Kenneth D. Lewis, the chairman and chief executive of Bank of America Corp., delivered a speech Friday to the National Black MBA Association in Washington. During his speech, titled "Banking on Balance," he touched on the week's events. Mr. Lewis described the current state of the financial sector with a mixture of optimism and realism. The scene is "less outright failure and more of the walking wounded," he told attendees. Following are excerpts.
Thank you, Geri. And thank you for helping to shape the deep culture of diversity and inclusion that makes us strong today. I appreciate all you continue to do for us.
I'd also like to thank Bill Wells, Barbara Thomas and all of the members of the National Black MBA Association… for all you do to help develop the leaders our companies need to compete in the global economy. It's an honor for all of us at Bank of America to work with you… and it's an honor for me to be here for the 30th anniversary of this conference.
The theme of the conference this year is "Catalyst for Change." That's good - the world is changing… the marketplace is changing… and we all need to be prepared to make the changes that will keep our companies and industries competitive in the global economy.
Financial services is no exception. This week's events provided more evidence… not that we needed more… that we are in the midst of an historic transformation in the financial services industry. Some institutions are just trying to hang on…some are fighting to survive…and some have already lost that fight. For those of us who are still strong, the great challenge is to fix what went wrong, fight through adversity and start investing in America's future again.
The financial services industry in the United States…and, to some degree, around the world… stands at a crossroads. Either we will learn the lessons of our recent history, and put those lessons to work making the changes that will strengthen the industry and promote stability in the future… or, as the poet George Santayana suggested 100 years ago, we will repeat that history over and over again.
This is our great opportunity… and it's what I'd like to talk to you about today: where we stand in the financial services industry today… how the market for business capital is changing, and what that means for your businesses… and how we are working to create a stronger, more secure financial services industry to serve our nation's economy.
I'd like to start by saying a few words about the economy.
Second quarter GDP has been adjusted up to about 3.4% on an annualized basis… economic activity has been helped by moderating gas prices, federal rebate checks, monetary stimulus and strong exports. We haven't yet seen the recession that many predicted. That doesn't mean we won't. Recent economic reports have been weak, including unemployment, which now tops 6%.
Our economy is suffering from several major shocks, and one major imbalance. The shocks include rising energy prices, which are contributing to inflation; and the crash in the housing market, which led to the credit crunch, our financial crisis and upward pressure on unemployment. The imbalance is the ratio of household debt…including mortgage debt… to savings.
The crash in the housing market, in hindsight, was inevitable. There were a lot of factors that played a role… think of it as a "perfect financial storm."
Before this decade, we had a long history of stable appreciation in home values… about 3-4% a year. During that time, people came to believe that housing prices never go down. In the last few decades, lending standards loosened as financial institutions and investors perceived little risk. Anybody remember the 25-year mortgage with 20 percent down?
Contrast that with loans with no money down, little or no documentation of the borrower's financial condition and offers to pay only part of the interest.
Then, earlier in this decade, the Federal Reserve drove interest rates to near record lows to ensure against deflation. Investors all over the world looked for better yields without … they thought … taking more risk. Wall Street obliged by bundling mortgage loans, many of them subprime, into packages that were eagerly bought by these investors.
In effect, the industry created a housing boom that was not based on economic fundamentals. And then the boom turned to bust.
The housing market crash is, of course, related to the one major economic imbalance I mentioned: the burden of household debt. U.S. household debt from the 1950s through the 1980s ranged from about 45% of national income up to 60%. And then it started to take off… today, the ratio stands at over 120%. That trend is not sustainable.
Today, the greatest source of imbalance is household finance. But in past crises, the source has been too much debt leverage in the commercial sector. Either way, as you can imagine, the problem of excessive debt poses a challenge to bankers, for whom interest income is an important source of profit.
The banks best able to meet this challenge are those whose business models balance interest income with fee income from services… whose consumer offerings balance loans with investments…and whose wholesale business balances credit with other services like treasury management and investment banking.
This point brings me to the agreement we announced on Monday to acquire Merrill Lynch. Our partnership with Merrill will, in my view, create a global financial institution with almost ideal balance. We'll have leading positions with U.S. consumers in all four of the major cornerstone products - deposits, card, mortgage and investments. And our small business, commercial and corporate banking businesses, which already do business with 99% of the U.S Fortune 500 and 80% of the Global Fortune 500, will now include a global, full-service bulge-bracket investment banking team to serve their clients.
I believe this partnership represents the strategic opportunity of a lifetime in financial services… and I believe that when we have successfully combined our businesses in a way that creates value for our customers and clients, Bank of America will be the strongest and most stable financial services institution in the world.
That's our goal for the future…but we have a more urgent challenge before us now: to help American households… and the American economy… recover. American consumers need time… time to restore some balance to their household finances. That's going to mean less overall borrowing… paying down existing debt… decreased consumption… and increased savings and investment.
