Book Review: Richard Florida's Who's Your City

I completed Who's Your City a couple of weeks ago, and wanted to summarize key points from it here. For those of you who are not familiar with Richard, he's the professor and author that originated the idea of the "creative class". He has discussed the role of the "creative economy" --- one which values creativity and new ideas --- and his new book focuses on the role of place. This is a great book, and I wanted to extend my thanks to the publisher for providing an advance copy for this review.

Richard's thoughts center on three key ideas:
1) "...place is actually more important to the global economy than ever before."
2) "Places are now more diverse and specialized -- from their economic makeup and job market to the quality of life they provide and the kinds of people that live in them."
3) "We live in a highly mobile society, giving most of us more say over where we live" -- take advantage of that mobility.


The Importance of Place
Richard's contention is that "...in today's creative economy, the real source of economic growth comes from the clustering and concentration of talented and productive people". In contrast to another great book, Thomas Friedman's The World is Flat, Florida indicates that now --- more than ever --- where you live is as important as what you do. Although globalization has levelled the playing field for workers in some respects, an individual's location is critical to their well-being, the quality of their lives, and their ability to capture synergies and economies of scale from those within their industry. Richard:

"The reality is that globalization has two sides. The first and more obvious one isthe geographic spread of routine economic functions such as simple manufacturing or service work....the second, less obvious side....is the tendency for higher-level economic activities such as innovation, design, finance, and media to cluster in a relatively small number of locations."

This is what Michael Porter calls the "location paradox" --- "Location still matters. The more things are mobile, the more decisive location becomes." Finally, as Florida illustrates in the first part of the book, "The key to our new global reality lies in understanding that the world is flat and spiky at the same time."


The Continued Specialization of Place
Here, Florida works from findings of others to illustrate the cities continue to "cluster" into specialities. Schumpeter and Solow, illustrate the importance of "creative destruction" (i.e. innovation and entrepreneurship) to economic growth and wealth, and discovered the startling fact that ... about 4/5ths of the US economy's growth per worker was attributed to technological progress."

Jacobs and Lucas illutrate the importance of cities to this process, and identified the importance of "talent clustering", which lead to a "multiplier effect" that is the "primary determinant of economic growth." Ultimately, they noted that "...a doubling of population resulted in more than two times the creative and economic output." --- synergy. "According to UN predictions, by 2030, more than 2/3rds of the world's population (4.4B people) will be urbanites."

In the end:

"What matters most today isn't where most people settle, but where the greatest number of the most skilled people locate. Because the returns from colocation among the ablest is so high, and because high-end incomes are rising so fast, it make sense for these workers to continue to bid up the price of real estate..."

Using this Knowledge to Your Advantage
The final part of the book helps the reader identify characteristics that are important to them and the cities that they may ultimately choose to reside in. This can serve as an excellent resource for those that want to understand regional dynamics, and the "personality" of their respective city.

Although this probably serves as the most directly useful core of the book, Richard has a wonderful website developed as a supplement, and so I will direct you there for additional information: http://creativeclass.com/whos_your_city/


In summary, this is a great book that does a great job of helping to illustrate the global changes that are taking place, and provide them in a context that allows the reader to make some informed decisions about where and why they make decisions on where they live. Given the critical importance of place to well-being and economic security, a visit to the website would be an enlightening first step.

Securitizations - An investor benefit?

Two recent WSJ commentaries highlight the delicate trade-offs that loan securitizations provide to the capital markets --- On one hand they allow lenders to diversify risk and investors to select the appropriate amount of it, but on the other they can make risk more difficult to quantify and evidence suggests they may actually increase the cost of the debt to the borrowers. These two articles discuss these trade-offs in greater detail.

Can the financial markets make a comeback?
This first article I found to be an excellent primer on securitization, by an early key participant in the industry, Ethan Penner: http://online.wsj.com/article/SB118817063701609287.html.

In addition to briefly explaining the process, Penner makes a couple of important points about the securitization process, using quotes from the controversial former investment banker Michael Milken.

