to Congress on these consul tations by March 16, 1979. Board may issue regulations—no deadline. Board must report recommendations to Congress by September 17, 1980, regarding im plem entation o f the IBA. F. Nonbanking Activities Nonbanking activities begun between July 26 and September 17, 1978, are grand fathered un til December 31, 1985. Nonbanking activities begun by July 26, 1978, are grandfathered u n til December 31, 1985, after w hich the Board may term inate permission fo r those activities. If permission is term inated, a ctiv ity must be divested w ith in tw o years. G. Foreign Treatment of U.S. Banks Secretary o f the treasury, w ith Board, co m p tro lle r, FDIC, and secretary o f state, must begin a study o f foreign treatm ent o f U.S. banks by December 16, 1978. Secretary o f the treasury must report his findings and recommendations to Congress by September 17, 1979. H. Representative Offices Representative offices must be registered w ith the secretary o f the treasury by March 16, 1979, or when established. I. McFadden Act President, in consultation w ith the Board, co m p tro lle r, FDIC, secretary o f the treasury, and attorney general, must report to Congress by September 17, 1979, "h is recommendations concerning the a p p lica b ility o f the McFadden A c t to the present financial, banking, and economic environm ents." 10 Federal Reserve Bank o f Cleveland Board later extended the com m ent period to November 23, 1979. A date has n o t yet been set fo r implem enting the final regulations th a t w ill come from these proposals. The Board proposed th at federal and state branches be subject to the same reserve requirements and interest rate ceilings as member banks, in order to "fa c ilita te the conduct o f monetary policy and prom ote vigorous and fair co m petition between branches and agencies and member banks by treating branches and agencies like member banks to the fullest extent possible.” Under the proposal, deposits o f a banking fa m ily, i.e., U.S. branches and agencies o f a single foreign parent bank and o f its foreign banking subsidiaries, w ill be aggregated when calculating required reserves. Aggregation w ill lead to a higher amount o f required reserves because reserve requirements are graduated. This is sim ilar to the treatm ent o f a member bank, whose branch deposits are aggregated fo r reserve purposes. A lthough its reserve obligation is calculated on an aggregated basis, a fa m ily o f branches and agencies may m aintain one reserve account at each Reserve Bank or branch in whose te rrito ry the fa m ily operates. This provision is significant because the fa m ily can borrow and obtain services from every Federal Reserve office at w hich it holds reserves. 4. McFadden Act. The I BA requires the presi dent o f the U nited States, in consultation w ith the Federal Reserve Board, the com ptroller, the FDIC, the secretary o f the treasury, and the attorney general, to report to Congress his recommendations concerning the McFadden A c t—a law preventing interstate branching by domestic banks. The president's recommendations, which are expected soon, are to concern "th e ap p lica b ility o f the McFadden A c t to the present financial, banking and economic environm ent...'' (IB A , Section 14). A major thrust o f the IB A is to observe the p rin ciple o f national treatm ent by restricting interstate branching by foreign banks because domestic banks face th a t restriction through the McFadden A ct. A review o f the McFadden A c t must face the question o f whether restriction o f interstate branching by domestic and foreign banks is in the national interest. 5. Foreign Treatment of U.S. Banks. A lthough the IBA focuses on the regulation o f international banking in the U nited States, the act also man dates a study o f foreign regulation o f U.S. banks. The IB A requires the secretary o f the treasury, the Federal Reserve Board and others to study and report to Congress on the extent to w hich U.S. banks "are denied, whether by law or practice, national treatm ent in conducting banking oper ations in foreign countries..." (IB A , Section 9). The report, subm itted to Congress on September 17, 1979, found th a t "U .S . banks have a substantial degree o f access to most financial markets abroad o f importance to th e m ....'' However, treatm ent o f U.S. banks "ranges fro m free and open regulatory environments in developed nations, w ith a few marked exceptions, to quite restrictive conditions in some nations in earlier stages o f development. However, a number o f developing countries are relatively accessible to foreign banks and a few actively encourage foreign presence." While "o n ly a few countries p ro h ib it foreign bank entry altogether," a large number o f nations take a "restrictive approach to foreign acquisition o f domestic banks." No discrim ination against U.S. banks vis-a-vis other foreign banks was fo u n d .5 FO R E IG N PURCHASES OF U.S. BANKS Foreign banks are acquiring substantial numbers o f U.S. banks. Foreign acquisitions o f tw o large U.S. banks, U nion Bank, Los Angeles, and National Bank o f N orth America, New Y o rk, were consummated in A p ril 1979. Foreign acqui sition o f Marine M idland Banks, B uffalo, this nation's tw e lfth largest bank, was approved by the Federal Reserve Board on March 16, 1979, and is still pending (see table 1). O ther U.S. banks have also been acquired recently, and press reports indicate th a t many more acquisition proposals are being prepared. Foreign banks cu rre n tly own at least 42 subsidiary banks in the United States w ith assets totaling at least $24 b illio n .6 Consummation o f 5. Department o f the Treasury, R eport to Congress on Foreign Governm ent Treatm ent o f U.S. Commercial Banking Organizations, September 17, 1979, pp. 431-4. 