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REGIONAL ECONOMIST | OCTOBER 1994 https://www.stlouisfed.org/publications/regional-economist/october-1994/a-welcome-to-interstate-banking-and-branching President's Message: A Welcome to Interstate Banking and Branching Thomas C. Melzer The United States has a long tradition of restricting interstate and branch banking that, with the signing in late September of new banking legislation, will finally come to an end. The new legislation has two major parts. The interstate banking section is straightforward: It allows bank holding companies, one year from now, to make acquisitions in other states—even where state law currently bars out-of-state institutions. The interstate branching portion of the law is a bit more complicated: It allows organizations, beginning in June 1997, to consolidate their multi-state holdings into a single branch network. It also grants states the right to opt out of interstate branching, if they choose, by passing a law forbidding such action before the new rules take effect. A number of states—including a few in the Eighth Federal Reserve District—are reportedly considering such opt-out provisions. How might this legislation alter the banking landscape? We are likely to see some of the following: fewer independent banks more branch offices greater convenience for bank customers greater geographic diversification of banking risk. As usual, it is difficult to predict with any certainty what the effects of new legislation will be on the number and size of banking organizations. But there is good reason to believe the changes will be less than startling: States have been moving in this direction for years. By forming regional interstate banking compacts and relaxing branching restrictions within their own borders, the states have, in effect, made the passage of this new law into an evolutionary, rather than revolutionary, step toward full nationwide banking and branching. We expect that many relatively small community banks will continue to thrive in the new environment. As the last issue of The Regional Economist reported, community banks are holding their own in California and North Carolina, where statewide branching has been permitted for more than a decade. A period of uncertainty, of course, will follow this legislation. Will it turn out to be worth it? The answer depends on what you think of the new law's primary goal: to remove the artificial barriers that have prevented financial institutions from competing on a level playing field, both with their peers and with financial institutions across the globe. Removing such barriers is a move toward greater competition. And competition in most any industry is a boon for that industry's users. Overall, then, despite the uncertainty it engenders, the new banking legislation should be welcomed with open arms. REGIONAL ECONOMIST | OCTOBER 1994 https://www.stlouisfed.org/publications/regional-economist/october-1994/demystifying-derivatives Demystifying Derivatives Michelle Clark Neely "Risky Business on Wall Street: High-tech super nerds are playing dangerous games with your money" —Headline, Time magazine, April 11, 1994 "They are mechanisms that our customers demand to try to make a volatile world appear to be more stable. They are nothing but a form of insurance." —John S. Reed, Chairman and CEO, Citicorp Although they've been around in some form since the 1840s; derivatives in recent months have obtained the notoriety usually reserved for drug lords and international terrorists, as the Time headline above suggests. Derivatives' dangerous reputation has been prompted by their growing size and complexity as well as by headline-grabbing losses suffered by companies like Procter & Gamble and mutual funds, like those of Paine Webber and Piper Jaffray. Participants in the derivatives market, like Citicorp's John Reed, say derivatives are not inherently dangerous, but are important risk-mitigating tools in today's complex business environment. Both users and dealers claim that the risks derivatives pose to financial markets are exaggerated and that further regulation will only impede efficiency in an otherwise healthy market. Who's right? To answer that, it's necessary to examine just what derivatives are, who uses them and why. The ABCs of Derivatives Derivatives are financial contracts whose values are linked to either an underlying asset, such as a stock, bond or commodity; a reference rate, such as the interest rate on three-month Treasury bills; or an index, such as the S&P 500. Derivatives developed to meet a variety of financial market participants' needs, the predominant one being the unbundling and efficient management of financial risks. Although derivatives seem complicated, their premise is really very simple: They allow users to pass on an unwanted risk to another party and assume a different risk, or pay cash, in exchange. A familiar example will illustrate. Suppose company XYZ uses a large amount of oil in its production process. Suppose further that XYZ's customers place orders for its products six months in advance at a predetermined price. Given the volatility of oil prices and XYZ's desire to earn some target profit margin, XYZ would like to protect itself from a potential increase in oil prices. It can do so by entering into a futures contract: XYZ agrees to buy a specific quantity of oil at a predetermined price on some future date. If the price of oil exceeds the contract price at maturity, XYZ has saved money and protected its profit margin. If the current, or spot, price of oil is less than the contract price, XYZ must pay the contract price, but has still protected its profit margin. In this case, XYZ has used a derivative as a form of insurance. The futures contract described earlier is a standardized version of the simplest type of derivative, called a forward contract. A forward contract obligates one party to buy, and another party to sell, a specified amount of an underlying asset, rate or index (often called an "underlying") at a specific price, on a specific date.1 The other basic type of derivative contract is an option. An option gives its holder the right but not the obligation to buy or sell an underlying at a price, called the strike price, during a specific period or on a specific date.2 An option holder pays a premium to obtain the contract because it is a one-sided deal: The buyer benefits from favorable movements in the price of the underlying (if he exercises the option) but is not exposed to losses should the price go the other way (because he can let the option expire). Another way to look at the derivatives market is to divide derivatives into "exchange-traded," or standardized contracts, and "over-the-counter (OTC)," or customized contracts. The oil futures contract described earlier is an example of an exchange-traded derivative. Every feature of the contract—the quality and quantity of the underlying, the time and place of delivery, and the method of payment—is standardized but the price. Futures and many options contracts, which are tied to bonds, equities, currencies and