Full text of The Southwest Economy : Second Quarter 2011

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Second quarter 2011

SouthwestEconomy
FEDERAL RESERVE BANK OF DALLAS

In This Issue
On the Record:
Mexico’s Economic
Reforms Propel
Postrecession Rebound
Bank Profits Rebound
as Loss Set-Asides Ease
Spotlight: Completing
the Regional Economic
Picture
Sizing Up Nanoelectronics:
Gauging the Potential for
New Productivity Wave

Texas Housing on Bumpy Road
After Stimulus Effects Fade

President’sPerspective
I

In an increasingly
globalized world,
geography still matters,
and to keep tabs on the
Texas economy, we must
study and nurture
our ties to Mexico.

have a special fondness for Mexico and its
people. I spent several of my formative years
there, learning the nation’s history, culture and
language. During my career, I have maintained
ties to our southern neighbor. From 1997 to
2001, I served as deputy U.S. trade representative, working closely with the Mexican government to help realize the benefits of the North
American Free Trade Agreement (NAFTA).
U.S.–Mexico trade surged in the wake of
NAFTA, which took effect in January 1994, and
much of that growth has benefited Texas. Mexico is Texas’ largest trading partner, responsible
for 34 percent of the state’s exports. Laredo and
El Paso handle 57 percent of all U.S.–Mexico
land-based trade. In an increasingly globalized
world, geography still matters, and to keep tabs
on the Texas economy, we must study and nurture our ties to Mexico.
To that end, the Federal Reserve Bank of
Dallas has developed and maintained a longstanding relationship with our partners at Banco
de México. Through regional meetings, informal
exchanges, conferences and shared research interests, we help contribute to the Federal Reserve System’s knowledge of the Mexican economy and to the Dallas Fed’s regional
perspective. Guillermo Ortiz, former governor of Banco de México and Mexican
secretary of finance, serves on the advisory board of the Dallas Fed’s Globalization
and Monetary Policy Institute.
Earlier this year, we were fortunate to host Banco de México Governor Agustín
Carstens to discuss economic growth, trade and monetary policy. In a conversation with Governor Carstens in this issue of Southwest Economy, readers will gain a
greater understanding of how Mexico’s fiscal, monetary and banking reforms helped
our neighbor’s economy rebound quickly from the recent recession.
Needless to say, Mexico has come a long way since my childhood years in
Mexico City. Macroeconomic growth and stability, established after the 1994 peso
crisis, have allowed Mexico to pursue reforms essential to improving the lives of its
citizens. That we now compare Mexico to other developed economies is a tremendous achievement and reflects the work of diligent and dedicated public servants
such as Governor Carstens.

Richard W. Fisher
President and CEO
Federal Reserve Bank of Dallas

Texas Housing on Bumpy Road
After Stimulus Effects Fade
By D’Ann Petersen and Adam Swadley

Tdrums
exas’ housing sector remains in the dolfollowing demand spikes in 2009

For a large proportion
of Texas buyers, the tax
credits were not the deciding
factor but a perk of buying
sooner—a shift that tended
to diminish sales following
the programs’ expiration
and weaken the market.

and 2010 aided by the homebuyer taxcredit program. When the federal government first offered the incentive in mid-2008,
Texas home sales and construction were
in a rapid descent that began with the
U.S. housing crisis and accelerated when
the state joined the nation in recession. As
part of broader housing measures, a series
of three homebuyer tax credits sought to
reduce bloated inventories and arrest freefalling home values—a condition felt more
profoundly at the national level than in
Texas.
How effective were the tax credits at
stabilizing the troubled housing market? National housing experts have offered wideranging estimates of the number of sales
the credits spurred, but no such figures exist at the state level. We attempt to measure
roughly how many Texas sales occurred as
a direct result of the tax credits—and what
proportion would have occurred anyway
but were accelerated to take advantage of
the program. Assuming the shift in purchases was substantial—and we believe it
was—we consider how long subsequent
sales might be diminished and whether current weakness can be attributed to it.
Our analysis reveals that the homebuyer tax credits, by bringing homeownership more within reach, likely induced a
modest share of Texas sales that would not
have otherwise occurred. However, a larger
proportion of transactions involved buyers
already planning to purchase who moved
ahead to take advantage of the credits. Of
course, some sales would have taken place
regardless of the credits in response to relatively low mortgage rates and affordable
prices or personal circumstances.
Texas’ relatively strong economy may
have contributed to sales as well. The state
had just entered recession when the first
credit was enacted, half a year after the U.S.
economy turned down in December 2007.
For a large proportion of Texas buyers, the

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

3

tax credits were not the deciding factor
but a perk of buying sooner—a shift that
tended to diminish sales following the programs’ expiration and weaken the market.
By the time the first credit was enacted
in July 2008, house prices had tumbled
in some of the hardest-hit states, including California, down 19.1 percent from the
national peak in 2006–07; Arizona, off 11.1
percent; and Nevada, down 15 percent.1
Texas prices actually increased a modest 1.3
percent over the period.2
Texas boasts a large supply of land and
has fewer building regulations. Thus, it has
larger swings in construction during booms
and busts—and less price volatility—than
many other states. Although Texas prices
held up relatively well, sales and construction were severely affected in the housing
bust’s initial years. Would-be Texas homebuyers—spooked by spiraling home values
nationally and reduced household wealth
from the U.S. financial crisis—put purchasing a home at the bottom of their to-do lists.
As in the nation, the homeownership rate in
Texas edged down and inventories swelled.

A Brief Look at Homebuyer Tax Credits
Table 1 provides a synopsis of the
three homebuyer credits covering home
purchases from April 2008 to September
2010.3 The Housing and Economic Recovery Act of 2008 (HERA) tax credit allowed
first-time purchasers a tax credit of up to
$7,500 and required them to repay the credit over 15 years. The second version, under
the American Recovery and Reinvestment
Act of 2009 (ARRA), removed the repayment requirement and changed the credit to
10 percent of a home’s price, up to a maximum of $8,000. The final version, under
the Worker, Homeownership, and Business
Assistance Act of 2009 (WHBAA), was more
inclusive, extending the time frame for the
ARRA credit for first-time homebuyers and
also allowing repeat homebuyers a credit of
up to $6,500. The final version also boosted
income limits.

SouthwestEconomy

Table 1
Homebuyer Tax Credit Programs Summarized
HERA (July 2008)

ARRA (February 2009)

WHBAA (November 2009)

Yes

Yes

No

$7,500

$8,000

$8,000/$6,500

Single: $75,000 to $95,000
Joint: $150,000 to $170,000

Single: $75,000 to $95,000
Joint: $150,000 to $170,000

Single: $150,000 to $175,000
Joint: $225,000 to $245,000

Repayable

Yes

No

No

Refundable

Yes

Yes

Yes

4/9/2008–12/31/2008

1/1/2009–11/6/2009

11/7/2009–9/30/2010

No

No

$800,000

First-time buyers only
Maximum credit
Income phase-out
range

Applicable dates
Maximum purchase
price

NOTES: HERA=Housing and Economic Recovery Act of 2008; ARRA=American Recovery and Reinvestment Act of 2009; WHBAA=Worker,
Homeownership, and Business Assistance Act of 2009.
SOURCE: “An Economic Analysis of the Homebuyer Tax Credit,” by Mark P. Keightley, Congressional Research Service, December 2009.

Chart 1
Home Sales, Construction Spike During Tax-Credit Period
Index, January 2000 = 100

Number, seasonally adjusted

200

30,000
Tax credit period

Tax credit period

170

25,000

140

20,000

110

15,000

80

Texas existing-home sales**

10,000

U.S. existing-home sales**

Texas single-family permits

Texas permits*
50

20

Texas existing-home sales

U.S. permits*

5,000

0
’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11

’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11

*Five-month moving average. **Six-month moving average.
NOTES: Vertical dashed lines represent tax credit expiration dates; shaded areas extend to closing dates.
SOURCES: Census Bureau; National Association of Realtors; Texas A&M Real Estate Center; seasonal adjustment by the Federal Reserve
Bank of Dallas.

