TEN Magazine

President’s message

Pursuing a safe, secure and reliable payments system : What can history tell us?

n recent years, the way we make individuals that can be payments has undergone a dramatic identified only through I change. Online banking and bill a Web address. In many payment, debit cards, greater credit card ways, though, these risks usage and smart cards rapidly are replacing our mirror what we have seen use of cash and checks, which have made up before in the development the traditional payments system throughout of our payments system. U.S. history. This payments revolution is far A common feature in the from over, with transactions through enhanced history of our payments mobile phones and new developments in system is that consumers, identification and authentication technologies financial institutions, the on the horizon. business community and For all of us, this evolving electronic public authorities all have payments system is bringing with it many played important roles in benefits, including lower costs, and greater helping to contain risk and build confidence. convenience and control when making Because this experience may shed some light payments. Also, we now have the ability to on the fundamental issues and risks, it is worth make payments on an instantaneous basis—an taking a brief look at how our payments system important feature for those of us engaged in has evolved to the present and the lessons that online shopping and last-minute bill paying. we have learned. At the same time, though, this new payments system is raising a vari- Wildcat banking ety of concerns, including identi- One of the earliest experiments in U.S. ty theft, data breaches, unauthorized payments history was when banks were allowed access to one’s financial accounts, misuse of to issue their own bank notes as a means of sensitive information and computer break- payment. Before the Civil War, most states downs. Some of us may already have firsthand authorized the banks they chartered to issue experience with such risks, having been targets bank notes or paper money in each bank’s of phishing attacks or victims of stolen credit own name. These notes were to be secured by card numbers or data breaches. a comparable amount of government bonds Part of these risks would appear to be or other acceptable assets deposited with the unique—a new technology is involved, new state banking authority. Banks were further players are providing payments services, and required to stand ready to redeem their notes electronic payments often go to businesses or for gold or silver coins upon the request of any

WINTER 2008 • TEN 1 noteholder. For any bank that failed to do so, doubt, inefficient. In fact, people often had to state authorities could close the bank and sell carry silver and gold coins just to be sure they the pledged securities to pay off the remaining could conduct business in distant locations. A noteholders. variety of private and public responses were On the surface, this framework appeared initiated to deal with the inherent problems. to establish a secure payments system, but a For example, private brokers would collect number of problems eventually arose. Most bank notes from merchants and individuals important, if the pledged securities declined and, for a fee or discount, would then present in market value, whoever held the notes could these notes to the issuing banks for redemption be less than fully secured and would have in gold or silver. Several publications even arose trouble finding someone to accept them at to report these discounts and thus extend such face value. The wide array of bank notes in information to a wide group of individuals and circulation—and the resulting opportunities merchants. for counterfeiters—further added to these Sound banks performed a similar role in questions of acceptability. collecting the notes of other banks and then Beyond this, a number of states even presenting them all at once for redemption. allowed bankers to buy depreciated bonds and The eventual solution to this seemingly then exchange them for notes on the basis of chaotic system was to make paper money the bond’s higher par value or issue price. This a more direct function of the government, oversight provided an instant profit to banks starting first with national bank notes, which in addition to the interest they could earn on had tighter standards for pledged securities, the bonds, thus encouraging some bankers and eventually leading to Federal Reserve to issue much greater volumes of notes. Such notes, whose issuance depends on the public incentives led to what became known as wildcat demand for currency and the Federal Reserve’s banking—one of the most colorful times in monetary policy operations. U.S. banking history. A handful of bankers with less than stellar reputations located their Payments by check banks in backwoods areas among the wildcats. After the wildcat banking era, our These inaccessible locations prevented people payments system began to change in other from coming in and redeeming notes for gold and even more significant ways. Deposits that and silver, thus enabling the wildcat bankers to could be withdrawn by checks quickly became continue capturing the extraordinary profits on the focal point of what was an emerging their inadequately backed currency. payments system. In comparison to notes, Although there is still debate about how checkable deposits demonstrated some notable severe the problems and losses were with advantages. People and businesses no longer wildcat banking, this system was, without had to carry as much currency around, and

2 WINTER 2008 • TEN checks proved to be especially ideal for large the return process on unpaid checks and to transactions and for transferring money over a provide prompt notification to the bank and distance. the customer who received the check. Like bank notes, though, checks have not been without problems. Anyone accepting a Lessons to be learned check bears the risk that a check might be a What can we learn from these experiences, forgery or have been written against an account and how do such lessons apply to the new with insufficient funds to cover it. payments revolution? While other forms of ID theft and financial Perhaps the most important things we fraud have drawn more of the headlines recently, can learn are that our payments system has the risks associated with checks are significant not been without risk during the different and certainly familiar to many businesses stages of its development and that consumers, and continue to draw their attention. These businesses, financial institutions and public risks, in fact, were portrayed some years ago authorities must all play a role in containing in the movie “Catch Me If You Can,” based risks and protecting those making and receiving on the life of a master of check forging, Frank payments. Abagnale, and his ability to easily pass off The basic issue in our payments system— fraudulent checks on unsuspecting parties. In historically and now—is in verifying the an interesting twist to that story, Abagnale now soundness of a payment and authenticating helps law enforcement agencies and businesses its source. With wildcat banking, people were design better systems for controlling the types sometimes faced with the issue of whether of check fraud and ID theft he had mastered. to accept the notes of a bank they knew To deal with the risks inherent in accepting little about. Similar problems arose with the checks, merchants, bankers and others now introduction of checks and not knowing if employ a number of approaches. These range someone had sufficient funds to cover the from asking for several pieces of identification checks they wrote. These verification issues from anyone cashing a check to using check were further complicated by the large number verification systems and penalty fees for bad of banks issuing notes and the enormous checks. Other steps include requiring cashier’s volume of checks being written. checks or bank letters of credit to make a major Now we are seeing a repeat of this problem purchase, and placing holds on the use of with electronic transactions, where individuals funds or shipment of goods until after a check and businesses may receive payments from has time to clear. Public laws further provide unknown sources and be at risk from a recourse for victims of check fraud. In addition, fraudulent exchange. Both consumers and banking regulations and clearinghouse rules businesses can be victims, and the efficiency, contain provisions designed to speed up integrity and prospects for a successful,

WINTER 2008 • TEN 3 innovative payments system can be jeopardized of consumers when they conduct transactions as a result. One further complication in through electronic terminals from their electronic banking is the proliferation of accounts at financial institutions. By setting a different payment channels—credit, debit, common platform for all financial institutions ACH, wire or PayPal—along with a wide and consumers to follow, this act provided an array of payment instruments—cards, important impetus to electronic banking and computers, phones and cell phones. Each may help establish a framework for additional of these combinations may have different public actions. vulnerabilities and thus different arrangements Another example of public-private and rules with regard to user safeguards and cooperation is the development of ACH for security, authentication processes, liability, and small electronic payments in which the Federal error resolution and responsibility. The result Reserve System and the National Automated is confusion and increased payments risk. Clearing House Association (NACHA) have Should electronic payments be addressed worked together as payments providers to in a manner similar to wildcat banking, where develop a framework and rules that facilitate the federal government eventually took over the safe, efficient and reliable movement of and standardized how currency would be small electronic payments among parties. issued, or more like payments by check, where a Although it may still be too early to predict wide variety of steps have been taken by private what combination of approaches will prove companies to limit the uncertainty? most fruitful in reducing risk and uncertainty Realistically, a combination of private in electronic payments, we must continue to and public approaches likely is necessary, and, do all that we can to build confidence in our ideally, these approaches should support each payments system. The advantages of a safe, other. Electronic banking developments have secure and reliable electronic payments system been very innovative, and private markets can are likely to grow over time, particularly as help ensure that this innovation continues e-commerce expands, consumers look for and new and better ways are found to protect greater convenience, and merchants seek participants. But we must also be confident faster and lower-cost payments channels. in the integrity and reliability of the means of And as before, our success will be defined by payments, and that’s where the public authority how private and public entities work together has a role. toward this common goal. On the public side, an example of a possible approach is the Electronic Fund Transfer Act of 1978, as implemented through Federal Reserve Regulation E. This legislation has been a very important step in establishing THOMAS M. HOENIG, PRESIDENT the basic rights, liabilities and responsibilities FEDERAL RESERVE BANK OF KANSAS CITY

4 WINTER 2008 • TEN The Federal Reserve System is committed to economic and personal financial education. On the website, you’ll find links to instructional materials and tools to increase your understanding of the Federal Reserve, economics and financial education.

