Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION SECOND QUARTER 2000 

FDIC
 

New York
 

Region
 

Division of 

Insurance 

Kathy R. Kalser,
 

Regional Manager
 

Robert DiChiara,
 

Financial Analyst
 

Norman Gertner,
 

Regional Economist
 

Alexander J.G.
 

Gilchrist,
 

Economic Analyst
 

Regional Perspectives 

◆ The Region’s Economic Conditions—Although the Region’s economic 

growth rate lagged the nation’s in 1999, the gap narrowed because of the strong stock 

market and a growing concentration of new high-value-added jobs. Forecasts by 

Regional Financial Associates call for the Region’s economic growth to continue in 

2000 but at a slower pace than the nation’s.The strong economy has increased demand 

for commercial real estate, particularly in large urban areas. As a result, vacancy 

rates are falling and rents are rising in many of the Region’s major cities. See page 3. 

◆ The Region’s Banking Conditions—The Region’s banks reported generally 

healthy conditions for the fourth quarter of 1999. Insured institutions benefited 

from increased noninterest income, stable credit quality, a steeper yield curve, and 

effective expense control. Lower charge-off rates reported by the Region’s credit 

card specialists partially offset the effect of competitive pressures on margins. 

Although average credit card delinquency and charge-off rates have improved in the 

Region, in 1999 the nation’s consumer debt service burden reached its highest level 

in ten years. See page 6. 

◆ Rising Interest Rates Could Pose Risk to the Region’s Insured Institutions— 

The Region could be more sensitive to rising interest rates and changes in mortgage 

preferences than the nation, because almost one-third of the Region’s banks are 

mortgage specialists, compared with 11 percent of banks elsewhere in the nation. 

Absent effective interest-rate hedging programs, higher interest rates could hamper 

earnings if funding costs increase faster than returns earned on assets. Furthermore, because mortgage specialists reported a larger percentage of assets in securities and a greater proportion of longer-term securities than other banks in the 

Region, the value of their investment portfolios may be more vulnerable in a rising 

interest rate environment. See page 7. 

By the New York Region Staff 

In Focus This Quarter 

◆ Banking Risk in the New Economy—This article summarizes current economic conditions, with a primary focus on potential risks to insured depository institutions. It explores the implications of long-term trends that have led to the 

New Economy. Recent high rates of economic growth with low inflation have been 

made possible by increases in productivity arising from new technologies, higher 

investment spending by businesses, and large-scale industrial restructuring. Underlying these trends has been a financial environment that has largely accommodated 

the growing borrowing needs of consumers and businesses. Market-based financing, 

provided in large part through securitizations and mutual funds, has made capital 

readily available to start-up “new economy” firms as well as mature companies that 

seek to merge or restructure. Despite the clear benefits of market-based financing in 

supporting economic activity, there are also concerns.A recurrence of financial market turmoil, such as that experienced in fall 1998, has the potential to quickly change 

the currently positive economic outlook to one that is far more challenging. Detail is 

provided on commercial credit quality, market sources of revenue, and other risks to 

watch in banking. See page 11. 

By the Analysis Branch Staff 

A Publication of the Division of Insurance 
The Regional Outlook is published quarterly by the Division of Insurance of the Federal Deposit 

Insurance Corporation as an information source on banking and economic issues for insured 

financial institutions and financial institution regulators. It is produced for the following eight 

geographic regions: 

Atlanta Region (AL, FL, GA, NC, SC, VA, WV)
 

Boston Region (CT, MA, ME, NH, RI, VT)
 

Chicago Region (IL, IN, MI, OH, WI)
 

Dallas Region (CO, NM, OK, TX)
 

Kansas City Region (IA, KS, MN, MO, ND, NE, SD)
 

Memphis Region (AR, KY, LA, MS, TN)
 

New York Region (DC, DE, MD, NJ, NY, PA, PR, VI)
 

San Francisco Region (AK, AZ, CA, FJ, FM, GU, HI, ID, MT, NV, OR, UT, WA, WY)
 

Single copy subscriptions of the Regional Outlook can be obtained by sending the subscription 

form found on the back cover to the FDIC Public Information Center. Contact the Public Information Center for current pricing on bulk orders. 

The Regional Outlook is available on-line by visiting the FDIC’s website at www.fdic.gov. For 

more information or to provide comments or suggestions about the New York Region’s Regional 

Outlook, please call Kathy Kalser at (212) 704-1308 or send an e-mail to kkalser@fdic.gov. 

The views expressed in the Regional Outlook are those of the authors and do not necessarily reflect 

official positions of the Federal Deposit Insurance Corporation. Some of the information used in 

the preparation of this publication was obtained from publicly available sources that are considered 

reliable. However, the use of this information does not constitute an endorsement of its accuracy by 

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
Regional Perspectives
 

Regional Perspectives
 

•	 Although the Region’s economic growth rate lagged the nation’s in 1999, this gap narrowed because of the 

strong stock market and a growing concentration of new high-value-added jobs. 

•	 The Region’s banks benefited from increased noninterest income, stable credit quality, and a steeper yield 

curve in fourth quarter 1999. Lower charge-off rates reported by the Region’s credit card specialists 

partially offset the effect of competitive pressures on margins. 

•	 Profitability levels of the Region’s mortgage specialists, which represent more than one-third of all banks 

in the Region, could be vulnerable to rising interest rates as consumer preferences for mortgage products 

change. 

The Region’s Economic and Banking Conditions 

Economic Conditions Remain Robust 

The nation’s economy ended the decade in the midst of 

its longest expansion on record, which is expected to 

continue in 2000, although at a gradually slowing pace. 

The Blue Chip Economic Indicators, a survey of 50 of 

the nation’s prominent economists, calls for a 4.5 percent increase in gross domestic product, the broadest 

measure of the nation’s economic activity, in 2000.1 This 

forecast follows three consecutive years of economic 

expansion in excess of 4 percent. Forecasts for the 

Region also call for economic growth to continue but at 

a slower pace than the nation. During the 1990s, the 

Region’s economy performed well, although its rate of 

growth was only two-thirds of the national rate, primarily because of slower population growth and higher 

business costs (see Chart 1). Although the Region’s economic growth rate lags the national average, the gap 

narrowed in 1999 because of the strong stock market 

and a growing concentration of new high-value-added 

jobs in the Region.2 

While the Region’s economy is expected to expand in 

2000, the rate of growth will vary among the states. 

According to Regional Financial Associates (RFA), the 

economies of Maryland and New York State are 

expected to expand more rapidly than the economies of 

other states in the Region and to match the nation’s 

strong economic performance (see Table 1, next page). 

The economies of Delaware and New Jersey also are 

1 Represents the April 2000 survey.
 

2 The Region’s and states’ economies are measured by the gross state
 

products. Forecasts for the Region are made by the Regional Financial Associates; forecasts are as of January 2000.
 

expected to perform well, although forecasts call for a 

rate of growth somewhat slower than the nation’s. Economic growth in Pennsylvania is expected to slow in 

2000, primarily because of limited population growth, 

tight labor markets, and reduced manufacturing activity. 

Consumer spending, an important driver in the nation’s 

and Region’s economies, is expected to grow at a healthy 

pace based on surveys conducted by the New York and 

Philadelphia Federal Reserve Banks. Those surveys, 

which include most of the Region’s states, estimate retail 

sales increases between 3 percent and 7 percent through 

the first three months of 2000, consistent with national 

trends.3 Spending gains on home furnishings, apparel, 

3 New York and Philadelphia Federal Reserve Bank Beige Books. January 19, 2000, and March 8, 2000. 

CHART 1 

Source: National Income and Product Accounts. Region’s economy is the 

sum of the state gross products, excluding Puerto Rico. 

During the 1990s, the Region’s Economy 

Expanded at Two-Thirds the National Rate 

90 

100 

110 

120 

130 

Index Value 

1990 1991 1992 1993 1994 1995 1996 1997 

New York Region 

Nation 

New York Regional Outlook 3	 Second Quarter 2000 
Regional Perspectives
 

TABLE 1 CHART 2 

Maryland and New York Economies 

Are Forecast to Expand Most Rapidly 

in the Region in 2000 

AVERAGE 

ANNUAL PROJECTED 

GROWTH GROWTH 

RATE RATE 

1990–1999 1999–2000 

STATE (%) (%) 

DELAWARE 2.7 3.4 

MARYLAND 1.9 3.5 

NEW JERSEY 2.4 3.2 

NEW YORK 1.8 3.7 

PENNSYLVANIA 2.5 2.1 

N.Y. REGION 1.9 3.2 

UNITED STATES 3.2 3.6 

Source: National Income and Product Accounts. Gross
 

State Products for 1998 and 1999 are Regional Financial Associates estimates. Projections for 2000 are
 

made by Regional Financial Associates. Forecasts as
 

of January 2000.
 

appliances, and cosmetics were highlighted. The surveys 

indicate that merchants expect “a good selling climate” 

to prevail during the first half of 2000, and preliminary 

data during the first few months of 2000 show that 

spending is equal to or exceeds last year’s volume. Conference Board surveys of consumer expectations suggest that despite some recent concern about oil prices 

and stock market volatility, consumers generally remain 

confident about the future (see Chart 2). 

Gains in the financial services, high-tech, and computerrelated industries also have contributed to the Region’s 

economic growth. An RFA study stated that the information technology industry is growing in importance to 

the nation and Region.4 Technology has been responsible 

for a significant share of the nation’s improved productivity and job growth. In fact, the RFA study states that 

between 10 and 12 percent of the Region’s jobs are related to information technology industries, roughly equal 

to the national average. Technology centers are being 

developed, particularly in the Washington, D.C.–Maryland corridor, Philadelphia suburbs, and New York 

City. New, but smaller, technology centers also could 

help invigorate the economies of Rochester, New York, 

4 Zandi, Mark. September 1999. Information Economy. Regional 

Financial Review. 

