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Winter 2015|2016
Volume 6 Number 3

F refront
New Ideas on Economic Policy from the FEDERAL RESERVE BANK
of CLEVELAND

Three Trends Influencing
the Region’s Growth

I NS I D E :
Trends in energy prices, steelmaking, and
auto production could determine the course
for the 2016 regional economy.

Return to Normalcy?
Protecting SmallBusiness Borrowers
Raises and Rises

F refront
New Ideas on Economic Policy from the FEDERAL RESERVE BANK
of CLEVELAND

Winter 2015|2016

Volume 6 Number 3

CONTENTS
1 Presidential Pulls
2 Upfront

Financial regulators find pockets of weakness; job access varies by county.

From the cover

4
Three Trends Influencing the Region’s Growth

Trends in energy prices, steelmaking, and auto production could determine
the course for the 2016 regional economy.

8 2015 Year in Review: Fourth District Labor Markets
The outset of a new year signals a look to the future, but it’s also cause
for reflection on the year that’s drawn to a close.

12 Hot Topic: Raises and Rises

As a poverty-reduction tool, raising the minimum wage isn’t without drawbacks.

16 Return to Normalcy?

Loss reserves are nearly back to pre-crisis levels, but will they be enough if
a new crisis strikes?

22 Policy Watch: Protecting Small-Business Borrowers
The absence of regulatory guidance for alternative lending could mean
trouble for small businesses.

26 Data and Decisions in an Uncertain World
Statistics are often revised in nontrivial ways.

31 In Case You Missed It

Missed the 2015 Policy Summit in Pittsburgh? Here’s a glimpse of what
we learned.

32 Book Review

America’s Bank: The Epic Struggle to Create the Federal Reserve

26
The views expressed in Forefront are not necessarily those of
the Federal Reserve Bank of Cleveland or the Federal Reserve
System. Content may be reprinted with the disclaimer above
and credited to Forefront. Send copies of reprinted material to
the Corporate Communications and Engagement Department
of the Cleveland Fed.
Forefront
Federal Reserve Bank of Cleveland
PO Box 6387
Cleveland, OH 44101-1387
forefront@clev.frb.org
clevelandfed.org

President and CEO: Loretta J. Mester
Editor: Amy Koehnen
Writer: Michelle Park Lazette
Managing Editor: Tasia Hane-Devore
Contributors:
Brett Barkley
Joel Elvery
LaVaughn Henry
Dan Littman
Maureen O’Connor
Robert Sadowski
Murat Tasci
Chris Vecchio
Guhan Venkatu
Christine Weiss
Ann Marie Wiersch
Mark Schweitzer, Senior Vice President, Outreach and
Regional Analytics
Lisa Vidacs, Senior Vice President, Corporate Communications
and Engagement
Design: Parente-Smith Design Inc.

Presidential Pulls
Loretta J. Mester, president and chief executive officer of the Federal Reserve
Bank of Cleveland, has shared her expectations for the economy, labor
markets, and more. For the full text of President Mester’s speeches, visit
www.clevelandfed.org, keyword “speeches.”

ECONOMIC RESILIENCY
“The resiliency of the economy through the episode in
August, as well as the strength in final sales in the third
quarter, suggests to me that there continues to be positive
economic momentum. I anticipate that after the weak
third quarter, growth will pick up over the rest of this year
and next, to an above-trend pace in the 2.5 to 2.75
percent range.”
INFLATION FIRMING
“I am reasonably confident because when you look at
the factors figuring into the inflation forecasts, inflation
expectations have been reasonably stable. We have
growth, above-trend growth. We have labor markets’
improvement continuing.”

—From a speech in Cleveland, Ohio, November 13, 2015

—From an interview on Bloomberg TV, August 28, 2015

REACHING GOALS
“In my view, the totality of evidence suggests that the
economy is at or very nearly at the Fed’s mandated
monetary policy goal of maximum employment, and with
growth resuming at an above-trend pace, I expect to see
further improvement.”
—From a speech in Cleveland, Ohio, November 13, 2015

A GRADUAL RISE IN THE FED FUND RATE
“One benefit of the gradual approach is [that] it will
allow us to recalibrate policy over time as some of the
uncertainties surrounding the underlying economy in the
post-crisis world, like the longer-run economic growth
rate, are resolved.”
—From a speech in New York, New York, October 15, 2015

A STRENGTHENING ECONOMY
“[T]he economy can handle an increase in the fed funds
rate. A small increase in interest rates from zero is not
tight monetary policy, and with the economic progress
we’ve made and that I expect to continue, monetary
policy can take a step back from the emergency measure
of zero interest rates.”
—From a speech in Columbus, Ohio, July 15, 2015

THE FUTURE PATH OF POLICY
“When it comes to monetary policy, timing isn’t everything.
. . . More important for macroeconomic performance
is the expected path of policy beyond liftoff because
expectations about the future path of policy can affect
today’s economic decisions.”

FOURTH DISTRICT OUTLOOK
“Overall, my forecast is that the Fourth District economy
will continue to expand and labor markets will continue
to improve. Household and business balance sheets have
improved substantially over the expansion, and with the
economy on firm footing, I expect that demand for business
credit in the region will continue to rise.”
—From an interview with the Pennsylvania Association
of Community Bankers, September 15, 2015

—From a speech in Columbus, Ohio, July 15, 2015
F refront

Upfr nt

Latest Large Loan Review
Finds Weaknesses
An examination by financial regulators finds lacking underwriting standards and high
credit risk for credits that involve millions of dollars and multiple institutions.
When it comes to loans shared
by 3 or more federally supervised
financial institutions in aggregate
amounts of $20 million and more,
credit risk remains high despite
a relatively favorable economic
environment, and there are pockets
of weakness, financial regulators
have found.
That’s the word from the 2015
Shared National Credits review
by the Federal Reserve Board, the
Federal Deposit Insurance Corp.,
and the Office of the Comptroller
of the Currency.
Even though the quality of shared
national credits has improved
following the financial crisis,
regulators are still seeing higher
levels of classified credits, or those
rated substandard, doubtful, or
loss, than they saw pre-crisis, explains
John C. Shackelford, a senior
examiner with the Federal Reserve
Bank of Cleveland.
And that “higher low” level of
classified loans actually increased
slightly between the 2014 review
and the most recent review because
of leveraged loan weakness and
because oil and gas credits are
challenged in the present low-oil
price environment.

second quarter of 2015 and examined
credits booked in recent years.
According to results released in
early November, oil and gas and
leveraged loans exhibit signs of
weakness. The SNC examination
noted weaknesses in underwriting
standards in 28 percent of the loan
transactions sampled, higher than
experienced in recent years. The
most frequently cited underwriting
deficiencies were minimal or no
loan covenants, liberal repayment
terms, repayment dependent
on refinancing, and inadequate
collateral valuations.
Banks in the Cleveland Fed’s region,
which comprises Ohio, western
Pennsylvania, the northern
panhandle of West Virginia, and
eastern Kentucky, have “a pretty
modest exposure in oil and gas,”
according to Shackelford.

Winter 2015|2016

“They have to rely on their
underwriting,” he explains. “They
cannot, should not, rely only on
the originating bank. They have
to do their own due diligence and
assessment and understand the
risks involved.”
The Shared National Credits review
began in 1977. Just this year, the
number of SNC examinations was
increased from 1 to 2 annually. The
next will take place in the spring. ■
— Michelle Park Lazette

Read more
See the full 2015 Shared
National Credits review:
http://tinyurl.com/pmtavs8

The percentage of shared national credits commitments considered
substandard, doubtful, or loss remains higher than pre-crisis levels.

The Shared National Credits (SNC)
review tests a sample of commercial
and industrial loans, allowing
regulators to observe and assess
banks’ risk ratings. The most recent
analyses were prepared in the

A number of banks in the Fourth
Federal Reserve District do
participate in shared national credits,
he notes, and regulators expect
them to do their due diligence.

Source: Shared National Credits Program 2015 Review.