All resources are free. photo by Scott Indermaur Scott by photo

6 WINTER 2008 • TEN irthdays, Christmas, graduation, weddings … for “ relatives, teachers, the cleaning woman...” Whether it’s from Starbucks, Target or a popular restaurant, most everyone on the Wietharn family’s list receives gift cards. It’s a no-brainer, says the Overland Park, Kan. wife and mother of two. Shopping time is condensed, shipping costs are minimized, and returns and exchanges are eliminated. “The failure is low” for both the giver and the receiver, Wietharn says. Many are in agreement. More than two-thirds of consumers polled said they expected to buy at least one gift card during the holiday season, according to a National Retail Federation 2006 survey. Gift card sales increase each year by billions of dollars. Such big bucks are prompting spinoff businesses and even more ways to use stored-value cards. The concept that perhaps started with prepaid phone cards more than a decade ago and has since transformed gift giving is now expanding beyond the mall into the workplace and even the doctor’s office. Stored-value cards allow more consumers than ever the option of an electronic payment in a variety of capacities. “It’s clear stored-value cards are meeting a host of needs and addressing perceived voids in payments options,” says Terri Bradford, a payments system research specialist at the Federal Reserve Bank of Kansas City. Bradford first examined stored-value cards a few years ago when they were emerging as a payment method. At that time, the

WINTER 2008 • TEN 7 extent to which consumers would accept the convenient for the giver as issuers expand cards was still uncertain, but now the answer their reach. Gift card “malls” are being set up seems quite evident. in places shoppers visit often, such as grocery “Yes, stored-value cards have definitely stores. These gift card kiosks feature a variety come into their own, albeit to varying degrees, of merchants and services––Barnes & Noble, depending on the category,” Bradford says. iTunes, The Gap––as well as general-use “These cards have become an important gift cards. Typically located near the stores’ and dynamic component of the payments checkout, these kiosks allow shoppers to quickly landscape, and their presence and popularity choose their gift card and denomination, pay, continue to grow.” and go. The gift card issuers pay a commission to Gift cards: Kiosks, websites both the companies that set up the kiosks, such “After diamonds, or perhaps a 42-inch flat as Blackhawk Network, and the stores that panel TV, nothing apparently says ‘Thinking allow the kiosks on their sites. These merchants of you’ like a gift card,” Bradford says. may benefit from increased foot traffic asa That’s Summer Richards’ mantra. The 14- one-stop shop for the cards as well as their own year-old Lee’s Summit, Mo. girl loves to shop products. but knows she can be hard to shop for. According to TowerGroup, consumers And rather than end up with a bad gift spent more than $80 billion on gift cards in (like the “Lady and the Tramp” DVD or the 2006. Of that, nearly $60 billion was spent on “High School Musical” CD––“I was stuck cards for specific merchants, such as restaurants with them”), Richards says she prefers gift cards or clothing stores, and more than $20 billion to her favorite clothing stores like Abercrombie was spent on general-purpose cards, which are & Fitch or American Eagle Outfitters. those that carry network logos such as Visa or Not only are gift cards ideal for recipients, MasterCard and are accepted anywhere the purchasing them is becoming even more network is accepted.

More than $80 billion was spent on gift cards in 2006

Open-loop cards $23 billion Fast food/ restaurant General $18 billion purpose

Closed-loop cards Miscellaneous $59 billion (gas, services) $12 billion Retail shopping $29 billion

8 WINTER 2008 • TEN Source: TowerGroup Summer Richards, 14, takes her gift card to Brighton Collectibles at Indermaur Scott by photo The Country Club Plaza in Kansas City, Mo., one afternoon while out shopping with her mom. Summer’s favorite gifts are gift cards.

While merchants may benefit from the gift Thousands of cards––mostly from card recipients spending even more than the popular retailers and restaurants in varying value of their card, there’s also a relatively high denominations––are posted on the site each chance the funds on the cards won’t be fully month. Traffic spikes during the holidays redeemed. In 2006, an estimated $8 billion, or through February, he says. 10 percent, of gift cards weren’t used, according Most site visitors trade their gift cards, to TowerGroup. Butler says. They still want gift cards, just from a different merchant. Plus, consumers are value This is where websites such as conscious and don’t want “stored money” to cardavenue.com come in. This site and others just sit in a drawer at home. like it facilitate the buying, selling and trading of consumers’ unwanted gift cards; sellers and traders are charged a small fee. The site’s General-purpose, payroll cards operators verify and secure all transactions, A second type of stored value-card are combating scammers who purchase gift cards the general-purpose card and payroll card, with stolen credit cards and then resell them which have similar features, Bradford says. The online. general-purpose cards can be loaded with funds Cardavenue.com Founder and CEO Bob in a variety of ways, including direct deposit, Butler started the website in late 2004 for “not and payroll cards most often are set up through very glamorous” reasons. an employer. In addition, many offer the ability “I had a couple of gift cards that I didn’t to reload funds. want,” he says. Both types of cards carry a network brand

WINTER 2008 • TEN 9 (MasterCard, for example), and may be used at if lost or stolen. For card issuers, this is an ATMs, online or at the point of sale. opportunity to convert cash payments to For instance, Wal-Mart and partners are electronic ones, creating new revenue from issuing a Visa-branded stored-value card that associated fees. consumers can load with payroll or other For employers, payroll stored-value funds at Wal-Mart stores, or via direct deposit. card programs can eliminate the expense of The card is accepted almost anywhere Visa is issuing paper checks to employees who don’t accepted, can be used at ATMs and is covered have an account for direct deposit. The cards by Visa’s zero-liability policy. also can eliminate the possibility of check These stored-value cards offer consumers fraud and make the payroll process faster and another electronic payment option, one that easier––reasons why TriCentury Bank, based may be especially important to those who in Simpson, Kan., developed a payroll card primarily use cash. several years ago for companies and its own “Prepaid products have provided the employees. marketplace with an offering that provides cash- Large companies, such as FedEx, like benefits, while offering the convenience McDonald’s and Coca-Cola, offer payroll card and ease associated with plastic,” says Dana programs to employees. Traci, vice president of prepaid and partner marketing for Discover, which has issued a general-purpose card since 2003. Flexible-spending, health In general, there has been a significant account cards increase in the use of all payment cards, A third type of stored-value card especially debit and credit cards, in lieu of is the flexible-spending and health-care writing checks or using cash. While not all reimbursement card. These particular cards consumers can obtain a debit or credit card, hold funds, often pre-tax income up to a anyone with cash can easily get a stored-value certain limit, contributed by employees to card. accounts offered by their employer. The money “The growing popularity of these stored- can be used for eligible dependent care and value cards may be linked to the country’s medical expenses and is typically accessed via millions of unbanked consumers, who a network-branded prepaid debit card as the often pay expensive fees for check cashing, expenses are incurred. money orders to pay bills and other services,” Benefits for contributors to health and Bradford says. flexible-spending accounts include convenience Stored-value cards are a way to reduce and time savings––reimbursement requests, these fees for the consumer, plus offer benefits which often require submitting receipts, are that cash doesn’t, such as eliminated or reduced. replacement Because the process is less cumbersome, employees are more likely to contribute, say employers. And both the employee and employer benefit from the reduction in taxable income. In January 2006, Cerner Corporation, a Kansas City-based supplier of health-care information technology services, launched Healthe––one of the first combined health plan ID and debit cards.