commodities, are the major types of exchange-traded derivatives. These are traded on the Chicago Mercantile Exchange and the New York Stock Exchange, among others. The standardization of these contracts makes them accessible to both retail and wholesale investors, as well as generally less risky. OTC derivatives are another story. Unlike exchange-traded derivatives, all terms of an OTC derivative are negotiated between two counterparties. That makes them more complex, less liquid and more difficult to value. OTC derivatives range from the very simple, such as the basic (or "plain vanilla") interest rate swap described in the chart, to the very complex, with exotic names like inverse floaters and naked call options.3 Chart 1 Plain Vanilla: Anatomy of Basic Interest Rate Swap SOURCE: Copyright © 1994 by New York Times Company. Reprinted by permission. [back to text] Derivatives and Risk Management How do OTC derivatives help businesses manage financial risks? Corporations can lower funding costs and diversify funding sources through derivatives. An American company, for example, may decide to issue debt in Germany rather than in the United States because of a slight difference in U.S. and German interest rates; by arbitraging the difference in interest rates and using a currency swap (an agreement to exchange one currency for another) to obtain the funding in U.S. dollars, the company lowers its costs. Another major use of derivatives is to hedge interest rate or exchange rate risk. An issuer of fixed-rate debt who anticipates a general increase in interest rates can enter into a forward swap (an agreement to swap some time in the future) to lock in the level of interest rates at the time the funding decision is made. Similarly an issuer of floating-rate debt can eliminate the risk of rising interest rates by purchasing a cap, essentially fixing an upper bound on the rate the borrower will have to pay, no matter what market rates do. Importers, exporters and companies that have significant overseas operations may find derivatives an ideal tool to manage exchange rate risk. A U.S. exporter to Mexico who is expecting a fixed payment in pesos could see profits disappear if the peso severely depreciates before the exporter gets paid. Companies facing exchange rate risk can use currency swaps and foreign exchange forwards or options to hedge expected future cash flows from foreign transactions. Betting the Ranch? Of course, any instrument that can be used to hedge can also be used to speculate. This aspect of derivatives, combined with the largely unregulated nature of the OTC derivatives market, is what has so many so spooked. Policymakers are concerned, for example, that banks' derivatives activity from either the end-user or dealer side may pose significant risks to the bank insurance fund. On the end-user side, the concern is that banks will be tempted to take large speculatory bets on interest rates that could impair their capital or lead to failures. Because a large proportion of U.S. OTC derivatives dealers are money center banks, some worry that the failure of one bank dealer may have a domino or systemic effect on the whole banking industry and, hence, taxpayers. The prescription for these and other risks, say derivative doomsayers, is tighter regulation. Derivative proponents like the International Swaps and Derivatives Association counter that the vast majority of end users and dealers are not taking excessive risks and that current risk management guidelines are sufficient to ward off reckless behavior. They are concerned that additional regulatory intervention will eliminate the flexibility and efficiency inherent in this market. A preferred alternative to tighter regulation, then, is increased transparency and better accounting of derivatives activity. Bank advisory organizations like the Basle Committee on Banking Supervision and the Group of Thirty have recommended a variety of management guidelines to mitigate some of the risks inherent in derivatives activity. Speculators Beware The principle that appears to be operating in discussions of derivatives is the adage "people fear what they don't understand." As derivatives have evolved from the plain vanilla to the more exotic, the ability of many to get a handle on the risks and rewards of these financial instruments has become much more difficult. Although thousands of firms have successfully used derivatives to protect themselves from adverse shocks, others have made foolish bets that have cost them dearly. At the least, policymakers want to be sure that investors and regulatory authorities know when firms are using derivatives to speculate rather than to hedge. For those wishing to speculate with derivatives, the message from investors and policymakers is pretty clear: We'll be watching you. Thomas A. Pollmann provided research assistance. Endnotes 1. Futures, foreign exchange forwards, forward rate agreements (forwards based on interest rates) and swaps (an agreement to exchange a series of cash flows at specified intervals) are the major types of forward contracts. [back to text] 2. An option to buy is called a call option; an option to sell is called a put option. Caps, floors, collars, swaptions (an option to enter into a swap), and options on futures contracts are the major types of option contracts. The mechanics of forward- and option-based derivatives are explained in both the Group of Thirty report and the Federal Reserve Bank of Atlanta (1993) report. [back to text] 3. See Federal Reserve Bank of Atlanta (1993) for descriptions of the more exotic derivatives products. [back to text] References Abken, Peter A. "Over-the-Counter Financial Derivatives: Risky Business?" Federal Reserve Bank of Atlanta Economic Review (March/April 1994), pp. 1-22. Basle Committee on Banking Supervision. Risk Management Guidelines for Derivatives (July 1994). Federal Reserve Bank of Atlanta. Financial Derivatives: New Instruments and Their Uses (December 1993). Group of Thirty. Derivatives: Practices and Principles (July 1993). International Swaps and Derivatives Association (ISDA). The GAO Report on Financial Derivatives: Good Facts and Bad Conclusions, An ISDA Position Paper (May 27,1994). United States General Accounting Office. Financial Derivatives: Actions Needed to Protect the Financial System (May 1994) REGIONAL ECONOMIST | OCTOBER 1994 https://www.stlouisfed.org/publications/regional-economist/october-1994/district-economic-update-will-the-sailing-remainsmooth District Economic Update: Will the Sailing Remain Smooth? Kevin L. Kliesen According to the U.S. Department of Commerce, output of final goods and services produced (gross domestic product) rose at a 3.8 percent annual rate in the second quarter, substantially above its long-term trend growth rate of 2.8 percent. Moreover, nearly 5.5 million jobs have been created since July 1991, the official end of the last recession. The Eighth District economy has also prospered recently: the District unemployment rate measured 5.4 percent in July, almost 1 percentage point lower than a year earlier and considerably lower than the 6.1 percent