When it comes to mutual funds, A. Michael Lipper is one of the most respected and most quoted experts around.

The founder and president of Lipper Analytical Services, Mr. Lipper heads a research organization that has mutual fund performance.

He and his top banking expert, Geoffrey Bobroff, recently talked to freelance writer Bill Tucker about the massive migration of banks into the mutual fund business.

Q.: Someone said recently that "spreads are dead" and that banks will be making more of their money from fee income. Is that true?

LIPPER: To paraphrase Mark Twain, reports of their death have been highly exaggerated. The history of finance is of cycles. I would not say categorically that spreads are dead.

As a matter of fact, [Federal Reserve Board Chairman Alan] Greenspan has made a wonderful spread between the cost of borrowing and the ability to buy government bonds.

As I see it, the banks have two problems - a competitive problem and a statement problem.

The statement problem is the need to improve ratios. And you can do that by the following methods: selling equity, improving earnings, or reducing assets. For many banks, the easiest thing has been to reduce assets and thereby shift deposits into mutual funds. It's my feeling that we're probably in the last year of that phenomenon.

The competitive problem is that the brokerage industry, in using money market funds as a way to gain relationships with accounts, could reduce banks to being just cash dispensers.

For a while, it looked as if the brokerage industry was going to be a substantial supplier of credit, not for the purpose of consumption for individuals or production for business. It is less clear today that that's what's going to happen.

It is clear that our fellow analysts seem to value fee income over spread income, even though it is conceivable that gross income could be higher,in well-chosen spreads.

Q.: But fees would be more reliable?

LIPPER: Fees are less volatile. Now, the intriguing thing is that banks, in many cases, are not utilizing the full fees that are available to them [from mutual funds].

BOBROFF: They can't take the full fees - at least not currently - if they're going to be competitive, because banks are starting from a different base and a different time sequence. And most bank funds are engaging in a deep reduction in competitive returns. So that when you really look at the practical revenues, it is really less than could have been achieved.

And if fixed interest rates stay within the same band they've been in, it may be difficult for them to improve that.

Q.: So it's just too competitive out there already.

BOBROFF: No, I think it's just where interest rates are. If interest rates were several hundred basis points higher, the ability to take more of your income in fees would be more accessible and justifiable.

LIPPER: Well also, the fees cover fixed costs as well as variable costs. And when revenues are low, there's far less coverage of fixed costs.

BOBROFF: One of the other things we're going to have to consider on the balance sheet issue is that more banks have been looking at their true costs of account creation and finding that the smaller savings account is too expensive.

LIPPER: The smaller savings account has a great amount of brick and mortar in it.

BOBROFF: The other element is that in the last half of the decade, many of the banks had their head in the sand, while the brokerage firms and the direct marketers were pounding away at the customers.

LIPPER: It's a major cultural change. The fund business is part of the securities business. The securities business tends to be driven by the incentive of compensation, and there are times when that compensation is very high. And that's a major cultural clash.

Q.: Somebody said in a recent interview that the problem will arise when the gunslinger on the bank floor is making as much as the regional executive.

LIPPER: Worse. Where the horror will come in is at the suburban branch banks, when the branch manager drives up proudly with his two-year-old Buick and the kid on the floor screeches in with his new BMW.

Q.: And it's the bankers who are going to have to adjust?

LIPPER: Well, a number of things will be adjusted. It's not yet clear what the Clinton administration is going to do in the savings-consumption battle.

It is possible they could take the point of view that banks are vital to society and need to be strengthened, and could do things that would inadvertently hurt mutual funds. We could go back to an era where a fixed rate is deemed to be attractive - in other words, a CD could actually make sense again.

Q.: How would that happen?

LIPPER: That could happen if the banks want to go back in the loan business, where they can get the spread, and interest rates and inflation rates become nat again, albeit at some higher level.

Q.: You think it's possible the banks won't go back into the loan business?

LIPPER: It depends on what's the next step in bank regulation.

BOBROFF: The housing market today is all fee income because everybody's selling. Very few banks today really administer mortgage loans. They're all repackaging them and making fees.

BOBROFF: Somehow we have to make the deposit side cheap enough for the bank to make the bigger spread if it wants to engage in a lending practice, which is a regulatory issue.

Q.: Are there many s mall investors left for that?

LIPPER: It's a surprisingly large number. Particularly after all the money supply creation we've had, there's an awful lot of cash out there.

BOBROFF: And we've also seen recently the new types of savings accounts that are tied to a market's performance, such as to the S&P 500.

