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FOR RELEASE ON DELIVERY A Lo n g -Run St r a t e g y for Mu t u a l Sa v i n g s Ba n k s Re m a r k s of DAVID P. EASTBURN Pr e s i d e n t Fe d e r a l Re s e r v e & nk of Ph i l a d e l p h i a At t h e 56t h An n u a l Co n f e r e n c e of THE Na t i o n a l A s s o c i a t i o n of Mu t u a l Sa v i n g s Ba n k s Ph i l a d e l p h i a Ma r r i o t t Ph i l a d e l p h i a ., Pe n n s y l v a n i a Ma y 18, 1976 A Lo n g -run St r a t e g y for Mu t u a l Sa v i n g s Ba n k s Now IS A TIME FOR MUTUAL SAVINGS BANKERS TO CONSIDER THEIR LONG-RUN STRATEGY. THE DEMISE OF THE FINANCIAL REFORM ACT HAS SPOILED SHORT-RUN CHANCES FOR A MAJOR BREAKTHROUGH FOR THE THRIFTS. W ill o p p o r t u n i t y k n o c k a g a i n ? Ho w s h o u l d s a v i n g s b a n k e r s r e s p o n d ? T h e s e , o b v i o u s l y , a r e q u e s t i o n s you w i l l ha ve to a n s w e r for YOURSELVES, AND PERHAPS IT IS GRATUITOUS FOR ME TO OFFER COMMENTS ON A MATTER THAT IS SO CLEARLY YOUR OWN BUSINESS. BUT THE FINANCIAL COMMUNITY AND, INDEED, THE WHOLE ECONOMY HAVE A GOOD DEAL AT STAKE IN WHAT YOU MAY DO. INTEREST THAT future. So IT IS FROM THIS STANDPOINT OF THE PUBLIC I'D LIKE TO OFFER A FEW THOUGHTS ABOUT YOUR LONG-RUN F i r s t , a w o r d a b o u t b r o a d e r p o w e r s for t h r i f t s ; s e c o n d , IMPLICATIONS OF BROADER POWERS FOR GROWTH; THIRD, IMPLICATIONS FOR HOUSING; AND FOURTH, THE IMPORTANCE OF PRICING IN HANDLING CHECKING ACCOUNTS. Po w e r to t h e t h r i f t s I HAVE A STRONG BELIEF THAT YOUR CURRENT FRUSTRATION IS ONLY ONE CHAPTER IN A LONG STORY ABOUT THE HISTORY OF FINANCIAL INSTITU TIONS. will T hi s s t o r y t e l l s m e t h a t c e r t a i n p r e s s u r e s — in t h e l o n g -r u n - HAVE INEVITABLE RESULTS. Co m p e t i t i o n has a w a y of d o i n g a w a y w i t h a r t i f i c i a l m a n -m a d e BARRIERS. We HAVE SEEN THIS CLEARLY IN AGRICULTURE. THE INGENUITY OF BUREAUCRATS TO PRESERVE THE SMALL FARM HAS BEEN WONDERFUL TO BEHOLD: PARITY, SUBSIDY, OUTPUT RESTRICTION— YOU NAME IT. I'M NOT PASSING JUDGMENT ON THE SMALL FAMILY FARM AS A WAY OF AMERICAN LIFE, BUT THE FACT IS THAT SOMEHOW THE FORCES OF COMPETITION INEVITABLY HAVE OVERRIDDEN OR WORKED UNDER AND AROUND ALL THESE DEVICES. In t h e w o r l d of f i n a n c e n u m e r o u s ki nds of s p e c i a l i z e d INSTITUTIONS HAVE SPRUNG UP OVER TIME IN RESPONSE TO NEEDS EX PRESSED by s o c i e t y . Mu t u a l s a v i n g s b a n k s w e r e o n e of t h e f i r s t . As THESE NEEDS HAVE MULTIPLIED AND THE KINDS OF INSTITUTIONS HAVE PROLIFERATED, HOWEVER, YOU— AS WELL