May 2014 – Economic Thinking In Action

Confirming the business background of financial services professionals

The NMLS is the legal system of record and free service for consumers to confirm that the financial-services company or professional is authorized to conduct business in their state.

A little bit about what the NMLS Consumer AccessSM provides:

Contains licensing/registration information on mortgage, consumer finance, debt, and money services companies, branches, and individuals licensed by state regulatory agencies participating in NMLS.
Information regarding federal agency-regulated institutions and their mortgage loan originators who are registered with NMLS.
Contains information that is self-reported to regulatory agencies or an individual’s employing institution by the licensed/registered company or professionals.
Is updated nightly on business days

Michael Lewis’s Flash Boys eye opening, fast moving account of High Frequency Trading

Michael Lewis’ Flash Boys is a fast moving eye opener for those of us who do not spend our days working in and around ‘dark money’ pools and the backrooms of Wall Street banks.

The book begins by laying out the major players in the High Frequency Trading (HFT) market place. These players include Wall Street banks, traders, stock exchanges, computer programmers and those that are related to those industries.

Lewis then, through a very fast moving person-focused narrative, describes how HFT techniques have hurt the average investor for many years; mostly without the average investor even knowing that they were injured. He describes how techniques such as stock ‘front-running’ and cross market arbitrage causes the average investor to pay more than they should for the trades that they make, The amount of injury for the average trade is small; but collectively as Lewis describes, the amounts are extremely large and in the billions of dollars.

The real strength of the book is Lewis’ ability to bring HFT practices and the workings of dark money pools (pools of money where untracked and untraceable stock trades occur) to the forefront and up for discussion. However, much more research is needed before determining if HFT and dark money pools are in fact good or bad for the working of the economy. For example, some of the trades such as cross market arbitrage trades which equalize the prices investors pay across different exchanges are arguably good for the working of the stock market and the economy. The same case could be made for trades that equalize prices across different time periods (even though the time periods are ridiculously small).

In any event, Lewis’ book, as usual, has shined a light on a area that was previously unseen or imagined by most of us.

— DDS

Business profits in graph format

Economic modeling of business profit losses in a breach of contract case

Modeling business profit losses

As discussed in a previous post, the plaintiff in this case is suing their landlord for breach of contract. The plaintiff alleges that the defendant landlord misrepresented the terms of the contract, specifically regarding how the property that they were leasing could be used.

At the heart of the issue, the plaintiff alleges that the defendant represented that they would be able to operate a live music venue restaurant from the location. The plaintiff alleges that the defendant’s failure to support the permitting and rezoning efforts constituted a breach of contract.

The premise lease was for 10 years. The plaintiff operated the live music for two years. In year three, since the facility did not have the proper permits, the facility operated as a restaurant that also provided catering and was also a destination for weddings and other events. The defendant terminated the lease after 3 years.

So how are damages analysed?

In this case there are three distinct types of damages: lost out-of-pocket expenses, lost profits from the termination of the premise lease, and lost expected profits from the performance of the contract. In this case, the three different types of damages are distinct.

Lost out-of-pocket expenses:

These are the expenses that the plaintiff expended on services and products, such remodeling the interior, architects, construction etc., but was not allowed to use because of the defendants actions.

The total cost of some items such as the cost of professionals hired to complete the re-zoning applications, is included in the analysis. In other situations, the un-used portion is relevant. For instance, the plaintiff constructed special performance stages and purchased sound equipment for the outside music performance, which they were able to use for three years. In these instances, the value of the use that the plaintiff received needs to be deducted, along with any salvage value, from the plaintiff’s cost.

Lost profits from the termination of the premise lease:

In this case, these are the losses associated with having to operate at a lower capacity. It will in essence be the difference between the profits that the plaintiff could have continued to earn had they continued to operate as a restaurant without the live music venue (‘but-for’ reduced operating earnings) and what they actually earned ($0) from the business following the termination of the lease. In this case, the plaintiff actually could, and did, operate the facility as a restaurant and wedding reception facility. The earnings and profits from year three, the time period that the business operated as a restaurant and special events facillity only, is used as a benchmark for the reduced operating capacity ‘but-for’ profits projections. The business shut down after the lease ended so the actual earnings are $0.

Lost expected profits from full performance of the contract:

These are the alleged lost profits associated with the revenue that the business would have earned had the defendant fully performed the contract and performed the necessary steps for the plaintiff to operate the live music venue on the leased premise.

The lost expected profits are calculated as the difference between the ‘but-for’ profits that the plaintiff would have earned had the defendant fully performed the contract and the business was allowed to operate as a live music venue and the profits that the plaintiff could have earned had they continued to operate the business in its reduced capacity as a restaurant-special events facility only. In this instance, the revenue from the two year time period is used to provide the benchmark for the ‘but-for’ and full contract performance profits.

Business lost profits in a breach of contract termination case

Background

In this case, the plaintiff, who was a owner of several outside music venues in the Dallas,Texas area, signed a eight year lease with the defendant for a 5 acre premise which included a restaurant. Upon signing the lease the plaintiff, built a large performance stage for outside music performances. The venue opening received a significant amount of press and the revenues exceeded its’ initial earnings projections.

After four months of operation, the City informed the owners that the premise was not zoned for the music venue and would need to be rezoned. The landowner initially agreed to assist the plaintiff in the obtaining the necessary permits and the rezoning application. The plaintiff undertook the necessary steps, such as building more parking, improving traffic flow, and improving water drainage around the premise to obtain the necessary permits and to have the property rezoned.

The final stage of the re-zoning required a property easement, or a right-a-way agreement, by the landowner to the City. At the final stage, the landlord reversed course and stated that they would not grant the easement to the City and ultimately could not support the rezoning efforts. The plaintiff ultimately were not able to offer live music at the facility. After several months of non-payment of rent in protest of the alleged contract breach by the landowner, a local court allowed the plaintiff to be evicted from the premise and the music venue closed.

Legal Issues

In this case the plaintiff is suing their landlord for breach of contract. The plaintiff alleges that the defendant landlord misrepresented the terms of the contract, specifically regarding how the property that they were leasing could be used. At the heart of the issue, the plaintiff alleges that the defendant represented that they would be able to operate a live music venue restaurant from the location. The plaintiff alleges that the defendant’s failure to support the permitting and rezoning efforts constituted a breach of contract.

See the next post for an analysis of the business damages…

Employer Labor Hoarding Part I:What is it?

Labor hoarding is a concept where employers hold onto workers during economic down times even though they don’t necessarily need them. The idea is that the cost of retraining employees is sufficiently high that it is more cost-effective for employers to retain employees even though they are under utilized.

Initially the concept of labor hoarding was used to explain an apparent contradiction in the economic literature.

The economic contradiction was that during economic expansions employers would not necessarily hire more people. Also it was observed that employers were not necessarily releasing employees when downturns occurred.

This observation also led to a apparent contradiction in the labor economic literature.

According to labor economic literature the average productivity of labor should increase during slowdowns and recessions. The fall of average productivity theoretically, would occur because firms would reduce their labor force during recessions and employees essentially would do more with less during economic contractions.

So for example, delivery workers would be assigned to additional routes during a contraction and instead of having two people cover two routes, the routes would be consolidated so that only one person would be needed.

Since the production level is the same (or least falling at a slower rate than the decline in workers) and the number of workers declines, the average productivity of labor would increase. Alternatively the marginal productivity of labor would increase since fewer workers are needed. (Recall, that there is a inverse relationship between the marginal productivity of labor and the number of workers.)

So what does the current economic literature say about labor hoarding?