10 WINTER 2008 • TEN Busy wife and mom, Lucy Wietharn, with daughter, Cate, 4, and son, Marshall, 6, loves the convenience and ease arber of purchasing gift cards. She can pick up them up while running errands. “At any time you can go get them,” Lucy says. photo by Gary B Gary by photo photo by Scott Indermaur Scott by photo

More than 11,000 employees and It’s the kind of convenience that gift card dependents under the Cerner health-care plan giver Lucy Wietharn loves about stored-value are able to access in real time their health-care cards, and she’ll continue to happily use them dollars at Cerner’s on-site health clinic and in as many ways as possible, she says. pharmacy with the swipe of their card, says Kelli Christman, Cerner spokesperson. T Cerner partnered with First Data BY BRYE STEEVES, SENIOR WRITER Corporation and United Missouri Bank, and is in the early stages of providing a similar card to other employers with on-site employee health further resources clinics. “When you leave the appointment, every Stored-value cards: financial aspect is settled up,” says Christman, A card for every reason … who has used the card since its inception. By Terri Bradford Cerner employees, herself included, have www.KansasCityFed.org/TEN responded favorably to the program. The program gives employees control over their health care, streamlines the care and payment process, and significantly reduces time COMMENTS/QUESTIONS are welcome away from work. and should be sent to [email protected].

WINTER 2008 • TEN 1111 arber photo by Gary B Gary by photo

or Marco Listrom, the challenges The environment at Valdes & Moreno in of running his own small company Kansas City, Mo., is respectful of differences may pale in comparison to what among its employees. This is challenging, but it could have been a steep climb up teaches staff members flexibility, tolerance and the career ladder when he entered the workforce how to learn from one another. The company decades ago. reflects the outside world, which, ultimately, is As a second-generation Mexican-American, good for business, Listrom says. he knew it might have been a struggle to advance “The success of our firm hinges on in a homogenous workplace. So Listrom, now how well we serve our customers, and that 54, has always been his own boss, creating the implies how well we manage productivity and kind of office environment he wants to work changes,” he says. in. While workplace diversity certainly is “I didn’t want to have to fight going trendy, it may actually be necessary to conduct upstream,” he says. “There’s a better way, a business competitively as the marketplace more diverse way.” continues to grow more global. But, if it’s not At Valdes & Moreno, his small institutional managed effectively, diversity can be costly, brokerage and investment banking firm (named says Alan Garner, an economist and assistant after his mother and grandmother), Listrom’s vice president at the Federal Reserve Bank of philosophy is: Diversity runs from the top Kansas City. down. “Sometimes in discussing diversity, we “The important thing for me to understand tend to oversimplify and make it sound as if (as a manager), is that not everyone is like me,” diversity automatically is an economic plus,” he says. Garner says. “That isn’t necessarily true.”

1212 WINTER 2008 • TEN arber

Garner recently researched whether differ, whether it’s something like marital companies’ increasingly diverse pool of workers status or the college they attended. Because of help or hurt economic performance. His its personal nature, diversity obviously affects conclusion: It depends. society at many levels, and the workplace is no photo by Gary B Gary by photo “Diversity can have both economic costs exception. and benefits,” Garner says. “Its effects on According to data from the Bureau of economic performance are complex and hard Labor Statistics, there are three key factors to identify clearly.” related to diversity that are affecting the U.S. While a more diverse staff will have a labor force: broader mix of skills and ideas that may benefit • The aging of the baby boom workforce, which output, it also might be difficult for them has begun retiring, will slow the growth rate to communicate with each other because of of the labor force overall. But the percentage different backgrounds or even languages. From of workers age 55 and older is projected to an economic standpoint, it’s not clear which rise 7 percent by 2050. factors would more greatly affect a workplace. • Women’s labor force participation is expected “As the workforce becomes increasingly to stabilize after peaking in 1999 and then diverse and continues to grow more global,” gradually decreasing. By 2050, women still Garner says, “organizations that master these will make up an estimated 47 percent of the tricky tasks are more likely to excel.” workforce. After nearly 15 years of business, Valdes • Racial and ethnic diversity in the workforce & Moreno is able to measure with certainty its is expected to continue increasing. Especially success in the marketplace. noteworthy is the projected decline in “We have achieved diversity,” Listrom says. the share of white, non-Hispanic workers from about 70.5 percent in 2005 to about Trends, effects of 50.5 percent in 2050––something that can be attributed to lower birth rates, among workplace diversity other factors. Changes in the country’s While many often think of diversity in immigration policy also could affect growth a racial or ethnic sense, people can be diverse in the Hispanic share of the labor force. in religion, country of origin, age, gender In addition to the growing diversity in the and many other ways. Even in the most labor force, U.S. companies more and more homogeneous environments, workers will are doing business in a global economy, with a

Workplace diversity

More older workers Stable share for women Rising nonwhite share

70 60 15 60 50 12 50 40 40 9 30 percent percent 30 percent 6 20 20 3 10 10 0 0 0 16-24 25-54 55 and up Men Women Black Asian All other

2005 2050 WINTER 2008 • TEN 13 Source: Bureau of Labor Statistics presence––and growth opportunities––in other In a way, it’s an unwritten part of the countries. Today, U.S. imports and exports of business plan for the Kansas City, Mo.-based goods and services add up to roughly 28 percent firm, which offers engineering, architecture, of the domestic economy. construction, environment and consulting Research on the effects of diversity differs, services around the globe. While it’s important Garner says. One unpublished experiment for the workplace culture, Burns & McDonnell that examined how diversity affected the realizes it affects the way the company does performance of student groups shows more business, says Melissa Wood, associate vice diverse groups can have the potential to perform president of human resources. better, but that’s not always the case. “We need to be cognizant that our In this study conducted by university clients look different, talk different and think professors, students were placed in groups different,” Wood says. “We need to evolve with that varied by age, gender and race. Their them” as the marketplace continues to grow performance was evaluated by group projects even more global. and individual exams. Sometimes diversity With this in mind, nearly all of the mattered; sometimes it didn’t. For example, company’s 2,000-some employees have “ Companies that manage diversity well just may get more ideas and cooperation out of any given level of talent than other companies. ” male-dominated groups performed worse than attended in-house sessions on diversity. A female-dominated and equally mixed gender diversity advisory committee was formed a few groups. Individuals who had been in a more years ago, and internal focus groups identify age- and gender-diverse group scored higher on diversity training opportunities. The idea is exams. Groups’ racial makeup didn’t appear to for employees to be self-aware and recognize affect group or individual performance. that differences must be appreciated in the Some research shows developing countries workplace, Wood says. This allows Burns & that are diverse grow slower than less-diverse McDonnell to meet its clients’ needs. developing countries. Ethnic fragmentation “It always goes back to the business client,” can cause struggles over how to divide the Wood says. “We can offer a client something “economic pie” rather than decision making for similar to their own background. We build the common good. A strong framework, such relationships.” as laws and property rights, as well as higher In contrast, a lack of commitment to levels of income per person, lessens the negative diversity could mean high staff turnover, or a effects. Other studies suggest more diverse cities team of employees not able to meet production may be more economically successful because goals. of the diverse workforce. There are a number of ways diversity can Managing diversity affect the workplace, Garner says. Whether it’s browsing the company’s Economic costs of diversity include: intranet section on diversity for a few minutes • Communication problems from different during the workday, or sampling ethnic foods languages and cultural assumptions; at the Diversity Day celebration held on-site • Different ways of motivating and annually, employees at Burns & McDonnell managing diverse employees; are encouraged to recognize the differences • Additional costs of education; and among each other––and their clients. • Differing views on public policies.

1414 WINTER 2008 • TEN g e s photo by Getty by Ima photo

Economic benefits of diversity include: As the marketplace continues to grow more • Increased access to talent; global and more diverse, research shows companies that • Better decision making as a result are able to make diversity an economic benefit are more of dissimilar ideas; likely to excel. • Increased ability to market across diverse cultures; and • Increased adaptability of the company needs to be a willingness to tackle tough to respond to the marketplace. issues. Employees may not want to embrace “To excel, positives from diversity must their co-workers’ differences, but they should exceed the negatives,” Garner says, adding, accept them. Effectively managing diversity “It may be necessary to change the company’s means problems, such as communication and culture.” coordination issues, need to be minimized, and The costs of diversity can be reduced benefits, such as the increased number of ideas in several ways, such as offering programs and access to a larger talent pool, need to be to improve communication, says Deth Im, maximized. workplace diversity coordinator at Harmony, “That’s just part of doing business,” Im an organization that offers programs for says. “The world is growing more diverse.” companies, schools and other groups in the Garner agrees. Kansas City metro area. “Diversity can either be a plus or a minus Im facilitates these sessions to prompt self- depending on the circumstances,” he says. awareness and create dialogue. His presentations “Companies that manage diversity well just include videos, interactive activities and role- may get more ideas and cooperation out of any playing exercises. given level of talent than other companies.” “It really gives folks a lens to view, and understand, diversity,” he says. “Most of us have biases and we make judgments. … One T of the worst things diversity training can do is BY BRYE STEEVES, SENIOR WRITER guilt people.” Instead, it’s important to create an COMMENTS/QUESTIONS are welcome environment of honesty, Im says. There also and should be sent to [email protected].