Note: 2000 represents first quarter only. 

Source: Conference Board 

Surveys of Consumer Expectations 

Suggest Continued Spending 

Index Value 

’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00

130 

Nation 

Middle 

Atlantic 

Region 

50 

70 

90 

110 

and Pittsburgh, Pennsylvania, where local economic 

growth has lagged the rest of the Region. While information technology companies are a growing and vital 

component of the New Economy (see “Banking Risk in 

the New Economy,” page 11), some of these entrants 

could be at risk if their performance does not meet Wall 

Street expectations or if equity and venture capital 

financing becomes more difficult to obtain. 

Commercial Real Estate Markets Tighten 

The strong economy has increased demand for commercial real estate in the Region, particularly in the 

large urban areas. Vacancy rates in New York City, 

Washington, D.C., and Wilmington, Delaware, are 

almost half the nation’s average. Office space is so tight 

in New York City that rents easily exceed $50 per square 

foot in many class-A buildings and are approaching 

$100 per square foot in some areas. Office vacancy 

rates in downtown Baltimore stood at 9.1 percent in the 

third quarter of 1999, down from 18.1 percent two years 

earlier. While the 12.6 percent office vacancy rate in 

downtown Philadelphia was above the national average 

of 9 percent for downtown areas, the city’s suburban 

vacancy rate was 8.5 percent, below the 10.1 percent 

national average. 

At this late stage in the current economic expansion, 

vacancy rate trends in the Region’s major metropolitan 

areas differ from those experienced immediately prior 

to the recession of the early 1990s. While vacancy rates 

for many metro areas were lower than the national average at that time, vacancies had started to rise in some of 

New York Regional Outlook 4 Second Quarter 2000 
Regional Perspectives
 

the Region’s major cities. The recession of the early 

1990s hit the Region’s real estate markets harder than 

other parts of the nation, in part because a significant 

amount of new office construction was being completed just as the Region’s economy was contracting and 

demand for space was declining. Many of the Region’s 

cities reported declining vacancy rates through most of 

1999.5 As a result, the Region’s commercial real estate 

markets appear better positioned in case of an economic downturn than these markets were ten years ago. 

Although vacancy rates are still declining in most of the 

Region’s cities, there are some areas of concern. For 

example, construction of office space has increased in 

eastern New Jersey, primarily in areas within commuting distance to higher-rent areas in New York City. 

Increased construction also is evident in the suburbs of 

Philadelphia and the Washington, D.C.–Baltimore area, 

and anecdotal evidence exists of speculative office 

development in the Pittsburgh; Albany, New York; and 

northern New Jersey markets. Although new office construction presently is substantially less than just before 

the last recession, an economic slowdown, depending 

on its depth and duration, could hurt the Region’s office 

markets. Because developers traditionally initiate projects based on current market conditions rather than economic forecasts, the amount of office construction 

should be closely monitored. 

Housing markets in many parts of the Region also are 

robust, following several years of stagnant prices, 

although they have not attained the growth rates of the 

late 1980s. Demand for new homes and resales has been 

particularly strong in areas experiencing the greatest 

levels of job growth. Home sales and residential construction increased in the latter half of the 1990s, particularly in the suburbs of New York City, Philadelphia, 

and the Washington, D.C.–Baltimore area; however, 

activity is still below levels reached during the 1980s in 

many of the Region’s cities. According to the National 

Association of Realtors, the median price for a singlefamily home in the Washington, D.C., metropolitan 

area, for example, rose 4.4 percent between December 

1998 and year-end 1999. In contrast, home prices in this 

area rose 12 percent in 1987 and 15 percent in 1988. 

Permits for new single-family homes slowed in 1999, 

possibly in response to higher interest rates, rising 4 

percent nationwide in 1999, compared with a 12 percent 

5 Vacancy rate data as of the third quarter of 1999. Source: C.B. 

Richard Ellis. 

increase in 1998. In the first two months of 2000, permit growth slowed further to 1.2 percent, compared 

with the same period in 1999. The Region experienced 

a similar rate of permit growth. In 1998, permits for 

new single-family homes increased at double-digit rates 

in Delaware, Maryland, and New York. In New Jersey 

and Pennsylvania, the increase was close to 9 percent. 

In 1999, however, growth slowed to less than 3 percent 

in most of the Region’s states. New York was the exception: new permits increased 6 percent, slightly higher 

than the nation’s growth rate. 

Region’s Dependence on 

Wall Street Increases 

The stock market has contributed greatly to the 

Region’s economic expansion, more so than in other 

parts of the nation. According to a recent Federal 

Reserve Board Survey, stocks, mutual funds, and retirement accounts represented two-thirds of household 

financial assets6 at year-end 1998, up from 42 percent at 

year-end 1989. Furthermore, nearly half of all households owned stocks in 1998, either directly or in mutual funds, compared with 32 percent of families ten years 

ago.7 Stock ownership is more concentrated in the New 

York Region than in other Regions. Studies show that 

the Region’s investors hold almost one-quarter of the 

nation’s total equity investments.8 In addition, Wall 

Street and related financial services industries have represented the primary source of earnings growth in New 

York City. Between 1994 and 1998, securities firms 

contributed approximately $23 billion to New York 

City’s economy, or more than one-third of the increase 

in total salaries, compared with 4.3 percent for the 

nation.9 The average salary for New York State’s 

186,000 securities and commodity brokers was approximately $230,000,10 and the New York State Comptroller’s Office estimated that bonuses on Wall Street 

totaled $11.4 billion in 1999, up 18 percent from one 

6 Household financial assets include savings and checking accounts,
 

stock, bonds, mutual funds, retirement accounts, cash value of life
 

insurance policies, and other managed assets.
 

7 Kennickell, Arthur B., Martha Starr-McCluer, and Brian J. Surette.
 

1999. Recent Changes in U.S. Family Finances, Results from the
 

1998 Survey of Consumer Finances. Federal Reserve Board, Division
 

of Research and Statistics.
 

8 The Investment Company Institute. 1995. State Distribution, Mutual Fund, Assets and Accounts.
 

9 Securities Industry Association. March 2000 Update. The New York
 

Securities Industry: Its Economic Impact on New York State and City.
 

10 Based on 1997 earnings data supplied by the Bureau of Economic
 

analysis. Represents most recent data available.
 

New York Regional Outlook 5 Second Quarter 2000 
5 

4 

1 

0 

Regional Perspectives
 

year ago. The economic multiplier of Wall Street is so 

significant that, for example, although the securities 

industry accounts for only 2 percent of the jobs in New 

York State, it was responsible for almost 60 percent of 

the increase in the state’s gross product between 1992 

and 1997. Because of the Region’s dependence on Wall 

Street, a downturn in the stock market, if deep and sustained, could weaken the economy in the Region more 

than in other areas of the nation. 

Strong Economy Helps Region’s 

Insured Institutions and 

Credit Card Specialists 

The Region’s banks reported generally healthy conditions for the fourth quarter of 1999. Insured institutions 

benefited from stable credit quality, a steeper yield 

curve, increased noninterest income, and effective 

expense control.11 With a flatter yield curve prevalent 

during 1998, the Region’s average net interest margin 

(NIM) declined during the year. In the latter half of 

1999, however, the average NIM rebounded as the yield 

curve steepened following increases in the Federal 

Funds rate. The ratio of loans to deposits also rose during the year, but the Region’s banks faced competition 

for core deposits, which declined marginally as a percentage of assets (see Charts 3 and 4). Credit quality 

CHART 3 

Noninterest Income Helps ROA... 

4Q ’97 

4Q ’98 

ratios improved for most loan segments, except for 

commercial and industrial loans, which showed a slight 

increase in the charge-off rate. 

Results of the Region’s credit card specialists12 reflected 

intense competition and increased consolidation among 

credit card lenders. The increase in the number of credit 

cards held by consumers has slowed as response rates on 

mailed card solicitations declined from a peak of 2.8 

percent in 1992 to 1 percent in 1999, an all-time annual 

low. In the past, response rates have declined as the volume of mailings increased, but in 1999 the number of 

mailed credit card solicitations actually declined. 

According to BAI Global, Inc., a market research firm 

that tracks credit card solicitations, direct mail solicitations dropped 17 percent in 1999 from record mailings 

of 3.45 billion in 1998.13 Some of the decline was attributed to the elimination of overlapping programs as card 

lenders merged or acquired competitors. Other lenders 

reduced mailings to combat margin pressures or shifted 

focus to new solicitation methods, including Internetbased marketing programs. Market saturation also contributed to lower response rates, as many consumers feel 

they have enough credit cards. With introductory rates 

on some credit cards nearing zero percent, card lenders 79.2

have fewer ways to compete as the differences among 80.4

card programs become less tangible. 81.0 

CHART 4 

...but Banks Face Competition 

for Core Deposits 

4Q ’98 

4Q ’97 

85 

1.041.05

1.11 

4.10

3.94

3.90 

2.14

2.28

2.79 

4Q ’99 

63.0

65.4

64.9 

37.0 

4Q ’99 

35.5

34.5 

75 

Percent 3 

2 

Percent 

65 

55 

45 

35 

Return on Net Interest Noninterest 25
 

Assets Margin Margin
 Loans to Deposits Efficiency Ratio Core Deposits/ 

Assets Note: Excludes Region’s credit card banks and banks less than three years old.
 

