As Commercial Real Estate Woes Mount, More Alarms Sound

The head of the Federal Reserve Bank of Atlanta raised cautionary flags about the moribund commercial real estate market (CRE). In an address before the Urban Land Institute in Atlanta today, Dennis P. Lockhart, whose comments were highlighted in the Calculated Risk blog, expressed concern "about the potential impact of CRE on the broader economy. Unlike residential real estate, there is not the same direct linkage from CRE to household wealth -- and therefore consumption -- caused by erosion of home equity. However, there could be an impact resulting from small banks' impaired ability to support the small business sector -- a sector I expect will be critically important to job creation."

He added that "about 40% of the CRE debt is held on commercial bank balance sheets in the form of whole loans. A lot of the CRE exposure is concentrated at smaller institutions (banks with total assets under $10 billion). These smaller banks account for only 20% of total commercial banking assets in the United States but carry almost half of total CRE loans (based on Bank Call Report data)."

Still, Lockhart said he did not expect the growing CRE crisis to have the same broad impact as the one triggered by subprime real estate loans in 2008. "While the CRE problem is very worrisome for parts of the banking industry, I don't see it posing a broad risk to the financial system. Nonetheless, CRE could be a factor that suppresses the pace of recovery. As the recovery develops, the CRE problem will be a headwind, but not a show stopper, in my view."

In a special report report on the CRE situation in its region, The Philadelphia Inquirer notes an effort to reverse the trend of converting old industrial buildings to chic offices, restaurants or apartments. Their plan: Fill the old industrial buildings with new industries, especially those developing so-called green technologies.

More from Knowledge@Wharton:

On Shaky Ground: Commercial Real Estate Faces Financial Tremors

Collateralized Damage: Commercial Mortgage Securities Are at a Standstill

Peter Linneman on Real Estate: The Storm Is Over, the Wreckage Remains

Education Elevating the Status of Women in India's Family Businesses

In India, women have always been powerful forces in politics. Indira Gandhi was probably the most dominating prime minister the country has ever had. Today, her daughter-in-law, Congress Party President Sonia Gandhi, is the most powerful person in New Delhi. But When it comes to business, women have had little opportunity -- expected to move from the parental hearth to the husband's home, rather than play any role in the company.

Now, however, globalization, liberalization, the decay of the institution of marriage and a growing emphasis on education have helped to raise the status of women, at least in family businesses, according to a new article in India Knowledge@Wharton. Of those driving factors, education may be the most important, the article reports. Says Pradeep Mukerjee, founder-director of Confluence Coaching & Consulting, "Education and exposure [to other cultures] have led to greater societal acceptance of women participating in various walks of life, including business."

More from Knowledge@Wharton and India Knowledge@Wharton:

Lending to Women Makes Good Business Sense -- and Lifts Up Whole Communities

What Is the Role of Women in Indian Politics? Growing Stronger...

The 'Underprivileged Majority': Merging Policy with Practice to Help India's Poor

 

In a Discouraging Unemployment Report, a Rise in Temporary Positions

The U.S. unemployment rate surged to 10.2% in October, according to the Labor Department. Another interesting data point in today's report: "Temporary help services added 44,000 jobs since July, including 34,000 in October. From January 2008 through July 2009, temporary help services had lost an average of 44,000 jobs per month."

Are employers using temporary workers as a hedge against taking on permanent employees in this early stage of a recovery? Perhaps, says Wharton management professor Matthew Bidwell. He notes that temporary employment "tends to be rather cyclical. These people are often the first to be laid off in a downturn, but they can also be the first to be hired as the economy recovers."

According Bidwell, not all temporary employees are included in the Labor Department's monthly unemployment reports, which count workers specifically employed by temporary help agencies. In addition, there are contractual workers, such as consultants and freelancers, who take on short-term assignments for companies. They are counted in the bi-annual population survey conducted by the Census Department. Employers will often "try to game the system" by treating such workers as permanent employees in all but name so that they don't have to provide them with health benefits or deal with payroll taxes.

"It is very hard to legally define who is a contractor and who is a regular employee," says Bidwell. "There is some suspicion that those problems might affect the census figures, so it is possible [the census] might undercount contractors. I have heard that argument used to explain why those numbers are stable while temporary employment has grown."

