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Federal Reserve Bank of Cleveland

Economic Trends
July 2007
(Covering June 20, 2007 - July 12, 2007)

In This Issue
Economy in Perspective
Tick-tock …
Inflation and Prices
May Price Statistics
Money, Financial Markets, and Monetary Policy
Assessing New Information: What’s Permanent, What’s Not?
Monetary Policy: What’s in a Few Words?
The Yield Curve’s Prognosis for Economic Growth
International Markets
Sovereign Wealth Funds
Economic Activity and Labor Markets
The Employment Situation
Employment and Firm Size over the Business Cycle
Regional Activity
Midwest Housing Markets
Banking and Financial Institutions
Fourth District Bank Holding Companies

1

Economic Trends is published by the Research Department of the Federal Reserve Bank of Cleveland.
Views stated in Economic Trends are those of individuals in the Research Department and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. Materials may be reprinted
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ISSN 0748-2922
2

The Economy in Perspective

Tick-tock…
07.12.07
by Mark S. Sniderman
The majority opinion among private economic forecasters is that the U.S. economy is in the last phase of adjusting to a series of disturbances from energy and housing markets. Most forecasters expect the economy to resume its
growth, at a rate close to its longer-term trend, sometime in next year or perhaps earlier, depending on how soon the
depressing effects of the housing markets start to wane.
Inflation, which has been uncomfortably high more often than not during the past few years, seems to be heading
back toward an acceptable range, although evidence on this point is not conclusive. Drawing a bead on the inflation
trend is tricky because there are many measures of inflation itself and of its underlying trend, termed core inflation.
All the measures tend to paint to a similar picture over time horizons of a few years, but we are in one of those periods when convergence is not yet evident: Some scorecards still show inflation hanging above 3 percent, while others
indicate that it has fallen to 2 percent or below.
Housing conditions are equally unclear. In terms of sales volumes and unit prices, new and existing homes have not
been moving congruently for much of the past year. New and existing homes are not perfect substitutes for one another in either features or location, and we use different sources to estimate their sale prices. On average throughout
the country, sales volumes have fallen more for new homes than for existing ones, but prices for new homes appear
to be holding up somewhat better than those of existing homes.
The housing market is important, not only for individual owners and would-be owners but also for its potential
macroeconomic implications. As housing credit markets tighten up, it is uncertain how the subsequent wave of
adjustable-rate loan refinancing will play out. For some homeowners, higher interest payments will undoubtedly
forestall spending elsewhere; for others, refinancing may not be possible at all. Apart from that, to the extent that
consumption formerly was supported by cash-out mortgage refinancing, higher interest rates and more fragile housing valuations are likely to become constraining influences. Yet, so far this year, consumption spending on the whole
appears sound.
The U.S. economy’s rebalancing after these housing and energy shocks takes place in the context of a much larger
and more profound rebalancing of world economic activity. Unless China, India, and a slew of other countries that
are relatively new entrants to global trading and financial markets abruptly slow down or reverse course, the economies of the United States and other developed nations may be entering a long period of adjustment
The energy market is one of the most important markets being affected by this rebalancing. Over extended periods
of time, as we have seen, energy is subject to substantial price swings, which can affect both economic growth and
measured inflation. Unless rising energy prices are offset by price movements for other goods and services, inflation will rise. If people view energy price increases as largely transitory, they are not likely to foresee an enduring
connection between events in the energy market and the general inflation rate. Indeed, during the past few years,
longer-term inflation expectations have held relatively steady in the face of elevated short-term inflation, a sign of
public confidence in the Federal Reserve. However, as investment advisors are fond of saying, past performance is no
guarantee of future results. However, monetary policymakers would be unable to ignore persistent price increases for
energy or for other goods and services, if those increases were accompanied by a notable deterioration in inflation
expectations.
3

While an expanded world economy offers promising opportunities for all who join, it introduces fresh complications
as nations work to harmonize their trading practices and agree on mechanisms for resolving their disputes. Global
economic expansion also provides greater scope for prices, interest rates, and exchange rates to fluctuate as differences in national savings propensities, regulatory systems, labor market practices, and other forces influence patterns of
consumption, investment, labor utilization, and productivity within and across countries. It is easy to underestimate
the strength and duration of these forces, for they play out incrementally over time and often reveal themselves in
prosaic ways. But play out they do.

Inflation and Prices

May Price Statistics
06.29.07
by Michael F. Bryan and Linsey Molloy

May Price Statistics
Percent change, last:
1 mo.a

3 mo.a

6 mo.a

12 mo.

5 yr.a

2006
avg.

All items

8.5

7.0

5.5

2.7

3.0

2.6

Less food and
energy

1.8

1.5

2.1

2.2

2.0

2.6

1.0

2.1

2.6

3.1

2.6

3.6

2.3

2.7

2.9

2.7

2.3

2.7

Finished goods

11.4

11.0

8.5

4.1

3.9

1.5

Less food and
energy

2.3

0.7

1.8

1.6

1.4

2.1

Consumer Price Index

Medianb
16% trimmed

meanb

Producer Price Index

a. Annualized.
b. Calculated by the Federal Reserve Bank of Cleveland.
Sources: U.S. Department of Labor, Bureau of Labor Statistics; and Federal
Reserve Bank of Cleveland.

Oil Prices
Dollars per barrel, weekly
80
75
70
65
60
55
50
45
40
35
30
25
20
15
2000
2001
2002

2003

Source: The Wall Street Journal.