WINTER 2008 • TEN 1515 1616 WINTER 2008 • TEN G REEN S PAN BOB by photo photo by bob g reen s pan bob by photo ot a bad way to earn a paycheck, with the popular toy manufacturer to produce Booker, 40, acknowledges, but it a large-scale, mass-market, multiplayer game was a long time coming. is a benchmark for NetDevil, which began in When he was a teen, just the Denver suburb of Louisville in 1997 with simple computer games like solitaire were just three part-time staff. It now employs more around, and Booker was an avid player of the than 75, and is growing as the popularity of tabletop game Dungeons and Dragons. It was games rapidly spans the globe. then, while patiently waiting for technology to For Booker, this may mean job security. advance, that “I knew exactly what I wanted to For the region, this industry may mean a do,” Booker says. significant economic impact. But by the time he got to college, majoring Business demand has pushed the software in video game design wasn’t an option. When industry into the projected top 10 growing he entered the workforce, Booker’s first jobs sectors in the country. Software publishing were mostly IT work for various companies, and computer design already have experienced though he was able to do some freelance design significant expansion in Colorado especially, work and later started his side business, Creative with the video game market standing out as Brain Studios. a key component of the industry, say Chad Now, working at NetDevil as a design Wilkerson, economist, and Megan Williams, director, Booker, along with others, is associate economist, both at the Federal Reserve responsible for game content. NetDevil’s virtual Bank of Kansas City’s Oklahoma City Branch. creations include Jumpgate, a multiplayer Wilkerson is also the Branch executive in the flight simulator, and Warmonger, a first-person Oklahoma City office. action game, among others. Wilkerson and Williams recently NetDevil staffers, including Booker, are researched what industries define (in terms of now developing LEGO Universe. Collaborating concentration and the number of employees)

WINTER 2008 • TEN 17 Defining industries—those that make a region or state different from the nation­—tend to drive growth. The industries that define specific states in the District vary widely, al- though some industries define several District states. Most District states have a large industry presence in the energy or agriculture sectors, or both. The seven states in the District are: Missouri, Nebraska, Kansas, Oklahoma, Wyoming, Colorado and New Mexico. In each state, recent employment growth has mirrored the growth of each of the state’s defining industries. Missouri’s industrial structure most resembles that of the nation, while Wyoming’s has the least resemblance.

• Aircraft mfg. • Farming • Cattle ranching

• Farming • Meat packing • Rail transportation

• Coal mining • Heating and cooling mfg. • Oil and gas extraction • Auto mfg. • Mining and quarrying • Farming

• Software publishers • Computer and equip. mfg. • Wired telecom

Tenth Federal • Cattle ranching • Oil and gas extraction Reserve District • Facilities support services • Oil and gas extraction • Technical and trade schools 18 WINTER 2008 • TEN • Rubber product mfg. Source: Bureau of Labor Statistics the Tenth Federal Reserve District, which is made up of western Missouri, Nebraska, Kansas, Oklahoma, Wyoming, Colorado and northern New Mexico. “Identifying defining industries and un- derstanding how they are changing can provide context for growth and help recognize future risks to the region,” Wilkerson says. The industries of the District continue to evolve, and although industry trends often mirror those of the nation, the regional variety still makes the District unique. It’s these defining industries that often dictate overall growth and economic strength, Williams says. g e s The District remains heavily concentrated in several long-standing industries, such as oil and gas, agriculture, and aircraft manufacturing. The outlook for these sectors is mixed; based on their research, Wilkerson and Williams project Aircraft Manufacturing is the modest growth at best. top defining industry in Wichita, Kan. Several emerging industries, however, may g etty by i ma photo affect the region favorably in both urban and rural areas, Williams says. Like the software industry, others with anticipated high growth include call centers, data processing, biosciences Defining industries in the region and wireless telecom. These sectors may have a When Scott Miller came to Wichita, Kan., direct impact on economic prospects. in 1988 to teach aerospace engineering at the As an area’s defining industries change, so university, he knew he was moving to the might the potential for economic growth there. Mecca of aircraft manufacturing, but he didn’t States with little growth in defining industries know to what extent until he heard children also had slow overall growth. Many industries bickering in a parking lot. that have no specific location requirements may “They were arguing about what type even offer new opportunities for growth in rural of plane had just flown overhead,” Miller America. remembers. “ Identifying defining industries and understanding how they are changing can provide context for growth and help recognize future risks to the region. ” “States with defining industries that have Research shows several District states’ prospered in recent years have grown quickly economies remain among the most distinct in overall, while states with defining industries that the country, but “aeronautics is pretty unique,” have struggled in turn have grown sluggishly,” Miller says, especially for Kansas. The industry Wilkerson says. has been prominent since planting its roots in

WINTER 2008 • TEN 1919 photo by bob g reen s pan bob by photo

Wichita almost a century ago. resources, and the partnership with Wichita Known as “The Air Capital of the World,” State University. The majority of the 300 or the city of 350,000-some is home to six major so students in aerospace engineering there find aircraft manufacturing companies as well as post-graduate work locally. It’s like six degrees McConnell Air Force Base. The area’s top of separation, Miller says; everyone in Wichita three largest employers are Cessna Aircraft Co., has a tie to the aircraft industry. Spirit Aerosystems Inc. and Raytheon Aircraft Though research is mixed on whether it’s Co. The manufacturing sector as a whole better for a state’s economy to be diversified employed 58,400 of 282,800 nonfarm jobs in or specialized, industries that define an area’s the Wichita metro area in 2004, according to economy seem to play a significant role the chamber of commerce. in growth through time. There’s no doubt Miller sees signs of industry expansion, the aircraft manufacturing industry defines something he attributes to its history, the Kansas. co-location of many aircraft companies and Wilkerson and Williams consider an

2020 WINTER 2008 • TEN industry “defining” if it is more concentrated Animal slaughtering and pro- in the region than in the rest of the nation. This cessing: Recent growth is a result of rising measurement distinguishes defining industries demand for meat products, especially beef. from driving industries, which may employ Plants are located throughout the District, large numbers of people but are not more particularly in rural Nebraska, Kansas important in the region than in the nation, and Oklahoma. such as the health-care industry. Defining “Overall, recent growth in these industries also account for at least 0.2 percent industries—which have defined the District for of employment in the region, which equated to so long—has been sluggish at best,” Wilkerson more than 25,000 jobs each in 2005. says. “They are unlikely to create a sizeable Based on these two criteria, Wilkerson number of jobs in the years ahead. The region and Williams analyzed a group of 15 defining may need to look elsewhere for new jobs.” industries in the District, which accounted for about 10 percent of the area’s total employment in 2005. The top five were the same in 1990. Emerging industries Unlike most of the long-time defining The District’s five most industries of the District, several saw rapid defining industries overall are: employment growth from 1990 to 2005. Oil and gas extraction: Employment As a result, they have become increasingly in the District is most highly concentrated in concentrated in the region, and may offer this industry; activity is up significantly after growth opportunities, Williams says. a period of moderate growth. High energy High-growth defining futures prices and new extraction possibilities have improved the outlook. Oklahoma, New industries in the District include: Mexico and Wyoming have the heaviest Gambling: New legislation has expanded concentration in the District, followed by gaming significantly in Oklahoma, New Mexico Colorado and Kansas. and Missouri, in both urban and rural areas. Business support services and data Farming: Employment has been weak processing services: While located mostly as technology replaces workers; little growth is in metro areas, increased technology allows call forecast, although ethanol production recently centers, electronic and mail order houses, and boosted farmland values and incomes in corn- data processing and related services to operate growing states such as Nebraska. in rural locations. Google, for example, recently Rail transportation: Computers have announced it will open a new data center in changed the industry’s operations considerably, Pryor, Okla., a town of less than 9,000. leading to a decrease in employment, but Retail superstores: Retail superstores, activity has improved recently. The industry such as Wal-Mart Supercenter and SuperTarget, is heavily concentrated in Nebraska, Kansas are now more concentrated in all of the District’s and Wyoming. seven states than in the nation as a whole. Aircraft manufacturing: Cutbacks Despite their growth opportunities and in national defense spending and struggling overall popularity, the desirability of superstores airlines have hurt the industry, and employment and casinos often is debated. The superstores has declined considerably since 1990. The generally offer lower prices and large selections, outlook is brighter as demand for personal air but can drive out locally owned shops, more so travel rises and spending for defense aerospace in rural areas than metros. Research is mixed production increases. on superstores’ effect on local employment.