6. Federal Reserve S tatistical Release G.11, September 10, 1979. Economic Review January 1980 11 Table 1 Three Large U.S. Banks Sought by Foreign Banks Acquiring foreign bank Acquired U.S. bank Name and location Marine M idland Banks, B uffalo, New Y o rk Assets before acquisition, 1 2 /3 1 /7 8 ($ bil) $14.2 Union Bank, Los Angeles National Bank o f N orth America, New Y o rk 5.3 4.4 Size rank in U nited States Name and location 12th Hongkong and Shanghai Banking C orporation, Hong Kong Assets before acquisition,3 1 2 /3 1 /7 7 ($ bil) Size rank in world Acquisition date $14.8 70th Pending 25th Standard Chartered Bank L im ited , London 15.8 66th A p ril 1979 34th National Westminster Bank Lim ited , London 36.8 17th A p ril 1979 a. Consolidated assets including companies more than 50 percent owned. the Marine Midland acquisition w ould bring th a t assets to tal to about $38 b illio n , or almost 6 percent o f to ta l assets o f large U.S. banks. In addition, foreign nonbanks control 65 U.S. banks w ith aggregate assets o f $13 b illio n .7 Some critics are alarmed by the sizes o f these foreign holdings and by the prospect th a t they may continue their rapid grow th. Reasons for Purchases Several factors make acquisitions o f U.S. banks attractive to foreigners. Some foreign banks w ant to expand th e ir a b ility to provide w orldw ide services to th e ir m ultinational customers and increase th e ir attractiveness to new customers. For this purpose they need banking capability in the U nited States. Obtaining a bank in the United States also helps diversify a foreign bank's sources o f earnings and deposits and can provide a depend able source o f dollar funds. In addition, the U nited States is an attractive place in w hich to do business and have assets because o f its relative political and economic stability. Foreign banks tha t wish to enter the large U.S. banking m arket may fin d it quicker and cheaper to do so through an acquisition than by establishing a new bank. A cquisition provides a 12 Federal Reserve Bank o f Cleveland going concern w ith an established customer base. Moreover, the shares o f many U.S. banks are currently selling below book value, making them attractive to purchase.8 In a ddition, the depreci ation o f the U.S. dollar in 1977 and 1978 made U.S. assets cheaper in terms o f foreign currencies. Reviews of Existing Policy Foreign acquisitions o f U.S. banks have prom pted reviews o f U.S. policy tow ard such acquisitions. Review is being accomplished in several forum s. Muriel Siebert, New Y o rk State Superintendent o f Banking, w rote a le tte r on February 16, 1979, to Representative Reuss, Chairman o f the House Com m ittee on Banking, Finance, and Urban A ffa irs, detailing her concerns on the m atter and urging a review at the federal level. Obviously, her office takes a close look at these issues in the process o f reviewing acquisition applications. Several congressional com m ittees are examining the matter. The Senate C om m ittee on 7. Considerable Increase in Foreign Banking in the United States Since 1972, R eport b y the C o m ptro lle r General o f the U nited States, August 1, 1979, p. 20. 8. Robert Metz, "Banks as Lure to Foreign Bids," N ew York Times, A p ril 16, 1979, p.D-4. Banking, Housing, and Urban A ffa irs held hearings in July and the House Subcommittee on Commerce, Consumer, and M onetary A ffa irs held hearings in August. The Chairman o f the House Subcommittee on Financial In stitutions Supervision, Regulation, and Insurance in March asked the General A cco u n t ing O ffice (GAO) to review the m atter and report its findings to the subcommittee. In response, the GAO has made one report, and a second is expected soon. The subcomm ittee may hold hearings early in 1980. Further, Senator Heinz o f Pennsylvania has asked Congress to impose a m oratorium on bank acquisitions to allow tim e to study th e ir ram ifications. Many proposed acquisitions o f U.S. banks require p rio r approval by the Federal Reserve Board o f Governors under provisions o f the Bank H olding Company A ct. The Board recently accomplished a major review o f its policies tow ard foreign bank holding companies and on February 23, 1979, adopted a statement o f those policies. A d d itio n a lly, form er Federal Reserve Board Chairman M iller has noted th a t Congress considered the m atter in its deliberations on the IB A .9 Also, the I BA-mandated presidential review o f the McFadden A c t is like ly to include an exam ination o f the question, discussed below, o f whether foreign banks have an unfair advantage over th e ir U.S. com petitors in terms o f th e ir freedom to acquire other U.S. banks. Some critics view w ith alarm the growing foreign share o f the U.S. banking market. While part o f the fear o f foreign control may be mere xenophobia, some people argue th a t some foreign banks' close relationships w ith th e ir own governments may influence th e ir U.S. banking decisions. Fairness is another issue. A foreign bank may be able to purchase a U.S. bank th a t another U.S. bank, a w orldw ide c o m p e tito r o f the foreign bank, is prevented fro m buying. If the target bank is in another state, a U.S. bank is prevented from purchasing it by the McFadden A c t or the Bank Holding Company A ct. If the target bank is in the same