Activity Spikes in Tax-Credit Period
The homebuyer tax credits appear to
have helped Texas’ housing industry, even if
only temporarily. Monthly data show existinghome sales and new-home construction
spiked with the tax-credit programs (Chart 1).
New-home sales data are not available at the
state level; single-family construction permits
serve as a good proxy. During the first years

of the national housing crisis, Texas builders
cut back sharply. By the time the tax credits
were instituted, new-home inventories were
relatively low, unlike existing inventories,
which were elevated. Thus, the tax incentives
spurred activity as builders added inventory
to meet increased buyer traffic.
Annual data for Texas show a decelerating pace of sector decline from 2009 to 2010

SouthwestEconomy 4

(–0.7 percent for new-home permits and –5.5
percent for existing-home sales), following
much larger reductions in the prior years
(Table 2). It’s difficult to separate whether
the leveling off in housing activity resulted
from the government’s tax-relief efforts or the
improving state economy in late 2009. Either
way, it was welcome news for an industry
entering its fifth down year.

Incentive Prompts Some Texas Sales
The temporary Texas housing activity
pickup coincided with the last two taxcredit programs—the ARRA and WHBAA
plans, which likely produced a greater
impact than the first credit, requiring buyer
repayment. Several government and privatesector analysts have estimated the number
of additional sales nationally attributable to
the ARRA and WHBAA; we extend these
estimates by looking specifically at Texas.
We closely followed the approach used
in a Congressional Research Service (CRS)
report that examined the impact of the tax
credits on U.S. housing demand.4 As a starting
point, we reproduced U.S. estimates using the
CRS methodology and achieved comparable
results.5
For our first look at the incentives’ effect
in Texas, we adhere to CRS’s methodology
exactly as it was applied in its U.S. review but
use Texas seasonally adjusted existing-home
sales data and Texas single-family home permits as a proxy for new-home sales (Table 3,
Scenario 1).6 Three sets of transactions are
calculated, reflecting a range of price elasticities for housing.7 The elasticities estimate the
sensitivity of home sales given a change in
price.8 We then adapt the analysis under two
additional scenarios, each assuming different
month-over-month sales growth rates.
In the first of the two additional views
(Scenario 2), we consider a situation in which
Texas home sales continue slipping as they
did in 2008 by assuming that the monthover-month sales growth rates are the same
as in 2008. In the next exercise (Scenario 3),
we assume that home sales return to a more
normal pattern, in which month-over-month
sales growth rates equal their average from
2000 to 2008. The Texas estimations using our
assumptions (Scenarios 2 and 3) are slightly
more conservative than those produced using
the CRS methodologies (Scenario 1 in Table
3) but are still very similar.
We looked separately at Texas home
sales from February 2009 to September 2010,
the final closing date for the tax credit program. According to our estimates, total sales

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

exceeded what would have been achieved
at 2008 month-over-month growth rates
(Scenario 2) by 126,275 units and surpassed
what would have been achieved at 2000–08
average month-over-month growth rates
(Scenario 3) by 92,251 units.
Combining these figures with the sum
of estimates in Table 3 suggests that if sales
occurred at the 2008 rate, 5 to 14 percent of
additional Texas sales over that 20-month
period could be attributed exclusively to
the tax credits’ impact on improved home
affordability. That leaves 86 to 95 percent of
additional sales attributable to buyers who
shifted forward their planned purchase in
order to take advantage of the tax credit.
Similarly, assuming 2000–08 sales activity, 7 to 21 percent of induced purchases can
be attributed to the tax credits. This implies
that the remaining 79 to 93 percent were
buyers already in the market, anticipating a
purchase (Table 4).
The large sales drop immediately following expiration of the final tax credit supports the idea that many purchasers simply
changed their timing. We estimate conservatively that the negative effects of shifted
demand on Texas home sales and construction will trail off between now and the end
of 2011.9 This is consistent with the views of
housing-sector contacts in the Federal Reserve Bank of Dallas' Beige Book, who expect to see market improvement in the latter
half of 2011 or early 2012.10

Table 2
Texas Construction, Sales Fall at Slower Pace in 2009 and 2010
Year

Permits

Percent change

Existing-home sales

Percent change

2004

142,153

8.0

239,111

10.8

2005

162,414

14.3

267,130

11.7

2006

159,822

–1.6

293,268

9.8

2007

116,758

–26.9

275,347

–6.1

2008

77,625

–33.5

231,450

–15.9

2009

65,845

–15.2

213,644

–7.7

2010

65,376

–0.7

201,936

–5.5

SOURCES: Census Bureau; National Association of Realtors; Texas A&M Real Estate Center; seasonal adjustment by the Federal Reserve
Bank of Dallas.

Table 3
Estimated Additional Texas Home Sales Due to Tax Credits
Scenario

1. Number of sales equal to 2008
levels (Congressional Research
Service)

2. Sales continue to slump at 2008
monthly growth rates

3. Sales return to "normal" pace
of 2000–08 average monthly
growth rates

Elasticity

ARRA (02/09–10/09)

WHBAA (11/09–09/10)

–0.5

2,881

5,160

–1.0

5,762

10,320

–1.5

8,643

15,479

–0.5

1,898

3,980

–1.0

3,797

7,960

–1.5

5,695

11,941

–0.5

1,944

4,706

–1.0

3,887

9,411

–1.5

5,831

14,117

Price Recovery Elusive

NOTE: An elasticity of –0.5 implies that a 1 percent reduction in price leads to a 0.5 percent increase in quantity of homes demanded.
Other elasticities are interpreted similarly.

When the tax credits were approved,
Texas home values hadn’t eroded as they
had elsewhere in the U.S. (Chart 2). However, Texas home prices fell in 2008 and
were largely unchanged during the taxcredit period, according to the Federal
Housing Finance Agency (FHFA) purchaseonly home price index.11
The median price for an existing
home in Texas was $150,527 at the end of
the program last September, virtually unchanged from $150,947 in June 2008, before
the first version was enacted.12
Since the expiration, however, Texas
and national home prices have slipped.
Texas values dropped 2 percent in first
quarter 2011 from the prior year, with seasonally adjusted quarterly changes slightly
negative in fourth quarter 2010 and first
quarter 2011, FHFA data show.
Little 2011 Texas home price data are
currently available. Inflation-adjusted Realtor
median price figures have fallen 4.2 percent

SOURCE: Authors' calculations.

Table 4
Estimated Share of Sales Induced by ARRA and WHBAA
Scenario
2. Sales continue to slump at
2008 monthly growth rates

3. Sales return to "normal" pace
of 2000–08 average monthly
growth rates

Elasticity

Texas (percent)

U.S. (percent)

–0.5

4.7

7.7

–1.0

9.3

15.3

–1.5

14.0

23.0

–0.5

7.1

10.8

–1.0

14.2

21.7

–1.5

21.3

32.5

NOTE: An elasticity of –0.5 implies that a 1 percent reduction in price leads to a 0.5 percent increase in quantity of homes demanded.
Other elasticities are interpreted similarly.
SOURCE: Authors' calculations.

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

5

SouthwestEconomy

Chart 2
Prices Slump Following Tax-Credit Expiration
Year/year percent change, seasonally adjusted
12

Tax credit period

10

U.S. FHFA
purchase-only price index

8

4

in Texas—will not recover
fully until excess inventory
is eliminated. While the Texas
foreclosure rate is lower than
the nation’s, foreclosures

Texas FHFA
purchase-only price index

6

Prices—nationally and

2

Year/Year Percent Change in Price
Year
Texas
U.S.
2004
3.6
9.3
2005
5.9
9.4
2006
6.7
3.6
2007
3.8
–1.3
2008
–0.6
–8.5
2009
1.0
–1.5
2010
–1.8
–4.0

0
–2
–4
–6
–8
–10

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

NOTES: Vertical dashed lines represent tax credit expiration dates; shaded areas extend to closing dates.

are a significant portion

SOURCE: Federal Housing Finance Agency.

of supply.
Chart 3
Home Inventories Remain Elevated
Months in inventory
12
11
10
9
8
7

Tax credit period

Average Annual Months in Inventory
Year
Texas
U.S.
2004
5.9
4.3
2005
5.4
4.4
2006
5.0
6.3
2007
5.6
8.7
2008
6.5
10.0
2009
6.9
8.3
2010
7.4
9.0

U.S.