2004

2005

2006

2007

The headline CPI surged 8.4 percent (annualized rate) during the month—its highest monthly
growth rate since the aftermath of Hurricane
Katrina, in September 2005. The monthly CPI
advance reflects elevated food prices and sharply
higher energy prices. Energy prices have risen at
an average annualized monthly rate of roughly 30
percent during the first four months of the year
and soared nearly 90 percent in May. The total or
“headline” CPI increase exceeded analyst expectations and was a marked acceleration from longerterm CPI-measured inflation trends. The relative
price of energy, notably petroleum, has fluctuated
rather widely over the past few years, after having
shown a persistent and sharp rise during the first
half of the current decade.
While the monthly headline inflation measure is
a reasonably good approximation of the changing
costs that households actually face, they are not
very reliable measures of the inflation trend that a
central bank hopes to contain. The core inflation
measures, which reduce the influence of short-term
price volatility coming from certain index components—like petroleum—have revealed a relatively
more favorable pattern over the past few months.
For example, the CPI excluding food and energy
was up a modest 1.8 percent (annualized) in May
while the median CPI fell to 1.0 percent, its slowest
monthly growth rate in almost four years. And the
monthly growth rate of the 16 percent trimmedmean CPI dropped to 2.3 percent in May, below
its 3-month, 6-month, and 12-month averages.
In their June statement, the Federal Open Market
4

Relative Prices
Ratio
1.20
CPI: Food and beverages /
1.15
CPI excluding food
1.10
1.05
1.00
0.95
0.90
0.85
0.80
0.75
0.70
0.65
CPI: Energy /
0.60
CPI excluding energy
0.55
0.50
1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007
Source: U.S. Department of Labor, Bureau of Labor Statistics.

Housing Prices
1-month annualized percent change
7.0
6.0
5.0

CPI: Rent of
primary residence

3.0
2.0

0.0
1995

CPI: Owner’s
equivalent rent of
primary residence
1997

1999

2001

2003

2005

2007

Sources: U.S. Department of Labor, Bureau of Labor Statistics; and
Federal Reserve Bank of Cleveland.

CPI, Core CPI, and
Trimmed-mean CPI Measures
12-month percent change
4.75
4.50
4.25
4.00
3.75
3.50
3.25
3.00
2.75
2.50
2.25
2.00
1.75
1.50
1.25
1.00
1995

Median CPIa

CPI

Core CPI

16% trimmed-mean CPI a
1997

1999

2001

Owner’s equivalent rent of primary residence
(OER), which accounts for nearly one-quarter of
the overall CPI, rose at a mere 1.0 annualized rate
in May—its slowest monthly growth rate in nearly
four years. Some of the recent deceleration in
monthly OER growth comes from a more moderate rise in rents and may be a consequence of a
housing market that continues to flounder. However, some of the recent deceleration in monthly OER
growth may also come from accelerating utilities
costs, which are generally assumed by a landlord,
and thus, subtracted from the OER housing cost
measure. So recent patterns in the OER measure
might not remain as favorable as the most recent
data would suggest.
The inflation trend over the last 12 months, as measured by the CPI, CPI excluding food and energy,
and the 16 percent trimmed-mean CPI, is between
2¼ and 2¾ percent. Inflation in core service prices
has ranged largely between 3 percent and 4 percent
over the past year, while prices for core goods (i.e.,
commodities less food and energy commodities)
continue to decline.

4.0

1.0

Committee asserted that “Readings on core inflation have improved modestly in recent months.
However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated.”

2003

2005

a. Calculated by the Federal Reserve Bank of Cleveland.
Sources: U.S. Department of Labor, Bureau of Labor Statistics, and
Federal Reserve Bank of Cleveland.

2007

Meanwhile, households’ year-ahead inflation
expectations remained a bit elevated at 4.2 percent
in June, while expectations for inflation over the
next 5 to 10 years, which are more correlated with
movements in core inflation, fell from 3.7 percent in May to 3.3 percent. Longer-term inflation
expectations are back in the 3 percent–3½ percent
range in which they’ve generally fluctuated for
nearly decade.
Professional forecasters and financial market participants are more optimistic about the inflationary
environment. A consensus forecast from the Blue
Chip panel of economists suggests that core inflation will register 2.3 percent in 2007 and 2008.
This is the same rate as market-based measures of
inflation expectations, which show that investors
anticipate that the CPI will grow between 2¼ and
2½ percent over the next decade.
5

Core CPI Goods and Core CPI Services Core CPI Inflation and Forecasts
12-month percent change
8.00
1-month annualized
7.00
percent change
6.00
Core services
5.00
4.00
3.00
2.00
1.00
0.00
-1.00
-2.00
-3.00
Core goods
1- month
-4.00
annualized
-5.00
percent change
-6.00
1995
1997
1999
2001
2003
2005
2007
a. Calculated by the Federal Reserve Bank of Cleveland.
Sources: U.S. Department of Labor, Bureau of Labor Statistics,
and Federal Reserve Bank of Cleveland.

12-month percent change, December
3.5
Consensus
Top 10
average

3.0

2.5

2.0
Bottom 10
average

1.5

1.0
1995

1997

1999

2001

2003

2005

2007

Source: Blue Chip panel of economists, June 10, 2007.

Household Inflation Expectations*

Market-Based Inflation Expectations*

12-month percent change

Percent, monthly
3.50
Adjusted 10-year TIPS-derived expected inflation a
3.25
3.00
2.75
2.50
2.25

6.0
5.5

One year ahead

5.0
4.5

Five to 10 years ahead

4.0
3.5
3.0
2.5
2.0
1.5
1.0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
*Mean expected change as measured by the University of Michigan’s
Survey of Consumers.
Source: University of Michigan.

2.00
1.75
1.50
1.25
1.00
0.75
1997

10-year TIPS-derived expected inflation
1999

2001

2003

2005

2007

*Derived from the yield spread between the 10-year Treasury note and Treasury
inflation-protected securities.
a. Ten-year TIPS-derived expected inflation, adjusted for the liquidity premium on
the market for the 10-year Treasury note.
Sources: Federal Reserve Bank of Cleveland; and Bloomberg Financial
Information Services.

6

Money, Financial Markets, and Monetary Policy

Assessing New Information: What’s Permanent, What’s Not?
07.11.07
by John Carlson and Bethany Tinlin

Short-term Interest Rates*
Percent, weekly average
8
7
6
5
Two-year
Treasury note

Threemonth
Treasury
bill

4
3

Intended
federal funds
rate

2
One-year
Treasury bill

1

0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
*All yields are from constant-maturity series.
Source: Federal Reserve Board, “Selected Interest Rates,” Federal Reserve
Statistical Releases, H.15.