state, purchase may be prevented because of anticom petitive considerations. Some critics note the absence o f reciprocity in the current situation. Superintendent Siebert has found on the basis o f discussions w ith her counterparts in other countries th a t "n o developed co u n try other than the U.S. w ould perm it any significant local bank to be acquired by a non domestic b a n k .''10 It is argued th a t the United States should use foreign interest in purchasing U.S. banks as a lever to make possible U.S. bank purchases o f foreign banks. If the United States permits the current surge o f acquisitions to run its course, our leverage to negotiate reciprocity w ill be lost. Finally, it has been argued th a t it w ill be d iffic u lt fo r federal or state authorities to ade quately supervise a U.S. bank owned by a large Issues Involved A cquisitions o f U.S. banks by healthy wellmanaged foreign banks hold several advantages fo r the United States. An infusion o f capital from the purchasing bank can make the U.S. in s titu tio n stronger. A ffilia tio n w ith a large foreign bank, particularly one w ith operations in many nations, can enhance a U.S. bank's a b ility to provide service to its customers. A foreign takeover may even infuse better management and greater e ffi ciency in to the acquired bank. Bank com petition in the United States may increase, benefiting the banking public. F inally, the possibility o f purchase by foreign interests may increase the market value o f bank shares, making it easier fo r U.S. banks to raise new capital. However, advocates o f a review o f U.S. policy toward acquisitions raise several criticism s. 9. Letter fro m Federal Reserve Board Chairman G. W illiam M ille r to U.S. Representative Henry Reuss, March 6, 1979. 10. Letter fro m Superintendent Muriel Siebert to U.S. Representative Henry Reuss, February 16, 1979. A sim ilar conclusion was reached in a study recently made fo r Congress. "A lth o u g h evidence o f impedim ents to foreign (including U.S.) acquisition o f very large indige nous banks is largely im pressionistic,...inform ed judgments suggest th a t, as a general m atter, such acquisitions w ould be discouraged by most governm ents." Departm ent o f the Treasury, R eport to Congress on Foreign Governm ent Treatm ent o f U.S. Com mercial Banking Organizations, September 17, 1979, p. 432. G overnor Wallich has noted, however, that "U .S . banks have in the past acquired sizable ownership interests in large foreign banks." Statement by Henry C. W allich, member o f Board o f Governors o f the Federal Reserve System, before the Com m ittee on Banking, Housing, and Urban A ffairs, United States Senate, July 16, 1979, p. 13. Economic Review January 1980 13 foreign bank th a t perhaps owns many nonbanking businesses abroad. It may be d iffic u lt fo r bank examiners to be certain th a t the U.S. bank is not influenced by its foreign owners to make loans to related foreign companies. Such loans may seem necessary to the parent but may be unwise from the view point o f m aintaining soundness o f the U.S. bank. IN T E R N A T IO N A L B A N K IN G F A C IL IT Y The New Y ork Clearing House Association has proposed th a t a new type o f International Banking F a cility (IBF) be perm itted in the U nited States. A lthough located in the U nited States, IBFs w ould compete in the Eurodollar deposit and lending market. New Y o rk State has passed enabling legislation, b u t the Federal Reserve Board o f Governors has not yet decided whether it w ill make the required regulatory changes. To be com petitive in the Eurodollar market, banks must be able to pay interest on deposits w ith o u t lim ita tio n s on m inim um m aturities or interest rate ceilings; to afford com petitive rates, banks need to be free o f reserve requirements on deposits. Banking offices in the U nited States do not have these necessary freedoms fro m regu lation. Consequently, U.S. banks operate in the Eurodollar market through foreign branches, some o f w hich are tra ditiona l branches w hile others are "she lls." A shell branch has practically no office or staff, and is ty p ic a lly established on a Caribbean island or in another area where it is free o f taxes and unencumbered by U.S. regulations on interest and reserves.11 W ith a "s h e ll" branch, Eurodollar operations are conducted from the parent bank office in the U nited States but are recorded on the books o f the shell. The New Y ork Clearing House Association has proposed th a t tax laws and banking regulations be changed to facilitate the establishment in the U nited States o f IBFs th a t could conduct Eurodollar banking. An IBF w ould be able to accept deposits from and lend funds to o n ly its parent bank, other IBFs, and foreign residents. 