MySpace's Fall from Favor Threatens Deal with Google

In 2006, which is ancient history in the online social network world, Wharton marketing professor David Bell told Knowledge@Wharton that "there is a fad or a fashion component to all these networks. Some will come and go." At the time, MySpace had risen to the dominant position in what was then a new sector, luring users from early-riser Friendster by offering a better array of tools for sharing photos and music.

Now MySpace is the network that's losing traffic, and that threatens to diminish the value of a $900 million search agreement it has with Google by about $100 million, according to an article in the Financial Times. Knowledge@Wharton also noted MySpace's loss of traffic in a recent article, "Early Tremors: Is It Time for Another Social Network Shakeout?"

“On many dimensions -- building traffic, brand-building, etc. -- MySpace has been an unmitigated success," says Wharton marketing professor Eric Bradlow, who co-directs the Wharton Interactive Media Initiative. "However, the question remains: What is the viable business model for a social networking web site? [MySpace] started with ... advertising [charging fees based on the number of times the ads were viewed], has been moving towards widgets, and may move towards targeted ads based on the network data.  However, as with any start-up, what business you end up in is not always the business you start in.  I think the same will be true for My Space.” Widgets are tools that attract MySpace visitors to third-party services, generating revenue for MySpace.

Others have noted the differences in social media environments as a factor driving people to or from any particular site. A recent CNN report noted a study by market research firm Nielsen Claritas which found that people in more affluent demographics are 25% more likely to use Facebook, while the less affluent are 37% more likely to be on MySpace. 

Railroads May Rebound, but They Still Face Fundamental Challenges

Announcing his deal to buy the 77% of the Burlington Northern Santa Fe railroad that his company does not already own, Berkshire Hathaway chairman Warren Buffett described it as "a huge bet and one that I'm very happy to make, but it's not a bet on next month or next year. We're going to own it forever."

But forever is how long he may have to wait if he's betting that Burlington Northern and other freight rail companies will take significant market share from the trucking industry, according to W. Bruce Allen, a Wharton professor of business and public policy and director of the Wharton Transportation Program. Railroads have inherent benefits over trucks in such areas as fuel efficiency and manpower requirements, he notes, adding that those advantages are not likely to diminish in the foreseeable future. But, he adds, "people have been saying for 50 years" that those advantages should help railroads take market share from the trucking industry. As measured by the value of goods shipped, trucks carry about 80% of the freight shipped in the United States. Railroads carry less than 10%. The rest is handled by boats, barges and pipelines.

One reason railroads have not cut into the trucks' market share is reliability, according to Allen. "In his just-in-time world, companies can't tolerate delays, and railroads are far less reliable than trucks."

One new advantage may come from a demographic shift. "The good old boys who drive the trucks are reaching an age where they would rather be driving Winnebagos," notes Allen. But as the older drivers retire, trucking companies have been having a hard time finding replacements who are willing to tolerate the demands of long-haul trucking, including more rigorous drug testing than is required for other lines of work. Railroads face the same problems, but they require much less manpower than trucks. A 100-car freight train -- on which each car can carry more than any truck -- requires a crew of just two people, Allen explains. "You would need more than 100 truck drivers to move the same amount of freight."

How Luck and Savvy Helped Ford Improve Products and Profit

Ford was the only American automaker that did not get a boost from U.S. taxpayers as the economy was still looking for the bottom earlier this year. Now, Ford looks like a world beater. Today, it posted a surprising $1 billion profit for the third quarter. While the company does not expect a full year of profitability until 2011, Ford today raised its projection for that year to "solidly profitable" from "break-even or better." The good news on profits follows good news on products. On October 27, Consumer Reports said that "Ford has secured its position as the only Detroit automaker with world-class reliability" after the influential magazine gave 90% of Ford's North American models a reliability rating of average or better. "Ford’s sustained production of vehicles that are as dependable -- or better than -- some of the industry’s best dispels the notion that only Japanese manufacturers make reliable cars," the usually praise-averse magazine declared in its Cars blog. "Other than the Toyota Prius, the reliability of the four-cylinder Fusion and Milan ranks higher than that of any other family sedan. Both of those Ford... products continue to beat the Honda Accord and Toyota Camry, while the upscale Lincoln MKZ tops its rivals, the Acura TL and Lexus ES."