ROA = return on assets Note: Excludes Region’s credit card banks and banks less than three years old.
 

Source: Bank and Thrift Call Reports Source: Bank and Thrift Call Reports
 

12 Credit card specialists are defined as insured institutions that report 

at least 50 percent of assets as loans and at least 50 percent of loans 

as credit card receivables. 11 Excludes banks that received charters after December 31, 1996, and 13 BAI Global, Inc. 1999. Credit Card Mail Volume Declines, As Conbanks that specialize in credit card lending. sumer Response Rates Reach All-Time Low. 

New York Regional Outlook 6 Second Quarter 2000 
12 

Regional Perspectives
 

Industry trends affected the results of the Region’s credit 

card specialists. The Region’s nine credit card specialists, 

which accounted for 32.5 percent of total managed card 

receivables14 reported by insured institutions nationwide 

as of December 31, 1999, reported a lower average return 

on assets (ROA) and average NIM for the fourth quarter 

of 1999 than the previous year. These trends were consistent with credit card specialists nationwide. Yields earned 

on prime credit card loans have declined as lenders have 

reduced rates to compete for accounts. Higher noninterest income buffered the effect of lower NIMs (see Charts 

5 and 6). Card lenders increasingly have turned to additional forms of noninterest income, such as higher fees 

on late accounts and charges for balance inquiries, to 

counter lower yields earned on traditional credit card 

loans. (For more information, see “Noninterest Income 

Grows in Importance” in the New York Regional Outlook, first quarter 2000.) The Region’s credit card lenders 

also benefited from a decline in the credit card charge-off 

rate. Lower personal bankruptcy filings (which declined 

by 8.3 percent in 1999), a strong economy, an influx of 

cash from mortgage refinancing, and improved underwriting and risk-based pricing enhanced credit quality 

ratios reported by the Region’s credit card specialists. 

Although the number of bankruptcy filings is high historically, preliminary studies show that the downward 

trend in personal bankruptcy filings has continued 

through the beginning of 2000.15 

Although returns on credit card lending continue to 

exceed returns earned by most of the banking industry, 

CHART 5 

Higher Noninterest Income Offsets 

Pressure on Credit Card Profitability... 

16 

14 

4 

1Q92 1Q93 1Q94 1Q95 1Q96 1Q97 1Q98 1Q99 

Net Interest Margin 

Noninterest Income 

3.0 

2 Return on Assets 

2.5 0 

10

Percent 8 

6 

and credit quality measures improved in 1999, the outlook for the credit card segment nationwide is mixed. As 

interest rates declined from 1997 through the first half of 

1999, some consumers paid off credit debt with proceeds 

from refinanced mortgage loans, alleviating pressure on 

credit card loans. Refinancings have declined, however, 

as interest rates climbed in early 2000, and a potentially 

slower economy could have implications for consumer 

credit quality. Although average credit card delinquency 

and charge-off rates have improved, the consumer debt 

service burden (the ratio of debt service payments on 

household consumer and mortgage debt as a percentage 

of disposable personal income) is rising; it reached 13.5 

percent for 1999, the highest annual level since 1989.16 

Higher charge-off rates on credit card loans generally 

have tracked rising debt service burden (see Chart 7, 

next page). Consumers, of course, have benefited from 

stock market gains, which are excluded from disposable 

income; however, instability in the stock market could 

disrupt this supplemental repayment source. 

Rising Interest Rates Could Pose Risk to 

Region’s Economy and Insured Institutions 

The Federal Reserve Board increased the Federal 

Funds target rate on five occasions between June 1999 

and March 2000, for a total of 125 basis points. These 

increases have resulted in higher short- and long-term 

interest rates since December 1998 (see Chart 8, next 

page). The ten-year Treasury bond rate, for example, 

CHART 6 

...and Credit Quality Ratios Have Stabilized 

5.5 

5.0 

Charge-offs 

Past Dues 

1Q91 1Q92 1Q93 1Q94 1Q95 1Q96 1Q97 1Q98 1Q99 

4.5 

Percent 4.0 

3.5 

1Q91 

Source: Bank and Thrift Call Reports for the Region’s Credit Card Source: Bank and Thrift Call Reports 

14 Managed credit card receivables include on-balance sheet and securitized credit card loans.
 

15 CIBC World Markets. March 23, 2000. Credit Card Industry.
 

Weekly filings through March 4, 2000. 16 Source: Federal Reserve Board.
 

New York Regional Outlook 7 Second Quarter 2000 
Regional Perspectives
 

CHART 7 

was 180 basis points higher at the end of first quarter 

2000 than fourth quarter 1998. The Region’s economic 

growth declined more than the nation’s following hikes 

in the Federal Funds rate in the mid-1990s and could 

follow a similar pattern if rates continue to rise. (See 

“Higher Interest Rates May Curtail the Region’s Economic Expansion” in New York Regional Outlook, 

fourth quarter 1999.) 

The decline and subsequent rise in interest rates during 

the latter half of the 1990s could affect interest margins 

earned by the Region’s banks, particularly banks that specialize in mortgage lending. During 1997 and 1998, as 

long-term interest rates declined and the yield curve flattened, home purchasers and consumers who refinanced 

existing mortgages favored longer-term, fixed-rate loans 

over short-term adjustable rate mortgages (ARMs). 

CHART 8 

Source: Federal Reserve Board. 

Yields on Treasury Securities Have Sharply 

Increased since Year-end 1998 

4.0 

4.5 

5.0 

5.5 

6.0 

6.5 

7.0 

30 yr 

Interest Rate (%) 

3 mo 6 mo 1 yr 2 yr 5 yr 10 yr 20 yr 

December 1998 

March 2000 

1981 1984 1987 1990 1993 1996 1999 

Sources: Bank and Thrift Call Reports; Federal Reserve Board. 

Changes in Charge-offs Track Debt Service Burden 

(Year-over-Year Percentage Change) 

Percent Change 

Charge-offs Percent Change 

Debt Burden 

–120 

–60 

0 

60 

120 

–8 

–4 

0 

4 

8 

CHART 9 

As Mortgage Rates Rise, 

Consumers Favor ARMs 

Note: ARM = adjustable rate mortgage 

Source: Federal Reserve Board, Federal Housing Finance Board, Monthly Interest 

Rate Survey. Data through fourth quarter 1999. 

’92 ’95 

30-Year Mortgage Rate (%) ARM to Total Originations (%) 

0 

15 

30 

45 

60 

5 

6 

7 

8 

9 

10 

’93 ’94 ’96 ’97 ’98 ’99 

Banks and other mortgage lenders responded to market 

demand by supplying long-term products at lower interest rates. During 1999, as long-term interest rates rose 

and the yield curve steepened, consumers switched to 

ARMs (see Chart 9). Refinancing activity and mortgage 

prepayments subsequently slowed, because it was no 

longer advantageous to refinance the 1997 and 1998 vintage mortgages at 1999’s higher rates (see Chart 10). 

The Region’s banks could be more sensitive to rising 

interest rates and changes in mortgage preferences than 

banks elsewhere in the nation because almost one-third 

of the Region’s banks are mortgage specialists, compared 

with 11 percent of banks elsewhere in the nation.17 Mortgage specialists’ NIMs could be constrained if interest 

17 Mortgage specialists are defined as banks that have at least 50 percent of assets in mortgage-related loans or securities. 

New York Regional Outlook 8 Second Quarter 2000 
Regional Perspectives
 

CHART 10 

1992 1993 1994 1995 1996 1997 1998 1999 2000 

0 

100 

200 

300 

Source: Federal Reserve Board, Mortgage Bankers Association. Mortgages are conventional 30-year, Federal Home Loan Mortgage Corporation. Indices have been 

reindexed to first quarter 1992. Data through March 2000. 

30-Year Mortgage 

Rate (%) 

(left axis) 

As Mortgage Rates Have Increased, Refinancings Have Declined More than Purchases 

Index Value 

(right axis) 

Refinancings 

Purchases 

6 

7 

8 

9 

10 

rates continue to rise because the maturity distribution of 

mortgage portfolios has lengthened since 1997, reflecting consumers’ preference for longer-term mortgages 

(see Chart 11). Concurrently, the proportion of volatile 

liabilities18 at these banks has risen as reliance on shorter-term, noncore funding has increased, reflecting stiffer 

competition for core deposits (see Chart 12). Although 

the Region’s mortgage specialists reported a higher ratio 

of core deposits to assets than the average for all banks 

in the nation, the percentage has declined over the past 

five years. Higher interest rates could squeeze earnings if 

the mismatch between the maturity and pricing intervals 

of loan portfolios relative to a bank’s liabilities is significant. Furthermore, banks and other mortgage holders 

may be faced with holding these lower-rate, long-term 

CHART 11 

mortgages in their portfolios or selling them at a loss 

until rates decline below pre-1999 levels. In addition, 

while a reduced pace of refinancings could stabilize the 

Region’s mortgage servicing income, a drop in mortgage 

originations could result in lower mortgage fees, an 

important source of income for mortgage lenders. 

Not only are mortgage specialists vulnerable to rising 

interest rates because of changes in mortgage demand, 

but they rely on spread income more than the rest of the 

industry. Although the proportion of interest income to 

operating income has declined, the Region’s mortgage 

specialists generated almost 75 percent of operating 

income from interest income in fourth quarter 1999, 

compared with 47 percent for the rest of the Region’s 

CHART 12 

Mortgage Maturities Have Extended... 