Job Accessibility
in Northeast Ohio
Lacking transit access, many lower-skilled workers miss out on jobs.
Mum’s the word when it comes
to job access in Northeast Ohio.
A recent report by the Fund for
Our Economic Future, an alliance
of Northeast Ohio funders
dedicated to advancing growth
and opportunity, notes job access
is the most important issue no
one is talking about. Poor job
accessibility can increase jobless
rates and make it harder for
families to move up the economic
ladder. To get people talking, the
Fund convened focus groups of
representatives from the civic
and nonprofit sectors across the
region, including representatives
from the Federal Reserve Bank
of Cleveland.
From land-use decisions and
business locations to per capita
spending on transportation, it
turns out regional leaders have
much to say about job access.
While the Fund plans to continue
to raise the level of awareness
around this issue, one of our
takeaways from the focus group
was the need among local business
leaders and policymakers for a
better understanding of accessibility
by job type and how accessibility
varies across the Northeast Ohio
region. This is the subject of a new
study from the Cleveland Fed’s
Community Development staff
titled “A Long Ride to Work: Job
Access and Public Transportation
in Northeast Ohio.” It finds that

the largest share of Northeast
Ohio’s workforce—workers with
only high school diplomas—
experiences the lowest levels
of job access. When job access
is measured by a 90-minute-orshorter transit ride, they are
able to reach, on average, just
28 percent of jobs in the region,
compared to workers with at
least a bachelor’s degree, who can
access around 35 percent of jobs
in the same transit commute time.
Moreover, access varies greatly by
county. In most outlying counties,
less than 10 percent of regional
jobs can be accessed in 90 minutes
or fewer.
Looking at the other side of the
coin—what percent of the labor
force is accessible to employers—
the Cleveland Fed finds that half of
Northeast Ohio’s top 10 employment
centers have access to only 15 percent
or less of the regional workforce.
Employment centers with the
highest concentration of low-skill
jobs tend to experience the lowest
labor-force accessibility rates.
What can Northeast Ohio business
and civic leaders do to increase
job access?
One approach is to build on
current strengths. Seven of the
8 counties included in the Cleveland
Fed study provide relatively good
public transportation service to
county residents. But because
each transit agency is countybased, limited services exist across
jurisdictional lines.

Such an approach would also
entail focused investment in the
region’s top job centers in terms
of business location and transit
connections. Viable opportunities
for transit-oriented development
such as along the Downtown–
University Circle–Ohio City
corridor should be leveraged in
concert with strategies to preserve
affordable housing as these areas
potentially gentrify. However,
more needs to be done to better
connect large suburban employment
centers, where most of the region’s
low-skill jobs exist.
Effective policy solutions will require
engagement among public and
private actors that influence economic
development, transportation,
housing, and workforce-development
decisions. Let’s keep the conversation
going around job access: The
region’s economic competitiveness
depends on it. ■
— Brett Barkley

Learn more about the Cleveland Fed’s findings
in “A Long Ride to Work: Job Access and Public
Transportation in Northeast Ohio.” Read it
here: http://tinyurl.com/pyfh7ss.
Also, check out work from the Fund for Our
Economic Future in “The Geography of Jobs:
The Increasing Distance between Jobs and
Workers in Northeast Ohio and Why It Matters
for Future Growth.” Find the PDF here:
http://tinyurl.com/nqq8ef9.
F refront

Three Trends Influencing
the Region’s Growth
Trends in energy prices, steelmaking, and auto production could determine the course for the
2016 regional economy.

Mark Schweitzer
Senior Vice President

Robert Sadowski
Senior Economic Analyst

Christopher Vecchio
Senior Research Analyst

“While there are challenges to the
District’s economy, consumer spending
is supporting continued growth.” (p. 6)

National economic growth continues at a moderate
pace, but this growth hasn’t prevented some
nervousness about the outlook for the US economy.
Notably, the stock market moved sharply lower in
the third quarter of 2015, though it has subsequently
recovered much of those losses. This decline in stocks,
according to market commentators, was in large part
due to concerns about geopolitical events and the
softness in emerging-market economies. And these
issues have continued to contribute to a volatile stock
market in the early part of 2016.
Focusing on our region, which comprises Ohio,
western Pennsylvania, the northern panhandle of
West Virginia, and eastern Kentucky, the data show
continued growth. However, we have noticed more
nervousness about the outlook for growth among
some of our regional contacts.
To supplement the District’s economic data, we
regularly collect qualitative assessments of the District
economy from a wide range of contacts. Over the
past year, those assessments have suggested a gradual
weakening of the District’s economic growth. At the
start of 2015, our Beige Book summary of the region’s
economy noted ongoing “moderate growth,” and most
of our contacts had “a positive outlook for the new
year.” By the November Beige Book, however, our
District’s assessment of growth was lowered to “modest,”
with factory output being “stable” on balance.
While the reports we’ve been receiving from Beige Book
and other business contacts are best interpreted as
mixed, fundamentals (such as employment growth)
for the broader District economy are good. So despite
the weakening sentiment of District contacts’ reports
and the cautious tone of the stock market, we continue
to expect growth across the District in coming months.

4 Winter 2015|2016

Three important trends underlie our view of the
District’s pace of economic growth.

Of course, direct employment is only part of the
story in affected regions: Suppliers, restaurants,
other service providers, and royalty-payment
recipients have all experienced the slowdown.
Helpful for continued District activity is that natural
gas production within the District includes other
components such as ethane, which is a building
block of the plastics industry. More positively,
anecdotal reports suggest ongoing investment,
albeit at a modest pace, in midstream natural gas
projects as well as the potential for construction
of one or more ethane crackers. These midstream
and downstream investments could potentially
support ongoing growth in the energy sector
despite today’s low energy prices.

The fall in energy prices has caused a significant
slowdown in oil and gas exploration in the
Marcellus and Utica Shales, though natural gas
production remains at historic highs.
Oil prices slid dramatically in late 2014 when
worldwide demand for oil failed to keep up with
rising supplies driven by renewed growth in
US production. Domestic production has
rebounded gradually over the past few years as
drillers have brought resources to market with
the combined technologies of hydraulic fracturing
and extended reach drilling, or ERD.
Use of these technologies has been growing in
the Fourth District, as well. Ohio and Pennsylvania
experienced 25.7 percent and 12.8 percent rises,
respectively, in oil and gas extraction employment
between January 2013 and January 2015, mostly
in the Marcellus and Utica Shale regions in
western Pennsylvania and eastern Ohio. However,
the number of active drilling rigs across the
District began a rapid decline in February 2015
and has declined more than 50 percent during
the entire year after peaking in mid-December of
2014. One evident point is that Fourth District
drilling is sensitive to natural gas prices, and this
sensitivity explains the slowdown in drilling
activity in 2012. However, recent oil and natural
gas price declines had an even larger impact on
drilling activity this year. While low energy prices
result in higher discretionary income for consumers
and wider margins for energy-intensive industries,
they also contribute to widespread layoffs by
exploration and production companies.

Fourth District drilling is sensitive to natural gas prices.
180

Dollars per million Btu

Units
• Fourth District rig count

160

• Henry Hub natural gas price

140

120

100

0
2000

2002

2004

2006

2008

2010

2012

2014

Source: Wall Street Journal/Haver Analytics, Baker Hughes.

F refront

Every state in our District has at least
twice the typical employment share of
primary metals workers.
The rising value of the dollar and the weakness
in oil and gas exploration have affected key
District industries, including steelmaking. Steel
producers are encountering difficulties even while
domestic market users of District manufacturing
products, namely construction and transportation
equipment, are seeing growth.
Critical suppliers to the oil and gas industry—
steel producers and steel service centers—have
been affected by the slowing in exploration,
but the larger issue has been the weakening in
developing markets and the strength of the dollar.
Foreign steel producers, benefiting from a drop
in the value of their home currencies but also
experiencing weak demand in their own countries,
have put significant downward pressure on
international prices of steel.
The decline in steel prices will likely impact the Fourth District’s
economic outlook.
750

US dollars per ton

700
650
600
550
500
450
400
350

10|2012 1|2013 4|2013 7|2013 10|2013 1|2014 4|2014 7|2014 10|2014 1|2015 4|2015 7|2015 10|2015

Source: Wall Street Journal.

