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Remarks by Robert P. Mayo President, Federal Reserve Bank of Chicago 23rd Annual Fall Management .Conference Northwestern University Evanston, Illi.nois November 7, 1973 The Chicago Financial Environment Chicago is one of the great and exciting cities of the world. It is a city whose citizens cannot help but feel its throbbing pulse and whose visitors typically speak enthusiastically about its i mpressive economic vitality. The rebirth of our city's heart a'1cl the tremendous expansion of its outlying manutacturing, servi'ce industries, shopping centers, and resi<lential activitJ~ provide much of ·the stimulus. And we have . outstanding art, opera, and one of the world's great symphonies. Our universities are nnexcelled. So are our parks. All of this is a base of justifiable civic and regional pride-- an environment in which . 1 dU.U .::1 ~i..Luug f_j_ua.uc.ic.1.l structure can and do flourish. Anyone who has endeavored to analyz.e something as complex as a financial environment knows it is hard to get ahold of. We all have some notion of what we mean by the term financial environment. Yet precise definition is something that is difficult to achieve. And depending on your vantage point the characteristics considered to make one financial environment 12 better" than another may vary widely. Embodied in the concept of a fin ancial environment are at least two distinct elements. The first is the capability o f the fin ancial cormnunity to satisfy local individual and busines s needs. And the second is whether the financial comm.un ity can appropri ately b e called a financial center. The first element concerns the pro duction of financial service for local consumption; the second the production of financial· service for export. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -2- Any city with a large population and conmensurate commercial and industri al activity will provide a sizable financial service base. Geographical convenience alone brings this about. But the ' simple fact that there is a concentration of users of financial services does not insure that all the financial demands of individuals and businesses will or can be satisfied locally or that _production of financial services for export to any si gnificant extent will take place. On the West Coast, for example, Los Angeles is a much lqrger city than San Francisco in terms of population; yet San Francisco is generally considered the greater financial center of the two . In the Southwest, Dallas is generally consid ered the finan- cial center although Houston is laq~er. As I have been alludin8 to, the essence of a financial center can be summarized under the two terms "specialization" and ''production for export . " So, it is clear that Chicago's prominence as a manufac- turing and transportation center assured the development of financial activities on a large absolute ·scale. Indeed, as in the case of New York--or in the earlier case of London--Chicago's industrial and commercial development has been functionally related to its development as a financial center. But beyond this, Chicago does indeed visibly specialize in financial services in the sense of produ cing them in a volume greater than pro portional to local needs and exporting them over an area much broader than its mm geographical limits. Such concentrations in the production of financial services as do arise result from the interplay of many factors, most of wh ich are subsumed under the well-knovm economic categories of "economies or scale" and "external economies . " https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Economies of scale generally re fers -3- to the ability of larger size firms to produce at lower ·average costs, while external economies refers to the benefits accruing to firms because they are located in a geographically compact area. While I in- tend no full-blpwn discussion .of these principles, it does seem worthwhile pointing out that such economies do appear to exist in the production of financial services. These economies favor large cities and further suggest why Chicago is a strong financial center. Ideally, it would be helpful to have comp l ete Chicago data bearing directly on the degree to which Chicago is a financial center as measured by the criteria mertt ioned already: degree of specialization in production of financial servi~es, as measured possibly by the percentage of employmen t, value . added, or output associated with financial industries relative to all economic activity and production for export. Unfortunately such specific data are not readily available, although some employment data by rnajor industry and geographic location can be obtained. I want to start out, therefore, by taking a broad , qualitative overview of the institutions and. financial activity that hi ghlight Chicago 's present stature as the financial center of the Hidwest , its stature as the second largest financial center in the country--indeed, its stature as one of the reost important financial centers in the entire worl d. There are several types of financial activity in which Chicago occupies a position of undisputed dominan ce. Chicago as a leading financial center . They clearly help rank No sophisticated analysis of th e data is required to demonst rat e Chicago's preeminence , for example, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -4- in providing markets for trading commodity futures . Across the country