Percentage of Mortgage Loans 1999 

40 

35 

30 

25 

20 

15 

10 

5 

0 

< 3 Mos 3–12 Mos 1–3 Yrs 3–5 Yrs 5–15 Yrs > 15 Yrs 

Source: Bank and Thrift Call Reports. Mortgage specialists as of 12/31/99. 

1997 

...While Volatile Liabilities Have Increased 

Source: Bank and Thrift Call Reports. Mortgage Specialists as of 12/31/99. 

20 

25 

30 

35 

Volatile Liabilities as 

a Percentage of Assets Dec ’96 Mar ’97 Jun ’97 Sep ’97

Dec ’97

Mar ’98

Jun ’98

Sep ’98

Dec ’98

Mar ’99

Jun ’99

Sep ’99

Dec ’99 

18 Volatile liabilities are funding sources that typically have short-term 

maturities or are subject to repricing in the short term. 

New York Regional Outlook 9 Second Quarter 2000 
Regional Perspectives
 

banks. Furthermore, mortgage specialists also generate 

lower NIMs because yields on traditional mortgages 

tend to be lower than for other types of loans. In fourth 

quarter 1999, the average NIM for the Region’s mortgage specialists was approximately 100 basis points 

lower than the average NIM for all banks in the Region, 

consistent with past years. 

Rising interest rates also could affect the valuation of 

bank securities portfolios. Mortgage specialists may be 

more vulnerable to changes in securities values because 

this group holds a larger percentage of assets in securities. As of December 31, 1999, the Region’s mortgage 

specialists held almost one-third of total assets in securities, compared with 19 percent for all banks in the 

Region. This relationship was similar for all banks 

nationwide. Furthermore, the maturity structure of 

securities portfolios held by the Region’s mortgage specialists lengthened during the past two years. At yearend 1999, approximately 31 percent of securities held 

by these institutions had maturities greater than 15 

years, compared with just under 10 percent one year 

earlier. In contrast, securities with maturities greater 

than 15 years represented between 20 and 23 percent of 

securities for the rest of the Region’s banks during the 

same period. Because security prices move inversely 

with interest rates and prices of longer-term securities 

are more sensitive to interest rate changes than shorterterm securities are, the value of security portfolios held 

by the Region’s mortgage specialists could be at greater 

risk in a rising rate environment. In fact, in fourth 

quarter 1999, the Region’s 117 commercial banks that 

specialize in mortgage lending reported net depreciation in securities’ value equal to 9.8 percent of average 

Tier 1 capital compared with net depreciation equal to 

5.1 percent for the rest of the Region’s banks.19 

19 Bank Call Report. Thrifts do not report securities’ appreciation and 

depreciation. Net appreciation and depreciation amounts were calculated on changes in values for securities held to maturity and unrealized gains or losses on securities held for sale. 

Implications 

Swings in mortgage preferences, reduced levels of refinancings, and rising interest rates could challenge the 

interest rate risk management programs of the Region’s 

mortgage specialists. During the past two years, the 

maturity of mortgage assets reported by the Region’s 

mortgage specialists has lengthened as homeowners 

took advantage of declining interest rates by refinancing into or originating new long-term, fixed-rate mortgages. During the same time, the proportion of 

shorter-term, volatile liabilities reported by the Region’s 

mortgage specialists rose, reflecting increased competition for core deposits. Absent effective interest-rate 

hedging programs, mortgage specialists’ margins may 

be pressured if funding costs increase faster than returns 

earned on assets. Furthermore, because mortgage specialists reported a larger portion of long-term securities 

than other banks in the Region, the value of their investment portfolios may be more vulnerable to rising longterm interest rates. Faced with margin compression, 

some mortgage specialists may be tempted to invest in 

higher-yielding, traditionally higher-risk securities to 

supplement income. Although mortgage specialists 

should benefit from increases in the spread between 

Treasury benchmarks and mortgage rates that occurred 

in early 2000,20 changes in mortgage demand coupled 

with rising interest rates could stress the profitability of 

the Region’s mortgage specialists. 

Kathy R. Kalser, Regional Manager 

Robert DiChiara, Financial Analyst 

Norman Gertner, Regional Economist 

Alexander J.G. Gilchrist, Economic Analyst 

20 Barta, Patrick. April 7, 2000. Mortgage Rates, Strangely, Remain 

Aloft. The Wall Street Journal. 

New York Regional Outlook 10 Second Quarter 2000 
In Focus This Quarter
 

Banking Risk in the New Economy
 

The Division of Insurance periodically assesses conditions in the economy and the banking industry to identify and evaluate trends that could adversely affect the 

performance of insured depository institutions. At this 

time, the banking industry as a whole continues to 

enjoy record profits and solid financial ratios.1 Much of 

the industry’s strength derives from the remarkable performance of the U.S. economy, which has been expanding for the past nine years. This article explores factors 

that have shaped this unusually robust economic environment and discusses how changes in the economy 

may create new types of risks for insured depository 

institutions. 

During 1999, the FDIC reported the first annual loss for 

the Bank Insurance Fund since 1991. This loss primarily resulted from an uptick in unanticipated and highcost bank failures. Some of these failures were 

associated with high-risk activities such as subprime 

lending, and some were related to operational weaknesses and fraud. The emergence of these problems in 

the midst of a strong economic environment raises concerns about how the condition of the banking industry 

might change if economic conditions deteriorate. 

The Longest U.S. Expansion 

In February 2000, the U.S. economy entered its 108th 

month of expansion, making this the longest period of 

uninterrupted growth in U.S. history.2 This recordsetting performance has also been marked by a recent 

acceleration in the rate of real gross domestic product 

(GDP) growth, which has exceeded 4 percent in each 

year since 1997. Meanwhile, price inflation has 

remained relatively subdued. The core inflation rate, 

which excludes the volatile food and energy components, was just 2.1 percent in 1999, the lowest core rate 

since 1965. 

Recent economic conditions have been highly conducive to strong loan growth, low credit losses, and 

record earnings for the banking industry. The important 

1 For a recent summary of financial performance and condition of the 

banking and thrift industries, see the FDIC Quarterly Banking Profile, fourth quarter 1999, http://www2.fdic.gov/qbp/. 2 The chronology of U.S. business cycles is available from the National Bureau of Economic Research, http://www.nber.org/cycles.html. 

question going forward is how long these favorable conditions might last. Is this remarkable economic performance the result of some long-term upward shift in the 

pace of economic activity, or is it the temporary result 

of a few transitory factors? More important, are there 

new and unfamiliar dangers that, at some point, could 

significantly impair banking industry performance? To 

evaluate these questions, we must assess the factors that 

have contributed to recent economic performance and 

think ahead to possible developments that could end this 

expansion. 

What Is the New Economy? 

The term used most often to describe the recent period 

of economic performance has been somewhat controversial: the New Economy. Much of the controversy has 

arisen because people interpret the term in different 

ways. Wall Street analysts use the term to refer to the 

high-technology sectors of the economy, such as computers and software, biotechnology, and especially the 

Internet. Some of these New 

Economy firms have been able to 

raise large amounts of capital and 

command market valuations in 

the tens of billions of dollars well 

in advance of earning a profit or 

even booking significant cash 

revenues. 

Economists tend to employ the term New Economy in a 

slightly different way. To them, it refers to evidence that 

some of the traditional economic relationships have 

changed. For example, intangible assets now appear to 

play a much larger role in the valuation of investments 

than they have in the past.3 Firms in some industries 

now may exhibit increasing returns to scale (rather than 

diminishing returns), reflecting the fact that the value of 

their product rises as it becomes a de facto industry 

standard.4 Individual decision making, too, may be 

changing. Some believe that investors have reduced the 

risk premium they demand to hold equity positions 

3 Nakamura, Leonard. Federal Reserve Bank of Philadelphia. 

July/August 1999. Intangibles: What Put the New in the New Economy? Business Review. http://www.phil.frb.org/files/br/brja99ln.pdf. 4 Brown, William S. March 2000. Market Failure in the New Economy. Journal of Economic Issues, 219–27. 

New York Regional Outlook 11 Second Quarter 2000 
In Focus This Quarter
 

because of their perception that holding equity is not, 

after all, substantially riskier than holding debt.5 Such a 

shift in investor attitudes could help explain why the 

price-to-earnings ratio for the S&P 500 index has 

recently approached all-time highs.6 

Perhaps the most important underlying change in the 

economy is the relationship between high rates of economic growth and changes in inflation. Economists have 

long maintained that rapid growth in economic activity 

has a tendency to lead to excess demand for goods (thereby raising consumer and producer prices) and excess 

demand for labor (thereby raising wage rates). But during 

the late 1990s, as growth accelerated and inflation 

remained low, economists began to reevaluate their 

notions of these trade-offs. Some argued that the low rate 

of inflation during this expansion was the fortunate result 

of temporary factors, such as a strong dollar and low 

energy prices, both of which could diminish or reverse 

direction over time.7 Only a few analysts were so bold as 

to suggest that the fundamental workings of the economy 

had changed in such a way as to allow a sustained period 

of high economic growth with low inflation. 

An early Wall Street description of the New Economy 

appeared in an article released by Goldman Sachs in 

January 1997.8 It describes a number of fundamental 

changes in the economy—driven by global competition 

and advancing technology—that may permit business 

cycle expansions to last longer than they have in the 

past. At the same time, it warned that longer economic 

expansions might have a tendency to contribute to 

greater financial excess and the possibility of more 

severe recessions and more sluggish recoveries. 