Implied Yields on
Federal Funds Futures*
Percent
5.30
Feb 1, 2007

5.25

a

June 13, 2007
July 10, 2007

5.20
5.15

June 27, 2007

5.10
5.05
May 10, 2007
5.00

a

Mar 22, 2007 a

4.95
Feb

Apr

Jun

Aug

2007
*All yields are from the constant-maturity series.
a. One day after FOMC meeting.
Source: Bloomberg Financial Information Services.

Oct

Dec

2008

Feb

After the Federal Open Market Committee
(FOMC) meets to determine its policy rate, it
issues a statement to explain its decision. That
statement typically includes a sentence to emphasize that future policy adjustments will depend on
the evolution of the outlook for both inflation and
economic growth, as implied by incoming information. Financial market analysts thus keep a keen eye
on the flow of new information to assess how it will
affect the Committee’s choice of the federal funds
rate target at upcoming meetings.
New information often does not affect the outlook
enough to warrant a policy action. During the past year,
for example, the policy rate—the intended federal funds
rate—remained unchanged. Because short-term rates
tend to be closely tethered to the policy rate, short-term
Treasury yields did not vary much relative to periods
over which the policy rate did change.
Although short-term rates varied some, they hovered at levels below the policy rate, providing a
sign that market participants expected the next
policy action to be a rate cut. To some extent, the
movements reflect changes in the expected path of
policy, given new information.
Prices of fed funds futures can also be used to infer
the expected path of policy actions via their implied
yields. Moreover, options based on those futures
provide a means to estimate the distribution of those
expectations. Implied yields based on futures prices
corroborate the view that during the first four months
of 2007, market participants built in a projection for
rate cuts later in the year, as new information indicated a weaker than expected level of economic activity.
During the late spring, however, incoming data
indicated that economic growth was rebounding to
a moderate rate. Indeed, on June 13, 2007, implied yields suggested that no rate cut was on the
horizon. This change in the expected policy path,
however, has not been sustained.
7

Estimated probabilities for alternative outcomes for the
October meeting indicate a similar reaction to the data.
Around June 13, 2007, market participants put a higher probability on a rate hike than a rate cut, although
neither outcome seemed likely at that meeting.

Implied Probabilities of
Alternative Target Federal Funds Rates,
October Meeting Outcome*
Implied probability
1.0

5.25%

0.9

More recently, the news on inflation has been relatively
favorable, increasing the prospect of a rate cut. In sum,
incoming news in recent weeks has altered expectations about the path of the fed funds rate, but not in
any convincingly permanent way. When looked at in
cumulative terms, the outlook seems little changed.

0.8
0.7
0.6
0.5
0.4

June 13

0.3

5.00%

0.2

4.75%

0.1
0.0
6/08

6/12

6/16

6/20

6/24

6/28

5.50%
7/02

7/06

Long-term interest rates have tended to move up
in recent weeks. Such rates are typically influenced
less by policy actions in the near term. Rather
they are influenced more by underlying economic
conditions and expectations about inflation. The
improvement in the economic outlook no doubt
contributed to the recent rise, which seems consistent with a more positive slope of the yield curve.

7/10

*Probabilities are calculated using trading-day closing prices from options on January
2007 federal funds futures that trade on the Chicago Board of Trade.
Sources: Chicago Board of Trade; and Bloomberg Financial Services.

Yield Curve
Percent, weekly average
5.4
5.3

June 27, 2007

Ideally, long-term inflation expectations are tightly
anchored and hence relatively fixed. However, in
his speech yesterday, Chairman Bernanke noted
“Although inflation expectations seem much better
anchored today than they were a few decades ago,
they appear to remain imperfectly anchored.” As an
example, the Chairman noted that TIPs-based measures of inflation expectations still move in response to
economic data and to current inflation news, “which
would not be the case if expectations were perfectly
anchored.” Regardless of the variation, there’s no clear
change in the pattern of expected inflation.

5.2
5.1
July 10, 2007

5.0
4.9
4.8

a
Feb 1, 2007

4.7

May 10, 2007

4.6

a
Mar 22, 2007

a

4.5
4.4
0

5

10
Years to maturity

15

20

a. Day after the FOMC meeting.
b. Day of FOMC meeting.
Sources: Board of Governors of the Federal Reserve System, “Selected
Interest Rates,” Federal Reserve Statistical Releases, H.15; and Bloomberg
Financial Information Services.

Long-term Interest Rates

Long-term Inflation Expectations

Percent, weekly average

Percentage points

9

4.0
Conventional mortgage

8

3.5

Ten-year adjusted
TIPS-derived expected inflation

3.0
7

2.5
2.0

6

1.5
5
1.0
4

20-year
a
Treasury bond

a
10-year Treasury note

3
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
a. Yields are from constant-maturity series.
Source: Federal Reserve Board, “Selected Interest Rates,” Federal Reserve
Statistical Releases, H.15.

Stable
Ten-year
TIPS-derived expected inflation

0.5
0.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Sources: Bloomberg Financial Information Services, Board of Governors of the
Federal Reserve System, “Selected Interest Rates,” and Federal Reserve Statistical
Releases, H.15.

8

Money, Financial Markets, and Monetary Policy

Monetary Policy: What’s in a Few Words?
06.29.07
by John Carlson and Bethany Tinlin
The Federal Open Market Committee (FOMC) left
the target level of the federal funds rate unchanged
at 5.25 percent this afternoon. It was the eighth
consecutive meeting at which the rate was held
steady. The inflation-adjusted fed funds rate rests
near 3 percent, or about 400 basis points above its
low of June 2004.

Reserve Market Rates
Percent
8
7

Effective federal funds rate

a

6
5

Primary credit rate b

4
3
2
1

b
Discount rate
0
2000 2001 2002

Intended federal funds rate b
2003

2004

2005

2006

2007

a. Weekly average of daily figures.
b. Daily observations.
Source: Board of Governors of the Federal Reserve System, “Selected Interest
Rates,” Federal Reserve Statistical Releases, H.15.

Real Federal Funds Rate*
Percent
6
5
4
3
2
1
0
-1
-2
2000

2001

2002

2003

2004

2005

2006

2007

*Defined as the effective federal funds rate deflated by the core PCE. Shaded bar
represents a recession.
Source: U.S. Department of Commerce, Bureau of Economic Analysis; Board of
Governors of the Federal Reserve System, “Selected Interest Rates,” Federal
Reserve Statistical Releases, H.15; Federal Reserve Bank of Philadelphia;
and Bloomberg Financial Information Services.