11. Income earned by a U.S. bank's branch in some Caribbean nations ty p ic a lly is not taxed by that nation or by U.S. states or cities, b u t is subject to U.S. federal income tax. 14 Federal Reserve Bank o f Cleveland Status of the Proposal New Y o rk State enacted, in June 1978, a law exempting IBFs fro m state and c ity taxes, provided favorable federal action on interest and reserve regulations follow s. A pparently, no other state has taken sim ilar action, although some are considering it and may act if the proposal is implemented in New Y o rk C ity. The Federal Reserve Board o f Governors in December 1978 invited com m ent on the clearing house's proposal by March 15, 1979, and subsequently extended the com m ent period to May 18, 1979. On July 16 the Board returned the issue to its staff fo r fu rth e r study and decided to reconsider it in about six months. Issues The clearing house argues th a t IBFs w ould provide substantial benefits to the U nited States. E m ploym ent in the United States w ill increase to the extent th a t Eurodollar banking operations are conducted in the U nited States instead o f abroad. The clearing house suggests an additional 5,000 to 6,000 jobs w ould be created in New Y o rk C ity in IBFs and in service industries th a t support banking such as law and accounting. Income tax and sales tax receipts w ould rise as wages are earned and spent, and federal corporate income tax receipts w ould rise as E urodollar banking oper ations pay income tax to the U.S. Treasury instead o f foreign tax authorities. In addition, banking m ight be more e ffic ie n t if E urodollar operations can be performed in the U nited States, close to the parent bank, instead o f abroad. Finally, U.S. banks w ould reduce th e ir foreign co u n try risk if more o f th e ir operations were conducted w ith in the United States. C ritics o f the proposal generally agree w ith the clearing house on these points, although some believe th a t the magnitude o f the benefits w ould be smaller than the clearing house suggests. Some argue th a t a U.S. bank needs tra d itio n a l foreign branches to compete fo r lending and other banking business abroad and if it has foreign branches it w ould continue deposit-taking and deposit-placing operations at the branches. Shell branches, by contrast, may be closed, but shell em ploym ent is small, so the relocation o f jobs to the U nited States w ould be correspondingly small. Critics p o in t to problems th a t IBFs could cause. One d iffic u lty is th a t a bank outside New Y ork w ould be p ut at a com petitive disadvantage because the McFadden A c t prevents it from establishing a branch in New Y ork to operate an IBF. Instead, it w ould have to operate an IBF through an Edge C orporation, which w ould have smaller capitalization and m ight be viewed by foreign depositors as less secure than the parent bank. This com petitive problem could perhaps be resolved by individual state legislation, where necessary, perm itting banks to establish IBFs in th e ir home states, or by an amendment to the McFadden A c t perm itting banks in other states to establish special purpose branches in New Y o rk to operate IBFs. A nother possible d iffic u lty o f the IBF proposal concerns the effect o f IBFs on the Federal Reserve's a b ility to conduct monetary policy. If some domestic deposits th a t are reservable were shifted to IBFs where they could not be reservable, a d im in u tio n in the Federal Reserve's influence over the money supply could occur. One route fo r this leakage could be fo r U.S. corporations to shift deposit funds to th e ir foreign subsidiaries, w hich, in tu rn , could place the funds in IBFs to obtain higher yields. In 1975, George W. M itchell, who was then vice chairman o f the Federal Reserve, testified to Congress on a similar proposal and said th a t preventing such a leakage may require “ an extensive and cumbersome system o f re g u la tio n ."12 C O N C LU SIO N It is clear th a t many changes in law and regulation o f international banking have recently been made or proposed, and th a t others w ill be forthcom ing. These changes are large in number because o f the coincidence in tim e o f the passage o f the I BA, the attractiveness to foreign banks o f acquiring U.S. banks, and the New Y o rk Clearing House proposal th a t regulations be changed so th a t more E urodollar banking business can be done in this co u n try. E volution o f financial in stitu tio n s is a continuing process, in domestic as well as international banking and finance. As financial in stitu tio n s evolve, regulation o f banking must also evolve to assure th a t the banking system can best serve the public interest. 12. Statement by Vice Chairman George W. M itchell, Board o f Governors o f the Federal Reserve System, before the Subcom m ittee on Financial Institutions Supervision, Regulation, and Insurance, House o f Repre sentatives, December 12, 1975. Governor Henry Wallich made the same p o in t in his testim ony to the Senate Com m ittee on Banking, Housing, and Urban A ffairs on July 16, 1979. Economic Review January 1980 15 The Local Labor-Market Response to a Plant Shutdown Michael L. Bagshaw Robert H. Schnorbus A lthough the shutdown o f a major manu facturing plant can have a severe and lasting impact on a local economy, labor markets adjust, at least p artially, to compensate fo r the loss o f jobs. A t the national level a plant shutdown may represent a reallocation o f resources th a t eventually benefits the whole economy. However, the area th a t has lost the plant is confronted w ith the need to make often painful adjustments. A plant shutdown im m ediately reduces the size o f the local labor market. While the la id -o ff workers' adjustments are a reflection of the d irect effects o f a shutdown, the loss is shared by others, both in the local and the adjacent areas, through a wideranging set o f in d ire ct effects. There have been several labor markets in the F ourth Federal Reserve D istrict th a t have been disrupted by major plant shutdowns in recent years. The A kron SMSA has been losing tireproduction facilities fo r many years. A kron's em ploym ent, however, has increased steadily over the last tw o years. In fact, its rubber-industry em ploym ent has increased as the corporate head quarters' w ork force o f A kron's rubber industry