If this hypothesis is correct, and an emerging New 

Economy would contribute to longer expansions and 

more severe recessions, there may be implications for 

how banks manage risks. Since the Great Depression, 

U.S. business cycle recessions have not necessarily been 

catalysts for large numbers of bank and thrift failures. 

5 January 24, 2000. Has the Market Gone Mad? Fortune.
 6 September 1999. Earnings: Why They Matter. Money.
 7 Brown, Lynn Elaine. Federal Reserve Bank of New England.
 

May/June 1999. U.S. Economic Performance: Good Fortune, Bubble,
 

or New Era? New England Economic Review. http://www.bos.frb.org/
 

economic/pdf/neer399a.pdf, and Brinner, Roger E. Federal Reserve
 

Bank of New England. January/February 1999. Is Inflation Dead?
 

New England Economic Review. http://www.bos.frb.org/economic/
 

pdf/neer199c.pdf.
 

8 Dudley, William C., and Edward F. McKelvey. January 1997. The
 

Brave New Business Cycle: No Recession in Sight. U.S. Economic
 

Research, Goldman Sachs.
 

During the period from 1983 to 1989, when the U.S. 

economy was in the midst of a long expansion, some 

1,855 insured banks and thrifts failed. This wave of 

failures has been attributed to a variety of factors, 

including severe regional economic downturns, realestate-related problems, stress in the agricultural sector, 

an influx of newly chartered banks and banks that converted charters, and high nominal interest rates.9 However, the potential for significantly more severe national 

recessions would represent largely uncharted territory 

that could cause losses and loss correlations to depart 

from historical norms, posing a new set of risk management challenges for the industry going forward. 

The Productivity Revolution 

As the essential element that links faster economic 

growth and low inflation, productivity growth is the cornerstone of the New Economy. Productivity refers generally to the amount of output that can be obtained from 

a fixed amount of input. Labor productivity is usually 

measured in terms of output per hour. Chart 1 shows 

that output per hour in manufacturing has risen at an 

average annual rate of 4.5 percent during the current 

expansion, compared with rates of just over 2.5 percent 

in the three previous long economic expansions. Moreover, productivity growth accelerated in 1999 to a rate 

of 6.3 percent. Why is productivity growing so fast now 

compared with previous expansions? Even economists 

who believe that economic relationships have fundaCHART 1 

Productivity Has Grown at a Faster Rate in This 

Expansion than in Previous Long Expansions 

Average Year-over-Year Growth 

in Manufacturing Output per Hour 

5.0% 

4.0% 

3.0% 

2.0% 

1.0% 

0.0% 

1961–69 1975–79 1983–90 1991–2000 

Source: Bureau of Labor Statistics (Haver Analytics) 

9 FDIC Division of Research and Statistics. 1997. History of the 

Eighties: Lessons for the Future, Vol. 1, An Examination of the Banking Crises of the 1980s and Early 1990s, 16–17. http://www. 

fdic.gov/bank/historical/history/contents.html. 

New York Regional Outlook 12 Second Quarter 2000 
In Focus This Quarter
 

mentally changed are hard-pressed to explain why all of 

the factors came together in the late 1990s and not 

before.10 Still, explanations for the increase in productivity tend to focus on three main factors. 

Increased Competition. Expanding global trade during 

the 1980s and 1990s has subjected U.S. firms to new 

competition from around the world. Annual U.S. 

exports of goods and services grew by over 230 percent 

(after inflation) between 1982 and 1999, while imports 

grew by 315 percent. The construction of new production facilities around the world in industries such as 

autos and chemicals has led to excess manufacturing 

capacity that has kept prices low. In other industries, 

including air travel, trucking, telecommunications, and 

banking, competition has been intensified through 

domestic deregulation. Facing intense competitive pressures and a low rate of general price inflation, firms 

cannot rely on annual price increases to help expand 

top-line revenue. Instead, there is pressure to continually cut costs in order to increase earnings. For many 

firms, this means adopting new technologies and new 

ways of organizing operations. 

Expanded Investment. U.S. firms of all sizes have 

invested in new technologies at a rapid pace during this 

expansion. Chart 2 shows that business investment in 

equipment and software represents almost one-quarter 

of total net GDP growth during this expansion, comCHART 2 

Business Investment in Equipment and Software
 

Has Been Robust during This Expansion
 

Average Percent Contribution of Real Investment 

in Durable Equipment and Software 

to Net GDP Growth by Expansion 

25 

20 

15 

10 

5 

0 

1961–69 1975–79 1983–90 1991–99 

Note: GDP = gross domestic product
 

Source: Bureau of Economic Analysis (Haver Analytics)
 

10 One possible explanation is that there is a learning curve for adopting new technologies and that technology diffusion is an inherently 

slow process. David, Paul A. Organization for Economic Cooperation 

and Development. 1991. Computer and Dynamo: The Modern Productivity Paradox in a Not-Too-Distant Mirror. In Technology and 

Productivity: The Challenge for Economic Policy, 315–47. 

pared with around 15 percent or less during previous 

long expansions. While this investment has been motivated by the need to cut costs, it has also been fueled by 

the availability of new computer technologies that have 

fallen in cost over time and by the ready availability of 

financial capital on favorable terms. 

Industrial Restructuring. The third aspect of the productivity revolution is large-scale restructuring in the 

U.S. corporate sector. Chart 3 shows that both the annual number and dollar volume of mergers in the late 

1990s far exceeded the pace of the so-called merger 

mania of the late 1980s. Two classes of firms are leading the new wave of mergers. First, companies in 

mature industries such as oil, autos, and banking are 

faced with excess productive capacity and intense price 

competition. For these firms, mergers are useful in 

expanding market share and removing redundant operations. Second, the largest dollar volume of mergers is in 

some of the most volatile emerging industries, including telecom, media, and the Internet. It is in these sectors of the economy, in particular, where the business 

models are evolving rapidly and where technological 

standards are still being determined. Firms in these 

industries that can grow rapidly through mergers have 

the chance to achieve long-term market dominance in 

what appear to be some of the fastest growing industries 

of the new century. 

The implications of the productivity revolution for the 

banking industry have been decidedly positive. Higher 

productivity has allowed a long expansion and faster 

economic growth with low inflation, all of which are 

conducive to robust financial performance by depository institutions. Higher rates of business investment 

CHART 3 

Note: M&A = merger and acquisition 

Source: Houlihan Lokey’s Mergerstat 

The Volume of Corporate Mergers Set 

Another New Record in 1999 

Number of M&A Deals M&A Deal Value, Billions of Dollars 

’70 ’72 ’74’76’78’80 ’82 ’84’86 ’88 ’90’92’94’96 ’98 

0 

2,000 

4,000 

6,000 

8,000 

10,000 

1,000 

1,200 

1,400 

1,600 

0 

200 

400 

600 

800 

New York Regional Outlook 13 Second Quarter 2000 
In Focus This Quarter
 

have generated demand for credit that is supplied, in 

part, by banks and thrifts. Perhaps most important, the 

recent large-scale industrial restructuring has been 

highly supportive of strong business credit quality. This 

process has moved economic resources to more productive uses in an orderly fashion, without the high levels 

of bankruptcies and defaults that often accompany 

industrial restructuring. Given the volumes of corporate 

assets that have changed hands in recent years (more 

than $1.4 trillion in 1999 alone), it is fortunate indeed 

that this restructuring has proceeded in this fashion. 

The Role of the Capital Markets 

A critical factor in heightened business investment and 

restructuring during this expansion has been the 

remarkably favorable conditions in the financial markets. Financial capital has generally been readily available to business borrowers, usually on favorable terms. 

One factor that has held down the cost of capital for 

publicly traded corporations has been sharply rising 

stock prices. Many of these firms have been able to use 

equity shares as a currency with which to finance mergers. Furthermore, existing accounting rules do not 

always require the amortization of good will that comes 

onto the balance sheet as a result of a merger.11 

By far the largest amount of external business financing 

has been debt financing. U.S. nonfinancial corporations 

issued net debt in the amount of $535 billion in 1999 

and repurchased equity shares, on net, for the sixth consecutive year. Businesses have used this debt to purchase capital equipment, finance mergers, and buy back 

equity shares. This increase in debt issuance has not 

been limited to highly rated corporations. Venture capital financing amounted to almost $15 billion in the 

fourth quarter of 1999 alone, with over 60 percent of 

that amount going to Internet firms.12 

Banks have been active participants in nearly every 

facet of this financing activity. Syndicated loan origination volumes rose by 17 percent in 1999 to just over 

$1 trillion, despite relatively high credit costs and facility fees, factors that helped keep total volume below 

1997’s record $1.1 trillion in issuance. Syndicated loans 

to leveraged companies also rose 17 percent in 1999 to 

a record $320 billion. More impressive still was the 

growth in high-yield transactions, which rose nearly 50 

11 April 17, 2000. Techdom’s New Bean-Counting Battle. Business 

Week. 

12 May 2000. Venture financing data are derived from a PriceWaterhouseCoopers/Money Tree survey, as cited in Upside, 43. 

percent in 1999 to $190 billion. It is difficult to determine precisely how much syndicated loan exposure 

resides on the books of insured institutions or, more 

important, how much high-yield exposure is retained by 

commercial banks. Loan Pricing Corporation estimates that 64 percent of high-yield volume in the first 

half of 1999 was retained by banks.13 Insured commercial banks are the dominant originators of syndicated 

loans, with a 79 percent market share of investmentgrade originations and a 56 percent market share of 

non-investment-grade originations in 1999. Commercial banks have also expanded their presence in the venture capital market. For some of the largest banks, 

profits from venture capital operations account for a 

large portion of total earnings. Chase Manhattan reported venture capital investment earnings of $2.3 billion in 

1999, accounting for 22 percent of total net income.14 

Innovation in the capital markets continues to provide 

new and more efficient vehicles for business financing. 

