You Can't Tell the Players With a Scorecard
Wriston, Walter B.
Thank you, Ed O'Brien.
It's a pleasure for me to be here today, and to have the chance to discuss definitions with such an objective and dispassionate group of experts in the financial services business.
In this world of full disclosure, annual reports are getting more and more revealing--even though one man in Florida can wipe out more individual savings with a few phone calls than all the disclosure in the world can save. Nevertheless, annual reports have their uses, and I read a few with the thought of learning about the financial services business. This is what I learned:
Company A is a major lender to both businesses and individuals. In 1979, they bought a large "industrial loan company," which offers commercial and residential real estate loans, equipment leasing, and passbook thrift accounts. They also formed "a joint venture corporation in Japan to offer selected consumer loan services." Their normal, everyday financial activities include writing insurance policies and the financing of everything from furniture to pianos, cars, other companies, aircraft, computers, telecommunications and medical equipment.
Company B also makes loans and takes deposits. It holds shares in a number of financial institutions and widely diverse business concerns. Its 1979 annual report states that "new closed-end property funds met with strong interest among customers.... In June, the building of the First National Bank of Atlanta was purchased for one closed-end property fund."
Company C owns "the seventh-largest publicly held savings and loan holding company" in the United States. They, too, take deposits, make loans, give mortgages and engage in the real estate development business. They are looking, the company states in its annual report, for "further possible ventures into related (financial) fields."
Company D serves "eight out of ten families in the U.S. every year." They take deposits and do commercial and consumer financing, mortgages and insurance. But that's not all they do. Company D retails its merchandise in over a thousand stores and in over 35-hundred franchised outlets. They sell shirts, ties, suits, dresses, blouses, coats, apples, oranges, milk, meat, hammers, power saws, and nails. They manufacture industrial and consumer products. They have a controlling interest in an airline, and run "one of the largest car rental companies in the world."
To broaden its range of services, Company E recently applied for and got a state bank charter. It now operates a full-service bank, which like any other bank, manages pooled accounts for pension plans. This gives them the opportunity to go after a $255 billion market in employee benefit plans.
Company F, like the others I've described, is in the financial services business. It "provides a full line of banking and investment banking services." In its annual report, Company F states that it is the country's "leading corporate investment banker." In October 1979, they "handled 67 percent of U.S. corporate financings." And they're not resting on their laurels either: "We expect that our company," their annual report states, "will be even more innovative and reach new heights in the financial services industry in the 1980s."
The annual reports I have been quoting were issued by a bank, a manufacturer, a brokerage house, a mutual fund, a finance company, and a steel corporation. Are their businesses clearly distinguishable, as the government and some sectors of our competition maintain? It is hard to tell them apart, even with a scorecard.
Company A, which finances everything from furniture to medical equipment, is General Electric.
Company B, with its closed-end property funds, is the Deutsche Bank--the largest financial institution in Germany and one of the ten largest in the world. Over three percent of its assets are in stock valued at today's prices. No American bank can offer the Deutsche Bank's range of services.
Company C, looking for more financial acquisitions, is the National Steel Corporation.
Company D, which sells shirts and suits, apples and oranges, hammers and nails, is Household Finance Corporation. Its financial operations contributed only 47 percent to its 1979 earnings. The other 53 percent came from merchandising, manufacturing and transportation. Commerce and banking seem to work well together in this company.
Company E, with its eye on the pension plan market, is the Fidelity Group. They and a half-dozen other mutual funds companies now own banks. It seems that, while we are all supposed to be equal before the law, in reality some animals are more equal than others. A bank, the Supreme Court ruled, can't own a mutual fund. But as we've seen, mutual funds can and do own banks.
Company F, which is not resting on its laurels, is Merrill Lynch. The heights they've already reached so impressed the that it headlined a story, "Merrill Lynch and Company, Bankers." The lead sentence nailed down the point precisely: "It sponsors a major credit card, holds billions of dollars in accounts subject to demand checking, and generates two-thirds of its profits from interest."
In the 1960s, Merrill Lynch didn't even sell mutual funds. Now, less than 30 percent of their income derives from commissions on listed stocks. The rest of their revenue cones from such diverse sources as option trading, investment banking, insurance sales, money-market funds, government bond trading, interest income and real estate sales--sales made by Merrill Lynch's own force of 4,000 realtors--and still growing--who operate throughout the country.
As some of you may remember, I have frequently applauded Merrill Lynch for offering the public, right now, the financial services of the bank of the future. Merrill Lynch accurately reflects the financial world as it really is, and offers a package of services that no U.S. bank can match.