WINTER 2008 • TEN 2121 In some areas, casinos have increased not from the immediate area. employment growth by double digits, often “I think gaming has been a real blessing for in Native American communities where the tribe,” Capps says. “It all started with bingo unemployment was high. But, there are (in the 1980s). It was successful and people potential economic drawbacks associated with loved it. Americans love to gamble.” gambling. In order to boost economic growth In 2006, Oklahoma brought in about in a casino’s surrounding area, the gambling $2.2 billion in gambling revenue. This is a 33 money must come from outsiders, not local percent increase from the year prior, according residents, Wilkerson says. Other costs may to the North American Gaming Almanac. include increased crime and more frequent There are 97 casinos in Oklahoma, although personal bankruptcy. not all are as large-scale and some don’t offer A little more than a year ago, the table games, but rather slot machines. Potawatomi Nation opened a 125,000-square- This means economic development and foot, Vegas-style casino off Interstate 40 near self-sufficiency for the Potawatomi Nation, Shawnee, Okla. The multimillion-dollar Capps says. facility includes restaurants and bars, and an FireLake Grand Casino has about 1,200 entertainment venue that has featured Wayne staff on its payroll, which is half the Potawatomi Newton, the Beach Boys and other performers Nation’s total employment, though not all are

“ Certain states in the region have seen growth in sectors that may have the potential to become defining industries. ” as well as events, such as cage fighting. The tribe members. The tribe doesn’t rely on this Potawatomi Nation plans to start construction industry exclusively, but casino revenue pays on a nearby hotel this year and hopes to add a for services, such as the health clinic or housing golf course in the future. assistance for some members. The idea is for FireLake Grand Casino “It is an industry where you can make to be a destination point, says Linda Capps, money relatively fast,” Capps says. “We Potawatomi Nation vice chairman. The casino wouldn’t be able to do a lot of things for our alone already has been an economic benefit (tribe) members if it wasn’t for profits from to the tribe, she says, as well as a boost to the gaming.” nearby towns’ commerce and quality of life by offering locals entertainment and dining Future growth options they would otherwise drive 40-plus At NetDevil, Brian Booker sees “huge miles to Oklahoma City for. The potential” in the computer games industry. He majority of FireLake’s patrons, attributes the growth and strong outlook to though, are several factors, including consumers’ increased time and comfort level online; overall increased access to computers and the Internet; and, perhaps most important, the rising popularity of this type of entertainment. In the District, states with both the largest overall growth rate and highest growth in defining industries recently were Colorado, New Mexico and Wyoming, Wilkerson says.

2222 WINTER 2008 • TEN athan M cKay athan photo by N by photo

In Kansas and New Mexico, the biosciences industry has been rapidly growing, especially in areas where a university and research campus are located. Similar to health-care-related further resources industries, this sector is projected to be among The Tenth District’s defining industries: the 10 fastest-growing in terms of wages and How are they changing? employment. By Chad R. Wilkerson and Megan D. Williams As the oil and gas industries in Wyoming The Tenth District’s defining see high growth, the machinery and equipment industries: Changes and opportunities rentals industry is increasingly important there. for rural communities This provides new opportunities in a sector By Megan D. Williams that has relatively high pay. www.KansasCityFed.org/TEN “Certain states in the region have seen growth in sectors that may have the potential to become defining industries,” Williams says.

T COMMENTS/QUESTIONS are welcome BY BRYE STEEVES, SENIOR WRITER and should be sent to [email protected].

WINTER 2008 • TEN 2323 , Back in the early 90s, John Miller had a hunch. He had returned to Murdock, Neb., to work the hayfields that had been in his family for more than a century. “When I was farming, there was a lot of time to ponder,” Miller says. “I just started thinking how can I add value to the product I was raising.”

iller was supplying hay to commercial buyers, but saw a void in the pet food industry for small herbivores, such as rabbits, guinea pigs and chinchillas. He wanted to develop a fresh hay- based product line that could be produced, packaged and distributed right there in rural eastern Nebraska. And Miller thought maybe, just maybe, a budding technology called the Internet might be the way to make his business venture a success. He was right. The advances in computer technology allowed Miller to research pet nutrition, partner with veterinarians and reach potential customers, all via the World Wide Web. What he didn’t realize was it would help Oxbow Pet Products eventually go global. “It’s almost a miracle this thing got started,” Miller says with a laugh.

24 WINTER 2008 • TEN WINTER 2008 • TEN 25 photo by bob g reen s pan bob by photo With the help of his then-12-year-old son, Miller created and printed thousands of United States research and product labels from their personal computer. The family set up an assembly line in the garage development expenditures to individually glue labels on plastic bags and stuff them with pet food using a homemade contraption––another one of Miller’s ideas. He was instrumental in getting his town In the United States, private industries of less than 300 residents Internet access, but had to make do with dial-up, “which drove you spend billions each year to discover the next crazy, but it was better than nothing.” Word started to spread online, and in great invention. 1997, Oxbow Pet Products received its first international order. His products are now In 2004, this sector spent about $300 exported to more than 20 countries. “They found us through the Internet,” Miller says. billion, which equates to about 70 percent Although at one time access was an issue, these days the advantages of technology of the total expenditures, on research and aren’t out of reach for rural America, says Jason Henderson, assistant vice president and development while universities, nonprofit or- executive of the Omaha Branch of the Federal Reserve Bank of Kansas City. Henderson ganizations, and the government and other recently researched how innovation can open doors and boost rural prosperity. federally funded organizations “Size and distance may limit a rural entrepreneur’s ability to produce radical spent just a fraction of this amount. new innovations,” Henderson says, “but adopting technologies helps invigorate rural economies.” Universities Technological innovation often spurs 13.6% economic growth by creating new products, improving efficiency and connecting to new Federal government markets––opportunities many small or remote 7.9% communities believe to be out of reach to them. The Internet, for example, allows some rural areas to provide business services and enables high-skilled services in remote communities. Federally funded The fastest-growing firms in rural America R&D centers are providers of professional and business 4.1% services, where operating costs are lower than in major metro markets and closer to home Nonprofits than overseas-based services. 4.1% While Miller says his location was a challenge at first, it ultimately was not a Industry 70.2%

Numbers are approximate. Source: National Science Foundation photo by bob g reen s pan bob by photo

John Miller, right, started Oxbow Pet Products on his family , farm in the 90s, using, what was then, budding technology, including dial-up Internet for product research and development. The pet food now is exported to more than 20 countries.

hindrance. Technology is more powerful. organizations, and government and other “The whole world is your market,” Miller federally funded organizations––on research says, and with the Internet “you can reach the and development to discover the next big whole world.” thing. While inventions are critical, Henderson cautions they alone don’t transform economies. Importance of innovation Innovation—the ingenuity behind the Innovation is the fuel entrepreneurs use invention—does. to power economic regions. It can boost rural “Innovations are commercialized inven- prosperity in three ways: by creating new tions that generate new economic value in the products, improving production processes and marketplace,” Henderson says. “The key play- opening doors to new markets, Henderson ers in this crucial game of innovation are rural says. entrepreneurs––inventions often are the prod- Private industries shell out billions uct of homegrown businesses.” annually—outspending universities, nonprofit During the past 50 years or so, more than