How did all that happen? Perhaps it was the same way that Ford managed to get by without loans from Uncle Sam -- a bit of luck and a bit of savvy. In an August Knowledge@Wharton podcast, Wharton management professor John Paul MacDuffie said Ford was able to pass on the government's help because "the CEO [Alan R. Mulally] -- who came from another industry [Boeing, in 2006], with some new perspectives -- managed to fashion a strategy that certainly was partly lucky, but also partly savvy in terms of getting a hold of some credit for Ford" before the financial crisis. That was "borrowed money they could pour into new products well before the crisis hit." He noted also that Ford would be able to "capitalize on being the one company that didn't take government aid" at a time when the so-called bailouts were "largely very unpopular with the public."

On the other hand, Ford's success may be hurting its continuing effort to reduce labor costs. A new labor contract modeled on one approved by members of the United Auto Workers at GM and Chrysler was rejected by workers at Ford's U.S. auto plants, The Wall Street Journal reported this morning. "The sad truth, at least in part, is that the UAW workers are punishing Ford for positive earnings," said Wharton management professor Lawrence G. Hrebiniak. Had Ford forcast a loss for the quarter, "the workers probably would have bowed to the company’s concessions more readily." Hrebiniak worries that the vote may be an example of labor not seeing a bigger picture or longer time horizon. "Are memories so short that people can’t remember what the incessant demands on big steel in the U.S. did to the industry, right up to its collapse?"

The Journal reported that the automaker will continue talks with the union to find ways to cut costs, and may look at moving some production to lower-cost locations if it can't remain competitive in the U.S.

Mutual Funds, Fiduciary Duty and Fairness

A case filed five years ago by three shareholders in the Oakmark Funds, run by Chicago-based Harris Associates, will get its day in court Monday when the U.S. Supreme Court hears arguments from the shareholders that the fees charged by the fund managers are too high and violate fidicuary duty – i.e., they are not set in the best interests of shareholders, as mandated by Congress almost four decades ago.

By some estimates, money-management fees in the mutual fund industry reached close to $100 billion last year in a $10 trillion industry, according to an article in The Wall Street Journal, which notes that “typically, the investment-advisory committee that manages a mutual fund takes a percentage of the assets.... That fee is negotiated with the mutual-fund board, which is set up to represent investors.”

The shareholders claim that Harris charged Oakmark “an effective rate of 0.88% on $6.3 billion in assets, nearly twice the 0.45% rate for an unrelated institutional client like a pension fund,” states The Journal. In addition, the shareholders cite “conflicting business and personal relationships among the trustees and Harris personnel,” including the fact that Oakmark’s board chairman, classified as an “independent director,” was a former Harris partner who continued to earn money from the firm, according to the article.

The Supreme Court’s case on mutual fund fees “is interesting for several reasons,” says Wharton legal studies and business ethics professor Richard Shell. “First, it shows that the problem of how business people set their own compensation in large firms extends to the mutual fund industry and predates the economic crisis. It turns out that mutual fund managers, like executives at big banks, have what some think is a pretty cozy relationship with the board members who set executive pay – and it may come as no surprise that those pay decisions are not always what an average shareholder would approve.”

Second, he notes, “it is further evidence that courts may be increasingly skeptical of the model that says, ‘Markets always get things right.’ Two Chicago-School, economics-minded judges – Frank Easterbrook and Richard Posner – sharply disagreed with one another in the lower court opinion in this case. Easterbrook said, ‘Trust the market and leave the pay issue alone.’ Posner said, ‘We can’t trust the market when there are conflicts of interest.’ Easterbrook got more votes than Posner in the court of appeals, but my guess is that Posner will win the day in the Supreme Court.”

A ruling is expected in June.

China's Local Private Equity Market Gets a New Boost

Renminbi (RMB) funds -- private equity funds raised in China's local currency -- have been in fashion of late. In August, U.S.-based private equity firm Blackstone Group and a number of its Western peers announced plans to set up their own RMB funds. Such funds have been underutilized but are now receiving renewed attention by foreign firms that are finding China’s private equity market more attractive than ever. “Right now, the A-share market [shares denominated in renminbi] is so good, and IPOs in the growth market offer a high price-to-earnings ratio,” says Joe Tian of DT Capital, a China-focused private equity firm in Shanghai.