has grown. In the spring o f 1979, the Dayton SMSA experienced the closing o f a Frigidaire plant th a t employed over 5,000 workers. However, the subsequent pattern o f Dayton's em p lo ym e n t/u n em ploym ent figures was n o t perceptively d iffe re n t either fro m most o f Ohio's other m ajor SMSAs or from D ayton's pattern p rio r to the plant closing. One o f the most w idely publicized plant closings in the Fourth D istrict occurred in the 16 Federal Reserve Bank o f Cleveland Youngstown-Warren SMSA in 1977 w ith the shut down o f the Campbell Works o f Youngstown Sheet & Tube Co., a subsidiary o f LT V C orp.1 In November 1979 U.S. Steel Corp. announced the permanent closing o f its McDonald and Ohio Works in Youngstown, a move th a t w ill idle 3,500 workers and managers. A lthough the im pact o f the U.S. Steel closings w ill n o t be know n fo r some tim e, the 1977 Campbell w orks shutdown can illustrate the adjustm ent mechanism o f a local labor m arket to a plant shutdown. The shutdown o f the Campbell Works plant was in itia lly projected to affect 4,000 to 5,000 jobs, or about 2 percent o f the to ta l em ploym ent in the Youngstown-Warren SMSA at th a t tim e. Yet, over the subsequent tw o years, the local em ploym ent/unem ploym ent figures returned to pre-shutdown levels. Because most o f the la id -o ff Campbell Works employees either found new jobs or accepted early retirem ent benefits, th e ir being laid o ff ceased to be a serious unem ploym ent problem to the local economy. E m ploym ent in the 1. It is im p orta n t to distinguish between a tem porary lay o ff, which is subject to recall, and a shutdow n, which perm anently affects em ploym ent. A shutdown can result fro m the closing o f o n ly a section o f a plant's facilities as well as from the complete closing o f a plant. In the case o f Youngstown's Campbell Works, operations th a t were discontinued included the production o f hot rolled sheets and plates, cold rolled sheets, some bar type products, and continuous weld pipe. Continued operations include p roduction o f seamless pipe, cold finished bars, and coke to support the Brier Hill Works. Chart 1 Unemployment Rates Seasonally adjusted U nem ploym ent rate, percent SOURCES: Bureau o f Labor Statistics E m p lo y m e n t and Earnings (Washington, D.C.: U.S. Departm ent o f Labor); Ohio La b or M arket In fo rm a tio n (Columbus, OH: Bureau o f Em ploym ent Services). Youngstown-Warren SMSA surpassed the earlier peak levels w ith in one year o f the shutdown. The Youngstown-Warren SMSA unem ploym ent rate, as shown in chart 1, has trended downward since A p ril 1978, paralleling the state and national unem ploym ent rates. Despite the dram atic recovery from the Campbell Works shutdow n, the fu ll labor-market effects o f the shutdown have been disguised by the adjustment process o f the local labor market. This article attempts to differentiate between the direct and indirect effects o f the post-shutdown labor-m arket adjustments in the Youngstown-Warren SMSA. TH E A D JU S T M E N T PROCESS OF LO CA L LABOR M A R K E T S Labor markets are constantly adjusting to changing economic conditions. Plant shutdowns are only one example, although perhaps the most dram atic, o f a whole series o f factors th a t change the demand fo r labor in a local economy. Seasonal and cyclical flu ctu a tio n s in demand also affect em ploym ent/unem ploym ent levels, w ith o u t alter ing the basic structure o f the local economy. A lthough plant shutdowns can occur, especially among marginal firm s, they are not usually associ ated w ith these types o f demand changes. Economic Review January 1980 17 Plant shutdowns are more ty p ic a lly caused by permanent changes in demand through either the secular decline o f an industry or the redistri bution o f industries to more profitable locations. A plant closedown may have o nly a tem porary effect on the local economy if it is offset by the b irth o f a new firm or the expansion o f an existing firm . Because the Campbell Works shutdown represents the decline o f an industry, it is assumed to represent a permanent loss o f jobs in the Youngstown-Warren SMSA. The direct effect o f a permanent loss o f jobs is the adjustm ent o f the laid-off workers themselves as they choose among new jobs, relocation, retirem ent, or unem ploym ent. In seeking em ploym ent, the laid -off workers compete w ith the rest o f the labor force fo r a diminished number o f jobs in the local economy. The direct adjustments o f the la id -o ff workers lead to indirect adjustments by others in the labor force w ho w ould have had jobs if those jobs had not been taken by the la id-off workers. The actual process o f these adjustments seldom takes place in a static labor market. Because these changes in demand and job turnovers are constantly occurring, jo b openings are con tin u a lly becoming available. The in itia l effect o f a plant shutdown is to increase d ire ctly the level o f unem ploym ent. Some la id -o ff workers leave the labor force, either through retirem ent or relocation. By leaving the labor force, laid -off workers do not appear in the unem ploym ent figures and, therefore, mitigate the increase in the unem ploym ent level. Relocation w ould have the same effect on the labor force and unem ploym ent levels in the local economy. However, the locality receiving the relocating w orker w ould then be required to adjust its labor force to either an increase in em ploym ent or unem ploym ent.2 Many workers seek new em ploym ent. Since many o f these workers have specific skills, they may fin d new em ploym ent in the remaining establishments o f th e ir industry or in closely related industries. If la id -o ff workers have d iffic u lty fin din g em ploym ent at a comparable skill level, 2. If the tw o labor markets are in the same state, the net effect on the state's labor m arket w ould be n u llifie d and thus go unnoticed in the state's labor-force statistics. 