rate for the entire U.S. If the current expansion continues unabated, it will equal the nation's postWorld War II average duration of 50 months by this time next year. Because what happens nationally is generally an important barometer for economic developments at the state level, this news, one would think, bodes well for Eighth District states. Should we be so optimistic? Can we expect the District economy to continue to mirror the performance of the national economy? Composition of the District Economy In 1990, the latest data available, the output of final goods and services—termed gross state product (GSP)— in the seven states of the Eighth Federal Reserve District totaled $729.3 billion (see pie charts).1 With output in all other states at just under $4.8 trillion, District output, broadly defined, was about 13.3 percent of the national total.2 Gross State Product by Industry: 1990 [back to text] The District economy, while diversified, is more manufacturing-intensive than the rest of the country. Manufacturing output, totaling nearly $167 billion in 1990, was almost 23 percent of GSP. In contrast, manufacturing output in all other states was only 17.9 percent of GSP. Indiana and Kentucky, both with important durable goods-producing industries like autos and household appliances, are the most manufacturing-intensive of the seven states, with Illinois the least manufacturing-intensive. Like the U.S., the District has basically a service-based, or nonmanufacturing, economy, providing the services of everything from doctors and computer programmers to secretaries and teachers. But while nonmanufacturing output makes up nearly 70 percent of District GSP, that was somewhat less than the 74 percent for the rest of the United States. In particular, the financial services and government sectors do not have as strong a presence in our seven-state economy as they do in the rest of the country. On the other hand, retail and wholesale trade and transportation and public utilities are relatively more important to the District economy. Industry Employment Trends Because output data at the state level are computed with a substantial time lag, economists must look at other indicators to get a more up-to-date portrait of a state's economic well being. One important statewide indicator is payroll employment growth. In general, if an industry is expanding (if the level of output is increasing), employment will usually rise—at least in the short run. Over a longer horizon, this need not be the case. For example, the percentage of workers in the automobile manufacturing sector has declined steadily over time even as auto production increased. Why? Because technological gains over the years have enhanced worker productivity: it takes fewer workers today to build an automobile than it did, say, 25 years ago. The data tables in this publication report nonagricultural (excluding agriculture and natural resources) payroll employment growth for the United States and each of the seven District states by industry. As is evident from these pages, U.S. payroll employment growth was quite strong in the second quarter, expanding at a 3.7 percent annual rate. This gain was up substantially from the 2.2 percent rate of gain in the previous quarter and was the fastest rate of growth since late 1987. More important, the sectoral gains were rather broadbased, occurring in construction (12.6 percent rate), services (6.1 percent rate) and wholesale and retail trade (4 percent rate). Even manufacturing employment rebounded in the second quarter (up at a 1.1 percent annual rate), after falling throughout most of 1993. In the District, on the other hand, payroll employment growth appears to have ebbed over the past two quarters. After registering a robust 3.1 percent growth rate in fourth quarter 1993, payroll employment growth has slowed from a 1.9 percent annual rate in the first quarter to a 1.5 percent annual rate in the second quarter, its slowest pace since early 1992. With declines in manufacturing employment in Illinois, Mississippi and Missouri, District goods-producing employment (manufacturing and construction) retreated considerably from its strong pace in the first quarter, falling at a 0.4 percent annual rate—the first decline in more than two years. By contrast, goods-producing employment growth remained strong in Arkansas. Some modest slowing was also evident in District service-producing industries. Since fourth quarter 1993, when employment in service-producing industries rose at a 3.6 percent rate, employment growth has slowed markedly, falling to a 2.4 percent rate of increase in I/1994 and to a 1.4 percent rate of increase registered in II/1994. Some of this slowing can be attributed to the Teamsters strike this past April, which caused temporary employment declines in the transportation and public utilities sector. In general, though, slow or slowing employment growth is evident in other service-producing sectors, like finance and real estate and wholesale and retail trade. Perhaps this pattern of moderating employment growth over the past two quarters is a transitory development, given the high degree of volatility of state employment data. For example, measured on a four-quarter basis (II/93 to II/94), District payroll employment growth has remained at 2 percent or more for seven consecutive quarters. On the other hand, while year-over-year payroll employment growth has increased for nine consecutive quarters for the United States, it has declined slightly for two consecutive quarters for the District. By no means an ominous development, this slowing does bear watching. Other Indicators Additional indicators can give us a clearer picture of the District's economic well being. One such indicator is the number of business failures. One can perhaps view business failures as a lagging indicator because they typically pick up after the onset of slow growth, not before. By this rule of thumb, the District economy still appears to be expanding: the number of business failures in the District declined 3.6 percent in the second quarter this year to 1,468, following a 1.6 percent rise in the first quarter. State by state, the number of business failures shows a mixed pattern. The number of business failures have increased for two consecutive quarters in Arkansas and Kentucky, but have fallen for three consecutive quarters in Illinois and four consecutive quarters in Indiana. Measured from four quarters earlier, though, District business failures are off 17.2 percent and are down in all states except Arkansas. Although just over 4 percent of total District output, the construction industry is sometimes viewed as a bellwether for future economic growth. If true, then we perhaps should be concerned about our future prospects. Construction employment growth was flat in the second quarter, after rising strongly over the previous two quarters. District housing starts in the second quarter totaled nearly 194,000 (annualized), down 7.8 percent from their first-quarter average of just over 210,000 and down 12.6 percent from the nearly 222,000 in fourth quarter 