Fueling this interest is ChiNext, China’s first Nasdaq-style stock exchange, which was formally launched in Shenzhen on October 23 to the enthusiasm of fund managers and private equity firms looking for an alternate avenue to exit investments.

Meanwhile, a host of factors, including China’s buoyant economy and expectations that the yuan will strengthen against the dollar, are driving investors to explore onshore options in greater numbers. Global private equity players hope that RMB funds will offer a new way to benefit from the growth of Chinese companies at a time when changing regulations are choking the old channel of foreign currency-based investing. Meanwhile, RMB funds allow them to tap China’s mounting pile of cash, which is poised to grow even more.

To read more about the rise of RMB funds in China, see the current issue of China Knowledge@Wharton.

Goal: More Milk with Fewer Cows

Is drinking organic milk from small farms kinder to the environment? Many Americans think so, but the data proves otherwise, argues David Galligan, a professor of animal health economics at the University of Pennsylvania School of Veterinary Medicine, who spoke during a recent conference at the Penn Museum called, “Globalization in Progress.”

A veterinarian and a dairy cow specialist -- whose quirky website includes posts such as the Net Present Value of a Dairy Cow -- Galligan believes most Americans are missing the big picture. Producing more milk with fewer cows, he says, means less input and less waste – and ultimately, less overall strain on the environment. “This is at the heart of the efficiencies of intensive agriculture – this dilution of these fixed animal costs, fixed maintenance costs,” Galligan says. “Because all of these animals produce manure, burp methane, consume resources and take up land space.”

For Galligan, this is more than theory. He backed up his argument with an interactive graphic analysis of figures from the United States Department of Agriculture. In 1950, the dairy industry supported 22 million cows and produced 117 billion pounds of milk – an average of about 5,314 pounds (about 664 gallons) of milk per cow per year. Today, the United States dairy cow population has dropped to 9 million cows that produce 176 billion pounds of milk – an average of 19,576 pounds (or 2,447 gallons) per cow per year. “That’s a tremendous story of efficiency,” Galligan says.

It may also be a story of environmental conservation, according to Galligan’s analysis. Based on the amount of milk the cows produced, Galligan calculated how much food each cow would have to eat – and consequently how much methane, nitrogen and phosphorus each would create. Analyze the output of noxious gases per cow, and things look bleak: methane, nitrogen and phosphorus gases have all steadily increased over time. Break it down by unit of milk, however, and a different story emerges: Since fewer cows are producing more milk, the overall emissions of methane, nitrogen and phosphorus per pound of milk has gone down.

Understanding the economics behind milk production and other forms of intensive agriculture is essential if the world is going to feed itself in the future, Galligan says. Based on current population growth, world food production will need to double by 2050, but arable land is expected to increase by just 1%, he notes.

“How will we feed these population centers?” Galligan asks. “Growing locally sounds good, but it can only put so many calories on the table and [generate] so many grams of protein per day. We [must] realize that we’re going to need intensive systems … to feed these large populations.... Society has a certain demand for animal products,” he says. “We should encourage production systems that minimize environmental impact while increasing production.”

Milk Yield Graph

Big Banks Offer Size and Reassurance, Despite their Shortcomings

Why don't big banks that "were recently on the verge of collapse" have to struggle to retain customers? The question is posed in an article in this week's New Yorker, which cites research published last year by Jack Bao, who at the time was a graduate student at MIT, and Alex Edmans, a Wharton finance professor.

The paper, "How Should Acquirers Select Advisors? Persistence in Investment Bank Performance," found that market share does not necessarily translate to the best returns for an investment bank's clients. "The entire industry seems to equate market share with quality, without stopping to check whether market share is actually positively related to performance," Edmans told Knowledge@Wharton, which reported on the paper last year.