AS MANY OTHERS— HAVE ASKED QUESTIONS ABOUT THE VIABILITY OF THIS KIND OF FINANCIAL STRUCTURE. HOW TO SEAL OFF INTO SELF-CONTAINED CELLS CERTAIN KINDS OF ACTIVITIES FOR CERTAIN KINDS OF INSTITUTIONS? EXPERIENCE SHOWS THIS IS VERY HARD TO DO BECAUSE HUMAN INGENUITY IS JUST TOO GREAT. YOU CAN ALWAYS FIND NEW WAYS TO CIRCUMVENT (I HAVE DIFFICULTY FINDING A VERB WITHOUT SOME OVERTONE OF MORALITY, ALTHOUGH NONE IS INTENDED) ARTIFICIAL RESTRAINTS TO COMPETITION. NOW ACCOUNTS ARE THE BEST CURRENT EXAMPLE. IN SHORT, I HAVE GREAT FAITH IN COMPETITION AS A LEVELLER OF barriers. Pe r h a p s you a r e n o t in a m o o d to be p a t i e n t , b u t I b e l i e v e THE LONG-RUN IS IN YOUR FAVOR. THE LONG-RUN WILL SERVE YOUR PURPOSES AND YOU SHOULD NOW BE FORMING YOUR STRATEGY WITH THAT IN VIEW. It WILL ALSO SERVE THE PURPOSES OF SOCIETY BECAUSE MORE COMPETITION USUALLY DOES BRING THE BENEFITS OF BETTER AND CHEAPER SERVICE. I SUSPECT YOU WILL NOT BE CONTENT TO LET THE LONG-RUN COME ABOUT ON ITS OWN; YOU WILL WANT TO HELP IT ALONG. THE ECONOMIST IN ME TELLS ME THAT YOU ARE WORKING IN THE RIGHT DIRECTION. Im p l i c a t i o n s of b r o a d e r p o w e r s for g r o w t h Co n s i d e r , for a m o m e n t , t h e e x p e r i e n c e of c o m m e r c i a l b a n k s DURING THE LAST DECADE. FROM MID~1960 THROUGH 1973 WAS A PERIOD OF GREAT EXPANSION OPPORTUNITY FOR BANKS. LIABILITY MANAGEMENT TECHNIQUES WERE DISCOVERED AND REFINED TO THE POINT WHERE BANKERS WERE SURE THEY COULD MEET ANY NEED FOR FUNDS BY BUYING MONEY. Ba n k s e x p a n d e d l o a n s , s h a v e d p r o f i t m a r g i n s , a n d i n c r e a s e d l e v e r a g e . Ba n k h o l d i n g c o m p a n i e s b r a n c h e d o u t into m o r t g a g e b a n k i n g , REITS, LEASING, CONSUMER LOAN COMPANIES AND MANY MORE BUSINESSES. It WAS A PERIOD OF HEADY GROWTH. By h i n d s i g h t , we find that these growth op portunities were NOT ALWAYS USED WISELY. THERE WAS A SIGNIFICANT INCREASE IN THE RISK EXPOSURE OF MANY COMMERCIAL BANKS. PROFIT MARGINS DECLINED, LEVERAGE GREW, AND CAPITAL POSITIONS BECAME NOTICEABLY WEAKER. THE RECESSION OF 1974-75 BURST THIS FRAGILE BUBBLE AND CREATED SOME VERY SEVERE PROBLEMS FOR BANKS THAT HAD OVEREXPANDED. THE PROBLEMS EXPERIENCED BY THOSE INSTITUTIONS INDIRECTLY WEAKENED THE ENTIRE system. Ba n k e r s a r e n o w n a r r o w i n g t h e i r s i g h t s , r e s t r i c t i n g g r o w t h OBJECTIVES, AND TRYING TO REESTABLISH PROFIT MARGINS AT LEVELS WHICH WILL ENHANCE THE FINANCIAL STRENGTH OF THEIR INDUSTRY. W hen y o u g e t b r o a d e r p o w e r s , you m a y c o n f r o n t a p e r i o d of SIMILAR GROWTH