While this is happening, we'll continue to see pressure on growth, and a sluggish economy… most likely well into next year. But in our greater economic story, restoring household fiscal balance is both necessary and good. Balancing our modern culture of consumer debt with our more traditional American culture of savings, thrift and investment for the future will mean fiscally stronger households, stronger communities and a stronger national economy.
When we combine economically sound consumer households with the other fundamental strengths of the U.S. economy… tremendous productive capacity… a culture of innovation and entrepreneurism… the best higher education system in the world… and the world's deepest and most flexible capital markets… we will see a return to strong economic growth.
I remain optimistic and enthusiastic about our economic future... provided that American bankers commit to doing what we need to do to help drive necessary changes in the American economy.
At Bank of America, we're really big on accountability. In that spirit, I'd like to own up to something I said early last year… quote: "As much as our global financial markets have grown," I said, "I believe growth will only accelerate in the years to come."
Obviously, I couldn't have been more wrong. My only defense is, I was far from alone.
Since a couple of hedge funds packed with subprime mortgages went belly-up in June 2007, the pain has been widespread… for homeowners, for investors, and for the financial services industry.
Over the past year, bank stocks are down 50% or more from their peaks. We've had more than a handful of high profile buyouts, and many of the industry's most prominent CEOs have resigned. The red ink is flowing - FDIC-insured institutions' profits fell 87% in the second quarter from a year earlier… thrifts lost $5.4 billion in the quarter… and the FDIC now lists well over a hundred banks on its "problem" list.
This week's events have led some to wonder if we're close to hitting the bottom of the market. I won't make a prediction. I will say that the industry, homeowners and investors have been through a lot of pain… and it's not over. There's a lot of bad debt out there that still needs to get cleaned out of the system. But it will… and in the meantime… at the risk of sounding like a contrarian… I'd like to put this situation in perspective.
So far this year, in addition to the handful of very high profile investment banks that have been acquired or failed, we've had ten commercial banks go out of business. No question that number will rise. But between 1986 and 1991 we had 2,121 bank failures. That's about 350 bank failures a year for six years. For a couple of reasons, I don't think we're going to see that rate of failure this time around.
First, there are simply fewer banks today. In the late '80s, we still had about 14,000 banks in this country, most small to mid-size banks with loan portfolios that were highly concentrated by industry or geography. After 20 years of consolidation, that number has been cut in half, and the banks that remain are, on average, more diversified.
And second, banks have, in fact, done a much better job in recent years distributing risk. That's not to say that we took all the right risks… clearly, we did not. But nonetheless, risk distribution - through syndicated commercial and corporate lending, and the securitization of all kinds of credit - spreads both risk and reward much more smoothly across the industry than in previous cycles.
The result, if you get past the headlines and look more broadly across the industry, is less outright failure, and more of the walking wounded. That poses its own challenges… but there's no question it's the lesser evil. It means that more institutions will muddle through, attract new capital or merge to survive… and fewer will fall into the lap of the U.S. taxpayer. I think that's a good thing - the survivors will be stronger, more diversified, and better prepared to thrive in cycles to come.
There are some obvious lessons learned from this episode. No asset is immune to the bubble effect - even housing. Distribution of risk is not the same as elimination of risk. Maybe most important: There are limits to the positive effects of financial leverage. The ability to increase demand through rising financial leverage can stimulate the economy. But it cannot create unlimited wealth out of thin air. Eventually, economic fundamentals always come back to remind us what's real and what's not.
To this point, in hindsight, I'd say that the decision to lift leverage limits on investment banks earlier in the decade was, at the least, a contributor to our current situation.
We've also had some reminders about what's important for survival. Capital strength and liquidity are important. Diversity of assets, revenues and geography are important. And, obviously, good judgment is critical. Everyone has been hurt by the housing crisis. But good judgment has, more often than not, meant the difference between those who will survive, and those who are already among the missing.
When I was starting my career, we had an executive named Buddy Kemp, who would tell the young loan officers: "God never intended for you to make more than 10% a year." Well, Buddy was right. Over the long-run, it's pretty hard to average much more than 10% growth in financial services, without something in the system being out of whack.
The question is, what to do about it? It seems unlikely that most companies would simply volunteer to pull back the reins on profit and growth in a hot market. But, in fact, that's precisely what needs to happen. Managers need to stay alert to how market conditions that prevail during a boom differ from historical norms… insist that their risk partners explain why any disparity in growth trends is justified or not… and take action to preserve long-term stability, sometimes at the cost of short-term results.
Achieving this level of self-discipline will be easier said than done. It's our great challenge. I can assure you that the executives I know in this industry who are still employed are dead serious about making the changes in credit policy and risk management that will promote not just growth for our industry, but stability as well.
No doubt we'll have help from our regulators.
Speaking of which, I have to give credit where it's due. The Fed, the Treasury, the OCC and the FDIC have performed very, very well through this crisis. Chairman Bernanke and Secretary Paulson, in particular, have made very difficult decisions… and, in my view, they've made the right ones. They understand the trade-offs, but their primary goal has been to stabilize the markets… to ensure accountability… and to respect the American taxpayer. Thus far, I think they've made the right moves.