18 Federal Reserve Bank o f Cleveland they may settle fo r a jo b w ith lower skill require ments and lower pay. U nlike the la id -o ff workers who leave the labor force or remain unemployed, the reem ploym ent o f the la id -o ff workers affects others in the local labor force, especially the previously unemployed. Reem ploym ent o f la id -o ff workers must displace other workers holding jobs or unemployed workers who w ould otherwise have acquired jobs.3 POST-SHUTDOW N STA TU S OF L A ID -O F F W O RKERS The post-shutdown status o f workers who were laid o ff as a direct result o f a plant shutdown was obtained via labor-force surveys. In the case o f the steel plant in Youngstown, surveys were conducted in Ju ly and August 1978 (about one year after the shutdown announcement and six months after the actual shutdown) to determine the labor-m arket status o f the la id -o ff w orkers.4 According to the survey 4,200 union workers were laid o ff by the Campbell Works shutdown. Six months later about one-third o f these workers (1,300 to 1,500) had been reemployed, b u t not necessarily in comparable or even permanent jobs. O f the remaining workers 400 to 600 relocated to another SMSA, and about 1,000 to o k early retire m ent.5 A p p ro xim a te ly 1,200 to 1,500, including those enrolled in retraining programs, were still seeking em ploym ent. Therefore, the labor-m arket 3. If a jo b opening is intended fo r a skill level beyond th a t o f an unemployed w o rker, the la id -o ff w o rker who does q u a lify fo r the jo b may have prevented a series o f prom otions th a t u ltim ate ly w ould have opened a jo b at a lower skill level fo r the unemployed w orker. Thus, all unemployed workers are, in a sense, com peting fo r any job opening. 4. In this survey 282 steelworkers, fro m both Brier Hill and Campbell Works, were interviewed in a random sampling. The estimates were based on reports obtained fro m the O hio Bureau o f E m ploym ent, union o fficials, and other local sources. The number reported did not include an estimate o f clerical and other w hite-collar per sonnel who may have been affected. The survey results were obtained fro m a w orking paper e n titled "D eveloping a Human Services Response to Economic C risis/' Center fo r Urban Studies, Youngstown State U niversity, October 1978. The Center fo r Urban Studies is cu rre n tly co n d uct ing fo llo w -u p studies on the im pact o f a plant shutdown. 5. The rather large number o f retirees may be the result o f the age o f the plant fa c ility and the relative m a tu rity o f the industry. Table 1 Distribution and Changes in Employment in the Youngstown-Warren SMSA Em ploym ent levels, 000 Industries Total3 April 1977 April 1978 Net change Change in SMSA,% Change in U.S.,% 182.3 189.2 6.9 3.8 Manufacturing 81.3 80.0 -1 .3 -1 .6 7.6 Durable goods 75.1 74.0 -1 .1 - 1 .5 11.3 Primary metals 42.3 36.3 -6 .0 -1 4 .2 3.9 Blast furnace and basic products 26.7 20.9 -5 .8 -2 1 .7 1.8 Fabricated metals 8.3 9.2 0.9 10.8 19.4 Machinery (excluding electrical) 6.6 6.6 0 0 16.6 Electrical equipm ent 3.4 3.3 -0 .1 -2 .9 7.8 Transportation equipm ent 9.6 13.7 4.1 42.7 13.6 Nondurable goods 6.2 6.0 - 0 .2 - 3 .2 2.3 Nonmanufacturing 9.4 101.0 109.2 8.2 8.1 10.2 Retail trade 37.2 39.1 1.9 5.1 7.9 Services 33.6 36.4 2.8 8.3 8.4 SOURCE: Ohio Bureau o f E m ploym ent Services. a. T otal em ploym ent represents total nonagricultural em ploym ent minus government em ploym ent. adjustment o f the laid-off workers—the direct e ffe ct—was about evenly distributed among those who found em ploym ent, those who le ft the labor force in the Youngstown-Warren SMSA through retirem ent or relocation, and those who were still unemployed. Considering the relatively large number of workers involved in this plant shutdow n, the Youngstown-Warren labor market was remarkably successful in reabsorbing the la id -o ff workers. A lm ost one year fro m the announcement o f the shutdown, only one-third o f the laid-off workers were still classified as unemployed. Because most o f these unemployed workers were unskilled, they qualified fo r retraining assistance. Indeed, the most current estimates indicate th a t about 600 laid-off workers remain unem ployed.6 E m ploym ent opportunities available to the laid-off workers in the Youngstown-Warren SMSA were augmented by the em ploym ent expansion in other industries, as shown in table 1. Between 6. Conversations w ith Donald Curry and A n th o n y Fortunato o f the Ohio Bureau o f Em ploym ent Services, Youngstown-Warren branch o ffice , Youngstown, Ohio, September 24, 1979, and O ctober 2, 1979, respectively. Economic Review January 1980 19 A p ril 1977 (prior to the shutdown) and A p ril 1979, the to ta l em ploym ent in the YoungstownWarren SMSA expanded by 6,900, or 3.8 percent. While this increase was less than one-half as rapid as the increase experienced by the nation, the increase locally was equivalent to one and one-half times the number o f workers laid o ff from the Campbell Works. Local em ploym ent declined by 1,300 in m anufacturing and by 5,800 in steelrelated industries—more than can be attributed solely to the