Ten questions for Philadelphia Fed President Patrick Harker

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PHILADELPHIA — While the glut of regulation and other changes have spurred bank consolidation over the past decade, particularly among smaller banks, an overlooked problem remains attracting and retaining young people in the industry, according to Patrick Harker, the president of the Federal Reserve Bank of Philadelphia.

In a sit-down interview with American Banker, Harker talked about the challenges facing community banks, including finding successors, the biggest threat to the financial system and the outlook for interest rate hikes through the year.

“I hear this a lot from community bankers, that they're concerned about that next generation of talent that's going to come in to the industry,” Harker said. “In a few cases I've heard people say, ‘I don't have anybody behind me, so I better merge or get acquired.’ ”

Harker, who started his career as a civil engineer before studying economics and later serving as the president of the University of Delaware, also talked about the importance of transportation and infrastructure in improving economic prospects. He cautioned lawmakers and the Trump administration that emphasizing economic growth without tackling those needs would likely lead to short-lived — or even counterproductive — outcomes. And the uncertainty about what policies might emerge from Washington is also acting as a mild damper on the economy, he said.

"One of my colleagues has an interesting phrase for describing the current mood of the economy: 'awkward optimism,' " Harker said. "There's lots of confidence, but that confidence needs to translate into action, and there's still a little bit of hesitation."

The full version of the interview can be found on our podcast here. Following is an edited transcript.

You’re an engineer by training. How did you go from engineering to being the president of the Philadelphia Fed?

PATRICK HARKER: There's a long and short story to it. I started as an engineer; I actually designed the control systems for subway vehicles in New York with a consulting firm. And then as I got more interested in transportation system, I started to realize a lot of the solutions weren't technical in nature but were economic. So I started to do more research on transportation economics and more general microeconomics and spatial economics, which sort of led to a series of projects that eventually took over a research center at the Wharton School on service industries — the first research center in the world devoted to service-sector work. That led me to study banking as one of the service industries, and after a series of steps in academic administration, here I am.

What do see as the strengths and weaknesses of the U.S. banking system?

One of the great strengths of the banking system in the U.S., to begin with, is the diversity of the system itself. We focus a lot on large institutions, but this district in particular is primarily made up of community banks. And community banks are absolutely the bedrock of the communities that they serve.

We have small institutions that understand their local market, understand how to serve that market. For example there's a bank that recently opened up in the district that is serving the Amish community — they understand the needs of the Amish community, which are different than other customers. I think that diversity is really important.

How do you think the banking system has changed since the crisis?

Well clearly, there have been consolidations. Consolidation is due to, I think, a variety of factors. One is the regulatory burden that particularly community banks face. And I think there's a growing consensus that there needs to be relief from that. There's also just technological change that's going on that will continue to drive some of this consolidation as well.

The third thing I hear a lot from bankers is the concern that, particularly in the community banking sector, they don't see their successors — the people behind them. In the old days of the large institutions providing bank training programs that then feed ... the community banking sector with a lot of talent — those things don't exist in the same way, and they changed. Particularly through the recession they've changed. I hear this a lot from community bankers, that they're concerned about that next generation of talent that's going to come into the industry. In a few cases I've heard people say, "I don't have anybody behind me, so I better merge or get acquired." That has nothing to do with regulation; that's really just a factor of talent.

But the No. 1 issue we hear from community banks in particular of concern — and it's a particularly hot issue today given what happened over the weekend — is cybersecurity [and] their inability to attract enough talent in that space. Like many people, they're not alone. Lots of firms are faced with the inability to get the kind of talent they need or want.

You mentioned technology as driving changes in the industry — where do you see that trend going in the future?

First, I think we have to step back when we talk about fintech and not just look at the recent past, but look at the evolution of the industry over a long period of time. Banking has always been deeply immersed in technological innovation and evolution. That's been true for a very very long period of time. So it's just a continuation of that change.

The difference is, and it's not just a banking issue, it's really a broader issue about our innovation ecosystem. It used to be that, Citi [for example] would have a big R&D lab that would develop that technology, that new ATM machine that would then be deployed. Pharma would do the same thing.

What changed is venture capital emerged, and the innovation is now startups being funded by venture capital who create the innovations, and those firms tend to be acquired and subsumed into the ... larger firms. So I think the mechanism for innovation has changed somewhat. Again, that's not just in banking, but it's across the competitive landscape. So what we call fintech today, what we're seeing right now is a lot of fintech firms are partnering up with banks, because the banks have something they don't have, which is expertise in banking and expertise in compliance and other issues.

We seem to be entering an era of deregulation. Is that a good thing?

Yeah, I do think that. First, there's no one-size-fits-all when it comes to regulation. I think systemically important institutions are clearly different from community banks, and we should recognize that in our regulatory frameworks. And we're starting to do that.

I think we tried to do that after the crisis, but after any crisis, it's human nature that the pendulum swings a little too far in one direction. But I think it's natural that it will start to swing back. But as it swings back, we don't want to lose sight of what worked. We had a crisis for a reason, and we want to make sure we don't swing the pendulum too far the other way.

Leaders in the administration and Congress have repeatedly emphasized that policy needs to be optimized for growth — 3% annual GDP is held out a lot as the target. What would it take to reach that level of growth, in your opinion?