As we go forward, I'd make just a few observations about financial services regulation… one specific, and a few general.
My specific point has to do with the decision last spring to open the Fed's discount lending window to investment banks. I've said before that, given the circumstances, this was absolutely the right decision. But now that it's done, our investment bank competitors must submit to more of the oversight, capital requirements and business restrictions that commercial banks are subject to. The logic seems pretty clear… if you're going to have a public backstop, you need to subject yourself to public oversight.
More generally, I'd offer that we need to be very cautious about how we respond to the current situation with new regulation.
This may not be a popular position right now, but not all de-regulation is bad. For example, in 1994 Congress passed the Riegle-Neal law, allowing interstate branch banking. The result has been industry consolidation, less geographic concentration and stronger, more diversified financial institutions. This change is one of the reasons we're not seeing the epidemic of bank failures we saw 20 years ago.
In the same way, the Gramm-Leach-Bliley law that allowed commercial banks and investment banks to merge has created at least two very strong institutions… one of which is Bank of America… that are stabilizing forces in the current crisis.
And, not all new regulation is good. Sarbanes-Oxley, for example, did create many positive and badly needed changes in executive accountability and board governance. But it also imposed very high compliance costs on many small businesses that hadn't done anything wrong, and weren't planning to.
If I can speak for bankers… we don't object to reasonable rules that enhance the safety and soundness of the system… or changes that would simplify the regulatory structure… provided that we don't impose heavy new burdens that harm the competitiveness of American companies. We don't want less rigorous regulation. We want clear, efficient, effective regulation that supports a strong and stable financial services industry. And we'll support ideas for reform that move us in that direction.
Before I conclude, I want to spend a few minutes talking specifically about middle-market finance… because I know many of you are here representing medium-size businesses and corporations.
Right now, banks of all sizes are feeling a lot of pressure on their balance sheets. Clients and prospects are coming to us saying that their other banks are cutting off lines of credit, or don't have the balance sheet capacity to help them finance their growth plans.
We understand that what middle-market companies need right now is a variation on the old "Three C's" of banking: capital, commitment and capabilities. Despite the pressure on households and consumers… and some deterioration in commercial credit quality… most of our middle market clients are holding their own. Many see great opportunities to grow, despite the current slowdown. And they need capital to pursue their goals.
So where is this capital going to come from - in the short-term, and in the long-term? I know some CFOs can feel the market for commercial capital changing.
What is changing - as I said earlier - is consolidation. The industry is getting smaller. And it should. Even as the number of banks in the country has fallen by half, the financial services industry for the past 20 years has been on a rapid growth spurt. Financial stocks' share of the market value of the S&P 500 tripled over the past 17 years. And over the past century, financial workers' share of U.S. income quadrupled.
Now, I'm the first one to defend the value that my industry adds to the economy. And much of the industry's growth comes from exporting financial services to other countries with less-well-developed financial sectors - which, obviously, should continue. But there are limits to how fast and how much the financial industry can grow without distorting market fundamentals. And I think it's clear that we passed those limits some time ago.
So those of us in the industry need to come to terms with a more rational view of the value we add to the economy… and more humility in understanding the limits of the magical powers of finance to create economic value. The result will be fewer overall institutions... but good growth opportunities for those with broad and deep capabilities.
The players will change. But important mechanisms for providing credit will stay with us. The number of banks in the syndications market has shrunk… but the demand is still strong, and there are still plenty of banks to get the job done.
Asset securitization will continue not only because it's one of the most effective risk mitigation tools we have… but also because the banks alone do not have sufficient balance sheet capacity to provide all the growth capital that American businesses need. Much of that capital must continue to come from investors… and securitization will continue to be one of the best ways get the users and providers of capital together.
This has been a tough week for the financial services industry. But I think we are proving that we can withstand some pretty serious shocks. We will continue to do so, and we will continue to be there to help America's companies of all sizes grow.
You have all come here to Washington this week to talk about how to become more effective catalysts for change. Seems like everybody in Washington is all about "change" these days. For the record, my money's on all of you.
The banking industry, too, must change. We must be more disciplined risk managers, attuned not only to the potential for growth, but also to the need for stable growth, and to the dangers of an economy or a market that is growing too much, too fast.
We must embrace the reality of what will be, at least in the short term, a smaller industry with a simpler approach to finance. We must acknowledge that, like any tool, financial tools that have created tremendous value over the years also can be abused when the industry takes a good idea too far.
We must shift our focus from an obsession with the fees that come from endlessly moving risks around… and return our focus to the relationships with our customers and clients that provide the foundation for long term growth and stability.
I am confident that my industry will answer this challenge… that we will emerge as a stronger partner for American consumers and companies… and I'm confident that by this time next year, we will see that light at the end of the tunnel that signals a return to strong economic growth for America.
I hope that those of you who see opportunity in these changes will think about joining us… our industry needs all the new talent we can get. And I hope that all of you find the greatest professional success…wherever your careers may lead you.
Thank you for giving me the opportunity to speak here today. It's been an honor.