Texas

Healthy market inventory level

6
5
4
3

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

NOTES: Vertical dashed lines represent tax credit expiration dates; shaded areas extend to closing dates.
SOURCES: Texas A&M Real Estate Center; seasonal adjustment by the Federal Reserve Bank of Dallas.

year to date, while the S&P/Case-Shiller Price
Index for Dallas–Fort Worth as of March was
down 2.5 percent from the same period in
2010. Even so, the tax credits appear to have
eased the U.S. home slide for a while.
Prices—nationally and in Texas—will
not recover fully until excess inventory is
eliminated.
While the Texas foreclosure rate is
lower than the nation’s, foreclosures are a

SouthwestEconomy 6

significant portion of supply.13 Texas existing-home inventories edged up in the latter
half of 2010 and, as of April 2011, stood at
7.8 months of supply based on the current
sales pace (Chart 3). Though the supply is
less than the national average of 8.6 months,
it’s still more than the six-month threshold
the industry regards as a balanced market
and above the point at which prices tend to
increase.

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

Chart 4
Delinquencies and Foreclosures Declining
Percent of loans, seasonally adjusted
6
U.S. delinquencies
5

Texas delinquencies
U.S. foreclosures
Texas foreclosures

4

While indications are

3

that the Texas housing market

2

may have bottomed out,
challenges remain.

1

0
’90

’91

’92

’93

’94

’95

’96

’97

’98

’99

’00

’01

’02

’03

’04

’05

’06

’07

’08

’09

’10

’11

SOURCES: Mortgage Bankers Association; seasonal adjustment by the Federal Reserve Bank of Dallas.

Texas Outlook: Positive Points
The national and Texas economies are
growing again. Still, a housing recovery remains elusive despite several government measures, including the homebuyer tax credits.
While indications are that the Texas
housing market may have bottomed out, challenges remain.
A higher share of foreclosures in 2009
and 2010 has contributed to elevated home
inventory, deflating prices. Relatively tighter
credit, partially reflecting lessons learned in
the housing bust, may also trim demand. Dallas Fed housing contacts say many would-be
first-time homebuyers do not have the credit
scores or down payment now required to
get a mortgage. Finally, a reduction in homeownership rates both nationally and in Texas
may suggest that consumers are rethinking
spending habits following the recession and
financial crisis and may be postponing homeownership.
On a positive note, state foreclosure rates
dipped in first quarter 2011 and remain below
the national average (Chart 4). Moreover, the
share of households behind on mortgage
payments (delinquencies) has declined significantly in Texas and the U.S. since the peak
in fourth quarter 2009.
With a strong state job growth forecast of
more than 3 percent in 2011, Texas housing
is poised to perform better than the national
average, even if the market lacks the vigor
seen in past recoveries.14

Petersen is a business economist and Swadley is a
research assistant in the Research Department at
the Federal Reserve Bank of Dallas.

Sinai, in The New Palgrave Dictionary of Economics, Second
Edition, ed. Steven N. Durlauf and Lawrence E. Blume,
Basingstroke, England: Palgrave Macmillan, 2008.
9
This estimate assumes that all additional sales occurring
during the tax period that are not attributable to the tax credit
are “shifted demand.” It does not account for sales induced
by mortgage rates and low prices alone. Further, it assumes
that the tax-credit-shifted demand effect is the only thing
depressing sales after the expiration of the credit. To the extent
that broader economic phenomena continue to depress home
sales and that sales are induced by price and mortgage rate
differences from our scenario assumptions, this estimate will
overstate negative effects on sales following the tax-credit
expiration and thus provide a conservative upper bound of the
time frame.
10
See the Dallas Fed Beige Book at www.dallasfed.org/
research/beige/2011/bb110413.html.
11
Other indexes are more volatile but give similar results:
The Freddie Mac Price Index looks most similar to the
FHFA series, and the S&P/Case-Shiller Index and the Texas
inflation-adjusted median price series show more of a drop
prior to the credits but overall flatness (despite volatility)
since.
12
Data are from the National Association of Realtors,
seasonally adjusted by the Federal Reserve Bank of Dallas.
13
See “Texas Dodges Worst of Foreclosure Woes,” by D’Ann
Petersen and Laila Assanie, Southwest Economy, Fourth
Quarter, 2009.

Notes
The U.S. market peaked in second quarter 2007, according
to the Federal Housing Finance Agency purchase-only price
index. S&P Case-Shiller data show the peak in 2006.
2
While the Housing and Economic Recovery Act was signed
into law in July 2008, the tax credit applied retroactively to
sales made from April 9, 2008, through Dec. 31, 2008.
3
The Worker, Homeownership, and Business Assistance Act
of 2009 included contracts signed by April 30, 2010, but
extended the qualifying closing date to Sept. 30, 2010.
4
See “An Economic Analysis of the Homebuyer Tax Credit,”
by Mark P. Keightly, CRS Report for Congress, Congressional
Research Service, Dec. 1, 2009.
5
The CRS methodology used the number of sales occurring
in 2008 as a baseline of what would have transpired in the
absence of the tax credit. The number of purchases induced
by the credit was calculated using a range of price elasticities
for housing. See the appendix of the paper cited in footnote 4
for full details.
6
New-home sales statistics are not available for Texas. Singlefamily building permits should be a good proxy for sales,
although the data may overestimate sales figures slightly.
7
Elasticity is a measure of consumer responsiveness to
a change in price. Formally, elasticity=(percent change in
quantity demanded) / (percent change in price).
8
For housing elasticity estimates, the CRS report mentioned
in footnote 4 cites: “Housing Subsidies: Effects on Housing
Decisions, Efficiency, and Equity,” by Harvey S. Rosen,
National Bureau of Economic Research Working Paper no.
1161, June 1983, and “Urban Housing Demand,” by Todd
1

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

14
Federal Reserve Bank of Dallas employment growth forecast
as of April 2011.

7

SouthwestEconomy

OnTheRecord

A C o n v e r s a t i o n w i t h B a n c o d e M é x i c o ’s G o v e r n o r A g u s t í n C a r s t e n s

Mexico’s Economic Reforms Propel Postrecession Rebound

Dr. Carstens has led Mexico’s central bank since January 2010, after serving as the
government’s secretary of finance and as deputy managing director for the International
Monetary Fund. He holds a PhD in economics from the University of Chicago and received his
undergraduate degree from Mexico’s Autonomous Institute of Technology. Carstens recently
visited the Federal Reserve Bank of Dallas and met with a group of the Bank’s economists.
Q. What is the outlook for 2011 growth, and

what are Banco de México’s biggest challenges
ahead?

A. Since 2010, Mexico has experienced a
very strong recovery. Inflation went from 3.5
percent in 2009 to 4.4 percent in 2010, and
the increase included the impact of a higher
value-added tax. Right now, inflation is back
at 3.7 percent. The economy grew very fast
in 2010, and it is very likely that it will grow
soundly in 2011.
We have been operating under an inflation targeting scheme since 2001 and have
been perfecting it over the years. Banco de
México has a permanent inflation target of
3 percent and has established a tolerance
bound or interval of plus or minus 1 percent.
Basically, our policy instrument is the equivalent of the Fed’s federal funds rate.
Core inflation [excluding food and energy] has behaved very well. We expect it to be
3 percent at the end of 2011. Noncore inflation is very volatile because it is composed of
agricultural prices and government-regulated
prices, which in Mexico are important. The
price of gasoline, for example, is regulated
by the government—sometimes with lags and
sometimes with leads relative to its international reference prices. For the last few years,
it has been subject to a very rapid rate of adjustment of more than 10 percent per year.
From the point of view of monetary policy management, the main challenge we face
is how to deal with noncore inflation: how
much of it we can tolerate and how much
we need to fight. There is always the consideration that as noncore inflation feeds into
core inflation and inflation expectations, the
central bank needs to do something about it.
Right now, the main challenge we face is the
current sharp increase in commodity prices:
Is it a one-time relative price change, or is