1993. Housing starts in the second quarter were off from their first-quarter level in all states except Kentucky and Tennessee, where they rose 9.4 percent and 1.7 percent, respectively, and remain below their fourth quarter 1993 levels in all states except in Arkansas. A final indicator is retail sales (for example, sales of clothing, food and automobiles). Because consumer spending is the largest sector of the economy, the retail sales sector is watched closely. In the second quarter this year, District retail sales rose at a 1.7 percent annual rate, following a 3.3 percent annual rate of increase in the first quarter.3 Over the past two quarters, retail sales have risen at a 0.2 percent rate in Illinois, a 0.7 percent rate in Indiana, a 1.8 percent rate in Missouri and a 10.7 percent rate in Tennessee. When inflation is factored in, however, retail sales have actually declined in three of the four District states over the past two quarters. Nevertheless, measured from four quarters earlier, retail sales are up 6 percent for the four states. One important caveat: trends at the state level are sometimes hard to gauge in as short a time as a few quarters. Thus, the weakness that is apparent in some indicators over the past two quarters may be temporary. A strengthening U.S. economy, along with a rebounding world economy, could perhaps reverse these trends. Further, state data is exceedingly volatile and subject to considerable revision. As a result, only time will tell whether this pattern is real or simply a statistical anomaly. Heidi L. Beyer provided research assistance. Endnotes 1. The seven-state area comprises Arkansas, Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee. [back to text] 2. This share has fallen over time. In 1980, District output measured 16.5 percent of all other U.S. output; in 1985, this share fell to 15.6 percent. [back to text] 3. Retail sales only includes data from Illinois, Indiana, Missouri and Tennessee, and it is not adjusted for inflation. [back to text] ABOUT THE AUTHOR Kevin L. Kliesen Kevin L. Kliesen is a business economist and research officer at the Federal Reserve Bank of St. Louis. His research interests include business economics, and monetary and fiscal policy analysis. He joined the St. Louis Fed in 1988. Read more about the author and his research. REGIONAL ECONOMIST | OCTOBER 1994 https://www.stlouisfed.org/publications/regional-economist/october-1994/riding-the-rails-a-look-at-light-rail-transit Riding the Rails: A Look at Light Rail Transit Adam M. Zaretsky The common joke in transportation circles is that people are really interested in getting their neighbors on public transit so they can drive their own cars on the open road. No one disputes the usefulness of public transportation, particularly in urban areas where dense populations cause tremendous congestion commuting to central business districts. To relieve this congestion, governments have often advocated the use of public transportation, arguing that it reduces pollution and the demand for energy at the same time. Thus, the development, construction and updating of mass transit systems— particularly light rail—have become major undertakings for many cities that see these systems as a cure-all for these traffic-related problems (see glossary for a definition of light rail and other transit terms). What Makes Public Transportation More Efficient? Compared with single-occupant automobiles, public transportation, especially rail systems, is a much more efficient way to move people around a metropolitan area. According to the American Public Transit Association (APTA), in measures of fuel efficiency, one full bus equals six autos, and one full rail car equals 15 cars. APTA concludes that 200 gallons of gasoline could be saved each year by every commuter who switches from driving alone to public transit; 85 million gallons could be saved from a 10 percent increase in transit ridership in the five largest U.S. cities; and 135 million gallons could be saved from a 10 percent nationwide increase in ridership.1 In terms of air pollution, APTA cites estimates that one person using mass transit instead of driving to work alone for one year reduces hydrocarbon emissions by 9.1 pounds, carbon monoxide emissions by 62.5 pounds and nitrogen oxide emissions by 4.9 pounds. Per passenger mile traveled, electric rail produces 99 percent less hydrocarbon and carbon monoxide emissions and 60 percent less nitrogen oxide emissions than a single-person auto. As for reducing congestion, one full 40-foot bus (about 70 passengers including standees) is the equivalent of 58 cars with an average of 1.2 passengers per car. This one bus is the equivalent of a line of autos that stretches six city blocks for traffic moving at 25 miles per hour.2 Comparing autos and heavy rail, where one full heavy rail car can accommodate about 180 people including standees, a train of six rail cars, holding about 1,080 passengers, is the equivalent of 900 automobiles. Thus, one full six-car heavy rail train is the same as a line of moving cars that stretches 95 city blocks for traffic operating at 25 miles per hour. As these statistics clearly show, public transportation is energy-efficient and capable of reducing congestion. Going From Here...To Where? Designing an effective public transportation system is more difficult than it used to be, as urban and suburban development has altered commuting patterns. Today, most commuting patterns are not from the suburbs or urban residential areas to a central business district, but are instead between points in the suburbs, as businesses have followed their work forces from downtowns to the suburbs. Although this change does not affect bus service much, as routes can be altered to match commuting patterns, rail service can be rendered obsolete because fixed routes cannot be altered quickly or cheaply. Yet, because rail transit is the most efficient mode of public transportation available, many metropolitan areas continue to construct new or update existing rail systems. In some instances, cities see development of a rail transit system as part of a larger development program aimed at luring industry. Without being able to showcase a modern and efficient rail system, cities often consider themselves behind the development curve. To prevent this, many cities, with aid from the federal government, have chosen to construct light rail systems. Accelerating Out of the Station Between 1984 and 1992, light rail, which is essentially an updated streetcar system, was the fastest-growing segment of railway systems, which also include heavy rail and commuter rail. One indicator of this nationwide growth is the number of transit vehicles in active service. From the 733 light rail vehicles operating in 1984, the number grew to 1,058 by 1992, a 44 percent increase.3 Over the same period, heavy rail vehicles increased only 13 percent, from 9,083 to 10,245. Commuter rail systems, meanwhile, added 338 vehicles, an 8 percent increase. Vehicle miles operated also demonstrates light rail's growth: Light rail went from 16.8 million vehicle miles in 1984 to 28.7 