6 Winter 2015|2016

It’s an important headwind in the region because
steelmaking still maintains a significant presence
across the District. Every state in our District has
at least twice the typical employment share of
primary metals workers, with Ohio’s share sitting
at 2.6 times larger than national figures.
Steel production declined 11.5 percent nationally
from the third quarter of 2014 to the third quarter
of 2015, though it has slowly risen since October
2015. Although this decline is not as large as the
decline during the Great Recession, when national
production fell more than 50 percent, according
to the Federal Reserve Board of Governors’
industrial production data, steel industry contacts
are not optimistic about today’s environment or
the near-term outlook. A lack of optimism will
likely weigh on the District’s economic outlook,
but other consumers of steel such as the auto
industry continue to perform at an elevated level.
Nationally and regionally, consumers are
increasing purchases of durable goods, particularly
automobiles, as their circumstances and balance
sheets improve.
While there are challenges to the District’s
economy, national consumer spending is
supporting continued growth in both the nation

The recent surge in automobile sales has bolstered District production.
Fourth District production

Fourth District % of US production

2,500,000
2,000,000
1,500,000
1,000,000
500,000
0

2006

2015

20
18
16
14
12
10
8
6
4
2
0

Source: WardsAuto.com.
Note: Production period is for the model year. The 2015 model year runs from October 1, 2014, through
September 30, 2015. Production includes cars, light trucks (SUVs and light-duty trucks), and medium-duty trucks.

and the region. Regionally, this situation is most
evident in one of the District’s key industries:
automobile production.
In recent months, automobiles have been selling
in the United States at a rate of more than
18 million per year. This is an extraordinary
figure, and it means that District auto production
has returned to more than 2 million cars per
year. District auto plants over the last several
years have produced about 17 percent of the
nation’s cars and light trucks—and they still do
despite the 2008 closure of Moraine Assembly,
an SUV plant in Dayton, Ohio. That plant
produced 212,000 Chevy Trailblazers and other
SUVs in the 2007 model year. District auto
contacts expect that the pace of growth in unit
sales will level out in the near-term, but they
remain optimistic in their outlook.

District auto production has
returned to more than 2 million
cars per year.

The Fourth District is experiencing some
headwinds weighing on the regional outlook,
but these are tempered by some favorable trends.
Pulling disparate trends together shows a mixed
economic outlook for the District, but one still
consistent with continued growth, albeit at a
moderate pace. Meeting the needs of domestic
consumers represents almost 70 percent of US
output, so with an improved labor market and
with household balance sheets in better condition,
most national forecasters are expecting steady
growth in consumption. This powerful factor
supports the national outlook, and it should
similarly support District growth. ■
SUM AND SUBSTANCE
The Fourth District economy
continues to expand, but it's facing some
persistent headwinds.

F refront

Year in Review:
Fourth District Labor Markets

The outset of a new year signals a look to
the future, but it’s also cause for reflection
on the year that’s drawn to a close.

Joel Elvery
Economist

The Cleveland Fed’s Fourth District, which includes Ohio, western
Pennsylvania, the northern panhandle of West Virginia, and eastern
Kentucky, experienced some employment progress in 2015, but
just how much? Here, we explore the District’s employment situation
over the past year by examining the performances of six major
metropolitan statistical areas in the region—Cleveland, Cincinnati,
Columbus, Lexington, Pittsburgh, and Toledo.

Maureen O’Connor
Staff Writer

Christopher Vecchio
Senior Research Analyst
8 Winter 2015|2016

For the most part, unemployment rates dropped and employment levels increased across the District. As
of November 2015, all 6 metro areas had unemployment rates at or below the national rate. Pittsburgh’s
unemployment rate was essentially flat from 2014 to 2015, while its regional counterparts all experienced
declines ranging from 0.3 percentage points (Columbus) to 1.3 percentage points (Cleveland).

Unemployment Rates

Toledo

Cleveland

5.0%
5.5%

2015 (Nov.)
2014 (Nov.)

-0.8%

United States Nov. 2014 – Nov. 2015

Pittsburgh

4.4%
4.8%
Columbus

4.1%
4.4%

5.0%
5.1%

2015 (Nov.)
2014 (Nov.)
Cincinnati

Lexington

4.4%
5.7%

2015 (Nov.)
2014 (Nov.)
Note: Data are seasonally adjusted.
Source: Bureau of Labor Statistics’ Current Population Survey and Local Area Unemployment Statistics program.

3.9%
4.3%

Still, Pittsburgh recovered its pre-recession employment level by 2012, much earlier and quicker than
most major metropolitan statistical areas (MSAs) or the nation. This to some degree accounts for its stable
unemployment rate and employment over the past year. On the employment side, the MSAs all experienced
more growth in 2015 with the exception of Lexington. While that region still posted gains in 2015,
employment grew more quickly in 2014. Note that these employment data come from the Quarterly Census
of Employment and Wages, which is less timely than other sources but significantly more accurate.

Year-Over-Year Total Employment Growth Rate

Toledo

2015 (June)
2014 (June)

0.1%

United States June 2014 – June 2015

1.9%
1.6%
Pittsburgh

2015 (June)
2014 (June)

2014 (June)

0.8%
0.4%
Columbus

2.5%
3.2%

0.1%
0.0%
Cincinnati

2015 (June)

Note: Data are seasonally adjusted.
Source: Bureau of Labor Statistics’ Quarterly Census of Employment and Wages, December 2, 2015.

Cleveland

1.9%
1.8%

Lexington

2.5%
2.1%
F refront

Does drilling further into sectoral employment indicate dissimilarity between the employment
performance of these MSAs and the nation? In some cases, yes. From 2014 to 2015, the nation gained
a bit of employment in the information sector. At the metro level, all 6 MSAs experienced fairly severe
declines with the exception of Cincinnati, where information employment was flat. For natural resources
and mining, the nation’s employment declined by 3 percent while several MSAs experienced gains.
And in both Columbus and Lexington, 6 major sectors gained more employment than did the nation.
The tables below catalog year-over-year employment changes by sector at the metro and national levels.

Year-Over-Year Percentage Change in Employment June 2014 – June 2015
Cincinnati

Cleveland

Columbus

Lexington

Pittsburgh

Toledo

United States

Total employment (seasonally adjusted)

1.9

0.8

2.5

2.4

0.1

1.8

2.0

Construction

4.5

1.1

3.5

10.2

0.0

6.6

4.7

Leisure and hospitality

3.3

1.8

2.4

6.4

0.7

1.7

2.8

Professional and business services

0.9

0.1

1.8

2.3

1.8

3.5

2.6

Education and health services

1.3

1.1

3.9

5.5

-0.5

-1.5

2.4

Trade, transportation, and utilities

2.2

0.9

2.9

2.1

-0.1

2.6

2.2

Financial activities

2.2

1.2

3.9

3.1

-0.7

2.0

1.9

Manufacturing

3.0

0.7

2.9

1.3

-0.3

2.7

1.2

Government

0.5

0.2

1.2

-0.7

2.0

0.6

Information

0.0

-4.1

-4.9

-5.8

-1.1

-7.3

0.6

Natural resources and mining

1.4

0.4

8.1

-0.4

-2.6

2.6

-3.0

Greater than 3.0

2.0 to 3.0

1.0 to 2.0

-1.0 to 1.0

-2.0 to -1.0

-3.0 to -2.0

Greater than -3.0

Note: Some missing values for Cincinnati and Cleveland were imputed.
Source: Bureau of Labor Statistics' Quarterly Census of Employment and Wages, December 2, 2015.

Year-Over-Year Percentage Change in Employment Level June 2014 – June 2015
Cincinnati

Cleveland

Columbus

Lexington

Pittsburgh

Toledo

United States

Total employment (seasonally adjusted)

19,185

7,593

23,931

6,161

1,417

5,160

2,820,218

Construction

1,806

408

1,168

1,062

-5

811

297,723

Leisure and hospitality

3,914

1,866

2,470

1,789

815

556

424,762

Professional and business services

1,398

169

2,926

810

2,957

1,165

501,116

Education and health services

1,990

2,106

5,485

1,625

-1,084

-714

495,798

Trade, transportation, and utilities

4,222

1,665

5,341

976

-168

1,417

579,634

Financial activities

1,322

702

2,667

279

-474

183

149,954

Manufacturing

3,266

850

1,993

397

-245

1,172

143,597

Government

567

224

1,714

-312

-797

743

137,439

Information

-586

-839

-317

-188

-224

15,625

Natural resources and mining

263

-20

-313

-65,399

Note: Some missing values for Cincinnati and Cleveland were imputed.
Source: Bureau of Labor Statistics' Quarterly Census of Employment and Wages, December 2, 2015.

Winter 2015|2016

Each MSA has a set of sectors in which it specializes. The employment concentration of these sectors is
substantially higher in the metro areas than at the national level. Based on this aggregate relationship,
the sectors with a higher concentration of employment are considered major drivers of the local economy.
The table below shows the 2 most concentrated sectors for each MSA. For the most part, the activity in
these sectors had a meaningful impact on the overall employment performance in their respective MSAs.
The only outlier, Lexington. The metro area’s positive employment performance from 2014 to 2015 was
driven by other sectors.