Any changes in the policy rate would have come
as a great surprise to market participants. Indeed,
implied yields and estimated probabilities based on
fed funds futures indicate that a rate change is not
likely before the end of the year. An adjustment to
the post-meeting statement language, on the other
hand, was widely anticipated.
Language changes were seen as necessary to account
for the evolution of the outlook for both inflation
and economic growth since the last meeting. In its
rationale for the May meeting decision, where rates
were held steady, the FOMC said that economic
growth had slowed and core inflation remained
“somewhat elevated.” Two favorable readings on CPI
core inflation and some good news on economic activity altered the FOMC’s basis for its rationale. The
June statement reads: “ Readings on core inflation
have improved modestly in recent months. However,
a sustained moderation in inflation pressures has yet
to be convincingly demonstrated.”
Concerning economic growth, the statement reads
“Economic growth appears to have been moderate
during the first half of this year, despite the ongoing adjustment in the housing sector.” This compares with the May meeting statement, “Economic
growth slowed in the first part of the year and
the adjustment to the housing sector is ongoing.”
In the FOMC’s assessment of risk, the statement
repeated last meeting’s language that “the Committee’s predominant policy concern remains the risk
that inflation will fail to moderate as expected.”
Initial market reaction saw both equity prices and
bond yields rise. Then after some erratic move9

ments (the S&P index dropped briefly into negative
territory), stocks finished the trading session lower
than just prior to the statement’s release and virtually unchanged on the day. The 10-year Treasury
yield finished the day higher by about 5 basis points
and near the level to which it jumped immediately
after the announcement.

Implied Yields on
Federal Funds Futures*

Implied Probabilities of Alternative
Target Federal Funds Rates
September Meeting Outcome

Percent
5.30

Implied probability
1.0

Feb 1, 2007

a

June 13, 2007

5.25
June 27, 2007

0.9

5.25%

5.20

0.8
0.7

5.15

0.6

5.10

0.5

Existing home sales

0.2

CPI, Industrial production,
UM Consumer sentiment

4.50%

5.00%

4.75%

5.00

5/10

5/16

5/22

5/28

6/03

6/09

May 10, 2007

a

4.95
Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
2008
2007

5.50%

0.1
0.0
5/04

a

5.05

0.4
0.3

Mar 22, 2007

6/15

6/21

6/27

*Probabilities are calculated using trading-day closing prices from options on
January 2007 federal funds futures that trade on the Chicago Board of Trade.
Sources: Chicago Board of Trade; and Bloomberg Financial Services.

*All yields are from the constant-maturity series.
a. One day after FOMC meeting.
Source: Bloomberg Financial Information Services.

Money, Financial Markets, and Monetary Policy

The Yield Curve’s Prognosis for Economic Growth
06.26.07
by Joseph G. Haubrich and Brent Meyer

Yield Spread and Real GDP Growth*
Percent
12
Real GDP growth
(year-to-year percent change)

10
8
6
4
2
0
-2
-4
1953

Yield spread:
10-year Treasury note minus 3-month Treasury bill
1963

1973

1983

1993

2003

*Shaded bars indicate recessions.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; and
Board of Governors of the Federal Reserve System.

Since last month, the yield curve has steepened
considerably, with short rates falling and long rates
rising. As a consequence, the yield curve is no
longer inverted. That is, long rates are once again
higher than short rates. One reason for noting this
is that the slope of the yield curve has achieved
some notoriety as a simple forecaster of economic
growth. The rule of thumb is that an inverted yield
curve (short rates above long rates) indicates a
recession in about a year, and yield curve inversions
have preceded each of the last six recessions (as defined by the NBER). Very flat yield curves preceded
the previous two, and there have been two notable
false positives: an inversion in late 1966 and a very
flat curve in late 1998. More generally, though, a
flat curve indicates weak growth, and conversely, a
10

Yield Spread and
Lagged Real GDP Growth
Percent
12
One-year-lagged real GDP growth (year-to-year percent change)
10
8
6
4
2
0
Yield spread:
10-year Treasury note minus 3-month Treasury bill

-2
-4
1953

1963

1973

1983

1993

2003

Sources: U.S. Department of Commerce, Bureau of Economic Analysis;
and Board of Governors of the Federal Reserve System.

Predicted GDP Growth
and the Yield Spread
Percent
6
Real GDP growth
(year-to-year percent change)

5
4

Predicted
GDP growth

3
2
1
0
Yield spread: 10-year Treasury note
minus the 3-month Treasury bill

-1
-2
3/02

3/03

3/04

3/05

3/06

3/07

3/08

Sources: U.S. Department of Commerce, Bureau of Economic Analysis; the
Board of Governors of the Federal Reserve System; and authors’ calculations.

Probability of Recession Based on the
Yield Spread*
Percent
100
90
80
70
60
50
40

Forecast

Probability
of recession

30
20
10
0
1960

1966

1972

1978

1984

1990

1996

2002

2008

*Estimated using probit model. Shaded bars indicate recessions.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; Board of
Governors of the Federal Reserve System; and authors’ calculations.

steep curve indicates strong growth. One measure
of slope, the spread between 10-year bonds and
3-month T-bills, bears out this relation, particularly
when real GDP growth is lagged a year to line up
growth with the spread that predicts it.
The yield curve had been giving a rather pessimistic
view of economic growth for a while now, but with
the inversion gone, this is less pronounced. The
spread has turned positive: With the 10-year rate at
5.20 percent and the 3-month rate at 4.66 percent
(both for the week ending June 15), the spread
stands at 54 basis points, up a lot from May’s −23
basis points. Projecting forward using past values of
the spread and GDP growth suggests that real GDP
will grow at about a 2.3 percent rate over the next
year. This prediction is on the low side of other
forecasts, in part because the quarterly average
spread used here remains negative.
While such an approach predicts when growth is
above or below average, it does not do so well in
predicting the actual number, especially in the case
of recessions. Thus, it is sometimes preferable to
focus on using the yield curve to predict a discrete
event: whether or not the economy is in recession.
Looking at that relationship, the expected chance
of a recession in the next year is 15 percent, down
a quite a bit from Mays’s value of 35 percent and
April’s 38 percent. The 15 percent is close to the
16.9 percent calculated by James Hamilton over at
Econbrowser (though to be fair we are calculating
different events: Our number gives a probability
that the economy will be in recession over the next
year. Econbrowser looks at the probability that the
quarter fourth quarter of 2006 was in a recession).
Of course, it might not be advisable to take this
number quite so literally, for two reasons. First, this
probability is itself subject to error, as is the case
with all statistical estimates. Second, other researchers have postulated that the underlying determinants of the yield spread today are materially different from the determinants that generated yield
spreads during prior decades. Differences could
arise from changes in international capital flows
and inflation expectations, for example. The bottom
line is that yield curves contain important information for business cycle analysis, but, like other indicators, should be interpreted with caution.
11