WINTER 2008 • TEN 2727 two-thirds of all innovations have been adopted, Financial gains improved or developed by small entrepreneurial Rural places are typically not viewed as a firms, leading to dramatic transformations in seedbed for invention and innovation, typically the economy. producing less than one patent for every 10,000 Innovation improves production processes, people compared to the more than 2.5 patents and in turn boosts productivity. Henderson produced in metro areas, Henderson says. points to agriculture as an example, citing Many rural businesses that do adopt technologies such as tractors, hybrid seed corn technology often see higher economic returns and pesticides, all of which led to a surge in than those that don’t. Entrepreneurs with high- productivity growth. tech manufacturing firms earned about 50 “The number of labor hours to produce percent more than low-tech factory owners, 100 bushels of corn dropped from 80 in 1850 according to Census Bureau data from 2006. to less than two today,” he says. With new technology comes new com- Innovation also affects manufacturing petitive pressure; businesses unable to keep up and retail industries in ways ranging from don’t survive. Adopting maturing technologies Henry Ford’s assembly line car production often depends on rural communities’ ability to to Wal-Mart’s efficient distribution to the disseminate knowledge. Internet’s quickened communication. From Factors such as size and remoteness can 1999 to 2004, manufactured shipments sold raise the cost of transmitting knowledge and via e-commerce increased 30 percent while information even though the Internet and other overall manufacturing shipments increased by communication technologies have improved “ It takes a while to fully integrate technology into a business and then reap its full benefits. ” just 1 percent. Now, about 25 percent of all connections. These high costs often decrease manufactured shipments are e-commerce. in time. E-commerce technology allows rural “It takes a while to fully integrate firms to market their products to customers technology into a business and then reap its in places previously unreachable. Since 2003, full benefits,” Henderson says. “Entrepreneurs e-commerce sales in the retail sector have often face steep learning curves before they can grown 25 percent annually while overall retail decide how their existing business practices sales have grown just 6.8 percent. need to change.” For example, Internet visits to the outdoor For Paul Eurek, there were several advantag- superstore Cabela’s, which is headquartered in es to opening a third office for his international rural Sydney, Neb., increased 36 percent in software development services company in rural 2005. central Nebraska. Xpanxion is headquartered Sales in the agriculture business also have in Atlanta, with its largest office in Pune, India, benefited from Internet access. By 2004, the and its newest office in Kearney, Neb. number of farmers using the Internet had While it may seem an odd mix of locations grown to more than 50 percent. Although or an unusual place to operate a highly farmers tend to go online for price tracking, technical business, company chairman Eurek information gathering and communication says technology “makes it look like we’re all in purposes, buying farm products via the Internet the same office. … There really are no physical is growing more popular. boundaries.”

2828 WINTER 2008 • TEN photo by bob g reen s pan bob by photo

Access to a high-quality workforce, lower Public policy: Connecting to operating costs and less employee turnover rural America prompted Eurek to look to rural areas to expand. Many university and college systems Because he wasn’t limited geographically, nationwide were designed as institutions Eurek decided to move back to his native area of technology transfer to rural places––an and open a 15-person office there about a important role for public policy. From their year ago. beginning, land grant universities were charged “I think it (locating in remote areas) is with discovering new technological innovations the future,” Eurek says. “Part of the reason I and transferring them to rural regions. A goal of wanted to do this in Nebraska was to show it a land grant university’s research and extension could be done.” missions is to enhance communities’ economic

WINTER 2008 • TEN 2929 viability and quality of life through this transfer rural communities around the state, according of technology. This technology transfer process to the university. takes many forms across the nation’s land grant Smaller, non-land grant universities are campuses. also shifting their research and curriculum to For example, the Food Science Institute reflect the evolving technological impacts on and Meat Science Facility at Kansas State agriculture. University provide research, teaching and Northwest Missouri State University, technical assistance for new and existing with its student body of just more than 6,000, products for related industries. Similarly, the recently began offering a minor in precision University of Wyoming in Laramie recently agriculture––a concept that incorporates added a third off-campus research center as technology with farming and geography part of its overall mission to tie the university studies. Goals of precision agriculture include to area agriculture. improved crop yield, more efficient fertilizer “ Most of the students, they’re going back to the farm. So, we’re helping to train a new wave of farmers. ” Located in the towns of Lingle, Powell and application, reduced erosion and pollution, Sheridan, the centers are made up of acres of better management decisions, more accurate cropland, feedlots and livestock labs. The goal record keeping, and increased profit. of this integrated research is to get results to “The old, traditional ways (of farm

Assistant professor Jamie Patton, center, in green, and students test soil erosion in pits near the Northwest Missouri State University campus in Maryville. Precision agriculture incorporates technology into farming to maximize production and efficiency. ary barber ary photo by g by photo

30 WINTER 2008 • TEN businesses) are just falling by the wayside,” says Jamie Patton, assistant professor of soil sciences. “Anywhere you look, technology is being incorporated.”

It’s important to teach this in the classroom, g reen s pan bob by photo Patton says, because “most of the students, they’re going back to the farm. So, we’re helping to train a new wave of farmers.” Universities are a vital part of knowledge transfer, which means conducting research and disseminating information. It can improve rural America, Patton says. Other public policy efforts that emphasize the importance of technological adoption to rural prosperity include the National Institute of Science and Technology programs that provide technical and business assistance to small manufacturers. Another policy example is the Agriculture Innovation Center established by the 2002 Farm Bill to fund technical and business docks. The company employs 50, including an development assistance for agricultural IT staff member. producers. The organization helps them write “First you have one computer, then you business plans, conduct research and provide have two and three. … There’s just been this counselors to help new venture creation in the gradual, continual evolution,” Miller says. agricultural sector. “This idea would not have become a reality Additionally, Henderson says, rural without computer technology.” communities need to find ways to tap technology in the private sector, where T the majority of research and development BY BRYE STEEVES, SENIOR WRITER expenditures come from. This private money often is geared toward developing products, as opposed to public programs, which focus on advancing basic research. further resources For many rural businesses, adopting The power of technological technological innovations to enhance innovation in rural America production and create products will boost both By Jason Henderson productivity and prosperity, Henderson says. www.KansasCityFed.org/TEN That certainly was the case for John Miller’s Oxbow Pet Products. Today, Miller continues to operate from the family farm in Murdock. But now the old barn is transformed into modern office space. COMMENTS/QUESTIONS are welcome There are three new buildings and four loading and should be sent to [email protected].

WINTER 2008 • TEN 3131 Update... ary barber ary on by g i on by trat u s photo I ll photo

n the midst of the ongoing fore- was held at the Ewing Marion Kauffman closure surge, consumer education Foundation. is the key to prevention, but help These ongoing efforts are in line with is available to those facing default, part of the Fed’s mission of spurring economic experts say. growth through community development, The Federal Reserve Bank of Kansas City which includes financial education, asset has hosted a number of events focusing on building and entrepreneurship. housing issues, including two forums at its Attendees included educators, real estate Kansas City office, one at its Denver Branch agents, regulators, lenders and representatives and other events at the Oklahoma City and from nonprofits and government agencies. The Omaha Branches. forum and its question-and-answer session On Nov. 6, the Kansas City Fed partnered were an opportunity for these organizations to with the social services nonprofit Mid America learn about foreclosure issues from each other Assistance Coalition to sponsor a forum on as well as Kansas City Fed staff. home mortgage foreclosure issues. This event Kelly Edmiston, senior economist at the

32 WINTER 2008 • TEN Kansas City Fed, presented his research on the borrowers paid a higher interest rate than causes of increased foreclosures both nation- someone with good credit would have been ally and regionally. Additionally, Edmiston and charged. Their adjustable-rate mortgages often research associate Roger Zalneraitis authored started out with good “teaser” rates, but became the paper, “Rising foreclosures in the United unaffordable for some borrowers as teaser rates States: A perfect storm,” which will be featured expired and market interest rates rose. in an upcoming issue of TEN and was pub- During this period, the U.S. homeowner- lished in the Kansas City Fed’s fourth quarter ship rate was at an all-time high; many of the 2007 Economic Review. new homeowners were lower-income house- Also at the forum, a panel of experts holds. Some have been able to pay their mort- discussed the roles their organizations play gages; others have defaulted. Many borrowers in foreclosure prevention and intervention. said they didn’t understand fully the terms They were: Marjorie Major of Neighborhood of their loans, or the extent to which their Housing Services of Kansas City, Inc.; Gregg payments could increase. Lombardi of Legal Aid of Western Missouri; The resulting sharp rise in foreclosures and Pam Hilder Johnson of Greater Kansas also has caused several major lenders to fold or City Housing Information. Also on the panel file for bankruptcy. The impact has been felt was Ariel Cisneros, senior community affairs worldwide with falling stock prices, especially advisor for the Kansas City Fed’s Denver in mortgage companies, and cast a dark cloud Branch, who discussed the foreclosure task force formed in Colorado in late 2005. The Kansas City Fed dedicates its resources to foreclosure prevention and consumer assis- Kelly Edmiston, senior economist at the tance through economic research and commu- Kansas City Fed, recently gave a presentation on nity involvement throughout its District. This foreclosure rates in Missouri and Kansas, which are near includes western Missouri, Nebraska, Kansas, all-time highs. Oklahoma, Wyoming, Colorado and northern New Mexico. Its message for consumers: Help is available. At the recent forum, Edmiston first explained the extent of the foreclosures in the Kansas City metro area, which spans parts of both Missouri and Kansas, and then the causes and potential effects in the future. “I think the foreclosure problem is going to get a little worse before it gets better,” Edmiston said. “But consumers are not without options.”

