Bankers have little sense of history. For most, their view of the future is myopic.
Many changes have been gradual so few understand that today’s banking structure is recent. Those who operate or regulate the financial industry look out a year or two at most. There is little recognition of the forces shaping their industry.
Double entry accounting helped give birth to banking as did trade. A method to exchange credit for purchases for business was needed. Credit was more effective than using barter or transporting gold and other currency from one distant community to another. These were technological innovations at the time.
Currency was first backed by hard assets, such as silver and gold, but there was no uniformly accepted system. Many banks, as well as nations, printed their own money. Perhaps bit- coin is a modern version of bank “notes”?
In the United States, our banking system was so fragile that J.P. Morgan was able to bully his fellow bankers into saving their industry in a panic. He locked them in a room with plenty of liquid refreshments, but no facilities to relieve themselves. That was more than 100 years ago, and Mr. Morgan’s efforts gave birth to the Federal Reserve System. So much power, it was thought, should not be placed in an individual! During the recent sub prime crisis, Morgan’s approach might have been better.
One of the things that has remained constant are periodic financial panics.
Change is inevitable. But I do not see the banking system as evolving. Rather I believe that the current banking system will not exist in a generation.
Technology is forcing change. For example, transaction costs are a fraction of what they were, and they will continue to shrink. The second change will occur when the next financial crisis happens. It will not be handled as well as the most recent one.
Let us look at technology first.
Transaction costs will continue to be reduced so check cashing, cash transfers and other banking processes will be commodities. More bills will be paid online, and checks deposited in the same manner.
Cash ATM machines have extended banking access for customers. The use of cell phones to charge for purchases will reduce cash needs. In some emerging nations, cell phone banking is replacing cash and credit cards.
Most small retailers pay an inordinate amount to accept a small credit card charge. But technology is so cheap that cooperatives will be set up to compete with credit card companies at lower costs.
What will technology bring? I like Henry Ford’s statement “If I’d have asked people what they wanted, they would have said a faster horse.”
One large credit card company is the largest Internet banker. It also is one of the largest car loan lenders. It does not have branches. Other Internet bankers are growing and will replace many banks. Retailers like Wal-Mart are entering the industry. Competition from the brokerage industry through money market funds has temporarily been beaten back by draconian SEC regulations and the banking lobbies, but this will be temporary victory. Other competitors will arise.
Many people of all ages bank through the Internet and pay bills on the Internet. This ought to reduce paperwork. (Ironically banks and brokerage houses mail out responses for these online transactions. It reminds me of the Hollywood producer whose secretary asked if she could toss out old files. “Certainly,” he said. “Just make sure you make copies!”) My point is that the use of the Internet for banking is just at its birth. There are more efficiencies that will occur.
Technology is now attainable so that many, not just a few rich large organizations can access and afford it. Indeed, new entrants into “banking” will be at an advantage because they will not be tied to old technology. An analogy could be made to the cathode tube manufacturers, none of whom went into the chip business.
Access to equity, rather than loans, will bypass the banks and the large distributors such as Goldman Sachs and Morgan Stanley.
I do not believe it will be done through crowd sourcing, although the Internet will be instrumental. Rather I think that the Muslim form of financing- profit and loss sharing, rather than loans- will dominate, as it did in Germany a few decades ago.
My second point has to do with the way a new financial crisis is handled. Sometime over the next 15 to 20 years we will have another collapse of the financial industry. I believe that the revulsion of the people will result in the breakup of To Big to Fail (TBTF) institutions.
Few economists or regulators understand what causes these collapses. You cannot, in my opinion, prevent a problem that you deny. Politicians will not be the savours. Indeed they will help cause this collapse by removing regulatory funding and regulations. They have a short term point of view (clouded with re-election issues) and are too self-serving to do anything except react to a crisis. If you doubt this, look at the revision to restrictions in bank trading that just appeared in the spending bill.
The S&L/Mutual Saving Bank collapse was, in my opinion, a mix of lending funds long but borrowing short in inflationary times, and the unbundling of regulations from the Hunt Commission recommendations without new regulations and oversight for the industry.
The sub-prime crisis had different roots. These included drive by appraisals, banks lending down payments, the falsifying of applications (mostly by the “unregulated” mortgage bankers), the significant amount of refinanced mortgages (40 percent in late 2005/early 2006) and the use of predatory lending (which was mostly financed by large banks). The reader could add many more items to this list.
Was it the fault of investment bankers? They generated demand for the product, but they acted as conduits. Was it the regulators who lent a blind eye to abuses or the politicians who reduced oversight budgets? Could you look to economists, regulators and bankers who talk primarily to themselves and those in related industries? They are deaf to outside information. I recall at the May 2006 Federal Reserve Bank of Chicago meeting hearing of a modest slowdown when I piped up that I thought housing starts would go down by 20 percent. It turned out that my numbers, based on trends, were conservative.
Let me add that the aging of our population, changing racial demographics, employment “transitions” (manufacturing will be less than 5 percent of the workforce) and the spread between the very wealthy and the rest (reducing the middle class) will contribute to this collapse.
The Office of Financial Research just released (12-2-2014) a study to Congress on the risks to our financial stability. They cited:
1. Excessive risk taking during an extended period of low interest rates and low volatility.
2. An increase in market fragility resulting in declining market liquidity and persistent risks of asset fire sales and runs, and
3. The migration of financial activity away from banks towards less regulated parts of the financial system where threats could be significant, but more difficult to assess.
These all are risks, especially item #3, but where is a discussion of fraud in credit cards, identity thief, and/or the use of technology that fundamentally will change our financial system. Will there be more cyber-attacks? More fraudulent insurers like AIG who moved to England to escape oversight? How about poorly understood hedging techniques and derivative products where an attempt to regulate is being stalled. Here I predict that regulation will be shorn of all strength by lobbyists.
But what we can count on to bring about the next collapse is the general greed and stupidity of bankers, elected officials and defanged regulators who will trigger the events that a few will see, but fewer will believe until it is too late.
When the big banking institutions are broken up, many of their subsidiary functions in trading, brokerage, leasing and insurance will be handled by separate companies. This might be just as well as the banks do not really understand the relationship(s) that brokers have, for instance, with their clients.
Bob Chernow, a Milwaukee businessman, is the former vice chair of the World Future Society & former Chair of the Global Advisory Council.