these exchanges have experienced unprecedented trading over the past several months. There were 23.5 million contracts traded on all commodity exch arlges during fiscal 1973, up over 50 percent from the comparable year-earlier level and in dollar value more than double the value for 1972. This dollar value was more than two and one-half times as large as the value of all equities traded on the New York Stock Exchange during the same period. During fiscal 1973, the three commodity exchanges in Chicago accounted for 80 percent of the contracts traded on all commodity exchanges in the nation. The spectacular gains in contracts traded shown in recent months by coomodities exchanges must be viewed, of course, in the context of recent temporary surges in connnodity prices and relative stagnation in equities markets. But they are,even so, most impressive. An innovative spirit and willingness to buck substantial odds seem to have paid off in leadership by the Chicago financial connnunity in two other areas. change. One of these is the new Chicago Board Options Ex- Since the Options Exchange opened on April 26, 1973, trading voltnne has incre ased from an average of almost 1,600 contracts per day during May 1973--the first full month of trading--to almost 12,000 per day during the first two weeks in October. This reflects both the increase in the number of stocks with respect to which options were available (from 16 at the opening to more than 30 currently) and increases in the volume of trading of existing options. As you are undoubtedly awa re, the purchase of an option on the Chicago Boa rd Options Exchange is tant amoun t to purchas ing the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -5- right to buy one hundred shares of a common stock at a given price during a particular period of time . Thus, although the actual equities do not change hands, the rights to buy do and the volume of underlying common stock involved is one hundred times the number of contracts bought and sold. With this in mind and with reports that the list of issues on the exchange .might grow to perhaps 60 by the end of 1973 it is not startling that some observers are predicting daily volume on the Chicago Board Options Exchange representing more than the daily _ average volume on the American Stock Exchange. The current average daily trading volume already represents 1. 2 million shares . The Chicago Board Options Exchange is an important recent development for Chic ago. Four years of effort and $2.5 million were spent on development prior to the opening date last spring . Now that it is operating and is being much heralded , at least three other exchanges have indicated an interest in providing similar trading in options. Another example of the initiative which the Chicago financial community has shown in recognizing the potential deman d for a financial service and devising a means to satisfy that demand is the development over the past two years of the International Monetary Market of the Chicago Mercantile Exchange. This exchange ' s state-d purpose is to provide "breadth, depth, and resiliency" to the market in which forward contracts in foreign exchange are traded. It set out to achieve these ends by focusing all market decisions at one ge ographic point and by serving all segments of the market, including speculators with https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -6- whom the banks trading in foreign exchange had been reluctant to deal. Although still in its developing stages, the International Honetary Harket has experienced encouraging growth and appears to be well on its way toward achieving a permanent place on the national financial scene. Despite reservations on the part of some observers as to the role of speculative positions in the foreign exchange market, it is clear that the International Monetary Market is serving an important function. The awakening of international banking activities of Chicago banks has occurred only during the past fifteen years or so. · Yet international banking in the Chicago area dates back to the mid-19th century--a fact that is often overlooked. The heavy participation by foreign investors in the railroad boom of th e 1860's led to close financial relationships between Chicago banks and the European banking hous es . With th e extension of the railroads and the subse quent development of Chicago into the grain and meat-packin g capital of the world in the 1870 's and 80 's, local · banks began to participate exten..:.. sively in export financing. Extensive correspondent relationships be- tween Chic ago and forei gn banks were developed in th i s period--and also the establishment of several branches of forei gn banks in Chicago. But the broadly based growth of international banking in Chicago is a much more recent phenomenon. lagged behind New York as a center The fact t hat Chicago has of i.nternational banking activity is probab ly in part because of the intrinsic disadvantages of its inland location. Btt, to a large extent, it is simp l y be cause of its belated reentry into the field. The Hidues t's pos ition as an exporter of agricultural commo dities and manufactured goods and its ability to https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -7- directly export them from the land-locked Midwest following completion of the St. Lawrence seaway was bound, sooner or later, to attract Midwest banks into financing foreign trade. This did in fact occur, be- ginning in the late 1950 