Q. How did the Mexican economy handle the
global financial crisis?

A. I remember when, as a finance secretary, we prepared the budget for 2009. The
macro framework we presented in September 2008 was based on an expected GDP
[gross domestic product] growth of 3 percent
for 2009. And that was basically the consensus forecast. We were deeply affected when
the financial crisis erupted, and Mexico’s
GDP fell 6.1 percent in 2009. Trade collapsed dramatically after the fall of Lehman
Brothers [in September 2008].
In the midst of this turmoil, when all
the countries around the world were talking
about how they were going to expand fiscal
policy, we looked at the worsening public
finances and agreed on the need to raise the
value-added tax. That kept public finances
under control. Partly as a result, we had a
very strong rebound in the economy, and
that is why we expect GDP to grow between
4.5 and 5 percent in 2011.
Q. What accounted for Mexico’s resiliency
following the recession?

it something that has a dynamic component
that will feed into core inflation?
Another very important dilemma that we
face is the influence of U.S. monetary policy
on Mexico’s monetary policy and how much
our stance needs to be judged independently of or in relative proportion to the U.S. In
practice, as U.S. monetary policy has become
more lax, Mexico’s monetary policy has become tighter, without us adjusting the reference rate. This has attracted capital inflows.
Thus, the appreciation of the peso versus the
dollar has been an important factor in keeping
core inflation low.
This certainly implies that when the U.S.
starts unwinding its monetary policy stance,
our exchange rate will probably be affected
in some way. At that point, we might have to
make other types of decisions. The two decisions we have to make now are how to react
to commodity price increases and how we
should adjust or calibrate our monetary policy in terms of the changes in U.S. monetary
policy.

SouthwestEconomy 8

A. Mexico had two lost decades in terms
of growth and development, mostly due to
poor macroeconomic management. We had
major crises in 1976, 1982 and 1987 and then
a financial crisis in 1994, which cost 18 percent of GDP. All of this led to some important institutional changes in banking supervision and regulation, in terms of the central
bank and fiscal policy.
Our 1994 banking crisis not only made
us put the banking system back into shape,
but forced us to take some additional steps.
What is happening now is that the world
is catching up with Mexico. Since we experienced the banking crisis before other
countries, we were more resilient this time
around. Our banking system was left unscathed by the recent financial crisis. Mexico
is a country that in the near future can rely
on the financial sector to support its economic growth.
The other important reforms have been
in monetary policy and monetary policy
making. Two major steps were taken around

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

“Since we experienced the banking crisis before other
countries, we were more resilient this time around.
Our banking system was left unscathed.”
1993–94 and in 1995. Before that, monetary
policy making was clearly under fiscal dominance. The central bank was financing the
public deficit, and that led to very stubborn
inflation and to an unsustainable fixed-exchange-rate regime. Obviously, the effect
of high inflation was extremely detrimental
to the Mexican economy and society. Following the reforms, we moved to a floating
exchange rate regime and the central bank
gained its autonomy. Today, Banco de México has one of the strongest autonomy mandates in the world.
We also have a single monetary policy
mandate: the pursuit of price stability.
Compared to other countries, we do not
have a mandate of pursuing growth, which I
would say, for the most part, is a relief. Our
mandate also states that, at the constitutional
level, no authority can dictate the central
bank’s credit policy. It specifies very clearly
that we cannot grant any financing to the
government. This was a major breakthrough.
The last institutional development has
involved fiscal discipline. Before our credit
crisis in 1994, there was a lot of creative accounting and very blurry records of public
finances with periodic “surprises.” Things
have cleared up as time has passed. Now,
Mexico is completely transparent in its fiscal
accounts and, I would say, has developed a
very deeply ingrained responsibility in both
the federal government and, over the years,
in Congress. This has been institutionalized,
as it is now set by law. Unless there is an important underlying reason, the budget needs
to be balanced. There are some exceptions—in case of a natural disaster or another clear reason to deviate. In those circumstances, the government has to explain to
Congress why it is necessary to deviate from
the balanced-budget goal and also present a
plan to bring the budget back into balance.

ordination in order to make
the rest of the macroeconomic framework consistent with the exchange rate.
At that time, Mexico had a
relatively lax fiscal policy.
We also had problems in
the banking sector, and significant capital inflows. At
some point, it became obvious that the exchange rate
was not consistent with the
macroeconomic framework. We began to
experience speculative attacks on the peso.
All hell broke loose. We had a combination
of a balance-of-payments and banking crisis.
At that point, we made a very important decision: We got rid of the fixed exchange rate.
Mexico operated under a sort of fixed
exchange rate for decades. In the early
1990s, not only Mexico but many emerging
countries were under the veil of an economics doctrine, which established that in
a small, open economy, a floating exchange
rate would never work because it would be
extremely volatile and lead to poor economic performance.
Since then, many countries have gradually shifted from fixed to floating exchange
rate regimes. I believe these measures have
been extremely useful. Moving to flexible
rate regimes has really made emerging markets far more resilient. In Mexico, the combination of a flexible exchange rate regime
with a strong mandate for the monetary authority has transformed the monetary policy
framework established by the central bank
into a really solid anchor. This framework
certainly proved to have worked well during
the most recent global financial crisis.

Q. Mexican banks held up well during the global

floating exchange rate?

financial crisis. What accounts for their superior
performance? Are there changes planned to
comply with Basel III, the international bank
regulatory update approved last year?

A. In the early 1990s, there was a major
problem with policy coordination in a way
similar to what Europe is currently experiencing. When you have a fixed exchange
rate, you need to have sufficient policy co-

A. After our crisis in 1994, a major boost was
given not only to upgrade our supervisory
capacity and our regulatory instruments but,
to some extent, to be ahead of the curve. As
a matter of fact, many of the standards that

Q. What was the significance of adopting a

are now being addressed and created as part
of Basel III are in the process of being implemented in Mexico.
Mexico will implement Basel III in the
coming months. Why? Well, because, basically, we are already there. For example,
a major advance in Basel III is how much
core capital [equity and cash reserve funding] must comprise basic capital. There were
many aspects of the capital definition that
were weak before—for instance, the provisions for deferred taxes. Liquidity provisions,
we have already taken care of.
The Mexican banking system was very
resilient to the recent real shock to the economy. Banks continue to be profitable. They
have only reduced the rate of credit granting as a precautionary measure, in response
to how their operations were unfolding in
the rest of the world. To counteract tightening credit—and this was the only important
countercyclical measure implemented—authorities used the development bank network to assume part of the credit risk from
certain transactions and induce banks to
take more risk. These actions turned out very
well. Moreover, the program has not cost the
Mexican government a cent because there
was no intrinsic risk in those transactions.

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

9

SouthwestEconomy

Bank Profits Rebound
as Loss Set-Asides Ease
By Kelly Klemme and Kenneth J. Robinson

Last year, the banking
industry both nationally
and regionally recorded
its highest net income
since 2007.

B

anks across the U.S., including the Eleventh Federal Reserve District, appear to be
recovering from the financial crisis that began
in mid-2007.1 The news is welcome because
a healthy banking sector spurs economic
growth by providing financing for businesses
to expand investment spending and for consumers to purchase goods and services.
Data for 2010 show strong profit growth,
with banks across the nation rebounding from
a net loss in 2009 and those in the Dallasbased Eleventh District almost doubling their
profits. There was also good news regarding
asset quality: Problem loans are starting to
moderate. And there are indications that the
banking industry has grown more efficient,
supporting more operations at lower cost.
However, concerns linger about the
sustainability of profits because the recent
improvement can be attributed almost entirely to a reduction in what banks set aside
to cover future loan losses. Banks refer to
this as their provision expense, and it usually falls as asset quality improves. But there
is a limit to how far it can decline and contribute to profitability.