POTENTIAL. NEW SOURCES OF FUNDS AND NEW INVESTMENT OPTIONS MAY PRESENT YOU WITH ENTICING EXPANSION OPPORTUNITIES. Yo u r s u c c e s s in t h e l o n g -run m a y d e p e n d on ho w w e l l y o u have LEARNED FROM THE COSTLY MISTAKES OF THOSE BANKS WHICH WERE PRE OCCUPIED WITH GROWTH. YOU HAVE DEVELOPED GREAT SKILL AND A SUB STANTIAL COMPARATIVE ADVANTAGE IN MORTGAGE LENDING. As YOU MOVE AWAY FROM THIS FAMILIAR GROUND, IT WILL BE IMPORTANT TO KEEP EXPOSURE MANAGEABLE UNTIL YOU ARE SURE YOU APPRECIATE ALL THE NUANCES OF THESE INVESTMENTS THAT CREATE CREDIT RISKS. Im p l i c a t i o n s for h o u s i n g Mu t u a l s a v i n g s b a n k s w e r e f o u n d e d to e n c o u r a g e s a v i n g s an d TO FINANCE HOUSING. WHETHER OR NOT SUBSIDIZING HOUSING THROUGH THE THRIFT INSTITUTIONS IS A SENSIBLE AND EFFICIENT WAY TO ENCOURAGE HOME CONSTRUCTION IS SOMETHING ELSE AGAIN, BUT THAT SUBSIDY OBJEC TIVE IS CLEARLY IN THE MINDS OF LEGISLATORS WHEN THEY LOOK AT MUTUALS. It helps to explain Re g u l a t i o n Q ceilings, t a x d e d u c t i o n s to b u i l d LARGE LOAN RESERVES, AND LIMITS ON ASSET DIVERSIFICATION. WHEN Co n g r e s s f i n a l l y d o e s b r o a d e n y o u r p o w e r s , I h o p e it w i l l f o l l o w THE PRINCIPLE THAT EQUAL POWERS CARRY WITH THEM EQUAL RESPONSIBILITIES. If it c o n t a i n s s o m e p r e f e r e n t i a l t r e a t m e n t in t e r m s of interest rates PAID BY SAVINGS BANKS, IT WILL BE DOING SO WITH AN EYE TO PROMOTING HOUSING. And if t h i s is t h e w a y e v e n t s , in f a c t , t u r n o u t , you can use THE RIGHT TO INVEST IN A BROADER RANGE OF ASSETS IN EITHER OF TWO WAYS. One IS BY REDUCING MONEY FROM FINANCING MORTGAGES AND PUTTING IT INTO OTHER KINDS OF ASSETS. ANOTHER IS BY ALLOCATING SOME OF YOUR MEM. MONEY TO A PROGRAM OF BROADENING THE ASSET PORTFOLIO. The d i s t i n c t i o n is i m p o r t a n t b e c a u s e d i v e r s i f i c a t i o n a t the EXPENSE OF HOUSING MAY BE TREATED AS A BREACH OF FAITH BY THE COMMUNITY AND BY LAWMAKERS. If YOU REALLOCATE A SUBSTANTIAL PROPORTION OF FUNDS FROM HOUSING TO OTHER ASSETS, YOU COULD FIND YOURSELF WITH MORE RESTRICTIONS ON INVESTMENTS LATER. T his is s i m p l y a s u g g e s t i o n t h a t in y o u r l o n g -run s t r a t e g y YOU MAKE AMPLE ALLOWANCE FOR WHAT MANY CONSIDER TO BE YOUR SOCIAL RESPONSIBILITY TO HOUSING, ANY LONG-TERM PROFIT ANALYSIS MUST INCLUDE THE COSTS OF UNDERMINING THE PRIMARY RATIONALE FOR GRANTING THRIFTS SOME COMPETITIVE PREFERENCES AS AN OFFSET TO THE POTENTIAL SHORT-RUN BENEFITS OF IMPROVING YIELDS AND SPREADING RISKS. Pricing B r o a d e n e d p o w e r p o s e s a n o t