plant shutdown. A lthough the Youngstown-W arren SMSA experienced relatively strong grow th in nonmanu facturing em ploym ent, transportation equipm ent was the only local m anufacturing industry to exceed the national rate o f increase in employ- The Application of Intervention Analysis to the Campbell Works Shutdown The shutdown o f a plant can affect to ta l em ploym ent/unem ploym ent levels o f the local labor market in several ways. Prior to a shutdown, there is no way to predict w hat type o f pattern may result fro m a shutdown. The im pact o f a shutdown could cause any o f the fo llo w in g : 1. a one-step change in the level o f the em ploym ent/unem ploym ent series if all adjustments occur instantaneously; 2. a sh ift in the growth trend o f the series if adjustments are made gradually over a period o f tim e; 3. a s h ift in the seasonal or cyclical pattern o f the series due to the new structure o f the local econom y; or 4. a com bination o f these three effects. One o f the m ajor problems associated w ith measuring the effects o f the Campbell Works shut down is to determine the type o f pattern caused by the shutdown. This determ ination is very im portan t, because an assumption o f the type o f pattern sh ift leads to the type o f analysis per form ed and thus affects the outcome o f the analysis. If, fo r example, an a p rio ri assumption o f the type o f pattern s h ift is made and this assumption is incorrect, then incorrect results may be derived from analysis based on this assumption. Consequently, rather than using methods based on a p rio ri assumptions, the method o f intervention analysis has been used in this stu d y.1 In this method one o f the principal steps is to perform tests on the data to determine w hat type o f pattern sh ift (if any) occurred rather than using an arbitrary pattern shift. Intervention analysis, as used in this study, consisted o f fo u r basic steps applied separately to the to ta l em ploym ent/unem ploym ent series. First, the relationship between the to ta l e m p lo ym e n t/ unem ploym ent levels in the Youngstown-Warren SMSA and the corresponding national series was estimated fo r the tim e period between January 1971 and August 1977 (a period before the announce ment o f the shutdown). Second, this relationship was used to forecast the levels o f both SMSA em ploym ent and unem ploym ent fo r the tim e period fro m September 1977 through A p ril 1979 (a period th a t included the plant shutdow n), using the actual values o f the national series during this period. T h ird , the differences between these forecasts and the actual values o f the SMSA em ploym ent and unem ploym ent series over this tim e period were used to id e n tify a pattern fo r the impact o f the shutdown. Finally, a model was estimated th a t included this pattern o f impact. This procedure provided an estimate o f the actual impact o f the plant shutdown. This last step also included tests to assure th a t the pattern o f impact chosen in this analysis was correct. 1. For a detailed discussion o f this m ethod, see G. E. P. Box and George C. T iao, "In te rv e n tio n Analysis w ith Applications to Environmental Problems," Journal o f the Am erican Statistical Association, 70 (1975): 70-79. 20 Federal Reserve Bank o f Cleveland ment, largely because o f an increase in small-car production at the nearby General M otors plant in Lordstow n, Ohio. Indeed, this expansion accounted fo r much o f the reem ploym ent o f the la id -off Campbell Works employees. A lthough em ploym ent in the fabricated metals industry expanded, the Youngstown-Warren SMSA did not fu lly share in the increased em ploym ent th a t was generated by national grow th in the industry. Some la id -o ff workers were employed at nearby steel plants, such as the Brier H ill Works; others were te m po rarily recalled at the Campbell Works. Chart 2 However, the overall decline in steel-related em ploym ent lim ite d jo b opportunities in the steel industry. T O T A L LA B O R -M A R K E T A D JU S TM E N TS Using data fo r Ohio and the nation as standards o f comparison, the fu ll impact o f the Campbell Works shutdown was observed in the changing level o f blast-furnace em ploym ent in the Youngstown-Warren SMSA (see chart 2). In the cyclical expansion th a t occurred between 1975 Blast-Furnace Employment N ot seasonally adjusted Number o f persons employed, in thousands 1975 1976 1977 1978 1979 SOURCES: Bureau o f Labor Statistics, E m ploym ent and Earnings (Washington, D.C.: U.S. Departm ent o f Labor); Ohio Labor M arket In fo rm a tio n (Columbus, OH: Bureau o f Em ploym ent Services). Economic Review January 1980 21 and 1979, blast-furnace em ploym ent in the nation experienced seasonal swings in em ploym ent levels, w ith peaks occurring in the summer months and troughs occurring in the w in te r months. E m ploy m ent in both the state and the SMSA showed a sim ilar seasonal and cyclical pattern. The cyclical trend in the Youngstown-Warren SMSA was clearly disrupted by the plant shutdown at the end o f 1977, resulting in a seasonal trough in January 1978 th a t was much deeper in both the state and the SMSA than in the nation. Assuming th a t the Campbell Works shutdown was the o n ly em ploy ment disruption th a t occurred in the SMSA since 1975, the drop in the SMSA's blast-furnace em ploym ent fu lly reflects the 4,200 jobs th a t were perm anently lost. The national level o f total em ploym ent was taken to be an indicator o f how to ta l em ploym ent in the Youngstown-Warren SMSA w ould have performed w