Table 1
Contributions to Bank Profitability
U.S.
Percent of average
assets

Eleventh District

Effect
Difference
on
(basis points)** ROAA

Percent of average
assets
2009

2010

Effect
Difference
on
(basis points)** ROAA

2009

2010

Net interest income

3.06

3.26

20

+

3.57

3.49

–8

–

Noninterest income

2.07

1.81

–26

–

1.61

1.21

–40

–­

Noninterest expense

3.18

2.98

–20

+

3.39

2.89

–50

+

Provision expense

1.96

1.21

–75

+

1.17

0.68

–49

+

Taxes

0.03

0.28

25

–­

0.19

0.26

7

­–

Other items*

–0.05

0.06

11

+

0.09

0.06

–3

–

Net income (ROAA)

–0.10

0.66

76

0.52

0.93

41

Revenue

Expense

* "Other items" includes securities gains/losses and extraordinary items.
** A basis point equals one one-hundredth of a percentage point.
SOURCE: Quarterly Reports of Condition and Income, Federal Financial Institutions Examination Council.

SouthwestEconomy 10

Improved Profitability in 2010
Last year, the banking industry both
nationally and regionally recorded its highest
net income since 2007. Return on average assets (ROAA) also reached a three-year peak in
2010—0.66 percent for banks nationally and
0.93 percent for those in the Eleventh District.
The better performance regionally reflects the
relative strength of the area’s economy and
general absence of a major housing bubble.
Asset-quality problems also appeared to
abate. Nationally, noncurrent loans reached
a record high of 5.5 percent at the end of
2009.2 Since then, asset quality has steadily
improved. A similar picture emerges in the
district, although the noncurrent loan rate
peaked at only 2.7 percent in 2010.3
Profits in banking and other industries
are defined as the difference between revenues and expenses. One major source of
bank revenue is net interest income, or the
difference between the interest earned on
loans and securities and the interest paid
on deposits and other funding. Another important revenue source is noninterest income, sometimes referred to as fee income.
It includes earnings from service charges,
trading revenue, asset sales and investment
advice.
Banks’ major expense categories are
noninterest expense, which includes items
such as labor costs and building maintenance, and provision expense, for reserves
set aside to cover loan defaults. In a deteriorating economy, defaults become more
likely and banks increase their loan-loss
reserves by increasing their provision expense. Conversely, as economic conditions
improve, banks are able to set aside less,
reducing their provision expense.4
Table 1 shows the major components
of profitability for U.S. and Eleventh District
banks and their contribution to earnings in
2009 and 2010. Among banks nationally, the
76-basis-point improvement in profitability,
as measured by ROAA, can be traced almost
entirely to a drop in provision expense. A
basis point equals one one-hundredth of

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

Chart 1
Movements in Profitability Driven by Changes in Provision Expense
A. U.S. Banks
Percent

2.5

2

1.5

Return on average assets

1
Provision expense
(percent of average assets)

.5

0

–.5
’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10

B. Eleventh District Banks
Percent
2.5
2
1.5

Return on average assets

1
Provision expense
(percent of average assets)

.5
0
–.5
–1
–1.5

–2
’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10
SOURCE: Quarterly Reports of Condition and Income, Federal Financial Institutions Examination Council.

a percentage point. For the district, profitability increased 41 basis points despite less
revenue. For these banks, lower revenue was
more than offset by declines of about 50 basis
points in both noninterest expense and provision expense.

Earnings Sustainability
Banks’ improved profitability has been
characterized as “a drastic reversal from 2009,
when the prospect of widespread loan defaults forced them to set aside billions of dollars to cover losses.”5 Interpreted this way, the
upturn may seem less resilient. Lower provision expense means banks are setting aside
less money for future loan losses. As the overall economy improves and asset-quality prob-

lems diminish, such a reduction is expected.
Given that there is a limit to how much
provision expense can fall and thus contribute to profitability, and that revenue has
recently increased little, if any, is bank profitability stagnating? Or will increased revenue,
or perhaps efficiency gains, help sustain bank
profitability?

Provision Expense and Return on Assets
Some historical perspective might shed
light on these questions. While declining provision expense is a big contributor to recent
bank profitability, that development is neither
new nor unusual. Historically, provision expense changes have been important factors
affecting movements in bank profitability.

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

In periods of relative banking prosperity, such as the 1990s, provision expense and
profitability are fairly constant. But during
times of stress, when banks must set aside additional funds to cover possible loan defaults,
the associated provision expense increase
coincides with declining bank profitability.
This was true for U.S. banks in the recent financial crisis (Chart 1A), and it was also true
for Eleventh District banks in the late 1980s,
when the industry experienced severe difficulties (Chart 1B).6
For U.S. banks, provision expense increased 169 basis points from 2006 to 2009
(Chart 2). This coincided with a decline in
profitability of 147 basis points. In the district,
provision expense increased 118 basis points
in the mid-1980s. During this period, ROAA
fell 206 basis points. Provision expense in
both downturns was the single-biggest contributor to profitability movement, far outpacing other components.
During periods of recovery, though, this
trend is reversed. As Chart 1 reveals, we are
beginning to see a decline in provision expense at banks nationwide as the recovery
takes hold. Similarly, provision expense fell
sharply in the district in the late 1980s after
banking difficulties subsided.

Weakness in Revenue
If banks are showing weakness in revenue measures, as seen in Table 1, how
durable can the recent profitability upturn
be? Again, historical perspective is useful. Revenue measures at both U.S. and district banks
rose fairly steadily until peaking in the mid-tolate 1990s (Chart 3).
Since then, overall revenue has trended
lower. Revenue sources differ somewhat,
with banks in the district deriving a greater
proportion of revenue from net interest
income than banks nationally, and banks
nationwide deriving a relatively larger
proportion of revenue from noninterest
income. However, despite this revenue decline, banks were able to earn a healthy return on assets of 1 percent or more, at least
until the onset of the financial crisis. So a
lack of recent revenue growth is not necessarily cause for concern. An increasingly
competitive marketplace tends to pressure
revenue and overall profitability.7 Yet, banks
have earned robust profits even in the face
of a sustained revenue decline.

Maintaining Profitability
The banking industry has confronted
significant competitive issues over the past

11 SouthwestEconomy

Chart 2
Higher Provision Expense Biggest Contributor to Declining Profitability
Change in basis points
250

U.S. 2006–09

200

169

150

0

less money for future loan

problems diminish, such a
reduction is expected.

118

50

means banks are setting aside

improves and asset-quality

118

100

Lower provision expense

losses. As the overall economy

Eleventh District, 1984–87

–50
–100
–150

–147

Net interest income
Noninterest income
Noninterest expense
Provision expense
Taxes
Other items
ROAA

–200

–206

–250
NOTE: Components of return on average assets (ROAA) are calculated as a percent of average assets.
SOURCE: Quarterly Reports of Condition and Income, Federal Financial Institutions Examination Council.

Chart 3
Bank Revenue Trending Downward
Percent of average assets
8

U.S.
7

Eleventh District

Noninterest income
Net interest income

6
5
4
3
2
1
0
’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’04 ’06 ’08 ’10 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’04 ’06 ’08 ’10
SOURCE: Quarterly Reports of Condition and Income, Federal Financial Institutions Examination Council.

two decades. Interstate branching restrictions were eliminated with the Riegle–Neal
Interstate Banking and Branching Efficiency
Act of 1994, increasing industry consolidation. And entities such as hedge funds and
money market funds lured customers away
from banks.
Despite the pressures on revenue,
banks were able to maintain profitability.
One possible explanation may be that increased efficiency offset declining revenue,
thus mitigating the pressure on profitability.
FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

Noninterest expense, as a percent of average assets, can be used as a rough measure
of bank efficiency.
Noninterest expense is a broad category that includes employee salaries and
benefits, facility and equipment expenses,
advertising and marketing costs and other
types of overhead. If bank efficiency is improving, it is expected that noninterest expense would decline relative to assets. That
ratio, after increasing fairly steadily, peaked
in the mid-to-late 1990s at U.S. and Elev-

12 SouthwestEconomy

Chart 4
Lower Noninterest Expense Points to Improved Efficiency
Percent of average assets
4.5

U.S.
Noninterest income
Net interest income

4.0

Eleventh District

Recent data suggest that the
banking industry, with

3.5

improved profitability and
fewer problem assets, is in the

3.0

early stages of recovery.
2.5
’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10
SOURCE: Quarterly Reports of Condition and Income, Federal Financial Institutions Examination Council.

enth District banks and has since trended
downward (Chart 4).
For banks in the U.S. and the district,
falling salary and premises expense relative
to assets accounted for roughly half of the
overall decline. In other words, banks are
now able to support more assets at a lower
cost. That may reflect recent advances in
information technology.8

Rebuilding Balance Sheets
Recent data suggest that the banking
industry, with improved profitability and
fewer problem assets, is in the early stages
of recovery from the worst financial crisis
since the Great Depression. Adjustments
continue as banks strive to rebuild their
balance sheets and position themselves for
the future. These changes, coupled with
declining revenue, could be contributing
to a spate of mergers and acquisitions. In
2010, for example, 172 bank mergers were
announced. Of this total, more than threefourths involved sellers with fewer than
$1 billion in assets. So far this year, 44 deals
have been announced, and almost all involve sellers with assets below $1 billion.9
Concerns remain about the source of
the industry’s profits, but these may be misplaced. Put in historical context, the recent
rebound in profitability that has been driven almost entirely by a drop in provision
expense is both welcome and expected. As
the economic recovery advances and asset
quality improves, the upturn in profitability
should continue.