Top 2 Most Concentrated Employment Sectors Per Fourth District MSA
MSA

Sectors

Share of Employment

Employment Level

Cincinnati

Manufacturing
Professional and business services

11.2
15.7

113,666
159,226

Cleveland

Manufacturing
Education and health services

12.4
18.6

125,367
188,662

Columbus

Financial activities
Professional and business services

7.2
17.1

70,757
168,442

Lexington

Manufacturing
Natural resources and mining

11.8
1.8

30,780
4,740

Pittsburgh

Education and health services
Financial activities

20.1
6.1

224,541
68,134

Toledo

Manufacturing
Education and health services

15.2
16.7

44,055
48,514

Note: Most concentrated sector is listed first.
Source: Bureau of Labor Statistics' Quarterly Census of Employment and Wages, December 2, 2015.

To sum it all up:
• Columbus and Lexington performed at the national level or better in terms of employment gains in 2015
• Cincinnati and Toledo were just below the national trend
• Cleveland posted smaller gains
• Pittsburgh had limited employment gains
In other words, 2015 wasn’t a banner year for employment gains in these MSAs, though there was moderate

growth. All 6 of these metro areas had lower unemployment rates than did the nation, and this means their
employment growth was large enough to absorb many available workers.
Read more

The Cleveland Fed’s Fourth Federal Reserve District is profiled in Metro Mix,
our publication providing snapshots of economic conditions and prospects
for the 6 MSAs featured here. For more information on their economies,
including data and analyses, visit clevelandfed.org/MetroMix.
F refront

H t Topic

Raises and Rises
As a poverty-reduction tool, raising the minimum wage isn't without drawbacks.

As policymakers and economists across the country debate the merits
and pitfalls of an increase, the federal minimum wage sits at $7.25 per
hour for non-tipped workers and $2.13 for tipped workers. Ohio and
West Virginia, two states within the Federal Reserve Bank of Cleveland’s
Fourth District, which comprises Ohio, western Pennsylvania, the northern
panhandle of West Virginia, and eastern Kentucky, have state minimum
wages that exceed the federal minimum. Two others in the District,
Pennsylvania and Kentucky, match it. As pressures to raise wages escalate
across the nation, some major metropolitan areas such as San Francisco
and Washington DC are taking matters into their own hands and effecting
area-wide raises—for better or worse. Large companies, too, many in
food service and retail industries, are feeling the pressure as calls come
in from multiple corners to raise wages for their lowest-paid workers.
We wanted to know, to what extent might a rise in the minimum wage
affect hiring and employment, and who would feel the pinch? We sat down
with Murat Tasci, senior research economist at the Cleveland Fed, and
asked him some tough questions.

Winter 2015|2016

“It’s not clear how an increase would unambiguously
help with a poor household’s problem.” (p. 15)

Murat Tasci
Economist

Forefront: The federal minimum

wage was last raised in 2009.
What drives the current push
for an increase?
Tasci: Since the US federal

minimum wage is set nominally,
over time it tends to decline in
terms of its purchasing power.
Changes since the 1980s coincide
with a decline in the real hourly
minimum wage to around $6 per
hour (normalized to 2015 levels).
This time around, though, in real
terms the minimum wage doesn’t
seem to be exceptionally low
relative to its high levels in the
late 1970s. It’s hard to speculate,
but I’m presuming the stagnant
median household income over the
past two decades has something
to do with it. In 2007, median

household income was $57,357,
but fell substantially during
the Great Recession. The most
recent data for 2014 indicate that
real median household income
recovered, but only to $53,657.
Forefront: One aspect of the

current debate about raising
the federal minimum wage is
that doing so may cost jobs
and increase unemployment.
What are your thoughts?
Tasci: Evidence points to

disemployment effects, meaning
that a minimum wage increase
reduces employment for the
groups of workers in the intended
population. The argument for raising
the minimum wage is often not
about the effects on employment
numbers. Instead, the intention is
F refront

Real minimum hourly wages are not substantially low relative
to the high levels of the 1970s.
9

Dollars per hour

Percent
People earning below
minimum divided by total
hourly workers (right axis)

8
7

14
12

Real minimum
hourly wage
(left axis)

3
2

Normal minimum
hourly wage

1
0
1974

2
89

0
2014

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Haver Analytics.

to provide a higher living standard
for lower-skilled workers. But if
the additional labor cost incurred
from a higher minimum wage
leads employers to cut jobs, the
policy will produce a substantial
unintended consequence. While
the estimated effects are small,
much of the evidence suggests that
the negative effects on employment
in response to raising the minimum

wage fall disproportionately on
low-skilled workers. An important
note to the existing research is
that it has largely relied on small
changes in the minimum wage
to identify effects. Many of the
current proposals would be
for larger changes, potentially
making the employment effects
estimates unreliable.

Forefront: What benefits

and pitfalls are there to
raising the minimum wage
piecemeal by city or state
rather than federally?
Tasci: One obvious benefit is the

cost of living might be different
by location. So if the motivation
is to raise the living standard
of lower-wage earners, the right
benchmark should be different
in New York City than in, say,
Youngstown, Ohio. On the
other hand, if the locations are
physically close, firms might
relocate to avoid facing a minimum
wage hike in one location, thereby
shifting employment to another
location without worker benefit.
Forefront: What effects would

increasing the minimum
wage have on employment,
particularly in the current
labor market in which large
corporations have generally
recovered from the recession
but smaller businesses might
still be struggling?
Tasci: An increase poses another

If the additional labor cost incurred from
a higher minimum wage leads employers
to cut jobs, the policy will produce a
substantial unintended consequence.

Winter 2015|2016

challenge for the strength of the
recovery. Not only is the labor
market recovering from one of the
deepest recessions in US history,
but it also faces intensifying
challenges from technological

Small businesses will be especially affected
because they often lack other instruments
to absorb cost increases.

changes. Lower-skilled workers
performing routine tasks are
increasingly replaced with machines
and software, thereby reducing
demand for human labor. Assuming
we’ll face similar results in line
with empirical evidence, a
substantial increase will reduce
job creation. How much will
depend on the magnitude of the
change. Small businesses will be
especially affected because they
often lack other instruments to
absorb cost increases.

of the people likely to benefit from
an increase are teenage members
of wealthier households. In the
end, then, it’s not clear how an
increase would unambiguously
help with a poor household’s
problem, especially if it increases
the likelihood of losing a job. As
a poverty-reduction tool, minimum
wage is a very blunt one, and
research suggests that its negative
employment effects are amplified
for exactly the groups needing
targeted poverty measures.

Forefront: What effects would

Forefront: Is there a course

increasing the minimum wage
have on family income?

of action that could help
mitigate any unintended
consequences of a federal
minimum wage hike?

Tasci: It depends on who we’re

talking about. Undoubtedly, there
are single parents who earn minimum
wage working one or more parttime jobs, and most arguments
in favor of an increase emphasize
the positive income effects on such
households. But minimum wage
is not a function of household
income, so it follows that raising
it doesn’t necessarily target this
type of household. Really, many

Tasci: When minimum wage

has negative effects, it’s because
it induces distortion into the
marketplace. A society can decide
whether it prefers to induce this
distortion and raise incomes for
a group of low-wage earners in
spite of the risk of increasing the
number of unemployed from the
same group. But it might make
more sense to devise a targeted
poverty-reduction measure for the
low-income households directly,

such as with the Earned Income
Tax Credit. This particular credit
depends on household income,
so it would benefit the single
parent in the previous example. As
long as the parent’s total income
meets certain thresholds, his or
her tax burden will be substantially
alleviated, effectively raising the
household’s income.
Forefront: What’s presently

on the minds of those who
study minimum wage and
unemployment, something
that may be obscure
but significant?
Tasci: I think to understand the

effects of the minimum wage, one
must be aware of the characteristics
of most minimum-wage earners.
Plus, the fraction of workers who
earn at or below the minimum
wage is quite close to its lowest
levels, around 3.9 percent of hourly
paid workers in 2014, down
from 15.1 percent in 1980. This
substantial decline cannot be
attributed to the changes in the real
minimum wage, suggesting that
the market for minimum wage jobs
is probably disappearing. ■
— Tasia Hane-Devore

SUM AND SUBSTANCE
Raising the minimum wage won't
necessarily reduce poverty.