The New Yorker article looks also at consumer banking, where four banks -- Citigroup, Bank of America, JPMorgan Chase, and Wells Fargo -- control commanding shares of consumer deposits, credit cards and mortgages. "This isn’t because the big banks have been making a special effort to be customer-friendly," the article states, "On the contrary, in the credit-card market they’ve slashed credit lines and jacked up interest rates. In retail banking, they haven’t capitalized on the benefits of size (like lower borrowing costs) to cut prices for their customers, the way big retailers like Walmart do. Instead, they typically pay lower interest rates on deposits than smaller banks do, and charge higher interest rates on loans. Overdraft fees, too, have typically been higher at big banks than they are at smaller ones."

The customers remain, according to the magazine, because it is hard to switch banks in an era of online banking. But it also argues that "the big banks have the further advantage of their brands, however tattered the brands may be. It’s nearly impossible for consumers to evaluate how healthy a bank is. So, at a time when banks are failing with some regularity, the size and ubiquity of these big banks is reassuring."

Why India's Garment Factory Boom Produces Jobs with Little Security

India has sewn its way toward a more reliable income for nearly 35 million garment industry workers in recent years. Agricultural laborers left the fields to work in factories that sprouted as the economy gained steam. But as demand for exports has dropped amid the global financial crisis, hundreds of thousands of Indian garment workers have found that their new line of work is on shaky ground. An industry council has said that thousands of the factories have shut down, taking 500,000 jobs with them. The number could reach one million, the council says. According to a new article in India Knowledge@Wharton, the sudden job losses highlight an industry where workers have few rights and where the support systems that help laborers in developed markets are lacking.

Can the New Version of Windows Undo the Damage of the Last?

The introduction of Windows 7 today is not a big deal for Microsoft. It's a huge and critical deal. As The Wall Street Journal reports from the launch event in New York today, the new operating system needs to address the perceived shortcomings of its predecessor, Windows Vista -- especially among business customers. Information technology managers largely shunned Vista, launched in January 2007, because of a reputation for bugs and a level of complexity so high that many customers would have had to buy new computer hardware to run the system.

"Microsoft made a mistake with this one," Wharton management professor Lawrence Hrebiniak told Knowledge@Wharton in a May 2008 article about Microsoft's future after Vista. "The company introduced something more complicated than [its predecessor, Windows] XP, and it requires more hardware." Wharton operations and information management professor Shawndra Hill called Vista "too complicated" and unnecessary. "We had Windows XP and were using it fine. Then Microsoft decided to provide us with something new. But there wasn't anything really new" about it.

Early reviews of the new system should cheer Microsoft. PCWorld magazine reports today that a survey of people who tested beta versions of the Windows 7 "suggests an adoption rate not matched since the introduction of Windows 2000, the acceptance of which was driven by Y2K fears." The survey, which was conducted by Information Technology Intelligence and Sunbelt Software, found that 78% of those beta testers had a good or excellent experience. "This strongly suggests that Microsoft has finally found the 'sweet spot' that Windows Vista so widely missed."

Notes The Journal: "Windows 7 also debuts as Microsoft struggles with problems it has never faced. In April, the company reported its first quarterly revenue contraction in its 23-year history as a public company. Windows accounts for between a quarter and a half of Redmond, Wash.-based Microsoft's $58 billion in annual sales." At the launch event today, Microsoft Chief Executive Steve Ballmer declared that "today is an important day for the computer industry. Certainly for Microsoft."

Certainly for Microsoft, indeed.

At Comcast, the Art of the Deal Drives Movement of TV Content to the Web

Comcast, the largest cable-television provider in the U.S., tells its hometown newspaper, The Philadelphia Inquirer, that it has lined up 24 cable channels to participate in a service that will allow its subscribers to view on the Internet all of the content they get from Comcast on television. The program was originally announced in June by Comcast and Time Warner, the second largest cable-television provider in the U.S. After a subsequent trial of the service last summer, with 5,000 customers, the company said it would make it available to all 24 million subscribers by January 1.

As noted in The Inquirer article and in a June Knowledge@Wharton report -- "Cable TV Follows Its Subscribers to the Internet" -- the service, now branded "On Demand Online," is part of a strategy by cable companies to hold on to their subscriber base as more and more television content becomes available on the web -- usually for free. Comcast's service will also be free -- but only to its cable subscribers. The programming will be shown on an enhanced web-based video player at Comcast's Fancast site and at Comcast.net.