We may see a whole reversal of the flow of funds if the FDIC protection and the guaranteed account value have a positive ring to investors.

Q.: Has Glass-Steagall hindered banks in the mutual fund business?

LIPPER: Glass-Steagall has retarded only the unimaginative - and those who wanted to take all of the fees.

Q.: Are all the brokerage houses going to be getting into alliances with banks, like the Dean Witter-NationsBank deal?

LIPPER: I don't think there is a correct strategy. I think there is correct execution, which is much harder.

The NationsBank-Dean Witter combination appears to have the elements that would make it successful. Now whether that success is going to be large enough is another issue.

BOBROFF: Joint ventures tend to be doomed from the get-go. They don't last long because one side or the other does not perform effectively.

LIPPER: And usually it's marketing.

Q.: So you don't see these joint ventures as very promising?

BOBROFF: My own assessment is that joint ventures tend not to last long.

LIPPER: Historically that has been the case. This is not the first time we've seen these arrangements. There were several in the 1970s.

BOBROFF: Citibank and Merrill Lynch had the major one. What they called the SIS account. The "Select Investment Advisory Service."

LIPPER: You also had Dreyfus and Irving Trust, and Bullock and North Carolina National.

Q.: They didn't work?

LIPPER: The marketing wasn't there.

BOBROFF: Also, the SEC got upset about the Merrill Lynch-Citibank case. What evolved was tantamount to a mini-account, rather than a true mutual fund. The only reason I know of it is that I worked on it from the SEC standpoint.

The other element is that joint ventures are positive only if you learn something from them.

Q.: What you're saying is that one side or the other will eventually say, "What the heck, I've learned it. I don't need them anymore.

LIPPER: it could happen that way. A lot depends on how important these activities are at the CEO level. If they're important, they will be given the resources and attention they need to succeed. What often happens is that it's important to one party but not the other.

BOBROFF: And then the fingerpointing starts.

LIPPER: if the revenues don't materialize, the claim will be that no one spent enough on marketing, nor did they allot the appropriate talent.

Q.: Marketing is seen more as the responsibility of the broker?

LIPPER: Well, it depends. There are cases where the deposit institution won't allow the broker access to customers.

BOBROFF: Part of it is data processing. As Michael suggests, the question is, is there commitment from the CEO down? Because within every bank there are fiefdoms. Will retail really want to expose its deposit base to this selling effort? Because the retail gets paid bonuses on its deposit levels, not mutual funds. it's the same struggle in almost any organization.

Q.: So as long as you have Glass-Steagall, you can't have a complete merger. And as long as you don't have a complete merger, there will be conflicts.

LIPPER: But even if Glass-Steagall went away, there are still cultural issues. Geoffs already brought up the data processing. Two organizations keep their data differently.

There are different regulatory approaches. The bank regulatory approach is safety and soundness and the investment is disclosure. They're two very different viewpoints.

For the relationship to work, both sides are going to have to be willing to give a great deal. if they do, then there's a reasonable chance.

On the other hand, you must recognize that, while this is happening, the nonbank financial organizations, such as insurance companies, are going to be building banking relationships with their clients.

And most of the nonbanks have historically been stronger marketers than the banks. So that it is conceivable that in the future the banks may want to reerect the Glass-Steagal wall to protect themselves.

Q.: They may decide they like the regulated environment?

LIPPER: Even though they may complain, it's an environment they know. They understand how to play the game.

Q.: On the other hand, you might have a new type of broker evolve, one who is more willing to work for a salary than commissions.

LIPPER: Absolutely. Now the question is, Will the new type of broker be a hybrid? Will he be capable of reproducing?

Q.: What do you mean by that?

LIPPER: The organization may shunt people into this area who are good but not great, who are not moving up the power structure of the parent. When was the last time that somebody from the bond department made it on the board of directors?

Q.: It could become a backwater.

LIPPER: That's right. It doesn't have to be.

Q.: So you're skeptical?

LIPPER: Yeah.

BOBROFF: It's gone to the jury, but the verdict's not in.

Q.: But is it worth a try?

LIPPER: I think there's an essential threat on the banking system that needs to be addressed, either by adopting a securities approach or by developing other techniques.

Q.: How would you like the headline to read: "Lipper Warns About Mutual Funds?"

LIPPER: How about "Cultural Issues Not Solved Yet"? That's all that we're saying. For most banks, the issue hasn't been solved. Deep financial and business analysis is needed. But undoubtedly, some banks will succeed.

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