Foreclosure surge arber The onslaught of subprime mortgage foreclosures has been ongoing since mid-2006. During the years prior, would-be borrowers who were unable to qualify for traditional mortgages, usually because of weak credit B Gary by photo histories, obtained subprime loans. These

WINTER 2008 • TEN 33 over the already-slumping U.S. housing mortgages and other adjustable-rate mortgages market. when payments reset; With a foreclosure rate of 1.12 percent, • The stabilization or decline in the Missouri falls below the country’s foreclosure appreciation of home prices, coupled with low rate of 1.4 percent, Edmiston said at the equity in many cases. forum. In some areas of the state, however, the This means borrowers who obtained a foreclosure rate is greater than 5 percent––much subprime mortgage and couldn’t make the higher than any overall state rate. Foreclosures payments when the initial rate increased, in in Kansas also are near all-time highs for the many cases, couldn’t sell their home at a price state. that exceeded what they owed. “Foreclosures are concentrated in urban Edmiston predicts foreclosure rates will areas, specifically in low- and moderate-income continue to grow through 2009. areas,” Edmiston said, “while foreclosure rates Not only can this be detrimental for the in rural areas of both states generally are low.” homeowner and family, the neighborhood and community can be affected if homes become abandoned and deteriorate––crime can ‘Perfect storm’ increase, property values may fall, tax revenues There is always an ebb and flow of fore- can decrease and lenders might shy away from closures, Edmiston said, but three conditions urban lending. recently merged to create what he calls the There are solutions for the homeowner, “perfect storm”: such as refinancing or prepaying (although • The rise in popularity of subprime sufficient equity is needed). Sometimes a lender mortgages; will work with the homeowner to circumvent • The inability to pay these nontraditional foreclosure, but often the homeowner avoids

Kansas and Missouri foreclosure rates

First Quarter 1979 to Second Quarter 2007

1.8

1.6

1.4

1.2

1.0

0.8

0.6 Foreclosure rate (%) rate Foreclosure 0.4 Missouri

0.2 Kansas

0.0 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year 34 WINTER 2008 • TEN Source: Mortgage Bankers Association contact out of fear. However, it can be difficult for a troubled borrower to work with his or her lender––because mortgages are packaged together and sold to investors, the loans aren’t held in the loan originators’ portfolios, which arber can create a disconnect between the borrower and lender. There is a nationwide hotline (888- 995-HOPE) through the NeighborWorks organization that can put homeowners in touch with local resources. Currently, though, B Gary by photo only about 5 percent of callers from Missouri are from the Kansas City area, although this metro area represents a much more substantial Ariel Cisneros, senior community affairs share of all Missouri foreclosures. advisor at the Kansas City Fed’s Denver Branch, was a “One thing we can take away from this panel member at the Kansas City forum. He spoke about meeting is more needs to be done,” Edmiston a recently implemented task force in Colorado. said. “We’ve got a problem getting this message out there.” Legal Aid, noted that initial counseling with a troubled borrower may take just a few hours, Taking action whereas working on a home foreclosure case Whether organizations offer preventative can take hundreds of hours. foreclosure counseling or mail information to Panelists also spoke of the importance of at-risk homeowners, efforts focus on educating working together for this common goal. the consumer with the hopes of preventing “Everybody has to have somewhere to foreclosure or mitigating its impacts. live,” said Johnson, of Greater Kansas City The Denver Branch hosted a similar Housing Information. foreclosure forum in August, Cisneros said The Kansas City Fed continues to host during the panel discussion. He shared insight roundtables throughout the District to do its from the Colorado task force and statewide part to aid homebuyers. hotline, which was formed about a year ago by “The best thing I think you can do,” 25 counseling agencies to work with individual Edmiston said, “is educate the consumer.” homeowners and resolve foreclosure issues. The hotline has received more than 20,000 calls, T mostly from those who are already delinquent BY BRYE STEEVES, SENIOR WRITER on their mortgage. Other data show 60 percent don’t contact or respond to their lender when facing default; a quarter of the callers aren’t further resources even sure what type of loan they have. For related information, please see the Federal Reserve “The hotline is looking for the best Bank of Kansas City’s materials from its 2007 Jackson resolution,” Cisneros said. “What is the right Hole Symposium, “Housing, housing finance & product for this individual and how can the monetary policy,” at www.KansasCityFed.org/TEN. hotline help?” All the panelists emphasized the impor- tance of seeking assistance early, when more options are available and problems may be re- COMMENTS/QUESTIONS are welcome solved with less difficulty. Lombardi, of and should be sent to [email protected].

WINTER 2008 • TEN 35 Notes

Branch executive learns of similar structure during visit to Canada

Chad Wilkerson, assistant vice president, economist and Oklahoma City Branch executive at the Kansas City Fed, recently accepted an invite to visit the central Bank of Canada’s main office in Ottawa. The purpose of the visit was to discuss the restructuring of branch offices at the two organizations and how regional economic research and analysis is conducted. National consumer Canada restructured its regional offices (Calgary, Halifax, Montreal, resource launched Toronto and Vancouver) about 10 years ago. The restructuring of the Kansas City Fed’s Branch offices The Federal Reserve recently launched in Denver, Oklahoma City and a national resource to help better inform Omaha has evolved these past few consumers who have concerns about years in a similar fashion. their banks. Each Kansas City Fed Branch Federal Reserve Consumer Help, admin- office now has a regional economist istered by the Kansas City and Minneapolis to serve as the lead officer and Reserve Banks, streamlines consumers’ inqui- Branch executive. Their jobs include ries to the appropriate organization without conducting regional economic research; giving the consumer struggling to do so on his or external and internal presentations about the her own. regional economy; working with the Branch’s Now inquiries or complaints can be sub- board of directors; and expanding relationships mitted via phone, fax, mail or online to one with area banking, business and community location. Additionally, the website provides leaders. answers to consumers’ frequently asked The Bank of Canada has senior economics questions about banking issues. representatives at each of its regional offices These efforts are in line with part of the with similar roles and backgrounds as the Fed’s mission to educate consumers, who Kansas City Fed’s Branch executives. Wilkerson provide the basis for a more stable economy by met with them and other staff during his two- making informed financial decisions. day visit. For more information, visit Canada’s economy is about one-tenth the www.FederalReserveConsumerHelp.gov. size of the U.S. economy, making it roughly the size of one of the 12 Federal Reserve Districts. “As the financial system changes, and the Fed changes, we hope to continue to learn important lessons from our collegues in central banking,” Wilkerson says.

3636 WINTER 2008 • TEN 2008 Survey of Community Banks The following banks in the Tenth District are celebrating one, five, 10 or 20 or more years as Federal Reserve members in January, February or March.