The reason it is so hard to tell the players, even with a scorecard, is that yesterday's image of a financial services business bears little relationship to today's reality.
The actual events of the financial world are confused with the image of what used to be. The image is that banks are places to deposit money and get loans; that brokerage firms are places where securities are bought, sold and distributed, that thrifts are places to maintain savings and obtain mortgages. Yet the reality of the actual events taking place is that computers, satellites, electronic funds transfer mechanisms, micro-circuitry and high-speed optical telephone lines are eliminating the constraints of time, geography and volume in financial transactions. A man in Texas takes his money out of a savings and loan, calls a toll-free telephone number in Arizona, and his money ends up in a money-market fund in Boston--or anywhere else on the globe.
The financial marketplace today is everywhere, any time. The parties to the transactions could be anyone with the ability to punch in the right numbers anywhere. Financial transactions are now being performed in living rooms via cable TV or through a terminal in a corporate treasurer's office. What will be the value of a seat on the New York Stock Exchange or a brick-and-mortar bank branch in an environment where every home has access to the Dow Jones and its bank accounts instantaneously? In this kind of world, electrons have become money, credit, securities or savings, and are more real than places.
The new technology has created an economic and financial world where low-cost financial transactions can and do take place every moment on a worldwide basis. The advent of electronic funds transfer and storage is as important to the financial system today as was the substitution of paper money for bullion. And it has created just as big a revolution.
For the securities industry, it means handling trading days of at least 150 million shares, moving ahead on a national market system, and the ability to place investment dollars of a growing number of U.S. investors in any foreign securities market. And it has meant money-market funds.
People down on the farm are withdrawing their money from savings accounts and buying money-market funds. These funds have done away with isolated pools of liquidity, since they invest not only in Treasury and U.S. Government agency securities, but also in large negotiable certificates of deposit, repurchase agreements, bankers acceptances, commercial paper, and Eurodollar certificates of deposit. Deposits are crossing state lines and international boundaries, and ending up in other banks whether McFadden likes it or not.
Money-market funds--essentially high-interest bank accounts for small savers--are the unique offspring of the marriage between Regulation Q and the toll-free telephone, with inflation and technology serving as matchmakers. In January and February of 1980, money-market fund assets grew at the rate of almost $8 billion a month, and in May of that year by over $9 billion. By way of contrast, it took Citibank 114 years to accumulate $1 billion in deposits.
This is what is happening in the real world. But in the "Alice-in-Wonderland" world of Glass-Steagall, McFadden, the Douglas Amendment, Reg Q and protected special interests, we still need ten messenger boys to get the money across the street--one messenger boy for mortgages, another for stocks, another for installment loans, and so on. We can send money around the world faster--in fact, at the speed of light--and have it enter through the back door--and indeed all the companies whose annual reports I referred to are doing just that--before the fastest messenger boy even steps into the street.
While the public tries to get the best financial deal it can--as it should--we have the sorry spectacle of bankers, insurance agents, securities dealers and data-processing firms going to Washington or into court to protect what Adam Smith called, "their own absurd and oppressive monopolies."
In the recent issue of , William Tucker comments that "the advocate of an unhindered free market is about as popular as the umpire at a baseball game." Surely this could not be true on Wall Street as Wall Street is seen, by friend and foe alike, as the bastion of the free enterprise system. But the cause of free enterprise is hurt, and Wall Street's credibility declines, when brokers testify before Congress that banks shouldn't underwrite revenue bonds, when banks testify against Merrill Lynch's Cash Management Account, when savings banks testify in defense of Regulation Q, and when data-processing trade associations sue the banks on behalf of such small, defenseless member companies as I.B.M. and G.E. to prevent banks from using their own computers. Every time one of us tries to tighten the chains around someone else, he insures that government will eventually do the same to him. It is a losing game for everyone.
Revenue bonds are a case in point. They barely existed in the 1930s, and, in fact, the Glass-Steagall Act never mentioned them. Today, however, they account for more than 70 percent of all long-term funds raised by state and local governments. General obligation bonds, which banks are permitted to underwrite, typically sell at prices lower than revenue bonds, and the reason is obvious--more people are scrambling for the same business. When banks are kept out of the revenue bond market, the public is hurt since borrowing costs for local governments are higher. And those who aspire to keep them out are hurting the entire investment community by joining the enemies of free enterprise.
The landmark date of 1984 is only a few years away, and the choice facing us becomes clearer every day: either free men and women working in free markets or Big Brother regulating everything. In Orwell's world of Big Brother and "doublethink," Jefferson's Declaration of Independence becomes "a panegyric on absolute government," and doublethink is "the power of holding two contradictory beliefs in one's mind simultaneously, and accepting both of them."