h e r p r o b l e m for y o u r l o n g -run STRATEGY: THE PRICING OF YOUR SERVICES. COMPETITION AMONG THRIFTS AND COMMERCIAL BANKS COULD BE VERY STRONG, It COULD EVEN FORCE INEFFICIENTLY MANAGED INSTITUTIONS— BOTH MUTUALS AND COMMERCIAL BANKS— OUT OF BUSINESS OR INTO MERGERS WITH STRONGER ORGANIZATIONS. W h a t 's m o r e , c u t t h r o a t c o m p e t i t i o n b e t w e e n c o m m e r c i a l b a n k s an d THRIFTS COULD WEAKEN THE ENTIRE FINANCIAL SYSTEM. SOME COMMERCIAL BANKS WILL NOT BE WELL EQUIPPED TO ENGAGE IN PRICE COMPETITION WITH THRIFTS FOR CHECKING ACCOUNT CUSTOMERS. YET, IT IS HARD TO IMAGINE COMMERCIAL BANKS BEING PASSIVE ABOUT PRICE OR ADVERTISING COMPETITION WHICH THREATENS A LOSS OF CHECKING ACCOUNTS TO THRIFTS. THAT BUSINESS IS TOO BASIC TO THEIR INDUSTRY FOR THEM TO GIVE IT UP WITHOUT A FIGHT. T he p i v o t a l d e c i s i o n in t h i s c o m p e t i t i v e s t r u g g l e w i l l PROBABLY BE THE PRICING OF CHECKING ACCOUNT SERVICES. THIS DECISION WILL DETERMINE HOW FAST YOUR DEPOSITS GROW, WHAT KIND OF MINIMUM RETURN YOU WILL NEED ON YOUR ASSETS, AND HOW PROFITABLE AND SOUND YOUR BANK WILL BE. FOR SETTING THIS PRICE. ONCE AGAIN THERE ARE TWO OPTIONS ONE IS "LOSS-LEADER PRICING." UNDER THIS STRATEGY THE PRICE WOULD BE SET BELOW THE COST OF PROVIDING THE SERVICE, SINCE THIS CREATES OPERATING LOSSES, SUCH AGGRESSIVE PRICING COULD NOT BE SUSTAINED FOR AN EXTENDED PERIOD, BUT IT WOULD ATTRACT A LARGE VOLUME OF BUSINESS RAPIDLY. A SECOND STRATEGY IS ONE OF "FULL-COST PRICING." In THIS INSTANCE THE PRICE SET WOULD BE ONE WHICH COVERS ALL OF THE COSTS OF PROVIDING CUSTOMERS WITH THE SERVICE AND INCLUDES A PROFIT MARGIN SUFFICIENT TO BUILD SURPLUS ACCOUNTS AT THE RATE YOUR INSTITUTION'S DEPOSIT BASE IS GROWING. THIS PRICE IS ONE THAT CAN BE SUSTAINED OVER A LONG PERIOD BECAUSE IT DOES NOT PRODUCE LOSSES WHICH UNDERMINE YOUR FINANCIAL STRENGTH. DEPOSIT GROWTH IS LIKELY TO BE MUCH SLOWER UNDER THIS STRATEGY, AND COMPETITION WITH COMMERCIAL BANKS IS LIKELY TO BE LESS INTENSE. I PREFER THE LATTER STRATEGY BECAUSE ITS LONG-RUN BENEFITS TO THE INDUSTRY EXCEED THE SHORT-RUN BONANZA IT PRODUCES FOR CONSUMERS. It would create a more stable banking environment, PRESERVING THE FINANCIAL SOUNDNESS OF INSTITUTIONS WHICH ARE EFFICIENT ENOUGH TO COMPETE AND AVOIDING THE PROBLEMS OF INTRO DUCING CONSUMERS TO A PRICING STRUCTURE WHICH CANNOT BE MAINTAINED. A RECENT STUDY BY DAVID CATES AND SAM CHASE FOR THE SOUTH CAROLINA Ba n k e r s A s s o c i a t i o n i n d i c a t e s t h a t fr ee c h e c k i n g has t h e p o t e n t i a l FOR BEING VERY UNPROFITABLE, ESPECIALLY FOR BANKS WITH LARGE