To better understand challenges Colorado B&TC of La Junta La Junta Colo. 84 confronting bank managers, the Federal Lusk State Bank Lusk Wyo. 74 Reserve Bank of Kansas City is conducting the St. Marys State Bank St. Marys Kan. 72 2008 Survey of Community Banks. First Community Bank Taos N.M. 70 The Fed is asking all banks with less Community B&TC Neosho Mo. 66 than $1 billion in assets in the Tenth Federal Bank of Holden Holden Mo. 63 Reserve District (western Missouri, Nebraska, Colorado Mountain Bank Westcliffe Colo. 29 Kansas, Oklahoma, Wyoming, Colorado and Bank At Broadmoor Colorado Springs Colo. 28 northern New Mexico) to complete the survey no later than March 15. Both a survey and its First State Bank Wheatland Wyo. 27 instructions, as well instructions for completing Bank of Wyandotte Wyandotte Okla. 10 the survey online, will be mailed in February. Canadian State Bank Yukon Okla. 10 The community bank survey, which can Emerald Bank Burden Kan. 10 be completed anonymously, is a valuable tool Exchange B&TC Perry Okla. 10 that allows the Federal Reserve to understand First State Bank Picher Okla. 10 bankers’ views on the operational and regulatory Auburn State Bank Auburn Neb. 5 issues banks face. It also provides insights on First B&TC Minden Neb. 1 bankers’ plans and expectations for the future. The Kansas City Fed will post survey results on www.KansasCityFed.org, as well as share the information through articles in Financial T Industry Perspectives and TEN magazine. Staff Compiled By TEN staff conducted a similar survey in 2004. Call Forest Myers or Eric Robbins at COMMENTS/QUESTIONS are welcome 800-333-1010 with questions. and should be sent to [email protected].

The Federal Reserve Bank of Kansas City hosted a dozen economic advisors from European embassies in Washington D.C., during a two-day visit in October. Participating embassies were Belgium, Estonia, Finland, France, Greece, Italy, Lithuania, Slovak Republic, Portugal, Spain, Sweden and the United Kingdom as well as the European Commission. Kansas City Fed senior officers discussed economic, banking and policy issues with the guests.

WINTER 2008 • TEN 3737 About... g e s hoto by g etty by i ma P hoto

western Missouri-based terrorist financial activity, says Susan Zubradt, vice organization was indicted last president of examinations and inspections at Aspring for funneling more than the Federal Reserve Bank of Kansas City. $1.4 million to Iraq by disguising Compliance is tough and penalties are itself as a charity to avoid detection––and severe, but banks overall have embraced their solicit donations. important role in the fight against terrorism, During a 12-year period, the Islamic Zubradt says. American Relief Organization illegally The backbone of anti-money laundering transferred money from its bank accounts in compliance is the Bank Secrecy Act, which Missouri to accounts in Jordan, and ultimately requires banks to have policies and procedures to Iraq. One of the organization’s employees to guard against money laundering. This had also worked for Osama bin Laden, helping includes employee training, testing of the to obtain satellite phones to coordinate al- compliance program, and a system of internal Qaida attacks on U.S. embassies in Africa. controls to ensure compliance, including More and more in the post-Sept. 11 world, reporting suspicious financial transactions. these instances of money laundering challenge The Kansas City Fed has an active role in the country’s financial institutions, which are this effort, ensuring compliance as part of its the front line of defense in combating illicit examination process of member banks in the

3838 WINTER 2008 • TEN Tenth Federal Reserve District. The District efforts,” Thompson says, “the events leading to includes western Missouri, Nebraska, Kansas, the passage of the PATRIOT Act pointed out Oklahoma, Colorado, Wyoming and northern just how complicated the world had become. New Mexico. Sept. 11 added more requirements and raised “The partnership among banks, bank expectations in terms of the importance of this supervisors and law enforcement has been part of our examination process.” integral in detecting and deterring money As a result of increased globalization, laundering,” Zubradt says. technology and the complexity of transactions, These efforts are producing positive results, moving money had become easier for criminals and illicit activity is being thwarted. while financial institutions’ ability to detect “These laws aren’t just about complying and monitor illicit activity had become more with regulations,” Zubradt says. “The ultimate difficult. goal is to safeguard our financial system from Traditional money laundering involves the abuses of financial crime.” illicit cash transactions such as deposits made in amounts less than $10,000 (to avoid the Banks’ role: Then and now institution filing a report), multiple times. Several laws aimed at fighting financial Or, cash amounts of less than $3,000 used crimes through the years have led to the to purchase money orders, cashier’s checks complexity of today’s Bank Secrecy Act, dating or traveler’s checks, also to avoid reporting back to its own inception in 1970 when the focus requirements. was stopping large amounts of drug trafficking New methods of money laundering cash from entering the banking system, says include the use of stored-value cards. Some of

The partnership among banks, bank supervisors and law enforcement “ has been integral in detecting and deterring money laundering. ”

Andrew Thompson, a Bank Secrecy Act expert these “pre-paid” cards can access cash at ATMs based at the Fed’s Denver Branch. internationally––funds can be loaded, and Banks were asked to report cash transac- often reloaded, onto a card in one country, and tions of more than $10,000. As a way around accessed at an ATM in another country. this, criminals moved money via check cashing Evolved money laundering techniques organizations, money services businesses, the require enhanced monitoring and detection postal system and casinos, which eventually be- procedures, Thompson says. came subject to the Act as well. By 1986, money laundering and related Key players activities became a federal crime. Because of There are a number of important players further prompting from Congress, in 1992 involved in regulating and enforcing the Bank banks and others were required to file reports on Secrecy Act: suspicious activity their institution identified. • Banks: Must have a formal, written Congress strengthened this law following compliance program, including regular the Sept. 11 terrorist attacks with the USA training and demonstrated systems to ensure PATRIOT (Uniting and Strengthening anti-money laundering compliance; America by Providing the Appropriate Tools • Financial institution regulators: Review Required to Intercept and Obstruct Terrorism) entities for compliance during examinations Act. and ensure correction of deficiencies; “Although we had more than 30 years • Financial Crimes Enforcement Network of experience with anti-money laundering (FinCEN): Compiles and coordinates the

WINTER 2008 • TEN 3939 distribution of the reports submitted by In Kansas City, participants in monthly financial institutions, and issues both the meetings include the IRS, FBI, Department of compliance guidance to the industry as well as Homeland Security, regional U.S. Attorneys’ the fines (along with the regulators) for serious Offices and local police. Staff from the Kansas compliance deficiencies; City Fed and other regulators attend to offer • Law enforcement: Reviews and investi- technical assistance with banking laws and gates reports of suspicious activity filed by banks regulations, Zubradt says. and other entities and prosecutes offenders. These reports and involvement from all In general, banks’ most common and parties have played a key role in the prosecution significant Bank Secrecy Act deficiency is of criminal activity, including illegal transfer of the failure to report suspicious activity, funds to the Middle East, international drug Zubradt says. trafficking, and insider embezzlement and fraud. To ensure compliance across the banking While the reports have been useful to industry, several agencies are responsible. The investigations, bank resources dedicated to Fed examines its member banks to assess their compliance can be significant. Recently the financial condition and check for compliance Treasury Department announced a four-prong

The Federal Reserve Bank of Kansas City stands ready to assist with “ any new anti-money laundering laws as part of its mission to supervise financial institutions and ensure sound banking practices. ” with banking laws and regulations. State- plan to ease the demands of complying with chartered banks that are not members of the anti-money laundering laws and regulations: Fed are examined by the FDIC; the Office • Develop a more risk-focused anti-money of the Comptroller of Currency examines laundering compliance review for smaller and nationally chartered banks. less complex institutions. • Narrow the definition of money services Suspicious Activity Reports business to better focus resources on those that The Bank Secrecy Act requires institutions present a significant risk of money laundering. to file Suspicious Activity Reports, which cover • Make anti-money laundering regulations 21 categories of activity, including terrorist easier to understand. financing. • Offer more feedback via FinCEN to While there has been a significant increase participating agencies on the data they receive in reports citing mortgage loan fraud and and analyze. consumer loan fraud recently, about half of the “The Federal Reserve Bank of Kansas reports filed are related to money laundering. City stands ready to assist with any new anti- More than 4 million reports have been filed money laundering laws as part of its mission nationwide since 1996, and nearly 1,000 are to supervise financial institutions and ensure filed each year by state member banks in the sound banking practices,” Zubradt says. District. After a bank files a Suspicious Activity Report, it is reviewed by an examiner and reports of “insider abuse” are flagged. Law enforcement officials regularly review the reports and meet T periodically as a group to follow up. BY BRYE STEEVES, SENIOR WRITER

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