Too many of us, unfortunately, practice doublethink. We defend free markets in public, but in our own offices and before government agencies we do our damnedest to create protected industries. This damages not only the fabric of the whole business community, but inevitably leads to the loss of freedom. It may be obvious, but it needs repeating: Protected markets are the exact opposite of free markets.
The philosophy of the divine right of kings died hundreds of years ago, but not, it seems, the divine right of inherited markets. Some people still believe there's a "divine" dispensation that their markets are theirs--and no one else's--now and forevermore. It is an old dream that dies hard, yet no businessman in a free society can control a market when the customers decide to go somewhere else. All the king's horses and all the king's men are helpless in the face of a better product.
Our commercial history is filled with examples of companies which failed to change with a changing world, and became tombstones in the corporate graveyard.
Investors in canal bonds in the nineteenth century who refused to invest in railroad bonds reflect the kind of vision I'm talking about. Besides saying the usual things--"There're too many moving parts," "I'll wait until all the technical problems are solved," "It'll always be too expensive to catch on"--some came up with an answer they thought irrefutable. "Railroads rust," they said. "But what can happen to a canal?"
The railroads themselves, with the help of the government, fell victim to the same delusion of protected markets and did not recognize new forms of competition. Though many of them received federal land grants to expand their rail networks, they shed bitter tears when government engineers dredged canals to help the barge lines. Some of them failed to realize that they were in the transportation business, and that steel rails were only a means to an end. Railroads continued to act and be seen by regulators as a monopoly long after the tracks had rusted, and the buses, cars and trucks were whizzing down four-lane highways and freeways, with jumbo jets flying overhead.
Peter Drucker points to another example, that of printing-press manufacturers who paid no attention to the new processes for office reproduction that came on the market after World War Two. One manufacturer, offered several of these processes by the inventors, turned them down; the systems were not "printing," he said, and the equipment wasn't being sold to "printers." The industry finally realized they faced a serious and powerful competitor, but only when they began to lose substantial business. They discovered that former customers were doing their own printing, with their own office reproduction equipment, and really did not care about nomenclature.
Too many companies, when faced with the losing verdict of the marketplace, have run to the government for help. Adam Smith wrote about them in 1776. "The cruellest of our revenue laws," he said, "are mild and gentle, in comparison of some of those which the clamor of our merchants and manufacturers has extorted from the legislature, for the support of their own absurd and oppressive monopolies." It is fair to say that the financial services business is not immune from this ancient practice. The Congressional Record is full of such pleas and they are all based on a fallacy which in the end is always exposed.
The false dream of mankind is the belief that we can somehow control others while remaining free ourselves. Half slave-half free didn't work in this country, and in any equitable system of government or justice, neither will the belief that only competitors should be regulated while we can do whatever we want. Protective regulation, once let loose, can and will strike all of us. George Shultz has written about the comparative advantage of government and of the free market. He has pointed out that government has to pay attention to equity and he puts it very strongly: "...fairness demands attention to equity of opportunity."
It is for this reason that unequal laws are a transient phenomenon, as by its nature government has to strive for equity.
Modern parlance talks about level playing fields. The poet John Donne wrote, "Never send to know for whom the bell tolls. It tolls for thee." It tolled for banks when the Monetary Control Act of 1980 gave the Federal Reserve vast new powers over the whole banking industry. It tolled for money market funds last year when President Carter invoked the Credit Control Act to impose reserve requirements on them. It tolled for Merrill Lynch when the Oregon attorney general ruled that their Cash Management Account was unlicensed banking and barred it from the state.
The public doesn't really care about our internecine problems. What the public wants and is entitled to is a fair return on its money. If we can't serve them, they will--and should--go elsewhere. And neither we nor the government has any right to stop them.
It's time we realized there's no social security for companies in the world marketplace, no seniority rights, no disability pensions. It's time we recognized the fact that the computer and the electronic revolution have created a new marketplace. The noted mathematician John von Neumann has seen this with great clarity and has written that electronics has overturned traditional concepts of time and geography, and consequently, traditional ways of doing business. It's time we recognized that we're all in the same business--financial services--and get on with the business of competing on equal terms for the public's dollar. At the end of the day, the public must be served in the most cost-effective way, so that he or she can make the best deal. I don't believe the public cares about market-segmentation problems. But I do believe they watch and listen to what we say in Wall Street about free enterprise, and they do judge whether our actions match our words. The children of our customers who entered college this past September will graduate in 1984. It is up to us to determine if free markets or doublethink will be the theme of their graduation address.