For example, issuance of asset-backed securities totaled 

$346 billion in 1999, up from only $50 billion in 1990. 

In this ongoing revolution in finance, market-based 

intermediaries, such as mutual funds and asset pools, 

have assumed an increasing role in the credit markets. 

Chart 4 shows that net holdings of credit market instruments by mutual funds, government-sponsored enterprises, and asset pools exceeded the debt held by 

depository institutions for the first time in 1997. 

CHART 4 

Market-based Lending Is Becoming More 

Important as a Source of Business Financing 

Share of Total Net 

Credit Market Lending1 

Market-based Lenders3 

Depository Institutions2 

0% 

10% 

20% 

30% 

40% 

50% 

60% 

70% 

’60 ’63 ’66 ’69 ’72 ’75 ’78 ’81 ’84 ’87 ’90 ’93 ’96 ’99 

1 Total net credit market lending is defined as net holdings of open-market paper,
 

government and municipal securities, corporate and foreign bonds, mortgages,
 

and other loans.
 

2 Depository institutions include commercial banks, savings institutions, and credit
 

unions.
 

3 Market-based lenders include mutual funds, closed-end funds, government-


sponsored enterprises, and asset pools.
 

Sources: Federal Reserve Board (Haver Analytics); Regional Financial Associates
 

13 September 13, 1999. Junk Loan Market Is Feeling the Pinch of 

Oversupply and Rising Interest Rates. The Wall Street Journal. 14 April 3, 2000.What’s Really Driving Banks’ Profits. Business Week. 

New York Regional Outlook 14 Second Quarter 2000 
In Focus This Quarter
 

While the expansion in market-based financing has 

made credit more available to business and consumer 

borrowers, it also creates some concerns. One issue is 

the susceptibility of the financial markets to periodic 

bouts of turmoil. These episodes, such as the one triggered by the Russian government bond default and the 

near-failure of the Long Term Capital Management 

hedge fund in the fall of 1998, can result in the interruption of capital flows even to creditworthy borrowers. 

During the 1998 episode, private yield spreads widened 

sharply as investors sought the safety of U.S. Treasury 

securities. Some companies that had planned to issue 

debt to the markets during that period were unable to do 

so. For companies whose business models depend heavily on a continuous supply of liquidity from the financial markets, the effects of these episodes can be 

catastrophic. For example, the relatively short-lived 

episode of financial turmoil during late 1998 resulted in 

significant liquidity problems for a number of commercial mortgage firms. Nomura, Lehman Brothers, CS 

First Boston, and others incurred losses, while Criimi 

Mae, Inc., was forced to declare bankruptcy. 

Because market-based financing has played such a large 

role in facilitating the orderly restructuring of the U.S. 

economy through mergers and the formation of new 

businesses, a recurrence of financial market turmoil 

could contribute to the end of the current expansion. 

Moreover, such an event could have serious consequences for business credit quality. A prolonged interruption of market-based financing could, in this very 

competitive economic environment, prevent businesses 

from restructuring themselves through mergers and 

deprive them of capital needed to invest in cost-cutting 

technologies. The loss of financial flexibility would 

leave businesses much more vulnerable to the effects of 

CHART 5 

competition and could result in more firms seeking 

bankruptcy protection. Such a scenario has the potential 

to bring about a significant increase in charge-off rates 

for business lenders. 

Financial Imbalances 

Another concern that arises from increased dependence 

on market-based financing is that it may contribute to 

the emergence of financial imbalances in the economy. 

These imbalances could, in turn, increase the potential 

for financial market turmoil as a result of some unforeseen shock to the markets. 

As recently as 1993, the public deficit was near the top 

of the list of economists’ concerns about the U.S. economy. During that year, the combined deficit of the federal, state, and local government sectors exceeded $300 

billion. However, on the strength of a long economic 

expansion, lower interest rates, and lower federal spending on defense, the consolidated government sector 

posted its second consecutive surplus in 1999 (Chart 5). 

As the government has moved from deficit to surplus, 

households and businesses have continued to borrow 

hundreds of billions of dollars every year. Taken together, the annual net borrowing of businesses and households has been referred to as the “private deficit.” In 

1999, the private deficit narrowed to $913 billion from 

a record $1.02 trillion the year before. Although this private borrowing indicates confidence on the part of consumers and businesses about future prospects, it also 

raises concerns about the ability to service debt if interest costs rise or if incomes level off or decline. 

New York Regional Outlook 15 Second Quarter 2000 

Flow of Net Sectoral Lending 

(Lending Less Borrowing), 

in Billions of Dollars Domestic Financial Sector 

Note: “Nonfinancial business” includes farm and nonfarm, corporate and noncorporate businesses. 

Source: Federal Reserve Board (Haver Analytics) 

Net Borrowing by Businesses and Households Represents a Growing “Private Deficit” 

–1,200 

–900 

–600 

–300 

0 

300 

600 

900 

1,200 

Foreign Sector 

Nonfinancial Business 

Households 

Government 

’80 ’81 ’82 ’83 ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 
In Focus This Quarter
 

The largest part of the private deficit was again 

financed in 1999 by domestic financial institutions 

($649 billion) and an inflow of capital from abroad 

($207 billion). Both of these sources of financing are 

potential causes for concern. The rapid expansion in 

credit created by the financial sector raises questions 

about credit quality. Financial institutions theoretically 

serve as the gatekeepers of the economy, financing only 

the most creditworthy projects and rejecting those that 

are not viable. The sheer volume of credit extended to 

businesses and households—almost $1.4 trillion in new 

net lending over the past two years—raises the possibility that underwriting has become more lax and that 

average credit quality is slipping. (See the inset box on 

page 17 for a discussion of recent trends in commercial 

credit quality.) 

Reliance on inflows of foreign capital raises a different 

set of issues. The fact that the U.S. economy has been 

growing significantly faster than the economies of its 

major trading partners has contributed to a U.S. trade 

deficit that reached $268 billion in 1999 and could 

exceed $300 billion in 2000. This deficit puts hundreds 

of billions of dollars annually in the hands of foreign 

investors. As long as foreign investors largely choose to 

reinvest their excess dollars in U.S. factories and financial instruments, as has been the case in recent years, 

the United States can continue to enjoy a strong dollar 

and relatively low inflation and low interest rates. However, if foreign investors should choose to invest elsewhere, they must sell their dollars in foreign exchange 

markets. Doing so would put downward pressure on the 

dollar and upward pressure on U.S. inflation and interest rates. 

Recent Shocks to the U.S. Economy 

Despite the potential for a declining dollar as a result of 

U.S. reliance on foreign capital, other adverse developments have confronted the U.S. economy over the past 

year. The two factors of most consequence to the macroeconomic outlook have been rising energy costs and rising interest rates. These trends have played a role in 

recent equity market volatility that may have implications for the future direction of the economy. 

Rising Energy Prices. After declining to a low of 

around $10 per barrel in December 1998, oil prices have 

risen dramatically over the past year and a half. The spot 

price per barrel of West Texas Intermediate crude 

peaked in March 2000 at just under $30 before declining slightly in April. The rapid increase in oil prices during 1999 was sparked by a cutback in output by oilproducing nations that was instituted just as global economic growth was recovering from the crisis of 1998. 

The OPEC nations and other major oil producers 

reached a new agreement in March 2000 that provides 

for a production increase of some 1.5 million barrels a 

day. But, because demand is rising and gasoline inventories remain lean, analysts do not look for a significant 

decline in gasoline prices in the near term.15 

The effects of higher oil prices on the U.S. economy at 

this time are uncertain. According to some estimates, 

the economy is only half as dependent on oil as it was 

25 years ago, when the United States was experiencing 

the effects of its first “oil shock.”16 Still, higher oil 

prices were responsible for nearly all the increase in 

consumer price inflation during 1999. While year-overyear growth in the Consumer Price Index rose from 1.6 

percent in December 1998 to 2.7 percent in December 

1999, the core rate of inflation (excluding food and 

energy items) actually fell. The question now is whether 

higher energy prices will be passed along to the rest of 

the economy through rising wage and price demands 

during the remainder of 2000. 

Rising Interest Rates. From low points at the end of 

1998, both short-term and long-term interest rates have 

risen substantially, contributing to a higher cost of debt 

service for businesses and households. At the short end 

of the yield curve, the Federal Reserve (the Fed) raised 

the Federal Funds rate six times between June 1999 and 

May 2000, for a total increase of 175 basis points. 

While part of this increase merely reversed the reduction in rates that took place in late 1998, the Fed also 

voiced concerns that inflationary pressures might be 

emerging because of continued rapid U.S. economic 

growth. Given the stated commitment of the Federal 

Reserve to price stability, most analysts expect the Fed 

to continue to push short-term rates higher until growth 

in the economy slows to a more sustainable pace.17 

Bond markets also pushed up long-term interest rates 

during this period. The yield on the ten-year Treasury 

15 Energy Information Agency (U.S. Department of Energy). April
 

2000. Short-Term Energy Outlook. http://www.eia.doe.gov/emeu/
 

steo/pub/contents.html.
 

16 March 11, 2000. Fueling Inflation? The Economist.
 17 See, for example, U.S. House of Representatives. February 17,
 

2000. Testimony of Chairman Alan Greenspan Before the Committee
 

on Banking and Financial Services. http://www.federalreserve.gov/
 

boarddocs/hh/2000/February/Testimony.htm.
 