1 s, with Chicago banks taking the lead. As American-based multinational corporations exr,anded foreign operations in the 1960 's, several Chicago banks moved to establish branches abroad. Introduction of the Government's Voluntary Foreign Cre dit Restraint program in 1965 put Midwest banks at a temporary disadvant age relative to banks in Hew York because individual bank lending ceilings were bas e d on the level of foreign credit in the past. But despite these ceilings (and they have been relaxed more recently) the growth of international activit ies by banks in Chicago and other large Midwest citi es has moved fo rward in unprecedented fashi.on. Since 19G 2, w,1~11 Lile first current foreign b ran ch of a Chica8o ba nk opened in London, the number of forei gn branch es of Chicago ban1·s has increased to 42. At the same time , three foreign b a nks currently h ave affiliated banks in Chicago and 17 foreign banl~s have representative offices. With the new Illinois law which became effective just l ast mon th permitting for eign banks to establish branches in t h e central downtown b usines s dis trict of Chien.co , the number of foreign banks with b anking offices :i.n Chicago is likely to increase si gnificantly ove r the cor.1ing months and years. Illinois state banking authorities have already r eceived appli c at i ons to est ablis h branches in Chicag o from 6 hi ghly respect ed foreign banks. and the branch opened this past Honday. One has al read y been approved Indication$ are that a mnnber of others will be making applications in the near future. In addition to foreir,n bran ch es of United St ates banks and United States branches https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -8- of foreign banks, five U. S. banks have Edge Act corporations in Chicago an d 4 Chic ago banks h ave 6 such corporations located in other U.S. cities to handle international business. Such an\ interest by Chicago banks in international banking business and by forei gn banks in locating in Chicago is reflected in certain balance sheet items of Chica go area banks . From mid-1968 to mid-1973, for example , demand depos it claims of foreign-owned b anks ag ains t Chicago banks almost doubled. Over the same time period, deposi t claims of Chicago area banks against f? reign banks increased five times . ~ In large part, this reflects the growth of ~ internat ional correspondent relationshi ps of Chicago area banks as they enlarged their international activities. With respect to loan and investment activities abroad, Chicago area offi.ces, though sti ll limited by the Voluntary Foreign Credit Restraint program , increased claims against foreigners to over $1.1 billion in Augus t of this year. One measure, however imperfect, of the capabili ty of a financial center to meet any type of financial demand that might be placed on it is the siz e of its larg st ·institutions . Unfortun t ely, the structure of U. S. banking dictated by state l aws varies widely from state to state and therefore makes suspe ct dire ct comparisons of the relative importance of different financial centers using summary measures such as the total de posits of their l argest banks. Even with this res ervation, howeve r, a listing of U. S. banks in descending orde r of deposit size shows the Bank of America of San Francisco first with the next six positions occupi e d by New York banks and the eighth position by Security Pacific National Bank of Los J\npeles. The ninth and tenth spots are occupied by Continental Illinois an d First https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis f -9- National Bank, respectively, both of Chicago. California has state- wide branching; New York will have it by 1976. Illinois, on th e other hand, does not pennit branches at all. So these rankings overstate the prominence of New York and West Coast banking institutions, especially if the ability to service large sophisticated customers is considered to be an important aspect of being a financial center. It is clear that all the deposits of the more than 1,000 branches of the Bank of Ame rica or all the deposits of the more than 200 -branches of the First National City Bank in New York are not available to service credi t demands of large custome rs in San Francisco or Hew York. They are retai l- oriented banks and a large proportion of their resources is committed · to l e nding in the local small business and cons umer loan markets. If banks in the various cities wer e ranked by the deposits they have available for meeting loan demands in the city itself, Chicago banks would stand cons iderably higher. Nevertheless, the very central- ization of the management of these branch systems in New York and San Francisco is itself an example of a service being rendered by a financial center to a broader area. To that e xtent, we may infer that branching r es trictions have inpeded Chicago's development as a financial center. I do not mean to ignore other banks in Chicago arid their significant cont ributions to Chicago's financial environment. As of December 31, 1972 the city of Chicag o had eleven banks in the larges t 300 Unit ed States b anks according to deposit s ize. Five of these banks had t otal dep osi t liabilities of more than $1 billion https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -10each and aggregate total deposits of over $26.5 billion. Of all cities in the Unit ed States only New York had a larger m.rrnb er of banks among the top 300 according to depos it size. In terms of total deposits of all its commercial banks, Chicago ranked third-even with no branching--behind New York and San Francis co. 