For more detail on these and other issues related to
using the yield curve to predict recessions, see the
Commentary “Does the Yield Curve Signal Recession?”

International Markets

Sovereign Wealth Funds
07.02.07
by Owen F. Humpage and Michael Shenk

Currency Composition of Worldwide
Reserve Holdings
Euros
25.8%

U.S. dollars
64.7%

British pounds
4.4%
Japanese yen
3.2%
All others
1.8%
Source: International Monetary Fund, International Financial Statistics,
COFER data.

Foreign Exchange Reserves
Trillions of U.S. dollars
6
5
World
4
3
2

Non-oil-exporting
developing countries
Oil-exporting
developing countries

1
Industrial countries
0
1972

1976

1980

1984

1988

1992

1996

2000

Source: International Monetary Fund, International Financial Statistics.

2004

The flip side of our current account deficits these
past 25 years has been an inflow of foreign savings.
These funds have been quite beneficial: They helped
to keep real interest rates lower than they otherwise
would have been, thereby promoting interest-sensitive sectors of the economy, like investment and
consumers’ durable spending. But would we be so
sanguine about the economic benefits of these financial inflows if foreign governments directed the
placement? Foreign governments are increasingly
interested in earning higher returns on their large
and growing reserve portfolios.
Most governments maintain portfolios of foreign
exchange reserves as insurance funds against temporary shortfalls or reversals in their foreign currency
receipts. Countries’ ability to sell their foreign exchange reserves in the face of short-lived problems
with their balance of payments helps them avoid
currency depreciations without either imposing restraints on imports and financial outflows or immediately adopting deflationary macroeconomic policies. Countries acquire foreign exchange reserves by
managing their exchange rates; they traditionally
invest their reserves in low-risk liquid assets like foreign government securities, interest-bearing deposits, or repurchase agreements. The U.S. dollar is the
key international reserve currency, accounting for
about 65 percent of the world’s total portfolio. The
euro, with approximately 25 percent of the total, is
a distant second, and the British pound comes in
third with 5 percent. The Japanese yen also plays a
noteworthy role as an official reserve currency.
A sharp increase in official holdings of foreign
exchange reserves began in the early 1990s and
accelerated after 2001, probably in response to the
global financial crises of 1997 and 1998 and the
12

Foreign Exchange Reserves
Trillions of U.S. dollars
1.4
1.2
China
1.0
Japan

0.8
0.6

Russia
Korea

0.4

sustained rise in oil prices. The gains seem large,
not only in an absolute sense but also relative to
traditional rules of thumb for reserve needs like
countries’ imports or their outstanding short-term
debts. The sharpest increase in reserve holdings has
occurred among the developing countries, although
Japan’s portfolio expanded rapidly through 2003.
China, which tightly manages the renminbi–dollar
exchange rate, holds the largest reserve portfolio,
approximately $1.2 trillion.

India
0.2
0
1972

1976

1980

1984

1988

1992

1996

2000

Source: International Monetary Fund, International Financial Statistics.

2004

Traditionally, reserve portfolios’ low yield has made
them rather expensive insurance funds, particularly
for developing countries where the rate of return
on domestic infrastructure and the interest cost of
foreign loans can be rather high. Concerns about
the opportunity cost of holding large and rapidly
growing reserve portfolios have prompted some
developing countries to seek higher yields.
In doing so, they have turned to sovereign wealth
funds. These are government investment vehicles
that seek a higher yield on official foreign exchange
receipts by diversifying into a broad range of assets,
including long-term government bonds, corporate
bonds and stocks, derivatives, commodities, and
real estate. These funds have a higher tolerance for
risk than do traditional official reserve portfolios.
To the extent that the financial resources contained
in sovereign wealth funds are not readily available
to monetary authority for exchange rate stabilization or balance-of-payments purposes, they are
distinct from official foreign exchange reserves.
Sovereign wealth funds have been around since at
least 1956. Countries that either owned or taxed
exported commodities—like oil—initially established them, effectively replacing real assets taken
from the ground with high-yielding financial assets
and thereby creating a revenue source for future
generations. Norway’s Government Pension FundGlobal is a prominent example of a commoditybased sovereign wealth fund. Such funds account
for an estimated two-thirds of all sovereign wealth
funds.
The emergence of reserve-based sovereign wealth
funds is fairly recent. Singapore created the first—
the Singapore Global Investment Corporation—in
1981. Korea started a reserve-based sovereign
13

wealth fund last year, and China recently completed the process of setting one up. Japan, Russia, and
India reportedly are also considering reserve-based
sovereign wealth funds.
Little is known about the aggregate size of sovereign wealth funds, but the U.S. Treasury estimates1
that they control approximately $1 trillion to $2.5
trillion. Including official foreign exchange reserves,
governments now control a portfolio of $6.3 trillion to $7.8 trillion. Many observers believe sovereign wealth funds will continue to demonstrate
strong growth, particularly if oil prices remain high,
and they project that such funds will eventually
become the single most important factor in global
financial markets.
The growing clout of sovereign wealth funds has
left a lot of anxious people wondering if statecontrolled investment funds will act like privately
owned investment funds. With the exception of
Norway’s, sovereign wealth funds’ operations are
notoriously opaque, which has given rise to many
questions: Will they invest for non-economic or
strategic reasons? Do they raise national defense
and security issues? Will they provide the firms in
which they hold a stake unfair access to their home
markets? Will they be subject to as much market
discipline as private investment funds?
And what may be the biggest concern: Will they
encourage financial protectionism? Germany recently announced plans for establishing an agency
to review investments by sovereign wealth funds
for national security reasons. The United States has
maintained a similar mechanism since 1988. While
these are legitimate concerns, they also could offer
individuals who simply do not appreciate competition—domestic or foreign—another means of seeking protection. How far, after all, might security
issues extend?