Benefit: "The democratization of capital" (Milken), namely securitization:

1. Allows borrowers better access to the credit markets
2. Allows "investors to better target where they want to be on the risk/return spectrum"

Costs:

1. Low regulatory oversight - (cited by author as both a benefit and a cost)
2. Conflicts of interest - appraiser vs. debt holder vs. ultimate debt owner
3. Lax underwriting
4. Poorer transparency - like some CDOs, more difficulty pricing the risk associated with a particular debt offering
5. Poor liquidity - As I learned the hard way trading the VIX earlier this year, per Milken "liquidity is an illusion" in the sense that trading can instantly dry up when everyone is on the same side of an investment bet

In the second article I'll reference here: The Cost of Complexity (see bottom of article): http://online.wsj.com/article/SB118903970710218805.html my friends at BreakingViews make the argument securitizations are a net cost for the ultimate borrowers. They point out that although mishaps like the S&L crisis are now less likely given the diversification of risk across multiple creditors, the net spread of mortgage rates over T-bills has actually widened for borrowers. I would argue that the comparison might not be so simple, but this is an interesting insight nonetheless.

More on REITs...

While some of the "smart" money is staying in REITS (see previous post: http://marketlevers.blogspot.com/index.html#4719226607486309556), some of it is also getting out: http://online.wsj.com/article/SB118541177778978399.html?mod=mkts_main_news_hs_h).

Blackstone, which recently bought Sam Zell's Equity Office Properties, has since sold approximately 48% of the buildings it acquired. Although it's too early to tell how much they will ultimately reap from the deal, there is concern that commercial real estate prices might not be sustainable.

The article also closes with an explanation of why Zell himself didn't handle the sale of these properties individually. Apparently, due to the tax status of REITs (they must pay out at least (90% of their taxable income as dividends), they cannot easily divest more than 10% of their portfolio annually. Yet another example where private equity, and Zell, use keen knowledge of tax regulations to maximize both sides of a transaction.

State of the US Housing Market

Link to article: http://online.wsj.com/article/SB118540759669178277.html

Today's WSJ article is a good reminder on the way that credit markets impact prices, along with the supply-demand relationship. As lending requirements tighten, and interest rates rise, buying power declines and demand drops. The drop in demand, coupled with the excess supply, are leading to significant price declines; but those demands vary considerably by market.

What's happening in your city: http://online.wsj.com/public/resources/documents/info-houseIndicatorQ207-sort.html

Although Economy.com doesn't see a bottom in housing market prices until mid-2008, any potential changes to interest rates will also be telling.

Inside money is still on REITs

Although I was never a heavy real estate investment trust (REIT) investor, those of you that were invested in these securities have done exceedingly well over the past 3 -5 years, and at lower overall risk thresholds. That being said, the market thus far this year has been flat to negative, and it looks like concern over interest rates, and recent deal multiples, are partially to blame. Insiders at major REITs feel disagree however, to the tune of 60MM in insider buys during the most recent quarter.

Judge for yourself: http://online.wsj.com/article/SB118471766230569645-search.html?KEYWORDS=reit&COLLECTION=wsjie/6month.

At the end of the day, one fundamental question is whether or not (given the current investment environment), there's a better place to park one's money. The stock market's a little frothy, and the ultra-wealthy have been placing bets in alternative investments like art and real estate for a long time. If you believe that the market may be at a mid-term top, and commercial or multi-unit real estate is reasonably priced, then who's to say that the REIT boom can't continue?

Residential Mortgage - Fallout Continues

The following article talks about foreclosures occurring in the Atlanta market:
http://www.nytimes.com/2007/07/09/business/09auctions.html?ex=1184644800&en=9c20414fded33de4&ei=5070&emc=eta1

Some interesting things to think about:
- impact of aggressive promotional loan offers on both home demand and home prices
- what is the "inflation adjusted" value of your home?
- the role of auctions in the residential real estate market
- when does it really make sense to refinance?