Read more
Want to know more about minimum wage effects?
See “Positive and Normative Effects of a Minimum
Wage” for more information: http://ow.ly/UOOoV
F refront

Return to

‘“One thing you’ve got to look at
is the business cycle. There’s
always a high, and there’s always
a low.”’ (p. 19)

Winter 2015|2016

Normalcy?
The levels of bank reserves for covering loan losses are nearly back
to pre-crisis levels. That may mean the industry is out from under the
overhang of bad debts that’s plagued it, but the question remains:
Would the reserves be enough if crisis strikes anew?

Michelle Park Lazette
Staff Writer

‘ “It’s hard to argue, 6 years
out from the financial crisis, that
we’re far enough out from it that
our memories have completely
disgorged the fact that really bad
things can happen.”’ (p. 20)

Nearly 8 years after the 2008 banking crisis began,
the cushion of income banks set aside to cover losses
is nearing pre-crisis levels.
Technically, the income cushion reserved for loan losses
is referred to as the ALLL, the industry’s allowance for
loan and lease losses, or “loss reserves” for short. It is a
reserve account set aside to absorb expected losses—
such as those that banks incur when borrowers don’t
repay loans or when investments fail.
Years before late 2007, when the recession officially
began, the ALLL as a percentage of total bank loans was
either dropping slightly or stable among institutions
in the United States and in the Fourth Federal Reserve
District, the region the Cleveland Fed serves. Then came
the tremendous spike when banks’ bad debts ballooned,
requiring banks to funnel funds into loss reserves.
ALLL to total loans more than doubled between late
2007 and early 2010, when the loan losses peaked.
Since the end of the first quarter of 2010, however,
the industry’s loss-reserves-to-total-loans percentage
has been steadily dropping, and in recent quarters the
percentage has flirted with pre-crisis levels.

F refront

Loss-reserves-to-total-loans ratios more than doubled
in recent years, but now are near pre-crisis levels.
4.0

Percent

3.5

For one, the ratio of the ALLL to total loans has gradually
returned to pre-crisis levels and hasn’t dipped below
what it was before the downturn, says Jason E. Tarnowski,
an assistant vice president at the Cleveland Fed.

US allowance for loan and
lease losses as a percentage
of US total loans

3.0
2.5

4D* allowance for loan and
lease losses as a percentage
of 4D total loans

2.0

“Even with some loan growth, the ratio of reserves to
those loans has kept pace,” he explains.

1.5
1.0
0.5
0
2002 03

Still, a question lingers: If, as the industry learned
the hard way, the pre-crisis levels of loss reserves did
not suffice in this most recent crisis, what’s to say
the same percentages today would suffice if another
downturn strikes?

Great Recession

08 09
June

14 2015

*4D: The Fourth Federal Reserve District comprises the state of Ohio, western Pennsylvania, the
northern panhandle of West Virginia, and eastern Kentucky.
Source: Bank call reports.

Downward trends
Of course, the loss reserves are not the only earnings
banks may use to absorb losses, Cleveland Fed
supervisors note. A bank’s equity, or capital, is inherently
loss reserves. It’s often said that the loan loss allowance
is for expected losses, and a bank’s equity is a cushion
for the unexpected. That latter cushion is, by design,
not returning to what it was pre-crisis.

Banks that are no longer shoveling earnings into
their reserves likely have more retained earnings for
accumulating capital and paying shareholder dividends,
says John C. Shackelford, a senior examiner with the
Federal Reserve Bank of Cleveland.
“And,” he adds, “you would hope to see more credit
availability.” Read: more lending.

“The difference between today and pre-crisis is banks
have much more capital than they had pre-crisis,”
Shackelford says, crediting actions taken by the
regulatory agencies. “They have much better metrics
at the portfolio level and the individual-loan level.
There are better monitoring systems. We put [the
largest banks] through the CCAR [Comprehensive

James Thomson sees the return of loan loss reserves
to pre-crisis levels as a signal that perhaps the banking
industry is back to normal, that a lot of the bad
credits bankers have been holding reserves against
are “finally cured.”
“If we’ve returned to normalcy, maybe we’ll start to see
lending come back,” says Thomson, professor and chair
of finance at the University of Akron and former vice
president and financial economist at the Cleveland Fed.
“Having bad loans on your books is a huge distraction.
You have to manage them. You have to try to collect
them. Maybe this is a first step toward lending starting
to come back.”
Banking supervisors with the Federal Reserve Bank
of Cleveland don’t see the shrinking loss reserves as
cause for concern.

Since the Great Recession’s end, bank lending has grown
61% in the Cleveland Fed’s region and 47% in the US.
900

Billions of dollars

Trillions of dollars

800

700

US total loans

600
500
400

6
4

4D* total loans

300

3
2

100
0
2002 03

Great Recession

08 09
June

0
14 2015

*4D: The Fourth Federal Reserve District comprises the state of Ohio, western Pennsylvania, the
northern panhandle of West Virginia, and eastern Kentucky.
Source: Bank call reports.

Winter 2015|2016

7
5

200

The volume of US banks’ problem assets has decreased
in recent years.
Capital Analysis and Review] exercise once a year
where they have to forecast what their losses would be
in hypothetical adverse scenarios. That helps forecast
how their loans might perform.”
In speaking to why lower loss reserves aren’t necessarily
out of turn, Cleveland Fed supervisors also note that
the metrics that reflect bad debts—90-days-past-due
debts; non-accruing debts, or those for which repayment of interest and principal is uncertain; and net
charge-offs—are all headed in the same direction:
down. Where bankers have fewer bad debts, bankers
need less cushion.
“If your performance metrics are showing improvement,
most likely your allowance and your provisions are
declining,” says Rich Gallagher, a Cleveland Fed senior
bank examiner. “One thing you’ve got to look at is the
business cycle. There’s always a high, and there’s always
a low. The allowance kind of follows the business cycle.
As things are improved, the allowance comes down.”
This return of loss reserves to pre-crisis levels is
occurring at a time when some bankers are taking
more risks and reducing underwriting standards such
as loan covenants and increasing leverage limits to
achieve yield in today’s low interest rate environment.
Bankers themselves report they are easing their standards.
The Federal Reserve’s July 2015 Senior Loan Officer
Opinion Survey on Bank Lending Practices asked
respondents from more than 70 banks to consider the
range over which their lending standards have varied
since 2005 and to report where their standards were
relative to the midpoint of that range.
Domestic and foreign banks generally reported that
lending standards are easing on some commercial and
industrial loans products for large and middle-market
firms. The survey found, too, that the lending standards
for smaller firms have been gradually loosening over the
past few years and that there’s been a gradual easing of
lending standards, as well, for all 3 types of commercial

250

Billions of dollars

200

Nonaccrual loans

150
100

Past due 90 days

Net charge-offs (quarterly)

0
2002 03

Great Recession

Source: Bank call reports.

08 09
June

14 2015

real estate loans: construction and land development
loans, loans secured by multifamily residential properties
such as apartment buildings, and loans secured by
nonfarm nonresidential properties such as office buildings.

‘An imprecise science’
What drives any institution’s loss reserves is the credit
risk by loan product each institution identifies, explains
the Cleveland Fed’s Gallagher. For example, similarly
sized banks may have different loss-reserves-to-totalloans ratios because one may concentrate in secured
real estate lending while another may book a significant
volume of unsecured commercial and industrial loans.
Industry observers say it’s hard to know definitively
whether the loss reserves at their current levels are enough.
“The adequacy of the loss reserve depends on the
quality of the loan portfolio,” says Thomson of the
University of Akron. “Historically, when the system’s
not under a lot of stress, when we’re not in a severe
economic downturn, a loss reserve of 1.5 percent is
probably more than adequate.”
Nationwide, the allowance for loan and lease losses as
a percentage of total loans stood at 1.40 percent as of

“The allowance kind of follows the
business cycle. As things are improved,
the allowance comes down.”