million vehicle miles in 1992, a 71 percent increase.4 In contrast, heavy rail, which has many more miles of laid track, increased only 21 percent, from 435.8 million vehicle miles operated to 525.4 million vehicle miles operated. Commuter rail increased 30 percent from 167.9 million to 218.7 million vehicle miles operated. The trend of passenger miles during this period is similar: Light rail increased 69 percent, from 416 million to 704 million passenger miles; heavy rail increased 6 percent, from 10,111 million to 10,737 million passenger miles; and commuter rail increased 18 percent, from 6,207 million to 7,342 million passenger miles.5 Some of the Stops Along the Way During the 1980s, seven light rail systems were built or significantly reconstructed, spurring the strong growth discussed earlier: San Diego (1981), Buffalo (1984), Portland (1986), Sacramento (1987), San Jose (1987), Los Angeles (1990) and Pittsburgh (1988). Two systems started up in the 1990s: Baltimore (1992) and St. Louis (1993). Many other cities are in various stages of development or construction (see map).6 Light Rail in America Light rail is booming. Besides the light rail proposals shown above, most of the cities with existing systems also have plans to expand. SOURCE: Phraner (1992) and U.S. Dept. of Transportation, Federal Transit Administration. Construction Costs The costs of construction vary by city, and as Table 1 shows, the cost per mile of track ranges from as little as $8.74 million in San Diego to as much as $88.33 million in Buffalo. Of course, costs depend on a variety of factors, not all of which are controllable by the development agency—land acquisition, for example. In some instances, an agency must purchase the land (or have the local government take the land through eminent domain), while in other cases, rights-of-way already exist or land is donated. The number and types of stations and the grade over which the system must travel also greatly affect costs. According to a 1991 report for the Urban Mass Transit Administration at the U.S. Department of Transportation, station construction costs can range from as little as $801,000 for a street-level station to as much as $16 million for a subway station. The report also shows that the average cost of constructing one mile of at-grade guideway is about $3.5 million, while constructing the same mile as a subway would cost $39.3 million. To put all this information in perspective, about 99 percent of San Jose's route miles are at-grade, while only 66 percent of Pittsburgh's are; Pittsburgh has 13 percent of its route miles as subway. In addition, San Jose's system has 22 stations, while Pittsburgh's has 13 stations. Thus, just because one city's construction cost per mile of track laid is lower than another's does not make the lower-cost city's system any better or worse. Operating Revenue One problem light rail systems face is that passenger revenue is never sufficient to cover operating costs, thereby requiring other revenue sources. Of the eight cities listed in the Table 1, San Diego recovers the greatest portion of operating costs from passenger revenue—70 percent—while San Jose recovers the smallest portion—12 percent. The average recovery rate for the eight cities is 33 percent. Thus, approximately two-thirds of a light rail's operating expense must be either raised through local taxes or subsidized by the government. Table 1 A Comparison of Recent Light Rail Systems Although it seems construction costs should increase with length, the chart shows this is not true. In fact, construction cost per mile of track varies dramatically by city. In addition, recovery rates from fare revenue for most cities are only one-third of operating cost. SOURCE: Tipton (1994). [back to text] According to APTA, nationwide transit revenue received as assistance from a government agency between 1984 and 1992 increased from 55 percent to 58 percent of total revenues, and this while passenger revenue was increasing; it grew by 39 percent to about $6.2 billion.7 At the same time, total government assistance, which includes subsidies, taxes levied directly by the transit system, bridge and tunnel tolls and nontransit parking lot revenue, increased 48 percent to almost $9.5 billion. Federal government assistance, however, declined 3 percent over this period, shifting a growing portion of the burden to local and state governments. Although this may translate into declining dollar amounts for transit agencies, it definitely results in a declining purchasing power of these dollars. For example, the Bi-State Development Agency, operator of mass transit in the St. Louis metropolitan area, reports in its fiscal year 1995 budget that federal assistance to the agency has remained relatively stable since 1988, at about $10.1 million per year. The purchasing power of these dollars, however, has not remained stable. In 1988 dollars, the agency's federal assistance has fallen from $10.4 million in 1988 to $8 million in 1994. Government assistance may relieve the symptom but does not cure the disease: Nationwide passenger revenue received between 1984 and 1992 was not sufficient to cover vehicle operating expenses. In fact, passenger revenue in 1992 accounted for only 37.5 percent of total revenue and covered only 82 percent of vehicle operating expense.8 Thus, one might question the feasibility of these rail systems if they cannot generate enough revenue to cover their operating costs. Should They Operate If They Must Be Subsidized? As economic theory tells us, a firm should generally not continue to operate if it cannot generate enough revenue to cover its operating costs. In some sense, then, government is subsidizing an operation that should shut down. Of course, one response to this argument is that the rail system's direct operating costs are not adjusted for the indirect savings from lower energy consumption and the lessening of pollution and congestion. In addition, public transit contributes a positive by product by providing affordable transportation for those who cannot afford other means of transport, like owning a car or taking a taxi. Although these adjustments to operating expenses are not directly measurable, they can play an important role in determining the viability of a system. Another potential solution to the passenger revenue problem is to raise the fare. Unfortunately, this does not usually work. Suppose, for example, that because the system is not earning enough revenue, its administration decides to increase the adult basic fare. In the beginning, ridership will decline, but not by too much because workers cannot quickly make new arrangements to get to work. Thus, rider demand is said to be inelastic, with the result being that, even though ridership falls somewhat, revenue increases. Over time, however, as workers do make other arrangements, ridership typically falls even more. In fact, in the long run, rider demand is said to be very elastic, and the result is that the decline in ridership overwhelms the fare increase, resulting in a revenue decline.9 This decline then leads to larger government subsidies