1. “Remarks by Acting Under Secretary for International Affairs Clay Lowery on
Sovereign Wealth Funds and the International Financial System,” June 21, 2007.
Available at <http://www.treas.gov/press/releases/hp471.htm>.
14

Economic Activity and Labor

The Employment Situation
07.09.07
By Peter Rupert and Cara Stepanczuk

Average Monthly Nonfarm
Employment Change

Nonfarm payroll employment rose by 132,000
jobs in June, edging above an average forecast
of 128,000. April and May payrolls were revised
upward a cumulative 75,000 (to 122,000 and
190,000, respectively). The average monthly gain
in the first half of 2007 was 145,000, which was
a step down from the first two quarters of 2006
(+188,000).

Change, thousands of workers
300
Revised
270
Previous estimate
240
210
180
150
120

The service sector showed continued firmness, gaining 135,000 jobs. Education and health services
rose sharply, posting its highest increase (+59,000)
since August 2006. Government (+40,000) and
leisure and hospitality (+39,000) showed strength,
but there were pockets of weakness in retail trade
(-24,000) and professional business services (9,000). In 2006 retail trade averaged a monthly loss
of 3,000 jobs per month, and professional business
services averaged a monthly gain of 42,000.

90
60
30
0
2004 2005 2006 2007 IIIQ IVQ
2006

IQ

IIQ
2007

Apr May Jun

Source: Department of Labor, Bureau of Labor Statistics.

Labor Market Conditions
Average monthly change
(thousands of employees, NAICS)
2004

2005

2006

Jan-May
2007

June
2007

Payroll employment

172

212

189

148

132

Goods-producing

28

32

9

–14

–3

Construction

26

35

11

–3

12

Manufacturing

0

–7

–7

–13

–18

Durable goods

8

2

0

–12

–13

–9

–9

–6

–1

–5

Service-providing

144

180

179

162

135

Retail trade

16

19

–3

13

–24

8

14

16

5

The goods-producing sector lost only 3,000 jobs,
which was better than its average monthly loss of
12,000 jobs so far in 2007. The construction industry edged up to a modest increase of 12,000 and
nearly counteracted the continued losses in manufacturing (-18,000). Manufacturing job losses were
concentrated in primary metals, computer equipment, wood products, and textile mills.

1

Nondurable goods

Financial

activitiesa

PBSb

38

57

42

18

–9

Temporary help services

11

18

–1

–8

–8

Education and health
services

33

36

41

46

59

Leisure and Hospitality

25

23

38

31

39

Government

14

14

20

28

40

Average for period (percent)
Civilian unemployment rate

5.5

5.1

4.6

4.5

4.5

a.Financial activities include the finance, insurance, and real estate sector
and the rental and leasing sector.
b. PBS is professional business services (professional, scientific, and technical services, management of companies and enterprises, administrative and
support, and waste management and remediation services.
Source: U.S. Department of Labor, Bureau of Labor Statistics.

15

Economic Activity and Labor

Employment and Firm Size over the Business Cycle
06.26.07
by Murat Tasci and Cara Stepanczuk

Average Percentage Share of Gross
Job Gains and Losses by Firm Size
Share of gross job gains (%)

Share of gross job losses (%)
1000+
500-999
250-499
100-249
50-99
20-49

Large firms in the United States create and destroy
jobs at a slower pace than small firms, but they
nevertheless make a large contribution to gross job
creation, gross job destruction, and the net change
in employment. (See “Employment Flows and Firm
Size” for an overview of these points1). A recent
study in Monthly Labor Review looks at recent
patterns of gross job gains and losses across different sizes of firms and argues that there is more to
the relationship between firm size and employment
than meets the eye.2

10-19
5-9
1-4 employees
-20

-15

-10

-5

0

5

10

15

20

Source: Monthly Labor Review, Bureau of Labor Statistics, March 2007.

Share of Employment by Size Class
Percent
50
500+ employees
45
1 to 99 employees

40

The study’s authors observe first that large firms
have been making sizable contributions to job
creation for some time. Using data from Business
and Employment Dynamics of Bureau of Labor
Statistics, they show that between the second quarter of 1990 and the third quarter of 2005, firms
with more than a thousand employees accounted
for nearly one-third (29.9 percent) of the total net
change in employment over the period, contributing 18 percent of gross job gains and 17.4 percent
of gross job losses. Small firms—those with 20 to
49 employees and those with 1 to 4 employees—
follow in terms of contributions to gross job gains
and losses.

35
30
25
100 to 499 employees

20
15
1990

1992

1994

1996

1998

2000

2002

2004

Source: Monthly Labor Review, Bureau of Labor Statistics, March 2007.

As relatively large firms grow, we expect to see the
fraction of employment they account for increase.
In some cases, this is what the authors find. Firms
with more than 500 workers, for example, saw their
share of employment increase from 41.4 percent to
44.2 percent over the period. On the other hand,
firms with fewer than 100 workers saw their share
decline, from 40.6 percent to 38.2 percent, during
the same time.

16

But here’s where it gets really interesting. The
authors discover that the role small and large firms
play in net job creation over the course of the business cycle changed over the period studied. During
that period, there were two recessionary episodes
in which net job losses occurred. During the first
(from the second quarter of 1990 to the first quarter of 1992), most of the net job loss (58.06 percent) came from firms employing fewer than 100
workers. But in the second episode (second quarter
of 2001 to the second quarter of 2003), this share
declined to a mere 18.67 percent. This sharp difference was not caused by differences in the shares
of gross job gains across the two recessions but by
higher job losses at large firms (which increased
from 15.9 percent to 20.06 percent).