Klemme is a financial industry analyst and Robinson is a research officer in the Financial Industry Studies Department at the Federal Reserve
Bank of Dallas.

Notes
The Eleventh Federal Reserve District consists of Texas,
northern Louisiana and southern New Mexico.
2
Noncurrent loans are those 90 days or more past due or
those with nonaccrual status (the stated interest rate was not
being paid).
3
Data were obtained from the Federal Financial Institutions
Examination Council’s Reports of Condition and Income. Data
for the Eleventh District banking industry have been adjusted
for structural changes involving recent relocations of banks
into the district.
4
Technically, the loan-loss reserve is known as the Allowance
for Loan and Lease Losses (ALLL). There are no formal
numerical requirements for banks’ ALLL. However, banks are
responsible for “developing, maintaining, and documenting a
comprehensive, systematic, and consistently applied process
for determining the amounts of the ALLL.” See Board of
Governors of the Federal Reserve System, SR 06-17, Dec.
13, 2006, www.federalreserve.gov/boarddocs/srletters/2006/
SR0617.htm.
1

Product restrictions were also relaxed. See “The Impact of the
Gramm–Leach–Bliley Act on the Financial Services Industry,”
by Abdullah Al Mamun, M. Kabir Hassan and Van Son Lai,
Journal of Economics and Finance, vol. 28, no. 3, Fall 2004,
pp. 333–47.
See “The Economic Effects of Technological Progress:
Evidence from the Banking Industry,” by Allen N. Berger,
Journal of Money, Credit and Banking, vol. 35, no. 2, April
2003, pp. 141–76.
9
See “Merged Banks Could Become Future Bait for Bigger
Banks,” by Rachel Witkowski, American Banker, March 29,
2011. Data on mergers are from SNL Securities as of April
28, 2011.
8

5
See “Banks’ Underlying Problem is Revenue,” by Eric Dash,
New York Times, Jan. 18, 2011.
6
For more on the 1980s banking difficulties in the Eleventh
District and how district banks have fared relatively better
in the current crisis, see “Eleventh District Banking Industry
Weathers Financial Storms,” by Kenneth J. Robinson,
Southwest Economy, Second Quarter 2010.
7
See “The Competitive Dynamics of Geographic Deregulation
in Banking: Implications for Productive Efficiency,” by
Douglas D. Evanoff and Evren Ors, Journal of Money, Credit
and Banking, vol. 40, no. 5, August 2008, pp. 897–928.

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

13 SouthwestEconomy

NoteWorthy

QUOTABLE: “The regional economic outlook is quite positive. Broad-based
hiring in every sector from energy to construction to services reflects the confidence employers have that the region is poised for sustained expansion.”
—Pia Orrenius, Research Officer and Senior Economist

DEMOGRAPHICS: Hispanic Population Exceeds Pre-Census Estimates
The Hispanic population’s growth the last decade proved
more significant than previous estimates had suggested.
The 2010 census showed that the nation’s Hispanic population rose 43 percent to more than 50 million. The increase
accounted for just over half of total U.S. population growth.
About one in six people in the U.S. identified themselves as
Hispanic. Texas had 9.5 million Hispanic residents, amounting
to 37.6 percent of its population. There were 1 million Hispanics (46.3 percent of the population) in New Mexico and nearly
200,000 (4.2 percent) in Louisiana.
The national Hispanic count exceeded the official Census
Bureau estimate by 1.9 percent, or about 1 million, according
to the Pew Hispanic Center, a Washington think tank. Pew extrapolated from the 2009 estimate to determine a comparative

2010 figure. It also found the Hispanic population was higher
than the estimate by 86,000 in Texas and by more than 20,000
each in New Mexico and Louisiana.
During the decade between official counts, Census Bureau estimates are updated based on birth and death records
and official immigration data. Estimates were much closer to
the true population in the most recent census than in previous decennial counts. In 2000, overall population estimates
were off by 6.9 million, including 3.1 million Hispanics.
Reasons for the latest discrepancy haven’t been analyzed,
but the Census Bureau said the 2000 underestimate was likely
related to unauthorized immigration and undercounting in
prior censuses.
—Yingda Bi

Natural Gas: Louisiana’s Haynesville May Have Overtaken Barnett
Louisiana’s Haynesville Shale may have become the nation’s most productive natural gas field in February, surpassing
the Barnett Shale formation in North Texas, which had held
the title since 2008.
Pipeline flows data from energy analytics firm Bentek
Energy LLC suggest the Louisiana portion of the Haynesville
Shale moved ahead Feb. 12, even after Barnett rebounded
from winter well freeze-offs. While few argue that Haynesville
is on a faster production track, confirmation of the timing of
its Barnett takeover won’t come until lagged well production
numbers are released. Both fields are in the Federal Reserve
Eleventh District.
Advances in horizontal drilling technology and lessons
learned from Barnett helped boost Haynesville production.

The first Haynesville well was completed in 2008, with production exceeding 5 billion cubic feet (Bcf) per day in less
than three years. It took Barnett almost 10 years to achieve
that level, government data show. Haynesville production
stood at 5.3 Bcf on Feb. 12, compared with Barnett’s 5.2 Bcf,
according to estimates based on flows. The figures rose to
5.5 Bcf at Haynesville and 5.3 Bcf at Barnett by month’s end.
Haynesville offers economic benefits to northwestern
Louisiana. Since January 2007, energy employment in the
Shreveport–Bossier City area has increased 78 percent, compared with 4 percent in Louisiana and 12.1 percent in Texas.
Haynesville has also lifted Louisiana state and local tax revenues and boosted household earnings.
—Adam Swadley

Electric Power: February’s Rolling Blackouts Chill Much of Texas
The North American Electric Reliability Corp. (NERC),
which oversees bulk power system reliability throughout the
U.S. and much of Canada, had anticipated a warmer-than-average Texas winter.
Instead, a record cold snap hit Texas in early February,
and rolling blackouts affected most of the state Feb. 2 when
weather-related mechanical issues knocked out 102 powergeneration units that provide about 7,000 megawatts (MW) of
capacity. The Electric Reliability Council of Texas (ERCOT), an
independent operator in the NERC system that manages service to more than 22 million customers, coordinated the rolling blackouts. Such planned outages are designed to conserve
power and prevent total blackouts.
The rolling blackouts largely took place over an eight-

SouthwestEconomy 14

hour period as demand reached 56,334 MW, taxing the impaired system. Texas electricity use peaks in the air conditioning-cooled summer; the ERCOT record of 65,776 MW
occurred last Aug. 23. Heading into winter, NERC predicted
peak demand of 48,066 MW in ERCOT’s service area. Such
forecasts help utilities meet demand for electricity, a product
that’s difficult to store.
The arctic front swept as far south as the Rio Grande Valley, producing the longest and coldest winter streak in Texas
in over 20 years. The Valley’s citrus crops survived, but Dallas
pre-Super Bowl events and work schedules were disrupted as
wind chills fell below zero. El Paso, outside of ERCOT’s area,
also endured rolling blackouts during the cold snap.
—Michael Weiss