once again. Ridership Problems Total passenger revenue, of course, depends on the level of ridership, and as the remark at the beginning of the article indicates, many people believe that public transit is a great idea for someone else. Even in the nation's most congested urban areas, usage levels do not reach much beyond 50 percent of workers.10 New York City, at about 53 percent, had the highest percentage of workers using public transportation in 1990, according to the Census Bureau. Usage percentages fall precipitously, however, as one looks down the list: Albany, NY, with the lowest percentage among the 26, saw only 15 percent of workers riding public transit. Of the 26 cities with the highest percentage, 16 are in the Northeast or on the Eastern Seaboard, which could indicate that there are regional differences in attitude toward public transit, that transit systems are more prevalent in these regions or that these areas are older and more congested. One of the causes of these low percentages is that people tend to drive to work alone. According to national data from the Federal Highway Administration, more than 73 percent of all commuters in 1990 traveled in single-occupant automobiles.11 Only 5 percent listed public transit as their primary means of commuting. Perhaps this is changing, however: An upward trend for ridership on the nation's light rail systems has occurred since 1986. Unlinked passenger trips on light rail have grown from 130 million in 1986 to 189 million in 1992, a 45 percent increase. Meanwhile, ridership on commuter rail increased only 3 percent, and ridership on heavy rail actually declined 5 percent. Not unexpectedly, ridership patterns differ from city to city. In most cases, actual ridership has fallen far short of the projected figures. This is important because, in many instances, local development agencies use ridership projections to convince the Urban Mass Transit Administration of the department of Transportation that their rail projects are worthy of government assistance. For example, Pittsburgh originally projected almost 90,000 passengers each week day; its preliminary counts showed about 20,000. Other cities, like Buffalo, Portland and Sacramento, exhibit similar trends, although not as dramatic. In contrast, St. Louis' MetroLink has performed better than preliminary projections said it would: Weekday ridership averaged about 26,000 passengers during the first year—about 53 percent greater than the projected 17,000 passengers. This led the Bi-State Development Agency to revise its projections upward, especially because MetroLink's airport station had yet to open. According to the Agency's fiscal year 1995 budget, the preliminary engineering estimate for ridership in 1995 was 5.3 million total passengers. The new projection for 1995 is now for 8.5 million riders—a 23 percent increase over 1994's 6.9 million expected riders. Metro Link still recovers only about 34 percent of its operating costs from passenger revenue, however. Thus, even light rail success stories are subject to the reality that overall usage levels are low. Since We've Built It, Can We Make Them Come? Getting commuters to use public transit as their primary means of transportation clearly presents a significant problem. Recent legislation aimed at curbing pollution levels in most major metropolitan areas could change this. Removing the tax-deductibility of employer-paid parking subsidies, thereby making workers bear the full cost of parking in downtown areas, and requiring the use of higher-priced alternative fuels instead of regular gasoline in certain cities to control smog levels both provide incentives that make public transportation more desirable. Both policies attempt to increase the money cost of commuting for single-occupant vehicles enough to encourage workers to accept public transit as a viable alternative. Last Stop: City Hall Despite the many problems that still exist in moving people from their cars to the trains, cities continue to build bigger and more sophisticated rail systems, partly because the federal government is willing to dole out the money to support these projects and partly because local leaders see a modern, efficient rail system as a selling point to attract business. How effective a rail system becomes, though, depends heavily on the commuting patterns of the area and the ability of industry to locate along the rail line in the future. One of the major reasons Washington, D.C.'s Metro is considered relatively successful is because businesses were able to locate themselves along the line, giving easy access to customers and workers.12 Growth like this, though, must be carefully planned by local development agencies. If the corridors chosen for rail construction do not match either the commuting patterns of workers or the areas amenable to future industry expansion, cities will end up with little more than expensive tourist movers paid for with government dollars. Glossary of Transit Terms Adult Base Fare Basic fare paid by one person for one ride; excludes transfer, zone and express service charges, peak period surcharges and reduced fares. Commuter Rail Railroad local and regional passenger train operations between a central city, its suburbs, and/or another central city. May be locomotive-hauled or self-propelled and is generally characterized by multitrip tickets, specific station-to-station fares, railroad employment practices, and only one or two stations in the central business district. Also known as "suburban rail." Fixed Route Service provided on a repetitive, scheduled basis along a specific route with vehicles picking up and discharging passengers at specific locations. Heavy Rail An electric railway with the capacity for a heavy volume of traffic and characterized by exclusive rightsof-way, multi-car trains, high speed and rapid acceleration, sophisticated signaling and high platform loading. Also known as "subway," "elevated (railway)" or "metropolitan railway (metro)." Light Rail An electric railway with a light volume traffic capacity. May use exclusive or shared rights-of-way, high or low platform loading, and multi-car trains or single cars. Also known as "streetcar," "trolley car" or "tramway." Operating Assistance Financial assistance for transit operations (not capital expenditures). Such aid may originate with federal, local or state governments. Passenger Miles Number of miles traveled by passengers determined by multiplying the number of unlinked passenger trips by the average length of their trips. Passenger Revenue Money, including fares and transfer, zone and park-and-ride parking charges, paid by transit passengers; also known as "farebox revenue." Rapid Transit Rail or motor bus transit service operating over a completely grade-separated exclusive right-of-way. Revenue Passenger Trips The number of fare-paying transit passengers with each person counted once per trip; excludes transfer and non-revenue trips. Ridership See unlinked passenger trips. Total Operating Expense The sum of vehicle operations, vehicle maintenance, nonvehicle maintenance, general administration