F refront

It’s hard to know definitively whether
the loss reserves at their current levels
are enough.
June 30, per bank call report data. In the Cleveland
Fed’s region, which comprises Ohio, western
Pennsylvania, the northern panhandle of West
Virginia, and eastern Kentucky, the same metric
was 1.43 percent.
“Obviously, we won’t know” until we know, Thomson
concedes. “But, if we have any faith in our ability to
simulate stresses on the portfolios and get a reasonable
picture under likely and adverse scenarios, I would
guess there’s nothing right now to suggest these
reserves are inadequate.”
But, Thomson acknowledges, if he’d told bankers in
2005 that their loan loss allowances were inadequate,
“you would have rolled your eyes” based on what the
reserves were relative to historic levels and relative to
charge-offs, or the assets banks write off as losses. Yet
as the recent past demonstrated painfully well, those
pre-crisis loss-allowance levels didn’t prove adequate
for the mountainous losses banks would suffer.
“The thing that we have to be careful of is that all of this
can be misleading,” Thomson explains. “You can miss
some stuff if there has been a discreet change in quality
or . . . some major economic downturn. Then, stuff that
looks adequate based on the recent past doesn’t look
adequate at all.”
That said, Thomson notes, “It’s hard to argue, 6 years
out from the financial crisis, that we’re far enough out
from it that our memories have completely disgorged
the fact that really bad things can happen.”
While it is the institutions’ responsibility to monitor
their loan portfolios, banking supervisors spend a
lot of time monitoring institutions’ risk-management
practices, Tarnowski and Shackelford explain.

“We have discussions with the chief risk officers, the
credit teams, and the loan officers to really determine
what new products or services they are getting into and
how they’re approaching markets from an underwriting
and interest rate perspective,” Tarnowski says.
“It’s an imprecise science,” Shackelford adds. “There’s
a lot to it to try to get it right. We focus on the riskmanagement practices and look at how [banks] assess
their risk and how accurate they have been over a
period of time.”
Beyond bank balance sheets and underwriting,
there’s a strengthening macroeconomy to consider
when assessing the appropriateness of loss reserves,
Tarnowski and Shackelford say.
“Financial institutions are greatly affected by the
environment,” Shackelford explains. “If house prices
are improving, that’s helping your consumers that have
equity. And when your businesses are having stronger
sales and earning money, it’s easier for them to repay
their loans.”
While some macroeconomic conditions (among
them improved unemployment and gross domestic
product figures) tell a story of growth, there are pockets
of stress such as low oil and steel prices that can affect
bank portfolios negatively, Shackelford notes.
If banks are assessing their risks accurately, lower loss
reserves should represent better credit quality in bank
portfolios, Tarnowski says.
Also, the return to pre-crisis levels of loss reserves
may indicate that banks’ provision expense, or the
reduction in earnings they incur when they add to their
loss reserves, is not going to be as high going forward,
Shackelford says.

Big change looms
Some banking supervisors would argue, Thomson
notes, that banks were under-reserving in the years
prior to the crisis.
There’s a balance they must strike: Banks are regulated
by bodies such as the Federal Reserve, the Office
of the Comptroller of the Currency, and the Federal

Winter 2015|2016

Deposit Insurance Corp., yes. But those institutions
that issue securities such as stock also are under the
thumb of securities regulators such as the US Securities
and Exchange Commission (SEC).
Whereas banking supervisors might want banks to
hold more in loss reserves as a course of business, the
SEC and the Financial Accounting Standards Board
(FASB) don’t want banks holding too much in their
reserves to the extent that they misrepresent their
earnings to investors. If banks provision more money
to their reserves, they reduce reported earnings and,
consequently, shareholders’ equity.
There’s potential big change on the horizon. Presently,
bankers are to assess incurred losses and set up loss
reserves accordingly, explains Bill Brewer, audit partner
with Crowe Horwath LLP in Cleveland, whose financial
services practice performs internal and external audit
and consulting work for financial institutions.
Following the financial crisis, there was concern that
accounting standards didn’t allow companies to recognize
losses via their loss reserves soon enough, notes Greg
McClure, also an audit partner with Crowe Horwath.
“The timing of when provisions are recognized has
been a concern for as long as I’ve been in the banking
industry, which has been 30 years,” McClure says.
“What happened was the financial crisis just accelerated
the pressure for the Financial Accounting Standards
Board to look at the issue again.”
In December 2012, FASB issued for public comment
its proposal to change financial reporting about expected
credit losses on loans and other financial assets in
what it called the CECL model, or Current Expected
Credit Loss impairment model. Under it, FASB aims
to require “life of loan” estimates of losses on loans and
debt securities. Said another way, CECL proposes that
bankers project and recognize expected losses over the
life of a loan rather than provisioning based on actual
losses incurred over a period of time.

Beyond bank balance sheets and
underwriting, there’s a strengthening
macroeconomy to consider when
assessing the appropriateness of
loss reserves.
Similar changes to accounting standards have been
introduced in other parts of the world.
“It will be a meaningful challenge to forecast what
could happen in the economy over the term of a loan,”
Brewer notes. “The ALLL estimate requires lots of
judgments, and this [change] introduces additional
elements of judgment.”
Most observers, he says, expect this change—which
isn’t to take effect until 2018—to have a meaningful
financial statement impact because they anticipate it
will result in higher loss reserves.
“Hopefully the intended outcome proposed under
CECL provides the necessary cushion for financial
institutions to absorb future economic shocks to the
loan portfolio and minimize the impact to financial
stability within the United States,” the Cleveland Fed’s
Tarnowski says.
The American Bankers Association asserts in an analysis
on its website that the “life of loan” loss concept “will
present significant problems to bankers,” among them,
requiring wholesale changes to ALLL estimation
systems and also straining the capital of banks that offer
long-term products because “losses that are possible
several years in the future will be recorded, while the
interest earned in the meantime is not.” ■

SUM AND SUBSTANCE
As banks set aside less money in loan loss
reserves, lending may increase, all while
examiners remain focused on risk management
practices and their accuracy.

Read more
The proposed change to the way banks provision money to their loss
reserves is explained in a recent Economic Trends piece by Cleveland Fed
researchers: http://tinyurl.com/zp2y6lg.
F refront

P licy Watch

Protecting
SmallBusiness
Borrowers
As alternative financing for small
businesses grows, so does the debate
over regulation.

Christine Weiss
Vice President, Legal

Ann Marie Wiersch
Senior Policy Analyst

Winter 2015|2016

Under the law, commercial-credit borrowers are
viewed differently from consumer borrowers. Business
borrowers, deemed more financially savvy than the
average consumer, are not protected under the majority
of consumer protection laws. For instance, credit
extended primarily for business purposes is not
covered by the disclosure requirements of the Truth
in Lending Act.
Lenders thus have a great deal of flexibility with respect
to the information they provide borrowers and the way
they disclose a product’s costs and features. As a result,
borrowers have reported confusion in understanding
the differences among various credit products and their
costs, as noted in a Federal Reserve Bank of Cleveland
report titled “Alternative Lending through the Eyes of
‘Mom & Pop’ Small Business Owners: Findings from
Online Focus Groups.” In practice, some borrowers have
found themselves in high-cost products with terms and
conditions they did not understand or interest rates
that were not affordable for their small businesses.

“The newness of the industry and the lack of regulatory
structure have given rise to questions about what, if any,
intervention is needed and what supervisory authority
agencies might have over small-business credit providers.”
(p. 25)

The Debate

The Alternative Finance Industry

Small-business advocates have called for disclosure
rules that require lenders to describe their product
terms and costs in clear and transparent language.
They have also encouraged curbs on subprime lending
and predatory practices that include stacking, namely,
the practice of providing a merchant cash advance
(MCA), a form of short-term funding, to a borrower
who has an outstanding advance from another lender.

Online alternative lending is one of several segments
that comprise the “fintech,” or financial technology,
sector. New fintech entrants are using technology
to serve the financial needs of businesses and consumers,
bringing innovative solutions to payments, lending,
and other financial services. These companies, many
of them startups, boast double- or triple-digit annual
growth rates supported by considerable venture
capital investment.

On the other hand, some industry proponents argue
that regulatory intervention could stifle innovation and
limit credit access for small-business customers who
need financing to thrive. These observers assert that
existing laws and regulations are sufficient to ensure
that the market functions safely. (The accompanying
table on page 20 sets forth a non-inclusive list of
applicable regulations.) They support industry efforts
to self-regulate and have urged policy makers to allow
market discipline to weed out the so-called “bad
actors” that engage in high-cost or predatory lending.
Much of the debate about borrower protections
centers on online alternative-finance companies that
provide MCAs to small businesses. These products
have a reputation for being expensive and are often
marketed to borrowers with FICO scores in the low
500s. Furthermore, to grow their customer bases,
some MCA providers rely on new business generated
by brokers that have been a source of concern about
misleading and unethical practices.