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

SpotLight

Texas Service Sector Outlook Survey

Completing the Regional Economic Picture

Tmy,heaccounting
service sector drives the Texas econofor 59 percent of private-sector output and employing close to 7 million
workers. Despite the service sector’s prominence, there are no timely state-level gauges
of its activity. To fill this regional data gap,
the Federal Reserve Bank of Dallas began
assembling the Texas Service Sector Outlook
Survey (TSSOS) in 2007. After a four-year
collection period, the data have been seasonally adjusted, with public release June 1.1
About 230 firms participate in the survey
monthly. Executives are asked about changes
to business indicators such as revenue, employment, prices and general business activity.
Responses are aggregated into balance indexes, similar to the Dallas Fed’s popular Texas
Manufacturing Outlook Survey (TMOS), where
positive values indicate growth or improvement while negative ones show contraction or
worsening conditions.2 TSSOS has a breakout
for the retail and wholesale sectors, called the
Texas Retail Outlook Survey (TROS).3
The recent recession and ongoing economic recovery provide good variation on
which to test how well key TSSOS indexes—
revenue, employment and general business
activity—reflect changing economic conditions. The negative readings of the TSSOS
indexes are in line with declining economic

ample, employment) is accounted for by variation in the included variables (survey indexes).
The first row in Table 1 shows the result of
including two lagged values of the dependent
variable—the predictive power of past performance—absent the survey variables. When
survey variables are added to the model, the
R-squared rises in all cases, signifying that the
survey index provides additional explanatory
power for the dependent variable.5
—Jesus Cañas and Emily Kerr

activity in Texas in late 2008 and 2009 (Chart
1). The general business activity index was the
first to enter negative territory, most likely reflecting respondents’ perception that national
business conditions were worsening before
those in Texas. The key TSSOS indexes turned
positive in late 2009, coinciding with the economic recovery taking hold.
Business tendency surveys such as TSSOS
and TMOS are particularly valuable because
they’re timely. Like the influential national
PMI index (formerly known as the Purchasing
Managers Index), these Texas measures come
out before other data, such as employment,
and provide crucial early clues about the direction of economic activity.4 The most important
gauge of their value is whether the indexes are
correlated with the economic activity they are
intended to measure. To formally test the explanatory power of TSSOS and TROS indexes,
we ran statistical regressions on state service
sector employment, retail employment and retail sales.
The results suggest the survey indexes
are a good fit for employment and other regional data—that is, statistically speaking, they
help explain what’s taking place. Explanatory
power is captured in the statistical measure Rsquared, which calculates how much of the
variation in the dependent variable (for ex-

Chart 1
Texas Service Sector Outlook Survey Reflects Recent
Recession, Ongoing Recovery

Notes
1
Information regarding the Texas business outlook surveys can
be found at www.dallasfed.org/research/surveys.
2
Each index is calculated by subtracting the percentage of
respondents reporting a decrease from the percentage reporting
an increase.
3
Retailers and wholesalers make up 12 percent of Texas output
and account for 1.6 million jobs.
4
See “Texas Manufacturing Survey Offers Advance Look at State
and National Economies,” by Franklin D. Berger, Federal Reserve
Bank of Dallas Southwest Economy, Third Quarter, 2010.
5
An R-squared reading of zero means no explanatory power,
while a 1 indicates complete explanatory power. A second-order,
autoregressive distributed lag model was estimated. Because
no autocorrelations were found, the model was estimated with
ordinary least squares. We report adjusted R-squared, which
corrects for the fact that R-squared will always increase as
independent variables are added.

Table 1
TSSOS Indexes Help Explain Regional Economy
(Quality of fit, adjusted R-squared)*

Index*
60
Revenue
Employment
General business activity

40

Lagged dependent variables only

20
0
–20
–40
–60

2007

2008

*Three-month, centered moving average.
SOURCE: Federal Reserve Bank of Dallas.

2009

2010

2011

Private service
employment

Retail
sales

Retail
employment

0.39

0.65

0.42

with TSSOS employment

0.54**

–

–

with TSSOS revenue

0.53**

–

–

with TSSOS business activity

0.54**

–

–

with TROS employment

–

0.68**

0.61**

with TROS revenue/net sales

–

0.69**

0.48**

with TROS business activity

–

0.66

0.53**

* An R-squared reading of zero means no explanatory power, while a 1 indicates complete explanatory power.
**Indicates the survey variable is statistically significant with 95 percent confidence.
SOURCES: Bureau of Labor Statistics; Federal Reserve Bank of Dallas; authors' calculations.
Seasonal and other adjustments by the Federal Reserve Bank of Dallas.

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

15 SouthwestEconomy

Sizing Up Nanoelectronics:
Gauging the Potential for
New Productivity Wave
By Keith Phillips, Adam Swadley, Jackson Thies and Mine Yücel

The long-term impact of new
technologies and innovation
extends beyond economic
effects, creating social and
cultural benefits.

The Federal Reserve Bank of Dallas, in cooperation with the Semiconductor Industry Association
(SIA), hosted a conference on nanoelectronics and the economy in Austin on Dec. 3, 2010.
Economists and scientists explored how information technology has affected U.S. productivity
and output growth and prospects for the future. A summary of conference highlights follows.
Presenters’ papers and presentations are available on the Dallas Fed website at
www.dallasfed.org/news/research/2010/10nano.cfm.

M
oore’s law, the technology axiom
holding that the number of transistors on
a semiconductor chip doubles every two
years, has led U.S. productivity growth over
the past three decades. Many scientists
expect this advancement to reach its limits
within 20 years. As transistors approach
their physical size minimums, potentially
ending Moore’s law, nanoelectronics may
hold the key to further reducing size, leading to enhanced productivity and growth.
While nanoelectronics’ potential
economic benefits are large, numerous
challenges exist, presenters at the Austin
conference said. To remain a leader in the
field, the U.S. must stay competitive in the
research, development and manufacture of
nanotechnology, which involves manipulating matter on an atomic and molecular
scale. There must also be cooperation
between governments, industry and educational institutions to ensure necessary
physical and human capital.
George Scalise, SIA president emeritus,
drew parallels between the emerging field
and semiconductors. He noted that while
government and industry were the initial
mainstay semiconductor purchasers, consumers—with their personal computers, cell
phones and other electronic products—now
account for 55 percent of demand.
Companies headquartered in the U.S.

SouthwestEconomy 16

represent more than half of world semiconductor production (Chart 1), Scalise said.
Historically, research and development and
manufacturing went hand-in-hand to create
jobs in the U.S., though increasingly manufacturing is shifting overseas. To encourage
industry growth in the U.S., the SIA established the collaborative Nanotechnology
Research Initiative (NRI) in 2005. Its goal is
development of a successor to today’s semiconductor technology by 2020. Membership
includes U.S. semiconductor companies,
30 universities and federal, state and local
governments.
Scalise expressed unease that the U.S.
regulatory and tax environment has put the
nation’s semiconductor factories at a competitive disadvantage to overseas plants. He
proposed four goals to lead the U.S. into
the “nano era”: (1) maintaining market leadership, (2) retaining technology leadership,
(3) keeping the semiconductor industry’s
No. 1 position in production, (4) creating
U.S.-based jobs at all levels, from research
to manufacturing.