'I'he Illinois branching prohibition is not th e only statut ory impediment to Chi cago 's developrr1ent as a financial center. Illinois law also prohibits the formation · of mult ib ank holding comp ani es, a means by which banks i n other states with restrictive branching laws achie ve some of the benefits of branching . Without e ntering into the current dis cussion over the merits or demeri ts o f these structural restrictions --and clearly their effect on the fin ancial development of Chic ago is l ess significant than the bro ader iss ue of public interest-on . 'C'?_T~ say h =1t , 5_!1 th ei!' ~'bsence, Chi c3:::;o ba'!"?.ks would fo rI!l the nuclei of sta t ewide banking organizations of one fonn or the other. Late in the 1960s several of the l arger Chicag~ banks saw what they pe rceived to be an escape from the severe restrict ions · on the ge ograph ica l scope of at least a pa rt of their ope rations: the one-b ank holding company. So long as they controlled on ly one bank, such companies . were exempt from re gulation by the Federal Reserve and could engage in nonb ank activities without limitation on their nature or locat :i.on. It was a for egone conclusion, of course, th at once a substantial number of l arge banks attempted to utilize the one-bank holding company to escape legal restrictions, legislation would be e nacted to l i mit that opportunity. Tht s, the Bank Holding Company Act Amendments of 1970 subjected one-b ank holding companies to Federal Reserve regulation, restricted .them to those activities "closely related to banking ," and https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -11- established a strict public interest test for propos ed acquisitions. Nevertheless, in its adminstration of the amended Bank Holding Company Act, the Board of Governors has not seen fit to impose geographical restrictions on nonbanking activities, and Chicago banks have taken full advantage of this freedom to acquire, or establis h de novo, financial service organizations with offices throughout the country. At present 42 of the 95 banks in the city of Chicago, including the 13 largest, are subsidiaries of one-bank holding compan ies. f~ Their $23 billion of domestic deposits repres ent over half of the ~ total domes tic deposits of all banks in Illinois. Among the excursions by the largest Chicago banks. · into nonbanking activities with a b road geograph ical dispersion of operations have been the acquisition of two la.r ge mortgage companies, a Flor ida trust company, and the establishment of an investment advisor to a real estate investment trus t in California. Pending is a proposal to acquire a consumer finance company with offices in more than 30 states . A large Midwestern bank outsi.de Chicago has applied for permission to acquire a savings and loan association in Arizona and another to establish de novo a mortgage guaranty i nsurance company to compete with existing companies in the national market. If these applications are approved Chicago banks can be e xpected to come forward with similar proposal s . As a partial offset to the limitations of restrictive branching and holding company laws in Illinois, an extensive correspondent banking network throughout the Midwes t has developed over the years, with Chicago banks taking the dominant role. Through this correspondent net- work smaller banks r eceive both credit and non-credit services from their https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -12- larger city correspondents. Some of these services are simply not available at the local level. Some otHers may be available but in inferior quality or at nnattractive prices. Chicago area banks compete vigoro usly to supply these outlying banks with demand depos it accounting, investment and portfolio advi ce , computer time, and other services. In addition· to the frow of services •fro m the city correspondent banks, the correspondent network permits Chicago banks to draw on the resources of smaller banks through such devices as the Federal funds market. Smaller banks are typically net sellers in this market and use their city correspondents to effectuate ·t heir sales. During periods of tight money and relatively high interest rates , smaller banks many times find the Federal funds market relatively more attractive and increase their net sales. In the firs t half of 1973, for example, net purchases of five large Chicago banks averaged over $2 billion per day. Net sales of Federal funds by smaller banks in the Seventh Federal Reserve District alone averaged $1 b:i.llion a day. Other Chicago financial institutions--some of which are among the largest ins titutions of their kind--expand the range of financial service s available in Chicago. panies in the U. s., A list of the largest finan ce com- for example, shows Chicago with a consume r finance company, a commercial finance compap.y, and a sales finance company among the leaders. There are almost a dozen brokers and/or deal ers headquartered in Chicago who managed or comanaged over 130 bond and equity issues in the calendar year 1972. Chicago's government security and equities markets are second only to New York. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis In addition, the insuran ce -13industry plays a large role in Chicago financial scene with several of the Nation's le aders headquartered here. And I haven't even mentioned the strength of Chicago's fin ancial giants in the savings ' • and loan field. In this brief sketch of the past development and present status of the Chicago financial environment, I have h ad to touch lightly on -a large number of inpor.t an t events and to ignore in their entirety certain others. I have only tried to put in perspective where our city n ow st ands as a i inancial center and how it got there. Before passing th e ba ton to the o t her speakers on our program , however, I would like t o pose seve ral ques t ions that may serve as a prod to th e dis cussi ons that follow. Chic ago is a fin an cial center? First, is it i npor tant whe ther The answer is yes . One mi ght over- stat e the case somewhat by asserting that Chicago's future as a vi ab le city may depend on it. _ Alth ough the trend is still in its incipiency and th ere is uncertainty as to its even tual outcome , the past de cade has seen some erosion of Chicago's industrial base . For a variety of r eas ons, sorne re late d to labor costs , othe r s to de t e riorating soci al overhead, crime, and a general decline in th e amenities of urban living , comranies have been migrating to th e suburbs , sr.1all towns, and other cities--often outside the Chicago area entirely-where problems are more eas ily solved. One obvious renedy s albeit no panacea, fo r Chicago's problems would be to develop further specialization in financial s e rvices to help replace some of the industrial activi ty it i s los ing. A similar substitution of finan- cial activities for declining indus t ri al activities h as been observable for years in both London an d New York , par ticul arl y the lat t er . https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -14Of course, it is a big jump from noting these developments elsewhere to advocating a conscious strategy to enhance Chicago's developments as a financial center. ' Several questions occur im- • mediately: How much effect can deliberate policies, public or private, have on the outcome in the face of the awesone forces of the marketplace? Even if Chicago were to realize its maximum .p otential . as a financial center, would the employment and .income thereby generat e d se rve to offset much of the industri a l emigration? Just what can be done to assist,# or lubricate Chicago' s development in the desired direction? What dl'>s ts would such actions entail and what wo uld be the ul tirnate benefits to th e Chicago bu ~:i. ness community and tl e public at l ar ge? One must guard against local ch auvinisra in wei ghing the altern atives. As in th e case of internation al trade, i t is ea y to fall into the pr ot e ct i oni st fall a cy th at everything c an and should be pr oduced loca lly. We should remember that our city, like all others, has comparative advantag~s in prod ucing some goods and services and comparat ive disadv ant ages in producing oth ers , and not tilt with windmills in an attempt to make Chicago a self- sufficient island. On the other h and, several factors argue aga ins t a too casual consideration of all conceivab l e pros and cons in we i ghing proposals that mir,ht affe ct Chicago's future as a financial center. One is that the intercity compe tition for the status and benefits of being a financial center is essentially a zero-stm game--i. e ., Chicago's gain would be Detroit I s and Omaha's loss (or New York's loss )--so does it matter. i.1 hat Another is that, in contrast to commercial or in- dustrial ·development, where location depends heavily on such intrinsic https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -15- factors as readily ava1.lable transportation, tax rates and access to natural resources and population, the · ~ocation of financial activity is much more likely to depend on historical accident or • on initiatives taken at some time in the distant past. The es- sentially space less character of such highly organized and impersonal markets as those for short-tenn Treasury securities or the equities of large corporations means that they can locate anywhere satisfactory facilities are available--particularly in these days of exciting new developments in electronic data transfer. However, once a market is firmly established in one place, sunk cos ts of physica l facilities and the gradual development of external economies tend to make the original location de cision irreversible. • In summa ry, I must conclude that Chicago h.as a great future as c finan t.:lal c.:e u i: er. But that future will r est largely on our innovativenes s in competing vigorously with not only New York and London and Frankfurt and Tokyo, but also with our sister cities in the Midwes t--De troit, llilwaukee, Indianapolis, St. Louis, Minneapolis, I'ansas City, just to name a few. Chicago's future as a financial center will see develo pment unanticipated by anyone in this assembly. We all know t hat the continued growth and prosperity of Chica go's financial co mmunity will depend more on its ability and utllingness to continue to iTu"'1ovate and take new risks than on any argument that, because o f its large population and industrial base, Chicago "ought to" rival Nei-, York as a financial center. We are number 2 in our nation, but like in the auto rental business let's be sure 1 \.1e try harder. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11 It is the key to greater achievement.
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