Net Job Change During Economic
Recessions and Expansions
Recession
1990:QII–
1992:QI

Expansion
1992:QII–
2001:QI

Recession
2001:QII–
2003:QII

Recovery
2003:QIII–
2005:QIII

1–4

3.69

7.25

−2.98

11.43

5–9

7.6

5.69

0.64

5.83

Number of
employees

10–19

12.16

7.46

3.5

7.26

20–49

19.9

11.57

8.52

11.29

50–99

14.71

9.29

8.98

8.99

100–249

15.12

11.82

12.31

11.79

250–499

7.15

7.77

9.88

7.48

500–999

2.37

6.77

10.5

5.65

1,000+

17.3

32.38

48.64

30.28

1–99

58.06

41.26

18.67

45.4

100+

41.94

58.74

81.33

54.6

Source: Monthly Labor Review, Bureau of Labor Statistics, March 2007.

1. “Employment Flows and Firm Size,” by Tim Dunne, and Brent Meyer,
Federal Reserve Bank of Cleveland, Economic Trends, (May 2, 2007).
2. “Employment Dynamics: Small and Large Firms over the Business Cycle,”
by Jessica Helfand, Akbar Sadeghi, and David Talan. (March, 2007) Monthly
Labor Review. Bureau of Labor Statistics. 130-3, pp. 39-50.

Regional Activity

Midwest Housing Markets
07.11.07
By Tim Dunne and Kyle Fee
In the first four months of 2007, U.S. home prices
declined slowly but steadily, dropping 1.4 percent
according to the Case-Shiller Index of Home Prices.
Cleveland, the only Fourth District city included
in the index, fell slightly more than the composite
index over the same period (1.8 percent). The index
measures the change in single-family house prices
in 20 large U.S. cities, holding the quality of homes
constant.

Case-Shiller Home Price Index
Index (Q1 2000 = 100)
220
200

Composite 20

180

Chicago

160
Detroit

140
120

Cleveland

100
80
2000

2001

2002

2003

2004

2005

Sources: S&P; Fiserv; MacroMarkets, LLC; and Haver Analytics.

2006

2007

Between 2000 and 2006, the composite index doubled in value, though Midwest housing markets experienced considerably less price appreciation than
those on the coasts. Cleveland’s and Detroit’s index
rose only about 20 percent; and although price appreciation in Chicago was considerably stronger, it
17

still lagged the growth of the composite index by a
substantial margin. The index’s top gainers over this
period were Los Angeles and Miami, where price
appreciation exceeded 170 percent. Moreover, Midwestern cities like Cleveland and Detroit started
with relatively low house prices, making the difference in absolute price appreciation between coastal
and Midwestern markets even greater.

Home Ownership Rate, 2006
Percentage
80
70
60
50
40
30
20
10
0
Cleveland Columbus

N.Y.

Cincinnati Pittsburgh

S.Francisco S. Diego

L.A.

Dallas

Boston

Seattle

Charlotte

Portland

Atlanta

Miami

Chicago

Tampa

Washington Denver

Minneapolis

Phoenix

Detroit

Source: U.S. Census Bureau.

Housing Opportunity Index
Index
80
70

2000
2006

60
50
40
30
20
10
0

Cleveland Columbus
Houston
S. Jose
Atlanta
Phoenix Riverside
Seattle
Baltimore
Cincinnati Pittsburgh
Charlotte
N.Y.
Portland
S. Deigo S. Barbara St. Louis
Austin

Sources: National Association of Home Builders; and Haver Analytics.

That said, there is a positive side to a more modestly priced housing market: Homeownership rates in
Fourth District cities are generally high. In Pittsburgh and Cleveland, home ownership rates exceed
70 percent. In contrast, the rate of home ownership
in expensive cities such as New York, Los Angeles,
and San Francisco has reached only 54 percent, 54
percent, and 59 percent, respectively—well below
the rates observed in the Fourth District and other
Midwestern markets.
An alternative view of housing affordability across
cities is provided by the Housing Opportunity
Index of the National Association of Home Builders (NAHB). The index measures the percentage
of homes sold in an area that a family earning the
median income could afford using traditional mortgage application requirements. To arrive at their
estimates of affordability, the NAHB assumes that a
family can spend up to 28 percent of its income to
finance a 30-year mortgage at market interest rates
(adjustments for property taxes and property insurance are included). In Cleveland, the index averaged 78.0 for 2006, indicating that a family earning
the median income ($60,700) could afford to buy
78.0 percent of the homes that had been sold in
the area. Alternatively, in San Diego—an example
of a high-price, high-appreciation coastal city—the
index is 4.9, so that a family with that city’s median income ($69,400) could only afford to buy
4.9 percent of the homes that had been sold in the
area. The indices have also been moving in opposite
directions over the past 6 years. Cleveland’s market
has become somewhat more affordable for homebuyers, while San Diego’s has clearly become less so.

18

Banking and Financial Institutions

Fourth District Bank Holding Companies
06.26.07
by O. Emre Ergungor and Cara Stepanczuk

Annual Asset Growth
Percent
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
1999 2000 2001 2002 2003 2004 2005 2006 2007

A bank holding company (BHC) is a company that
owns one or more commercial banks, other depository institutions, and nonbank subsidiaries. While
BHCs come in all sizes, we focus here on BHCs
with consolidated assets of more than $1 billion.
There are 21 BHCs headquartered in the Fourth
District that meet this definition as of the first
quarter of 2007, including seven of the top fifty
BHCs in the United States.
The banking system continues to consolidate
nationwide, a process that is evident in the Fourth
District. Between the beginning of 1999 and the
beginning of 2007, the number of BHCs in the
Fourth District with assets over $1 billion fell
from 24 to 21, but the total assets of the remaining BHCs increased every year except 2000. The
decline that year reflects the acquisition of Charter
One Financial by Citizens Financial Group, a BHC
headquartered in in the First Federal Reserve District, served by the Federal Reserve Bank of Boston.

Source: Authors’ s calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, first quarter, 2007.

Largest Fourth District Bank Holding
Companies by Asset Size
Dollars, billions
145
125
105
85
65
45
25
5
National
City

PNC

Fifth
Third

Keycorp

Mellon Huntington Sky

FirstMerit

*Rank is as of first quarter, 2007.
Source: Authors’ s calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, first quarter, 2007.