New York Regional Outlook 16 Second Quarter 2000 
In Focus This Quarter
 

As Commercial Credit Quality 

Indicators Slip, Trends in Commercial 

Lending Come to the Forefront 

Commercial lending, which includes both commercial 

and industrial (C&I) and commercial real estate (CRE) 

loans, represents the greatest source of credit risk to 

insured institutions and the deposit insurance funds. C&I 

loan growth continued to be strong in 1999, although it 

did moderate from 1998 levels, and recent underwriting 

surveys have reported a slight tightening of terms.18 Nevertheless, there are signs that commercial credit quality is 

deteriorating.19 Most notably, as seen in Chart 6, C&I loan 

charge-off rates, corporate bond defaults, and corporate 

bond rating downgrades relative to upgrades have all 

been trending upward recently. For example, C&I loan 

loss rates rose to 0.56 percent of total loans in 1999, nearly double the rate of loss experienced in 1997. Although 

C&I loan loss levels are well below historical highs experienced throughout the 1980s and early 1990s, these signs 

of credit quality deterioration are occurring despite 

extremely favorable economic conditions. 

At least three factors have contributed to weakening in 

corporate credit quality. First, corporate indebtedness has 

been rising, as businesses have been spending to increase 

productivity, cut costs, repurchase equity, and finance 

mergers and acquisitions. The second factor relates to a 

greater risk appetite in the financial markets. For example, originations of leveraged syndicated loans—in particular, highly leveraged loans—have tripled over the past 

five years. Finally, stresses within industry sectors hard 

hit by structural changes, global competition, and deflationary pressures have resulted in challenges for 

borrowers. 

Construction and development (C&D) lending continues 

to be one of the fastest growing segments of banks’ loan 

portfolios, while loss rates among CRE and C&D loans 

remain extremely low. However, there are indications 

that conditions could be worsening in some markets. In 

particular, as shown in Chart 7, strong office completions and construction activity have begun to outpace 

absorptions and are projected to continue to do so over 

the next several years. Moreover, these trends have 

implications for vacancy rates. The national office 

vacancy rate moved higher during 1999 for the first time 

since 1991 and is projected to climb higher. 

In addition, some local CRE markets continue to show 

signs of overbuilding. Last year, the FDIC’s Division of 

Insurance identified nine markets in which the pace of 

construction activity threatened to outstrip demand for at 

least two property sectors.20 Seven of these nine markets 

reported an increase in office vacancy rates in 1999. 

CHART 6 

0.0 

1.0 

2.0 

3.0 

4.0 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

0.0 

1.0 

2.0 

3.0 

4.0 

5.0 

Note: C&I = commercial and industrial 

Source: Moody’s; Bank and Thrift Call Reports (Research Information System) 

Deteriorating Indicators Suggest Weakening 

Business Credit Quality 

Insured Institution C&I 

Charge-off Rate 

Corporate Bond 

Default Rate 

Bond Ratings 

Downgrades to 

Upgrades (columns) 

18 Both the 1999 Senior Loan Officer Opinion Survey (Federal 

Reserve Board) and 1999 Survey of Credit Underwriting Practices 

(Office of the Comptroller of the Currency) point to more stringent 

C&I loan terms since the latter part of 1998. This tightening follows a four-year period of easing C&I loan standards and predominantly reflects an increase in loan pricing. 

19 For additional detail, see Sothoron, Arlinda, and Alan Deaton. 

FDIC Division of Insurance. First quarter 2000. Recent Trends 

Raise Concerns about the Future of Business Credit Quality. 

Regional Outlook. http://www.fdic.gov/bank/analytical/regional/ 

ro20001q/na/Infocus1.html. 

20 These markets are Charlotte, Orlando, Salt Lake City, Dallas, Las 

Vegas, Phoenix, Nashville, Atlanta, and Portland. See Burton, 

Steve. FDIC Division of Insurance. First quarter 1999. Commercial Development Still Hot in Many Major Markets, But Slower 

Growth May Be Ahead. Regional Outlook. http://www.fdic.gov/ 

bank/analytical/regional/ro19991/na/Infocus2.html. 

CHART 7 

0 

20,000 

40,000 

60,000 

80,000 

100,000 

120,000 

140,000 

’78 ’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’04 

0% 

5% 

10% 

15% 

20% 

Source: CB Commercial/Torto Wheaton Research 

U.S. Office Vacancies Rose Last Year 

for the First Time since 1991 

Completions, Absorption 

(000 sq. ft.) Vacancy

 Rate 

Completions 

Absorption 

Projected

Actual 

New York Regional Outlook 17 Second Quarter 2000
 
In Focus This Quarter
 

note rose from a low of 4.5 percent in October 1998 to 

6.5 percent by May 2000. Analysts have cited renewed 

demand for credit by a recovering world economy as 

well as concerns about inflation arising from the 

increase in energy prices as factors behind the rise in 

long-term rates. 

Higher energy costs and higher interest rates do not 

appear to have significantly slowed the pace of U.S. 

economic activity during the first quarter of 2000. The 

preliminary estimate of real gross domestic product 

growth during the quarter was 5.4 percent—a slowdown 

from the 7.3 percent rate of the fourth quarter of 1999 

but still well above what is considered a sustainable 

pace. Home construction, usually a sector that is particularly sensitive to movements in long-term interest 

rates, has remained surprisingly resilient. Still confident 

of their future prospects, homebuyers have increasingly 

turned to adjustable-rate mortgages to avoid some of the 

immediate costs of higher fixed mortgage rates. 

As for the business sector, higher costs for energy and 

debt service are most significantly affecting “Old Economy” firms that purchase commodity inputs and carry 

significant debt on their balance sheets. Airline companies in the S&P 500, for example, posted a year-overyear decline of 27 percent in net income from 

continuing operations during the first quarter of 2000.21 

Analysts have argued that New Economy firms, by contrast, are less vulnerable to recent economic shocks 

because they tend to carry little debt and consume relatively little energy. 

Equity Market Volatility. The notion that New Economy 

firms are less vulnerable to the effects of higher energy 

costs and higher interest rates may be one of the reasons 

that equity shares of firms in the technology sector 

began to dramatically outperform the broader market, 

beginning around the middle of 1999. Chart 8 shows 

that the technology-heavy NASDAQ index performed 

more or less in tandem with the Dow Jones Industrial 

Average between the end of 1996 and the middle of 

1999, but thereafter the NASDAQ soared far ahead of 

the Dow. Between October 1, 1999, and February 29, 

2000, the NASDAQ rose by 72 percent while the Dow 

declined by 4 percent. Moreover, this striking divergence between the equity returns of Old and New Economy companies was not limited to the U.S. markets. 

Parallel trends were observed in Europe, Japan, Korea, 

21 Bloomberg. The S&P 500 airline industry is composed of AMR 

Corp., Delta Air Lines, Southwest Airlines, and U.S. Airways Group. 

CHART 8 

and Hong Kong. The similarity in performance of the 

high-tech sectors across three continents suggests a 

worldwide flow of liquidity from investors to the shares 

of technology firms. 

However, emerging concerns about the technology sector contributed to significant volatility in technology 

0 

50 

100 

150 

200 

250 

300 

350 

400 

4Q96 4Q97 4Q98 4Q99 

Source: Bloomberg 

Tech Stocks Have, Until Recently, Far 

Outperformed “Old Economy” Stocks Worldwide 

January 1997 = 100 

United States 

NASDAQ 

DJIA 

May 12, 2000 

0 

200 

400 

600 

800 

1,000 

4Q96 4Q97 4Q98 4Q99 

Source: Bloomberg 

January 1997 = 100 

EASDAQ 

Bloomberg European 500 

May 12, 2000 

Europe 

0 

50 

100 

150 

200 

250 

300 

January 1997 = 100 

Japan 

4Q96 4Q97 4Q98 4Q99 

Source: Bloomberg 

JASDAQ 

Nikkei 225 

May 12, 2000 

New York Regional Outlook 18 Second Quarter 2000 
In Focus This Quarter
 

shares during March and April 2000. The NASDAQ 

index lost 30 percent of its value between March 10 and 

May 12, 2000. Analysts cited the Justice Department 

finding against Microsoft and doubts about the ultimate 

profitability of business-to-consumer Internet firms as 

two factors in the sell-off. 

Equity market volatility also poses a threat to the economic outlook. One concern is the so-called “wealth 

effect” that a declining stock market may have on consumer spending. Since 1995, rising stock prices have 

helped raise the market value of equities held by U.S. 

households, plus their holdings of mutual funds, by 

some $5.7 trillion. This windfall is an important reason 

that households have continued to reduce annual personal savings (to just 2.4 percent of disposable income 

in 1999) and increase spending on homes, autos, and 

other consumer goods. Although it is uncertain what 

effect a prolonged stock market correction might have 

on consumer spending, the potential wealth effect has 

surely grown as more households hold a higher percentage of wealth in corporate equities and mutual fund 

shares. (See the inset box at right for a discussion of 

how financial market volatility could affect banks.) 

The Economic Outlook 

Despite the effects of rising energy costs, increasing 

interest rates, and equity market volatility, the U.S. 

economy continues to grow at a robust pace. The consensus forecast of 50 corporate economists surveyed by 

the May 1999 Blue Chip Economic Indicators suggests 

that the economy will grow by 4.7 percent in 2000, 

while consumer prices are projected to rise by 3.0 percent from 1999 levels. Short-term interest rates are projected to rise only slightly by year-end from early May 

levels. In short, the consensus forecast indicates that the 

New Economy formula of rapid economic growth combined with low inflation will continue for the foreseeable future. If actual events conform to this forecast, the 

result will likely be another year of generally low loan 

losses and solid earnings for much of the banking 

industry. (See the inset box on the following page for a 

discussion of other risks to watch in banking.) 