Economic growth, by definition, is productivity growth plus the growth of the labor force. Let's start with the former. Productivity growth has been slow for quite a while; there's lots of hypotheses about why that is the case. One hypothesis, one which I am sympathetic to, is that as we shift more and more to a service economy, because manufacturing and agricultural productivity have been so high, so we have fewer and fewer people working in those industries, the next wave of innovation is going to be productivity in services.

We need to continue to focus on the education of our workforce to improve productivity. And that doesn't mean everybody has to go to a four-year college — as a former university president, it's an odd thing for me to say. But I am more and more convinced that other pathways to success need to be emphasized to young people today — whether it's a career in the trades or in other professions.

The second piece is the growth of the labor force. If you look back in history, prior to, say, 2005, the average growth was around 3.5%, about half of that, 1.7% was due to growth in the labor force. Well, we, the boomers, are retiring, and the millennials are coming in, even though the millennial generation is larger than the baby-boom generation. The millennials aren't coming into the workforce in the same way, and that is limiting growth, so in recent years the labor force growth has only been about 0.5%. So if we want to have that kind of growth we're talking about, we need to do things that will enhance infrastructure, education, long-term productivity growth, and we have to think about bringing people off the sidelines more productively into the workforce and potentially more people into the United States into the workforce.

The president mentioned in an interview with The Economist last week that the government may need to “prime the pump” to boost growth. What do you think of that idea, from a monetary-policy perspective?

If priming the pump means a long-term investment in things that will make the economy more productive — again, infrastructure, education and so forth — I'm for that. If it's a short-term stimulus to the economy that doesn't lead to those long-term productivity gains, I'm worried about that, because we are at or below the natural rate of unemployment right now. You look at the job markets, they're very tight, there's very little slack in certain professions. You just look at the higher rate versus the openings, and that gap has been pretty consistent over the last several quarters — or, one could argue, the last several years. Why? Well, there are jobs, but people can't folks with the skills to fill those jobs. So I'm a little worried that short-term stimulus would just create inflationary pressures. I'd rather see a plan for longer-term productivity growth.

What do you think is the biggest threat facing the financial system today?

What I hear from many people is just uncertainty. Not necessarily uncertainty with respect to bank deregulation, it's just not knowing exactly the path we're following.

One of my colleagues has an interesting phrase for describing the current mood of the economy: "awkward optimism." What he means by that is, if you look at all the surveys, whether it's consumer confidence, or business confidence, or whether it's at the national level, or our own manufacturing or nonmanufacturing business outlook — there's lots of confidence. But that confidence needs to translate into action, and there's still a little bit of hesitation. I want to be optimistic, I want to believe that we're going to get, say, tax policy change — but I'll wait. It's not clear which way the path is going, so I'll just wait and see if some of that uncertainty can be resolved before I make my final decision.

That's prudent. I sat on corporate boards before taking this job — that's exactly what the board members would do. So that, when I talk to folks, that's the biggest impediment right now, just not knowing ... where people are going. I'm not saying, because it's not my role to say which direction you go in, it's just a matter of resolving that uncertainty.

Is the FOMC still on track to raise rates three to four times in 2017? Do you expect a hike to come out of the June meeting?

So I had in my projection for this year, three. So I'll just speak for myself, not the committee. We had one, and I anticipate, if we stay on track with respect to at least my view of where the economy is and where it's going, for two more at least. Possibly more, depending on whether we start to see the wage pressures build and translate into inflationary pressures.

I think [June] should be a live meeting, for sure. We'll get more data between now and June. The only issue is the way inflation — where is it going? We're getting mixed signals on that right now. But I remain pretty confident we are close to our 2% target, and that if we don't see a deceleration of inflation but continued growth in inflation, I think June is a distinct possibility.

You launched an initiative last year aimed at improving equal access to financial services and inclusive development. Tell us more about that, and what have been your initial findings?

We call it out Economic Growth and Mobility Project, and it's based on almost two decades of work that we've done here in Philadelphia on a variety of issues. And for over 50 years we've been hosting a systemwide conference on reinventing our communities.

So we've been doing this work for a long time, and it's really in three areas. One is in job creation — what are the best practices that we need to know about communities developing good, sustainable jobs. Second is workforce development — some of what we were talking about earlier concerning not going to college but other pathways to successful careers. And then third is infrastructure.

Job creation, particularly for these old industrial communities, is difficult. And so we're trying to find ways of helping them think through where is their comparative advantage, and how do they build their economy.

Workforce development, we're studying a lot of different models of how people can acquire the skills for this new economy. This is the engineer in me — you're never going to beat a machine at its own game. Being a better robot than a robot is a losing proposition. So what are the skills that we need for a new economy and how can we help highlight best practices around the workforce development area. What are the jobs in America that pay above median wages where you don't need a four-year college degree? We have that broken down by metropolitan areas as well — so we know where they are, we know what the skill sets are, and we're building on that database.

The third area is infrastructure. If somebody has a job for you, and you have the skills for it, but you can't live anywhere near the job or get to the job, you don't have a job. And so you see this play out in places like the [San Francisco] Bay Area, you see this play out in cities like Philadelphia. We're doing some work right now with Scranton, Pennsylvania — a large logistics distribution hub for the Northeast. Low-income people in downtown Scranton, though, can't get those jobs because the transit is all designed like it has been for a century or more, to bring people into the city, not out to those jobs in the suburbs or in the rural areas. So thinking that through, how do you turn that all around, so low-income people who need a job and the companies who need to hire those people and get together and solve this problem.

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Economy Fintech M&A Community banks Policymaking Patrick Harker Federal Reserve FOMC