Income Stream
Percent of assets

Percent
4.0
Net Interest Margin
3.5

Income earned
but not received

3.0
2.5

1.75
1.50

ROA before tax and extraordinary items

1.25

2.0
1.5

2.00

1.00
First quarter,
annualized

0.75

1.0

0.50

0.5

0.25

0.0

0.00
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: Authors’ s calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, first quarter, 2007.

Fourth District BHCs of all asset sizes account for
roughly 4.8 percent of BHC assets nationwide,
and BHCs with over $1 billion in assets make up
the majority of the assets held by Fourth District
BHCs.
The income stream of BHCs in the district has improved slightly in recent years. The return on assets
has fluctuated between 1.7 percent and 2.3 percent
since 1998, and it edged down to 1.9 percent in the
first quarter of 2007 (Return on assets is measured
by income before taxes and extraordinary items,
because a bank’s extraordinary items can distort the
average earnings picture in a small sample of 21
banks). This decrease has coincided with a weakening of net interest margins (interest income minus
interest expense divided by earning assets). Currently at 3.0 percent, the net interest margin is at its
lowest level in over eight years.
Another indication of the strength of earnings is
the continued low level of income earned but not
19

Balance Sheet Composition
Percent of assets
42
Real estate loans

37
32
27
22
17
12

Commercial loans
Mortgage-backed
securities
Consumer loans

7
2
1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Source: Authors’ s calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, first quarter, 2007.

Liabilities
Percent of liabilities
55

Savings and small time deposits

received. If a loan allows the borrower to pay an
amount that does not cover the interest accrued
on the loan, the uncollected interest is booked as
income even though there is no cash inflow. The
assumption is that the unpaid interest will eventually be paid before the loan matures. However, if
an economic slowdown forces an unusually large
number of borrowers to default on their loans,
the bank’s capital may be impaired unexpectedly.
Despite a slight rise over the past two years, income
earned but not received at the beginning of 2007
(0.57 percent) was still well below the recent high
of 0.82 percent, registered at the end of 2000.
Fourth District BHCs are heavily engaged in real
estate related lending. As of the first quarter of
2007, about 38 percent of their assets are in loans
secured by real estate. Including mortgage-backedsecurities, the share of real estate-related assets on
the balance sheet is 50 percent.

50
45
40
35
30
25
20
15
10
5
0
1998

Large time deposits

Transactions deposits

Subordinated debt
1999

2000

2001

2002 2003

2004

2005

2006

2007

Source: Authors’ s calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, first quarter, 2007.

Problem Loans
Percent of loans
3.00
2.75
2.50
2.25
2.00
1.75
1.50
1.25
1.00
0.75

Commercial loans

Real estate loans

Consumer loans
0.50
0.25
0.00
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Authors’ s calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, first quarter, 2007.

Deposits continue to be the most important source
of funds for Fourth district BHCs. Saving and
small time deposits (time deposits in accounts less
than $100,000) made up 53 percent of liabilities at
the beginning of 2007. Core deposits, the sum of
transaction, saving, and small time deposits, made
up 61.5 percent of the district’s BHC liabilities as
of the beginning of 2007, the highest level since
1998. Finally, total deposits made up almost 70
percent of funds so far this year. Despite the requirement that large banking organizations must
have a rated debt issue outstanding at all times,
subordinated debt represents only 3 percent of
funding. As with large holding companies outside
the district, Fourth district BHCs rely heavily on
large negotiable certificates of deposit and nondeposit liabilities for funding.
Problem loans are loans that are past due for more
than 90 days but are still receiving interest payments, as well as loans that are no longer accruing
interest. Problem commercial loans rose sharply
starting in 1999, peaked in 2002, and settled below
0.75 percent of assets in 2004, thanks in part to
the strong economy. Currently, 0.64 percent of all
commercial loans are problem loans. Problem real
estate loans are only 0.52 percent of all outstanding real-estate-related loans, though they have been
20

creeping upward since 2005. Problem consumer
loans (credit cards, installment loans, etc.) remained relatively flat, declining slightly through the
first quarter of 2007. Currently, 0.37 percent of all
outstanding consumer loans are problem loans.

Net Charge-offs
Percent of loans
3.0
2.5
Commercial loans
2.0
1.5
Consumer loans
1.0
0.5

Real estate loans

0.0
-0.5
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Authors’ s calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, first quarter, 2007.

Capitalization
Percent
12.0
11.5
Risk-based capital ratio

11.0
10.5
10.0
9.5
9.0

Leverage ratio

8.5
8.0
7.5

7.0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Authors’ s calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, first quarter, 2007.

Coverage Ratio*
Dollars
21

Net charge-offs are loans removed from the balance sheet because they are deemed unrecoverable,
minus the loans that were deemed unrecoverable
in the past but are recovered in the current year. As
with problem loans, there was a sharp increase in
the net charge-offs of commercial and consumer
loans in 2001. Fortunately, the charge-off levels
have returned to their pre-recession levels in recent
years. Net charge-offs in the first quarter of 2007
were limited to 0.25 percent of outstanding commercial loans, 0.77 percent of outstanding consumer loans, and 0.14 percent of outstanding real
estate loans.
Capital is a bank’s cushion against unexpected
losses. The recent upward trend in capital ratios
indicates that Fourth District BHCs are sufficiently
protected. The leverage ratio (balance sheet capital
over total assets) at 10.0 percent and the risk-based
capital ratio (a ratio determined by assigning a
larger capital charge on riskier assets) at 11.7 percent are signs of strength for the district’s BHCs.
An alternative measure of balance sheet strength
is the coverage ratio. The coverage ratio measures
the size of the bank’s capital and loan loss reserves
relative to its problem assets. As of the first quarter
of 2007, the district’s BHCs have $16.84 in capital and reserves for each dollar of problem assets.
While the coverage ratio is below its recent high at
the end of 2004, it remains well above the levels of
the early 2000s.

18
15
12
9
6
3
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
*Ratio of capital and loan loss reserves to problem assets.
Source: Authors’ s calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, first quarter, 2007.

21