and purchased transportation. Unlinked Passenger Trips Number of vehicle boardings, including charter and special trips. Each passenger is counted each time that person boards a vehicle. Vehicle Maintenance Expense Expense of labor, materials, services and equipment used to repair and to service transit vehicles and service vehicles. Vehicle Miles Operated Sum of miles traveled by passenger vehicles, including mileage when no passengers are carried. Each vehicle is counted separately: an eight-vehicle train operating for one mile equals eight vehicle miles. Vehicle Operations Expense Expense for labor, materials, fees and rents required for operating transit vehicles and passenger stations including fuels for vehicle propulsion except electric propulsion power. [back to text] Thomas A. Pollmann provided research assistance. Endnotes 1. American Public Transit Association (1993), p. 17. [back to text] 2. See APTA (1993), p. 19. [back to text] 3. APTA (1993), p. 82. [back to text] 4. APTA (1993), p.79. [back to text] 5. APTA (1993), p.78. [back to text] 6. See Schumann (1992) for more information about light rail in these cities. [back to text] 7. APTA (1993), p. 51. [back to text] 8. APTA (1993), pp. 44-45 and 51. [back to text] 9. Ridership on commuter rail is more than twice as elastic in the long run as in the short run. See Voith (1991). [back to text] 10. APTA (1993), p. 77. [back to text] 11. APTA (1993), p. 76. [back to text] 12. Although Washington D.C.'s Metro system only dates back to the mid-1970s, its heavy rail ranked No. 2 behind New York's subway in the number of unlinked passenger trips in 1992. [back to text] References American Public Transit Association. 1993 Transit Fact Book, Washington, D.C. (1993). Bi-State Development Agency. FY1995 Budget, St. Louis, Mo. (1994). Phraner, S. David. "Vintage Trolleys: A National Overview," in Light Rail Transit: Planning Design and Operating Experience, Transportation Research Record No. 1361, National Academy Press (1992). Rutherford, G. Scott. "Light Rail Heavy Politics," Pacific Northwest Executive (October 1989). Schumann, John W. "Status of North American LRT Systems: 1992 Update," in Light Rail Transit: Planning, Design, and Operating Experience, Transportation Research Record No. 1361, National Academy Press (1992). Tipton, Virgil. "After A Year On The Job, Metro Link Toots Its Horn," St. Louis Post-Dispatch (July 31, 1994). U.S. Department of Transportation. Urban Mass Transportation Administration. UMTA Technical Assistance and Safety Program Office of Technical Assistance and Safety. Light Rail Transit Capital Cost Study, Prepared by Booz-Allen & Hamilton Inc. (April 5, 1991). Voith, Richard. "The Long-Run Elasticity of Demand for Commuter Rail Transportation," Journal of Urban Economics 30 (1991), pp. 360-72. REGIONAL ECONOMIST | OCTOBER 1994 https://www.stlouisfed.org/publications/regional-economist/october-1994/news-bulletins-from-the-eighth-federal-reserve-district Pieces of Eight: News Bulletins from the Eighth Federal Reserve District What's Driving the Bond Market? Conventional wisdom says that the demand for bonds is driven by the strength of the economy. According to St. Louis Fed economist David C. Wheelock, however, it's inflation—and the economy—that's recently been driving the bond market. "For the past 30 years, as inflation increased, the real value of bond interest payments decreased and, thus, the demand for bonds declined," says Wheelock. Recent history suggests, therefore, that although the bond market may dislike a strong economy, it always hates inflation. For more information, call 314-444-8808 and request a copy of the October issues of Monetary Trends. Beige Book Available on FRED® Eight times a year, St. Louis Fed economists take the economic pulse of the region by talking with Eighth District business leaders. This information is used to create the Beige Book, a summary of the 12 Federal Reserve districts' economic conditions for use by the Federal Open Market Committee (FOMC) in its deliberations on monetary policy. The report is released approximately two weeks prior to each FOMC meeting. Beginning this month, the Beige Book's most recent national and Eighth District economic summaries are available by accessing FRED (Federal Reserve Economic Data), the St. Louis Fed's up-to-the-minute electronic bulletin board. Besides the Beige Book, FRED contains more than 300 daily, weekly, monthly and quarterly data series. FRED allows you to browse through the data, print from the screen or download the data onto a diskette. The service is free—you pay only for the telephone call. To access FRED through a modem, dial 314-621-1824. For more information, call Tom Pollmann at 314-444-8562. Will Retiring Baby Boomers Doom the U.S. Economy? As the first round of baby boomers approaches retirement, Americans are beginning to wonder: How will the retirement of the baby boom generation affect the U.S. economy? St. Louis Fed economist Peter Yoo examines this question by studying the relationship between demographic changes and economic growth in the current issue of the Review, the St. Louis Fed's bimonthly economics journal. In a life-cycle, individuals retire and consume their savings. This implies that if a large fraction of the population is retired, society will save less and economic growth may be stunted. According to Yoo, however, this is not necessarily true. His research suggests that the mere retirement of the baby boom generation will not means lower economic growth or a diminished standard of living. For more information, please call Debbie Dawe at 314-444-8809 and request a copy of the September/October Review. Per Capita Tax Burdens in Eighth District States, 1992 Rank Among 50 States District State Local and State Tax Burden 14 Illinois $2,201.82 35 Indiana 1,785.02 39 Kentucky 1,754.60 41 Missouri 1,664.95 47 Arkansas 1,514.46 48 Tennessee 1,471.67 50 Mississippi 1,323.11 SOURCE: Public Policy Institute ! Regional Economist October 1994 Selected economic indicators of banking, agricultural and business conditions in the Eighth Federal Reserve District Data Commercial Bank Performance Ratios U.S., District and State All U.S. U.S. District <$15B1 AR IL IN KY MS MO TN Return on Average Assets (Annualized) 2nd quarter 1994 1.16% 1.28% 1.26% 1.32% 1.24% 1.10% 1.26% 1.24% 1.25% 1.33% 1st quarter 1994 1.15 1.27 1.24 1.28 1.24 1.06 1.24 1.22 1.23 1.33 2nd quarter 1993 1.19 1.22 1.27 1.43 1.49 1.27 1.04 1.41 1.20 1.35 Return on Average Equity (Annualized) 2nd quarter 1994 14.80% 14.90% 14.68% 14.35% 12.81% 11.72% 14.41% 13.57% 15.77% 17.00% 1st quarter 1994 14.69 14.79 14.46 13.99 12.77 11.23 14.19 13.28 15.49 17.11 2nd quarter 1993 15.45 14.75 15.11 15.96 16.00 13.71 12.34 15.42 15.13 17.92 Net Interest Margin (Annualized) 2nd quarter 1994 4.19% 4.40% 4.04% 3.97% 3.99% 4.00% 4.11% 4.40% 3.90% 4.19% 1st quarter 1994 4.10 4.60 4.26 4.26 4.37 4.23 4.25 4.63 4.11 4.35 4.49 4.84 4.55 4.57 4.94 4.49 4.31 4.96 4.40 4.72 2nd quarter 1994 1.61% 1.36% 0.78% 0.77% 1.00% 0.58% 0.84% 0.79% 0.72% 0.70% 1st quarter 1994 1.86 1.53 0.82 0.83 1.14 0.57 0.78 0.82 0.77 0.84 2nd quarter 1993 2.63 1.99 1.07 0.93 1.24 0.77 1.16 1.01 1.11 1.04 2nd quarter 1994 0.51% 0.45% 0.17% 0.10% 0.28% 0.12% 0.23% 0.12% 0.07% 0.33% 1st quarter 1994 0.46 0.41 0.16 0.12 0.25 0.09 0.24 0.12 0.07 0.28 2nd quarter 1993 0.84 0.72 0.39 0.12 0.41 0.21 0.46 0.38 0.46 0.50 2nd quarter 1994 2.34% 2.12% 1.74% 1.52% 1.74% 1.49% 1.68% 1.77% 1.92% 1.79% 1st quarter 1994 2.43 2.19 1.77 1.58 1.79 1.53 1.69 1.77 1.94 1.86 2nd quarter 1993 2.57 2.32 1.81 1.63 1.82 1.50 1.74 1.73 1.93 2.06 2nd quarter 1993 Nonperforming Loans / Total Loans 2 Net Loan Losses / Average Total Loans (Annualized) Loan Loss Reserve 4Total Loans NOTE: Data include only that portion of the state within Eighth District boundaries. U.S. banks with average assets of less than $15 billion are shown separately to make comparisons with District banks more meaningful, as there are no District banks with average assets greater than $15 billion. 