Technology Aids U.S. Economy
Bart van Ark, senior vice president and
chief economist at The Conference Board,
noted that information and communications
technology (ICT)—as evidenced by the
computer, email and cell phone—has accel-

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

Chart 1
U.S. Companies Lead in Semiconductor Production Share
Percent share
60

U.S. (51%)

50

40

30
Japan (20%)
20

While nanoelectronics will

Europe (12%)
10
Korea (13%)

Taiwan (4%)

0
’82 ’83 ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09
NOTE: Based on headquarters location of manufacturers.
SOURCE: Semiconductor Industry Association; adapted from a presentation by George Scalise on Dec. 3, 2010.

likely be an economic engine
in this century, it must
overcome many technological
and economic challenges.

erated productivity increases and contributed to economic growth. In the late 1990s,
the U.S. experienced a significant increase
in output per unit of labor partly because of
greater production and utilization of information and communications technologies,
he said.
Van Ark was concerned that advances
may be shifting from developed countries
to emerging economies, such as China and
India (Chart 2A). Emerging economies’
share of ICT investment as a percentage
of global ICT investment increased to 25
percent in 2007 from 10 percent in 2000
(Chart 2B). The long-term impact of new
technologies and innovation extends beyond economic effects, creating social and
cultural benefits, van Ark said. For example,
Facebook became a social phenomenon
made possible by ICT advances. He recommended that the U.S. provide incentives
for investment in productivity-enhancing
endeavors.
Jan Youtie, a Georgia Tech University
adjunct professor and principal research
associate, said the transition from nanotechnology discovery to application can be
measured by the ratio of research publications to patent applications.
She noted that the locations of nanotechnology research and commercialization
differ. In Texas, for example, corporate
entry into nanotechnology has exceeded
research activity because the state’s diverse

high-tech companies are well positioned
to benefit from knowledge developed and
shared by national and local universities.
Nanotechnology has the potential to
affect the entire economy and spawn additional technologies, Youtie said. Following
2006, research shifted from passive nanostructures—materials designed to perform
one task, such as polymers and aerosols—
to active nanostructures, which change or
evolve during operation, such as targeted
drugs or mechanical actuators (often used
to translate a rotary motion into linear motion). This development is expected to become evident in commercialization of active
nanotechnologies in the near future.

Moving From Microelectronics (Small)
to Nanoelectronics (Smaller)
Pushkar Apte, a consultant to the
technology consortium Sematech, said that
while nanoelectronics will likely be an economic engine in this century, it must overcome many technological and economic
challenges. Sematech and semiconductor
industry leaders have developed a roadmap
to aid creative collaboration and to identify
potential problems. The difficulties are too
numerous for a single entity to overcome,
Apte said, and nanoelectronics’ commercial
success depends on industry participants
working together. Most costs involve infrastructure investment, leaving a relatively
small part as labor expense.

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

17 SouthwestEconomy

Chart 2
Emerging Economies Gain in Information and Communications
Technology Investment
A. Growth of Total Investment by Period
Percent

30
Advanced economies
Emerging economies

25

Advances in information and

20

communications technology
may be shifting from
developed countries to
emerging economies, such as
China and India.

15

10

5

0
1985–95

1995–2000

2000–07

B. Total Investment Shares
Advanced economies

1990

Emerging economies

2000

2007

10%

12%

88%

25%

90%

75%

SOURCE: The Conference Board; adapted from a presentation by Bart van Ark on Dec. 3, 2010.

Sanjay Banerjee, director of the Microelectronics Research Center at the
University of Texas at Austin, delved into
the application side of nanotechnology,
noting the rapid advance of information
and communications technology over the
past 50 years. Some of the most important
achievements involve integrated circuits,
a large number of semiconductor devices
working together. Today, integrated circuits
(also called chips or microchips) are a
$300 billion industry and drive a $1 trillion
electronics business. Transistors, used to
amplify and switch electronic signals, are
imbedded in these microchips. The average
person owns more than 100 billion transis-

SouthwestEconomy 18

tors; they are key components of everyday
items, from cell phones to cars. Because of
technological advancements, 100,000 transistors can fit across a single grain of rice
and can cost less than that same rice grain.
Nanotechnology has the potential for
greater advances and improvements in
weight, size, speed, power consumption
and electronic circuit efficiency. As the
electronics industry moves from micro- to
nanoscale designs, thermal management
challenges abound because of increased
power densities. Nanotechnology offers
promising high-thermal-conductivity, lowcontact-resistance materials to solve heat
dissipation problems.

FEDERAL RESERVE BANK OF DALL AS • SE COND QUARTER 2011

Research is moving toward more exciting nanostructures that hold innumerable
possibilities, Banerjee said. However, for the
U.S. to maintain its dominant position, the
nation must ensure its education system is
up to the task. The U.S. attracts top talent
to its universities, but often loses promising individuals after they graduate. Revising
immigration law is critical so those attaining high levels of education remain in this
country, Banerjee said.

Nanoelectronics Enhances Other Industries
John A. Laitner, economic and social
analysis program director for the American
Council for an Energy-Efficient Economy,
focused on how nanotechnology can help
the economy achieve energy savings.
For example, a significant amount of
generated power is lost through electric
transmission lines. Nanotechnology could
improve such systems, potentially lowering costs and increasing the viability of
intermittent energy sources such as wind
and solar. Collection sites are often located
far from electricity-consuming urban areas.
New nanotechnology structures used in
high-capacity fuel cells could significantly
enhance efficiency and aid storage of
energy generated by intermittent energy
sources.
Thomas Kenny, a Stanford University
professor of mechanical engineering, similarly observed that nanotechnology has
numerous applications, from solar cells to
chip-cooling applications.
Still, considerable barriers remain,
he noted. The industry lacks methods for
large-scale manufacturing and integration
of distinct technologies. Encouraging further development will require innovative
funding. One financial source has been the
federal Defense Advanced Research Projects Agency (DARPA), which has various
teams working on nanotechnology-related
issues. Zyvex Labs, a private Richardson,
Texas-based company, has been developing
nanotechnology manufacturing. It received
funding from DARPA and the Texas Emerging Technology Fund, created by the Texas
Legislature in 2005.
Anthony Tether, a former DARPA
director, highlighted the importance of
nanoelectronics development for the U.S.
amid intense global competition. In military
applications, for example, nanoelectronics
sewn in soldiers’ uniforms will act as an
electronic interface, monitoring vital signs
and other critical information, he said.

Finding Nanoelectronics R&D Funding
John Hardin, executive director of the
North Carolina Board of Science and Technology, studied nanotechnology expertise
among various North Carolina companies
and found that the primary barrier to a
broader application of nanotechnology was
a lack of access to early-stage capital. A
second hindrance was obtaining use of university facilities and equipment, Hardin said
during a final panel discussion on methods
of funding for companies involved in nanoelectronics research and development.
Incentive for public/private partnerships for
equipment and facilities sharing, similar to
the federal government’s National Nanotechnology Initiative, is a possible solution.
The national program has invested almost
$14 billion in nanotechnology research and
development since 2001.
Clinton Bybee, managing director and
cofounder of Arch Venture Partners, said
there is a progression of ideas that begin
in national research labs and subsequently
develop into commercial technology. Commercialization is usually a seven- to 10-year
process, costing $50 million to $75 million.
Venture capital is typically interested
in investing at the early stages, when the
potential of the innovation may not be fully
understood. Bybee, who has been involved
in partnerships with governmental agencies,
noted that capital sources must be committed to a long-term investment.
Nanotechnology’s prospects to open
new frontiers at a time when the U.S. seeks
to further assert its global leadership argue
for a coordinated strategy, conference participants said. Public and private partnership in the still-developing field may hold
the most promise as global competition
intensifies. The U.S. economy faces many
challenges, including an aging population
and mounting government debt. Rising
productivity, potentially led by the advancement of nanoelectronics, could provide a
catalyst for new avenues of economic expansion.

Public and private partnership
in the still-developing field
of nanotechnology may hold
the most promise as global
competition intensifies.

Phillips is a senior research economist and advisor
in the San Antonio Branch, Swadley is a research
assistant, Thies is a senior research analyst and
Yücel is a vice president and senior economist at
the Federal Reserve Bank of Dallas.

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19 SouthwestEconomy

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The Texas Service Sector
Outlook Survey
New from the Federal Reserve Bank of Dallas:
a monthly gauge of Texas service-sector activity,
the largest part of the state economy. The Texas
Service Sector Outlook Survey (TSSOS) includes a
special breakout for retail and wholesale businesses,
the Texas Retail Outlook Survey (TROS). The new
measurements complement the longstanding Texas
Manufacturing Outlook Survey, the Dallas Fed’s
gauge of state factory activity.
Look for the Texas Service Sector Outlook Survey
and companion reports at
www.dallasfed.org/research/surveys

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