Specific to small-business services, estimates suggest
that at least 150 alternative-finance companies in
the US alone focus on extending credit to small firms.
These nonbank credit providers operate online and
offer a variety of products such as loans and cash
advances, as well as hybrid products that carry features
of both. Marketplace-lending platforms, also known
as peer-to-peer lenders, are among the largest and
most well-known. Other lenders competing for smallbusiness borrowers include MCA providers, direct
lenders who keep loans on their balance sheets, and
payment processors that lend to their business-account
holders. These lenders appeal to business owners
seeking alternatives to banks for a number of reasons
including 1) the owner’s inability to qualify or belief
that he or she will not be approved for traditional bank
financing; 2) the faster, simpler application process;
3) the easier lending standards; and 4) the potential
to obtain funding more quickly.

F refront

About Merchant Cash Advances
An MCA is a form of short-term funding typically offered
to small-business borrowers who primarily accept
credit card payments, for example, retail businesses or
restaurants. An MCA is different from a traditional loan
in that the small business, in essence, sells a portion
of its future receivables: cash up front in exchange for
a percentage of future sales. Unlike a traditional loan,
an MCA has no fixed term on the repayment of the
advance, no minimum monthly payment, and, generally,
no collateral or personal guaranty required. The cost

is based on the “factor rate” applied to the advance, a
rate which typically ranges from 1.2 to 1.4.
Here’s what happens in a typical MCA arrangement:
The borrower agrees to repay the lump-sum cash
advance by allowing the MCA provider to take a fixed
percentage of the borrower’s daily revenue until the
advance and associated fees are repaid. To pay back
the loan, the borrower then authorizes the MCA provider
to withdraw that fixed percentage of sales from the
borrower’s merchant account through which credit and
debit card receipts are processed. To determine the

Relevant Legislation
Regulation B This regulation prohibits discrimination in any aspect of a credit transaction, whether for consumer
of the Equal Credit or business purposes, on the basis of
Opportunity Act
(ECOA) • Race, color, religion, national origin, sex, marital status, or age (provided the applicant has the ability

to enter into a contract)

• Receipt of public assistance
• The fact that the applicant has exercised any right under the consumer credit protection act
It also requires a creditor to notify the applicant of its decision within 30 days from receipt of a
completed application.
Fair Credit The FCRA stipulates that a creditor must notify a borrower if a personal consumer credit report is pulled
Reporting Act in connection with a commercial transaction and an adverse action is taken based on that report.
(FCRA)

Such “adverse action” includes a denial of credit, a modification of the requested terms, or a change in
terms on an existing account.

Section 5 of the Section 5 prohibits unfair or deceptive acts or practices in or affecting commerce and applies to both
Federal Trade consumer and commercial transactions.
Commission Act
(FTC Act) Such acts or practices include

• Making misleading cost or price claims
• Using bait-and-switch techniques
• Offering to provide a product or service that is not available
• Omitting material limitations or conditions from an offer
• Selling a product unfit for the purposes for which it is sold
• Failing to provide promised services
State laws regarding Collection practices that may violate state laws vary from state to state, but may include
collection practices

• Making repeated collection calls in an attempt to harass a borrower
• Calling borrowers at unreasonable hours

• Making false allegations when attempting to collect from a borrower

Winter 2015|2016

total amount owed, one multiplies the factor rate by
the amount borrowed, for example, a $50,000 advance
multiplied by a factor rate of 1.2 equals $60,000, the
$50,000 loan plus the $10,000 fee.
However, the borrower may not realize that the factor
rate is different from the annual percentage rate (APR)
associated with traditional loans and credit cards in
which the interest accrues on the declining principal
amount as payments are made.
Given that the entirety of the interest is charged upon
origination of an MCA, there is no cost savings associated
with early repayment. In fact, the equivalent APR
actually rises when the advance is repaid sooner.
Assuming regular daily payments over the course of
12 months, the equivalent APR on this MCA would
be around 40 percent; but if repaid in 6 months, the
equivalent APR doubles to 80 percent. Although such
APRs are quite high, usury laws in most states apply
only to consumer loans. Moreover, because MCAs
represent the cash purchase of future card revenue assets,
they have generally been exempt from state and federal
agency regulations governing traditional loans.

Borrower Protections
Small-business advocates have urged policymakers to
consider regulatory intervention to protect alternativefinance-industry participants, especially borrowers.
Some advocates promote the implementation of smallbusiness-borrower protections similar to those in place
for consumers. They note that in contrast to larger,
established businesses with financial expertise on
staff and long-term banking relationships, newer and
smaller businesses often rely on the financial acumen of
their owners and may have limited access to traditional
credit. These small businesses increasingly are turning
to a growing number of alternative-credit providers for
their short-term financing needs.
However, there is evidence that some of the products
are much more expensive than traditional credit and
that their terms and conditions are not described clearly.
Though industry leaders have argued that regulation
would limit credit access to underserved small businesses,
policymakers might seek to balance that risk with steps

Business owners, deemed more financially
savvy than the average consumer, are not
protected under the majority of consumer
protection laws.

to ensure small-business credit is not merely available,
but also affordable and easy to understand.
The newness of the industry and the lack of regulatory
structure have given rise to questions about what,
if any, intervention is needed and what supervisory
authority agencies might have over small-business
credit providers. In July, the US Department of the
Treasury issued a Request for Information (RFI) seeking
input on the business models of online alternative
lenders, the potential for these lenders to reach the
underserved, and the need for changes to the regulatory
framework to support safe growth in the industry.
The RFI prompted over 100 responses from industry
participants and borrower advocates.
In November, members of the US Senate Banking
Committee issued a letter to Treasury and Small
Business Administration officials requesting greater
clarity on the fintech industry, its role in the credit
environment, and the need for greater transparency.
Within it, the senators expressed particular interest in
“understanding the opportunities, challenges, and risks
in these emerging trends in small business capital.” ■

SUM AND SUBSTANCE
Small-business borrowers are increasingly
turning to more expensive alternative financing,
prompting calls for clear disclosures.

Read more
Want to learn more about alternative lending? See “Alternative Lending
through the Eyes of ‘Mom & Pop’ Small Business Owners: Findings from
Online Focus Groups” at http://tinyurl.com/zvncnbf.
F refront

Charles Manski puts it
this way: A lot of times,
when we think something
has happened in the
economy, it hasn’t really
happened. He tells
Forefront why this is and
what can be done about it.

Data and
Decisions
in an
Uncertain
World

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As Charles Manski took to the podium at the 2015 Policy Summit, he conceded that this plenary
session—inspired by the book he wrote—would be drier than the conversation that preceded it.
“However,” he stressed, “it’s important.”
Manski, a professor of economics at Northwestern University and author of Public Policy in
an Uncertain World, went on to discuss how the assumptions made in producing statistics
aren’t necessarily well known and how statistics are often revised in nontrivial ways following
their first release.
He’s argued for a long time that government agencies should “forthrightly communicate
uncertainty” as it pertains to the numbers they report.
“We all use them—governments, businesses, mayors, private citizens—all use these official
statistics to make many important decisions, and I worry considerably that the quality of all those
decisions that we make may suffer if people misinterpret the statistics,” Manski explained.
Later that day, Forefront sat with Manski for an exclusive interview. An edited transcript of
our conversation follows.

Winter 2015|2016

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“It’s not that they make the stuff up, it’s not that
they’re lying, it’s not that it’s fraudulent research.
It’s more subtle than that.” (p. 29)

Manski: Statistics come out and

people take them seriously, and then
the same statistic may get changed a
month or 2 later, and something that
we thought had happened actually
didn’t happen. A particular place where
this happens is the quarterly estimates
of GDP [gross domestic product]
growth that come out from the
Bureau of Economic Analysis [BEA]
at the US Commerce Department.
There’s a whole sequence of these
estimates: There’s a first estimate and
then a revision a month later and
then a second revision 2 months later.
And then at the end of the year, they
get new data, and they revise it again.

People are forming opinions about
whether the economy is strong or
weak based on the initial estimate,
and then it turns out as the new data
come in and they do revisions of the
GDP data that it wasn’t correct.