2 Includes loans 90 days or more past due and nonaccrual loans SOURCE: FFIEC Reports of Condition and Income for Insured Commercial Banks 15 Commercial Bank Performance Ratios by Asset Size 2nd Quarter 1994 Earnings Asset Quality D = District <$100 Million $300 Million - $1 Billion US = United States $100 Million - $300 Million $1 Billion-$15 Billion NOTE: Asset quality ratios are calculated as a percent of total loans. 1 2 3 Loan losses are adjusted for recoveries Includes loans 90 days or more past due and nonaccrual loans Interest income less interest expense as a percent of average earning assets SOURCE: FFIEC Reports of Condition and Income for Insured Commercial Banks 16 ! Regional Economist October 1994 Agricultural Bank Performance Ratios U.S. AR IL 2nd quarter 1994 1.25% 1.21% 1.20% 1st quarter 1994 1.23 1.19 2nd quarter 1993 1.36 IN KY MS MO TN 1.14% 1.34% 1.52% 1.33% 1.23% 1.13 1.29 1.32 1.47 1.30 1.14 1.37 1.33 1.26 1.32 1.53 1.48 1.31 Return on average assets (annualized) Return on average equity (annualized) 2nd quarter 1994 12.45% 11.56% 11.50% 11.17% 13.63% 14.72% 13.38% 12.14% 1st quarter 1994 12.24 11.28 10.93 12.25 13.47 13.94 13.20 10.95 2nd quarter 1993 13.90 13.09 13.02 13.12 13.90 15.21 15.41 13.43 Net interest margin (annualized) 2nd quarter 1994 4.10% 1st quarter 1994 4.42 4.11 2nd quarter 1993 4.60 4.38 3.89% 3.70% 4.25% 4.12% 4.58% 4.10% 4.06 4.55 4.36 4.82 4.38 4.16 4.25 4.89 4.37 5.20 4.64 4.64 3.89% Ag loan losses / average ag loans (annualized) 2nd quarter 1994 0.09% 0.60% -0.09% -0.04% 0.01% 0.18% 0.21% -0.02% 1st quarter 1994 0.02 0.63 0.02 -0.07 -0.05 0.04 0.19 -0.05 0.16 0.33 0.18 0.48 0.12 1.11 0.56 3.06 2nd quarter 1994 1.31% 0.93% 1.33% 1.35% 2.03% 3.07% 0.91% 0.28% 1st quarter 1994 1.53 1.04 1.69 0.24 1.62 4.91 1.15 0.19 2nd quarter 1993 1.73 0.81 1.80 1.73 1.91 3.99 1.20 0.68 2nd quarter 1993 1 Ag nonperforming loans / total ag loans NOTE: Agricultural banks are defined as those banks with a greater than average share of agricultural loans to total loans. Data include only that portion of the state within Eighth District boundaries. 1 Includes loans 90 days or more past due and nonaccrual loans SOURCE: FFIEC Reports of Condition and Income for Insured Commercial Banks U.S. Agricultural Exports by Commodity Dollar a m o u n t s i n billions Commodity Apr May June Livestock & products .68 .69 .70 6.13 25.3% Corn .27 .22 .26 2.97 -12.2 Cotton .25 .29 .27 1.77 40.1 Rice .08 .09 .08 .71 20.4 Soybeans .25 .19 .19 3.51 -10.8 Tobacco .17 .14 .09 1.08 -11.5 Wheat .27 .31 .26 3.06 -16.9 3.45 3.55 3.30 33.29 -0.2 1 TOTAL 1 Year-to-date Change from year ago Includes commodities not listed here Indexes of Food and Agricultural Prices Growth1 Level II/94 I/94 II/93 I/94-II/94 142 148 143 -14.5 -0.9 Arkansas 135 -3.9 104 136 107 121 Illinois3 100 -11.9 11.6 4.3 Indiana Missouri 119 123 143 109 137 138 -13.3 -14.1 8.8 -0.7 Tennessee 146 149 143 -7.8 2.1 Production items 184 180 196 2.2 4.1 2.0 Consumer food prices 200 143 181 198 6.8 Other items4 141 Consumer nonfood prices 148 143 147 1.6 2.7 2.0 2.5 Prices received by U.S. farmers II/93-II/94 Prices received by District farmers2 Prices paid by U.S. farmers 145 NOTE: Data not seasonally adjusted except for consumer food prices and nonfood prices. 1 Compounded annual rates of change are computed from unrounded data. Index of prices received for all farm products (1977=100). Indexes for Kentucky and Mississippi are unavailable. 2 3 (1987-91 = 100) for 1993; (1988-92=100) for 1994 4 Other items include commodities, services, interest, taxes and wages. 17 Selected U.S. and State Business Indicators Compounded Annual Rates of Change in Nonagricultural Employment United States II/1994 I/1994 II/1993 Labor force (in thousands) 130,590 130,674 127,890 Total nonagricultural employment (in thousands) 112,995 111,976 110,251 Unemployment rate 6.1% 6.6% 6.9% I/1994 IV/1993 I/1993 Real personal income* (in billions) $3,791.1 $3,761.0 $3,658.0 Arkansas II/1994 I/1994 II/1993 Labor force (in thousands) 1,206.9 Total nonagricultural employment (in thousands) 1,011.0 Unemployment rate 5.5% 1,201.7 1,162.0 1,005.4 987.8 5.2% 6.3% I/1994 IV/1993 I/1993 Real personal income* (in billions) $28.0 $27.7 $27.3 Illinois II/1994 I/1994 II/1993 Labor force (in thousands) 6,089.2 Total nonagricultural employment (in thousands) 5,391.9 Unemployment rate 5.5% 6,047.3 6,015.2 5,392.6 6.3% 5,304.6 8.0% I/1994 IV/1993 I/1993 Real personal income* (in billions) $187.2 $185.8 $179.8 Indiana II/1994 I/1994 II/1993 Labor force (in thousands) 3,008.6 Total nonagricultural employment (in thousands) 2,632.8 Unemployment rate 4.8% 3,009.3 2,918.8 2,624.4 5.2% 2,587.0 5.5% I/1994 IV/1993 I/1993 Real personal income* (in billions) $78.5 $77.5 $75.0 18 ! Regional Economist October 1994 Kentucky II/1994 I/1994 II/1993 Labor force (in thousands) 1,794.7 Total nonagricultural employment (in thousands) 1,550.5 Unemployment rate 4.8% 1,810.6 1,794.6 1,546.5 1,530.6 4.9% 6.2% I/1994 IV/1993 I/1993 Real personal income* (in billions) $46.2 $45.8 $44.2 Mississippi II/1994 I/1994 II/1993 Labor force (in thousands) 1,239.0 Total nonagricultural employment (in thousands) 1,019.4 Unemployment rate 7.0% 1,219.0 1,213.7 1,003.2 1,005.7 6.9% 6.5% I/1994 IV/1993 I/1993 Real personal income* (in billions) $27.9 $27.5 $27.0 Missouri II/1994 I/1994 II/1993 Labor force (in thousands) 2,652.2 Total nonagricultural employment (in thousands) 2,459.1 Unemployment rate 4.9% 2,649.5 2,651.5 2,444.7 5.6% 2,389.2 6.4% I/1994 IV/1993 I/1993 Real personal income* (in billions) $72.5 $71.7 $70.1 Tennessee II/1994 I/1994 II/1993 Labor force (in thousands) 2,638.6 Total nonagricultural employment (in thousands) 2,386.3 Unemployment rate 4.6% 2,601.8 2,496.2 2,374.0 5.5% 2,320.9 5.8% I/1994 IV/1993 I/1993 Real personal income* (in billions) $67.6 Total Manufacturing $66.8 $63.9 Construction Government General Services Finance, Insurance and Real Estate Transportation, Communication and Public Utilities Wholesale/Retail Trade NOTE: All data are seasonally adjusted. The nonagricultural employment data reflect the 1993 benchmark revision. * Annual rate. Data deflated by CPI, 1982-84=100. 19
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