Meanwhile, also in an effort to contend with the growth of the web as a distribution channel for video, Comcast continues its talks to buy a 51% stake in NBC Universal from General Electric. The deal Comcast is pursuing would allow it to eventually buy the whole content-gushing operation. Having content of its own could help Comcast weather a gradual migration of cable subscribers to the web. Comcast already owns a large portfolio of web channels, and it is the nation's largest distributor of broadband Internet access.

Comcast appears wise to have a hand in multiple distribution channels and in content. As Wharton legal studies and business ethics professor Andrea M. Matwyshyn explained in the June Knowledge@Wharton article, "There's not one model or platform that's going to clearly win" the biggest share of the video audience. "Increasingly, there will be individual viewing styles. Some consumers will stick to cable. Others don't like watching TV on laptops. Others don't want TV and will pick shows à la carte. Viewing habits will be consumer specific."

A New Book Offers an Insider's View of the Financial Crisis

The inside stories about efforts by government officials and top financial leaders to prevent the collapse of the financial system are emerging with the publication today of New York Times reporter Andrew Ross Sorkin's book, Too Big to Fail: How Wall Street and Washington Fought to Save the Financial System -- And Themselves. The Times offers a sample today -- describing the conference calls and meetings over possible deals to save Lehman Brothers.

The players, who eventually failed to devise a rescue plan, included Timothy Geithner, then head of the Federal Reserve Bank of New York, and Henry Paulson, the Treasury Secretary whom Geithner would later succeed; plus top Wall Street bankers such as John Mack of Morgan Stanley, Richard S. Fuld of Lehman Brothers, and Bank of America's Ken Lewis. During a recent visit to Wharton, Mack described in detail his efforts to save Morgan Stanley from Lehman's fate. His dramatic tale, which he said could be told publicly because of the pending publication of Sorkin's book, was covered by Knowledge@Wharton in an article and video.

Walmart Shakes Up Another Sector with Price Cuts

The opening of a big Walmart store nearby has long been bad news for local retailers. But now that it's flexing its muscles in new sectors and online, Walmart is also squeezing margins for big box retailers like Best Buy and even the dominant player in the virtual retail world, Amazon.com. Walmart, jokes Wharton marketing professor Z. John Zhang, "really is trying to take over the world."

Walmart's consumer electronics ambitions were described in an April Knowledge@Wharton article, Best Buy vs. Walmart: Is There Room for Both, and Others?, after the two retailers rushed to claim customers from the recently departed Circuit City stores. Now, it has triggered a price war online in an effort to divert sales from Amazon. The Wall Street Journal reported this weekend that Walmart's incursion into book sales comes as Amazon, which made its name in books, has tried to extend its reach into new territories, including consumer electronics and clothing. Walmart triggered the price war last week, announcing it would drop the price for the 10 most popular books online to $10. Amazon immediately matched the price point, then did so again after Walmart cut its price to $9. So far, Walmart's lowest price: $8.99.

"This is really a very good strategy for both companies," says Zhang, whose research often focuses on pricing strategies. Walmart and Amazon are "trying to attract people to their web site with a low price [for one type of product], and then get them to buy something else while they are there." And, he notes, Walmart is wise to pursue the book sector, because it provides a juicy demographic segment. "Who buys books? Generally people with more education. People with more education generally have more income that they can spend on lots of things."

But Walmart has a long way to go to catch up to Amazon in the online retail business, The Journal notes, and the gap has been growing. Amazon's advantage is that "people are already comfortable shopping there, so they're going to feel comfortable buying new things from Amazon." But Amazon can't afford to lose its dominance of the book market. "From Amazon's point of view, the book is their category. You can't lose that or the whole thing is going to collapse. The question is, how far do you go to defend it?"

Zhang expects Amazon will hold on to its core turf because, even with high-volume discounts, publishers cannot give one retailer a better price than a competing retailer. And if Walmart is selling books for less than the wholesale price, he says Amazon will likely hit them with a lawsuit over predatory pricing.

This price war comes just in time for the holiday shopping season, the first since the economy has started to recover from the financial meltdown of 2008. Retailers are "nervous about what consumers will do this [year]. It's not just about whether the economy is better or if [consumers] have more money in their wallets. During the crisis, consumers learned some good lessons about the value of thrift.... And there are a lot of unnecessary items on those shelves."