Clearly, risks are associated with the economic outlook. 

Recently, higher oil prices and higher interest rates have 

been the most visible signs of trouble for the economy. 

New Economy companies may be less vulnerable to 

these effects, but even these firms have experienced a 

sharp decrease in equity valuations as investors reevalFinancial Market Volatility Could 

Pare Earnings for Banks Most 

Reliant on Market Sources of 

Revenue 

FDIC-insured banks are deriving an increasing proportion of earnings from noninterest sources (see 

Chart 9), particularly market-sensitive sources of revenue. This is especially true for larger institutions. 

According to Deutsche Banc Alex. Brown, the 18 

most active generators of market-sensitive sources of 

revenue earned over 25 percent of net operating revenue from these potentially volatile business lines.22 

While market-sensitive sources help to diversify revenue streams, they can also introduce increased 

income volatility in the event of financial market turbulence. Deutsche Banc Alex. Brown also reports that 

for those 18 banks that generated the largest amounts 

of market-sensitive revenues during the third quarter 

of 1998, the share of total revenue derived from 

market-sensitive sources declined from 23 percent to 

13 percent. Thus, a more sustained downward trend in 

the financial markets could particularly affect the 

earnings of large banking companies that rely heavily 

on income from sources such as venture capital, asset 

management and brokerage services, and investment 

banking. 

CHART 9 

15 

30 

45 

60 

75 

90 

1970s 1980s 1990s 

Noninterest Revenues Account for a Growing 

Share of Bank Net Operating Revenue 

Percentage of Net Operating Revenue* 

* Net operating revenue is the sum of net interest income and 

noninterest income. 

Sources: FDIC Historical Statistics on Banking; FDIC Quarterly Banking 

Profile 

Net Interest Income Noninterest Income 

0 

22 Net operating revenue is the sum of interest income and 

noninterest income less interest expense. According to 

Deutsche Banc Alex. Brown, these companies are Bank of 

America Corporation; Bank of New York Company, Inc.; 

Bank One Corporation; Bank Boston; BB&T Corporation; 

Chase Manhattan Corporation; Citigroup, Inc.; First Union 

Corporation; FleetBoston Financial; JP Morgan; KeyCorp; 

Mellon Financial Corporation; National City Corporation; 

PNC Bank Corp.; SunTrust Banks, Inc.; US Bancorp; 

Wachovia Corporation; and Wells Fargo & Company. 

New York Regional Outlook 19 Second Quarter 2000 
In Focus This Quarter
 

Other Risks to Watch in Banking
 

Subprime Lending 

•	 Subprime consumer loan portfolios contributed to 

the large losses associated with recent high-cost 

bank failures. During 1999, the FDIC reported the 

first annual loss for the Bank Insurance Fund since 

1991. The loss was primarily the result of an uptick in 

unanticipated and high-cost bank failures. FDICinsured institutions with at least 20 percent of Tier 1 

capital in subprime loans accounted for 6 of the 13 

bank failures that occurred between January 1998 and 

March 2000. Fraud and inappropriate accounting for 

residuals also played a role in some of these failures.23 

•	 Subprime lending remains an area of concern. 

Insured depository institutions that engage in subprime lending represent a disproportionate share of 

problem institutions. Of the 79 banks and thrifts on 

the problem bank list as of year-end 1999, 21 percent 

were institutions with at least 20 percent of their Tier 

1 capital in subprime loans.24 

Agricultural Lending 

•	 While a majority of agricultural institutions remain 

relatively strong, external conditions have put pressure on some agricultural producers. Many agricultural areas are experiencing low commodity prices as 

well as weather- and disease-related problems. Strong 

global competition and high worldwide production 

over the past several years have resulted in increasing 

inventories of many crops and poor prospects for a 

price turnaround in the near term. Moreover, in spite 

of record government farm payments in 1999, the 

U.S. Department of Agriculture projects that in the 

year 2000 one in four farms will not cover cash 

expenses, up to 20 percent of farmers will experience 

repayment problems, and 5 percent of farmers will be 

“vulnerable.”25 

23 See Puwalski, Allen. FDIC Division of Insurance. Second 

quarter 1998. Gain-on-Sale Accounting Can Result in Unstable 

Capital Ratios and Volatile Earnings. Regional Outlook. http:// 

fdic01/division/doi/outlook/2q1998/atlanta/infocus1.html. 

24 The problem bank list includes all insured depository institutions rated a composite “4” or “5.” 

25 “Vulnerable,” as defined by the U.S. Department of Agriculture 

Economic Research Service, applies to institutions that have 

debt/asset ratios above 0.40 and negative income such that they 

cannot meet current expenses or reduce existing indebtedness. 

•	 Some signs point to growing stress for agricultural 

institutions. Forty-two percent of FDIC-supervised 

banks active in agricultural lending showed a moderate or sharp increase in the level of carryover debt 

during third quarter 1999, compared with just 26 percent during third quarter 1998.26 In addition, net loan 

loss rates for agricultural production loans increased 

in 1999 to the highest level since 1991. However, at 

0.32 percent, the 1999 net loss rate is just one-tenth 

the rate experienced during the height of the agricultural crisis of the mid-1980s.27 

Operational Risk 

•	 Operational risks are becoming more prominent in 

the banking industry. Driven by consolidation and 

expansion into new product lines and markets, financial institutions are seeing an increase in operational 

complexity. Operational risk encompasses a host of 

factors not related to credit or market activities, 

including risks associated with processing transactions, legal liability, fraud, strategic missteps, and 

internal control weaknesses. Operational risks tend to 

be more pronounced when institutions engage in 

rapid growth, far-flung operations, and complex business processes. 

•	 Greater attention is being paid to operational risks 

in the financial industry. Recently, analysts have 

noted that the pressure to meet ambitious postmerger 

earnings predictions can result in cost-cutting measures that jeopardize the comprehensiveness and 

integrity of risk-management systems. In addition, 

the role that fraud has played in recent bank problems 

and failures reinforces the importance of adequate 

internal controls and audit procedures. The significance of operational risks to financial institutions has 

been noted in industry surveys and informationsharing efforts among financial firms.28 NetRisk Inc., 

a Greenwich, Connecticut, consulting firm, recently 

estimated that operational losses among financial 

institutions have exceeded $40 billion over the past 

five years. 

26 September 1999. FDIC Report on Underwriting Practices. 27 See Anderlik, John M., and Jeffrey W. Walser. FDIC Division of 

Insurance. Third quarter 1999. Agricultural Sector Under Stress: 

The 1980s and Today. Regional Outlook. http://www.fdic.gov/ 

bank/analytical/regional/ro19993q/kc/agricult.html. 

28 For additional detail, see March 2000. Operational Risk: The 

Next Frontier. RMA/PricewaterhouseCoopers Survey. April 6, 

2000. Tech Bytes: Banks Join Forces Against Operational Risk. 

American Banker. 

New York Regional Outlook 20	 Second Quarter 2000 
In Focus This Quarter
 

uate the long-term prospects. Equity market volatility 

threatens to dampen consumer confidence and the ability of businesses to continue to merge, restructure, and 

invest. 

The economy has become particularly dependent on 

financing delivered through the capital markets. In this 

more permissive financial environment, rising debt levels and greater dependence on foreign capital have 

emerged as financial imbalances that may contribute to 

future problems for the economy. Businesses and 

households with high levels of debt are more vulnerable 

to problems if interest rates continue to rise or income 

growth falters. Rapid credit creation by the domestic 

financial sector suggests the possibility of lax credit 

underwriting standards. Reliance on foreign capital 

raises concerns about what would happen to the value of 

the dollar and to domestic inflation if foreign investors 

decide to invest elsewhere. 

Some analysts suggest that the New Economy, driven by 

increased productivity, heightened competition, and 

robust investment, may be characterized by longer 

expansions. Financial market imbalances may, however, 

contribute to deeper recessions and more sluggish 

recoveries compared with earlier business cycles. 

For the banking industry, it is clear that a recession 

would mean slower loan growth, deteriorating credit 

quality, and impaired profitability. But the biggest 

threat to the banking industry is a recession that is tied 

to disruptions in the financial markets. The ready availability of financing to start new businesses and restructure old businesses has been key to the New Economy. 

The process by which businesses have invested and 

restructured in response to competition has been orderly from the perspective of bank creditors. If this 

process should be disrupted, we could see a much more 

disorderly process, with more bankruptcies and higher 

losses to lenders. 

This article was prepared and coordinated by the management and staff of the Analysis Branch of the Division of 

Insurance. Contributions and feedback from analysts across the Division were essential to its completion. 

Maureen E. Sweeney, Associate Director 

Paul C. Bishop, Senior Financial Economist 

Richard A. Brown, Chief, Economic and Market Trends Section 

Steve Burton, Senior Banking Analyst 

Steven C. Cunningham, formerly Chief, Financial Institutions Section 

Alan Deaton, Economic Analyst 

Diane Ellis, formerly Senior Financial Analyst 

Mary L. Garner, Senior Financial Analyst 

Brian Kenner, Financial Analyst 

Thomas A. Murray, Senior Financial Analyst 

Allen Puwalski, Senior Financial Analyst 

Arlinda Sothoron, Senior Financial Analyst 

Ronald Spieker, Chief, Regional Programs and Bank Analysis 

New York Regional Outlook 21 Second Quarter 2000 
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