NUMBERS OF SMALL ACCOUNTS. THESE RESULTS EMPHASIZE THE IMPORTANCE FOR MANAGERS OF HAVING RELIABLE ESTIMATES OF ALL THE COSTS ASSOCIATED WITH PROVIDING THIS SERVICE BEFORE THEY SET A PRICING POLICY THAT COMPETITIVE PRESSURES MAY FORCE THEM TO USE FOR AN EXTENDED PERIOD. The d i f f i c u l t y o f t h i s p r o b l e m a n d th e c h a n c e s for s e r i o u s er ror ARE EVEN HIGHER IF PAYMENT OF INTEREST ON THIRD-PARTY PAYMENT ACCOUNTS BECOMES LEGAL EVERYWHERE. St i l l a n o t h e r r e a s o n for a d o p t i n g a c o n s e r v a t i v e p o s t u r e is THAT YOU WILL HAVE TO REINVEST THE FUNDS PROFITABLY. ANY OF YOU SHOULD BE ABLE TO FIND GOOD USES FOR A FEW MORE DOLLARS AT ALMOST ANY TIME. B ut w h a t w o u l d you do w i t h t h e m o n e y if y o u r d e p o s i t b a s e WERE TO INCREASE BY 10 OR 15 PERCENT IN A FEW MONTHS? COULD ALL THOSE FUNDS BE PUT TO WORK AT ATTRACTIVE YIELDS OR WOULD THERE HAVE TO BE COMPROMISES ON EITHER YIELDS OR QUALITY IN THE PORTFOLIO? Su c h c o m p r o m i s e s m i g h t j u s t be e n o u g h to m a k e w h a t s e e m to be ATTRACTIVE FUNDS SUDDENLY UNPROFITABLE. Co n c l u s i o n s So m e of w h a t I've j u s t s a i d m a y s e e m i n c o n s i s t e n t w i t h th e STRONG POSITION IN FAVOR OF COMPETITION WHICH I EXPRESSED AT THE OUTSET. Let me r e a f f i r m t h a t o v e r th e lo ng h a u l , v i g o r o u s c o m petition AMONG BUSINESSMEN WHO ARE TRYING TO MAXIMIZE THEIR FIRMS' LONG-TERM EARNINGS WILL CREATE THE INCENTIVES FOR EFFICIENCY AND INNOVATION THAT SERVE SOCIETY'S BEST INTERESTS. THE KEY TO ACHIEVING THIS COMPETITIVE IDEAL IS FOR YOU TO KEEP THE LONG-TERM IMPLICATIONS OF YOUR DECISIONS FIRMLY IN MIND. IF, IN AN EFFORT TO GAIN SHORT-RUN ADVANTAGE, YOU SACRIFICE YOUR LONG-TERM GOALS, SOCIETY'S INTERESTS WILL BE COMPROMISED AND THE STAGE WILL BE SET FOR ADDITIONAL REGULATION OR LEGISLATION. In summary, I leave yo u w i t h t h e s e t h o u g h t s . Lo n g -run f o r c e s ARE WORKING IN THE DIRECTION OF EXPANDED POWERS FOR THRIFTS. WHEN YOU GET THESE POWERS, KEEP IN MIND THE PROBLEMS OF THOSE COMMERCIAL BANKS WHICH OPTED FOR RAPID EXPANSION STRATEGIES RATHER THAN PROFITS WHICH COULD BE SUSTAINED OVER THE LONG-RUN. REMEMBER ALSO THAT THE RATE PREFERENCES YOU ENJOY ARE PREDICATED ON SERVING THE COUNTRY'S NEEDS FOR MORTGAGE FUNDS. CAREFULLY. FINALLY, DO YOUR COST ACCOUNTING HOMEWORK YOUR PRICING DECISIONS WILL HAVE AN ENORMOUS IMPACT ON YOUR OWN PROFITABILITY AND THE SOUNDNESS OF BOTH THE THRIFT AND COMMERCIAL BANKING INDUSTRIES. THIS KIND OF LONG-RUN STRATEGY WILL SIMULTANEOUSLY SERVE YOUR CUSTOMERS, YOUR INDUSTRY, AND SOCIETY.
@FedFRASER