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Now, this can have quite the
implications. The regional Federal
Reserve Banks participate with the
Federal Reserve Board in making
monetary policy. The Federal
Reserve’s Board of Governors
is looking carefully at the GDP
numbers trying to decide whether
interest rates should be changed
and so on, and the members of the
Federal Open Market Committee
could decide that interest rates
should stay the same, perhaps

It can often happen that the first
estimate comes out and it looks

Photo courtesy of Northwestern University

good—the economy grew at an
annual rate of 3 percent, according
to the estimate. And then a month
later, new data come along and
the BEA at the Commerce Department
says, “Uh oh, the economy didn’t really
grow at a 3 percent annual rate. It
actually grew at only 1 percent.” Then
a revision comes in 2 months later,
and it’s, “We need to change it again;
actually, the economy contracted.”

Forefront: You said during your
plenary a few times, when we think
something has happened in the
economy, it hasn’t really happened.
Explain how that’s the case.

F refront

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because the economy looks one way,
and then a month later they find out,
“Uh oh, that was wrong.”
This happens quite frequently.
Forefront: What specifically are you
urging publication of as it pertains to
uncertainties when it comes to data
from the Bureau of Economic Analysis,
the Bureau of Labor Statistics, the
Census Bureau? Are you urging the
publication of the bare necessities
or something beyond that, and are
you urging it for all data or just for
certain kinds?
Manski: In principle, I would like to

have uncertainty expressed for all
the statistics that the federal statistical
agencies publish. But let’s focus on
some of the most important ones
like GDP growth, inflation statistics,
unemployment rates, income
distribution, and poverty rate. These
particular statistics draw an enormous
amount of media attention, and the
public really pays a lot of attention
to them. So let’s start with them.
And the question is, “Well, what
should we do?”

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People are forming opinions about
whether the economy is strong or weak
based on the initial estimate, and then
it turns out as the new data come in and
they do revisions of the GDP data that
it wasn't correct.

Winter 2015|2016

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The agencies, the Bureau of Labor
Statistics, Census Bureau, Department
of Commerce, and so on, they put
out news releases that get very wide
distribution. For the news releases,
you’re not going to go into deep,
technical detail, but the public needs
to have a sense of the uncertainty.
I think a simple way to do it is to
have a range. Instead of saying the
GDP growth is 2 percent, try to
measure the uncertainty and say the
GDP growth seems to be between
1 and 3 percent. Similarly for the
unemployment rate, instead of saying
it’s 5.5 percent, say it’s between 5.3
percent and 5.7 percent.
The basic point is to get across some
sensible notion of the magnitude of
the uncertainty.

Now, that’s fine for the news release.
For researchers, you need more than
that. For the academic researchers,
for firms making business decisions
that really want to understand things
better, then the statistical agencies
could dig deeper and provide much
more sophisticated measures of the
uncertainty for those groups to use.
Forefront: Why were you driven
to write a book [Public Policy
in an Uncertain World] on this
particular topic? I imagine one
of the reasons is that you see
evidence all around you that people
don’t pay enough attention to this
issue, that you see risks building or
some resulting consequences.

Manski: I’ve always been interested

in public policy. It has bothered me

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Five years, 10 years might be enough to see
how well a new policy is working in education
or in social welfare or in other areas of that
sort and then evaluate them and adapt them.

for many, many years that researchers
publish articles claiming to know
things that they don’t really know.
It’s not that they make the stuff up,
it’s not that they’re lying, it’s not that
it’s fraudulent research. It’s more
subtle than that.

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It’s important to know that data
alone don’t tell you anything when
you’re trying to do research. You
have to combine data with some
kind of assumptions, some theory,
about the way the world works.
The subtleties of research are what
kinds of assumptions people make
that they combine with the data.
There are huge incentives to get
flashy results that will draw our
attention. What that leads people
to do is to combine the data that
are available with very strong
assumptions that allow them to
draw strong conclusions.
The first thing I do when I read
any piece of empirical research, I
don’t look at the findings; I look at
what data were available and what
assumptions were made and how
the researcher combined the data
with the assumptions. I was finding
over and over and over again that the
available data, which are never as
strong as one would like, were being
combined with assumptions that were
not just strong but lack credibility.

At a point, about 5 or 6 years ago, I
decided I really needed to reach out
to a broader audience—that it’s not
sufficient for academic researchers
to understand these issues; it’s really
important for the public to understand
them because we’re talking about very
important public policy questions.
Forefront: It’s your assertion that
maybe policy doesn’t need to be
static, that maybe if data are going
to change, we should be flexible.
So what horizon do we set? If data
continue to be revised, how often do
we change policy that’s been set before
we render ourselves paralyzed?
Manski: If we admit that we don’t

know things and that we shouldn’t
be making policy once and for all for
eternity, then how often should we
be reevaluating things? It depends
on the circumstance. Some policies
are hard to reevaluate. An example
that’s current: California is beginning
what could be a $100 billion project
to build a high-speed rail system
that would go from Los Angeles to
San Francisco. You can’t really build

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it piecemeal and see what happens.
You have to build it all at once, and
it’s going to be a long time before
that’s reevaluated.
On the other hand, there are very
different kinds of public policy, as an
example, educational policy. What
should class size be? What should be
the role of educational testing? Well,
you get a new cohort of students
every year. We can have a much
shorter time horizon in evaluating
educational testing policies. Five
years, 10 years might be enough to
see how well a new policy is working
in education or in social welfare or
in other areas of that sort and then
evaluate them and adapt them.
The adaptations don’t have to be a
wholesale changing of a policy. They
can be fiddling at the margin and
making refinements.
The idea that I specifically
recommended—what I’ve called
“adaptive diversification”—would
allow one to do this in a continuous
way. Let’s use the example of
evaluating schools by test scores
or not. Some schools could be
under a testing regime and other
schools could be not using a testing
regime. They’re very different
policies, but what you could evaluate
smoothly is the fraction of schools
that are using a testing system or
are not using a testing system.
As the evidence accumulates, you
could modify the fractions. So in
the beginning when you don’t really
know, maybe half the schools get
one policy and half get the other.
As the data accumulate and it looks
like one policy’s working better than
the other, you go from 50/50 to
60/40 to 70/30, and then when you
finally feel comfortable enough that
one policy is really the best, then
everyone gets that policy.

F refront

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Forefront: Is there a particular use of
data without quantification of error
or without identification of a probable
range that makes you cringe the most?
Or is there one that you really like?
Manski: Let me talk about a case

where I think at least there’s a goodfaith effort to do it well. It’s not
perfect by any means, but I think
we could learn from it.

Climate change is a matter of
enormous controversy. It is not
a matter of economics, but it
certainly impinges on the economy.
There are thousands of scientists
that try to do forecasts of climate
change and try to understand what
the effects of policy changes would
be on the climate. The United Nations
has had this organization called
IPCC [Intergovernmental Panel on
Climate Change]; it’s an international
committee of scientists that’s
supposed to do forecasts of climate
change. They have tried to be very
careful in trying to separate what
are the things that we think we
know really well, where we can say,
“Yeah, that’s it,” and we can just go
with a point estimate on that, and
what are the things that we don’t

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really know very well but maybe
we can quantify it enough to put a
probability distribution on it.

But then they have a third category
of things that are really so uncertain
that we don’t even want to put
probabilities on them. In my literature,
in economics, we talk about that
as “ambiguity.” The scientists who
do work on climate change, they
call it “deep uncertainty.” They are
the parts of climate change that are
so uncertain that we just have to say,
“Well, it could be this scenario or
it could be another scenario, but we
can’t even put probabilities on it.”
I think that’s a nice model. ■
— Michelle Park Lazette

SUM AND SUBSTANCE
Data can change materially
after initial publication.

On the reel
Watch Charles Manski speak to the “enormous
responsibility” he says the media bear in
communicating uncertainty to the public. In
another short video, he explains why he’s more
concerned with one form of error than another.
http://tinyurl.com/qf4bnxa

Winter 2015|2016

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Charles Manski
Position

Northwestern University Board of
Trustees Professor in Economics,
Department of Economics
Fellow, Institute for Policy Research,
Northwestern University
Recent books

Public Policy in an Uncertain World:
Analysis and Decisions
Cambridge: Harvard University Press,
2013
Identification for Prediction and Decision
Cambridge: Harvard University Press,
2007
Social Choice with Partial Knowledge
of Treatment Response
Princeton: Princeton University Press,
2005
Education

Massachusetts Institute of Technology
BS in Economics, 1970
Massachusetts Institute of Technology
PhD in Economics, 1973

Photo courtesy of Northwestern University

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Full text of Forefront (Federal Reserve Bank of Cleveland) : Winter 2015-2016, Vol. 6, No. 3

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