Climbing 'Walls of Worry'

BY KENNETH CLINE

Steve Forbes Jr. says the economy—and outlook for financial services—may surprise on the upside.

|SYNOPSIS | Steve Forbes Jr., in an interview, describes challenges facing financial services, such as increasing political/regulatory pressures and the possibility of higher taxes. But he also anticipates that the underlying strengths of the American economy—corporate profitability and job growth—will produce a stronger economy than many expect. He also expects retiring baby boomers to help support continuing long-term demand for financial services.

Bank executives, like investors, sometimes "climb walls of worry" as they attempt to steer their institutions to a brighter future. And the list of things to worry about this year is certainly long: interest rates, inflation, real estate downturn, a slowing economy, terrorism, increasing regulatory pressures and an uncertain political environment.

But two-time presidential candidate and business magazine publisher Steve Forbes Jr. takes an optimistic perspective on these issues. In a recent interview with BAI's Banking Strategies, Forbes asserts that the underlying 'fundamentals,' the strengths of the American economy, will help financial institutions navigate through this sea of troubles. The real estate correction, for example, is unlikely to turn into a true collapse as long as job growth remains strong and retiring baby boomers will support continuing long-term demand for financial services, he says.

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Forbes will share more of his insights on stage in November at BAI's Retail Delivery Conference & Expo, where he will moderate a panel on 'Predictions for Profitability and Challenges' facing the financial services industry in 2008.

Q: What do you see as the major challenges ahead for financial services in the coming years?

Forbes: There will be several. One has to do with the controversy over many equity fund owners and managers reaping billions of dollars and the possibility of retaliation in the form of punitive taxation and regulation. There's the feeling in the minds of some politicians that the financial services sector is not like other businesses, such as software, trucking or highway construction. Politicians don't have a proper appreciation for the critical role financial services plays in the economy.

Closely related to this is the issue of taxation, both as it affects the broad-based industry and in terms of what kind of taxation we'll have, especially after the elections when the Bush tax cuts come up for renewal. We will have to deal with the death tax because it expires in 2010 and is then reinstituted in 2011.

Another issue is that of privacy. These are some of the upcoming challenges. There's nothing new here, but these issues do take on urgency from time to time.

Q: Of course, nobody can predict what will happen in the coming elections, but do you think the political long-term trend may be more negative toward financial services than in recent years?

Forbes: The financial services industry may suffer what in warfare is called 'collateral damage' from other issues, like income inequality. In terms of 2008, what happens in the area of taxation and elsewhere will obviously greatly depend on who wins.

I think, to be blunt, that the Republicans have more understanding of tax incentives. So far, many of the Democratic candidates, with the exception of Bill Richardson, have not exhibited a similar understanding.

The thing that's going to help financial services is that, on the personal side, there are the baby boomers who are going to be demanding more and more services. And on the institutional side, the growth of pension assets will also generate demand for more of those services.

Q: Looking beyond the political horizon, we have some worrisome macro-economic trends such as inflation, a real estate correction, the slowing economy, etc. Looking over those trends, do you have any thoughts about which may impact financial institutions the most?

Forbes: Let's start with the general economy. I think the economy is going to turn out to be stronger than some of the general media and some of the economic experts indicate. I think this year we'll see a very good second half, probably with rates in excess of 3% real growth.

The fundamentals are there. Corporations are very liquid, consumer jobs are still being created and incomes are still rising. Even though there is a housing slump, corporate balance sheets are still fairly strong. So I don't see a real economic slowdown on the immediate horizon.

Concerning monetary policy, which obviously affects interest rates, particularly short-term, the Federal Reserve still has too much liquidity out in the economy. You can see it in commodity prices, particularly in the price of gold. So I think we should be prepared mentally for rising short-term interest rates, perhaps a few basis points or more in the next few quarters.

Q: Speaking of interest rates, banks are really struggling right now with a narrow interest margin, the gap between what they pay for deposits and the rate at which they lend the money back out. Any thoughts on how long that situation will persist?

Forbes: I think that for at least the next two quarters this is going to be a problem. The reason is in the way the Fed runs itself—which is the same as most central banks run themselves. The Fed tries to guess the right interest rate and hopes the target is the correct one to achieve whatever goals it has in mind.

What I think it should do, however, is to let short-term interest rates float and focus on broad commodity averages. This would bring stability to the dollar, which is better than the hit-or-miss approach of trying to guess interest rates. Let the market tell us what the rate should be.

Q: In terms of real estate, do we face a real crisis or just a correction? How much worse can it get?

Forbes: There will still be some shakeout in real estate, as Bear Stearns recently demonstrated with its two troubled hedge funds. As for housing, I think there will, obviously, be a pause in new construction. But the demographics and other fundamentals that favor housing will continue.

If you're a buyer, this is going to be a very good market for you in the short term. I think that housing sales, especially as people go bargain-hunting in the next 12 months, are going to be respectable. It may take a year-and-a-half or so to work off excess inventories. But there will be no general collapse in the long-term demographic demand for housing.

Q: Which should support the overall market?

Forbes: It should, and since there's still plenty of liquidity out there, I don't at all foresee a high tech-like crash in the housing sector. Certain companies will go down, but overall I don't think we're going to have a collapse.

Q: So overall, your outlook is relatively optimistic?

Forbes: It's going to be an environment in which banks should do okay.

For example, as I mentioned, I think the economy in the second half of this year is going to be above expectations. It brings to mind the phrase about bull markets: 'climbing the walls of worry.' Everyone knows the problems are out there. That gives us the possibility of the markets rising higher because the bad news is, in effect, already baked in. I just hope policy makers take to heart the Hippocratic Oath: Don't harm the patient.

Q: You will be speaking at BAI's Retail Delivery Conference & Expo in November. Any final thoughts about retail banking in the United States?

Forbes: I think one of the amazing things is that with the rise of technology, you're seeing an increase in the demand for banking services. Once you are able to, in effect, bring technology to bear on a lot of basic banking services, it simply increases people's appetite for other services. So, especially as the baby boomers age, I think you're going to see more demand. In New York City, for example, there are more bank branches around than ever before.