ith o u t the Campbell Works shutdown. The method o f analysis th a t compares the behav ioral patterns o f to ta l em ploym ent/unem ploym ent o f a region or SMSA w ith those o f the nation is called intervention analysis. Estimates o f the im pact o f an event can be determined by this method o f analysis. (See box on page 20 fo r a fu rth e r discussion o f intervention analysis as applied to the Campbell Works shutdown.) Results derived fro m this technique indicated th a t a one-time sh ift in the levels o f both total em ploym ent and unem ploym ent occurred in the Youngstown-Warren SMSA in December 1977, three months after the announcement o f the shutdown. By the end o f th a t year, to ta l em ploy ment and unem ploym ent resumed th e ir historical pattern o f behavior relative to the corresponding national series. In all, to ta l em ploym ent was estimated to have declined by 4,600, and unem ploym ent increased by 3,200 over the last three months o f 1977 as a result o f the plant shutdow n.7 Since the change in em ploym ent/unem ploym ent levels must equal the to ta l change in the laborforce size, it follow s th a t the SMSA's labor force 7. The numbers w ith in a range o f in thousands, the —7.37 to —1.87 ranged between 22 represent the statistical best estimate significance. For em ploym ent measured range at the 0.95-significance level was fo r the value —4.62. Unem ploym ent —0.47 and 6.91 fo r the value 3.22. Federal Reserve Bank o f Cleveland must have declined by 1,400. Chart 3 illustrates em ploym ent levels fo r the SMSA, the state, and the nation; it also includes the SMSA's projected em ploym ent level w ith o u t the im pact o f the shutdown. The discrepancy between the 4,200 jobs lost from the Campbell Works shutdown and the estimated 4,600 em ploym ent drop may have several explanations. In addition to the 4,200 workers involved in the shutdown, a small number o f w hite-collar support staff were either laid o ff or transferred to other facilities after the shutdown. Also, a possible "rip p le e ffe c t," causing other cutbacks by businesses dependent on orders from Campbell Works or on the purchases o f the w ork force, could have co ntributed to jo b losses. In any case, the discrepancy was small enough to assume that the 4,600 em ploym ent drop was caused solely by the Campbell Works shutdown. The difference between the adjustments o f the la id -o ff Campbell Works employees and the to ta l labor-m arket adjustments in the SMSA indicates the extent to which the burden o f the plant shutdown was shifted to others in the local labor m arket—the indirect effect. W ithin six months after the shutdown, em ploym ent among form er Campbell Works employees had dropped by approxim ately 2,850 (or the tw o -th ird s who either le ft the labor force or remained unem ployed), compared to a to ta l estimated loss in em ploym ent o f 4,600. The loss o f unem ploym ent was, o f course, concentrated in the steel industry. Most o f the decline in the labor force was a ttrib u te d to Campbell Works employees; but the remaining 1,200 to 1,500 unemployed form er Campbell Works employees accounted fo r less than one-half o f the to ta l rise in unem ploym ent. Therefore, those previously unemployed bore the b ru n t o f the plant shutdown as the jobs th a t they may have obtained were taken by the la id -o ff workers. C O NC LUSIO N The response o f the Youngstown-Warren SMSA must be measured n o t o n ly in the adjust ments o f the la id -o ff Campbell Works employees, but also in the adjustments o f those in d ire ctly affected by the shutdow n. (See table 2 fo r a summary o f the direct and indirect effects o f the shutdown.) A lthough the adustment mechanism Chart 3 Nonagricultural Em ployment Seasonally adjusted E m ploym ent rate in thousands SOURCES: Bureau o f Labor Statistics, E m p lo ym e n t and Earnings (Washington, D.C.: U.S. Departm ent o f Labor); Ohio La b or M arket In fo rm a tio n (Columbus, OH: Bureau o f Em ploym ent Services). Economic Review January 1980 23 Table 2 Summary of the Impact of the Campbell Works Plant Shutdown Direct effect3 Change in em ploym ent Indirect effect Total effect -2 ,8 5 0 -1 ,7 5 0 -4 ,6 0 0 Change in unem ploym ent 1,350 1,850 3,200 Change in the labor force -1 ,5 0 0 100 -1 ,4 0 0 a. The size o f the direct effect is based on the simple mean o f the stated range. w orks best when local or national em ploym ent is growing strongly, the a b ility o f the YoungstownWarren SMSA to restore its pre-shutdown levels o f em ploym ent at comparable unem ploym ent rates in as short a tim e as one year attests to the strength o f the local labor m arket as an adjustm ent mecha nism. The fact th a t the Youngstown-Warren SMSA has n ot witnessed a collapse o f its economy or chronic unem ploym ent problems should not distract from the serious impact o f its declining steel industry. The local economy has shrunk relative to the national economy as a result o f the 24 Federal Reserve Bank o f Cleveland plant shutdown, and workers have relocated to find new em ploym ent. F urther reductions in em ploym ent w ill undoubtedly occur when the Brier H ill Works o f Youngstown Sheet & Tube Co. is phased o u t and when the McDonald and Ohio Works are closed by U.S. Steel. Unless new sources o f industrial grow th can be found to replace the jobs lost to permanent shutdowns, the economy o f the Youngstown-Warren SMSA w ill adjust by continuing to fall behind the national economy, both in em ploym ent and labor-force growth.
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