|The future of money in the information age.Ed.by James A. Dorne|
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THE FINANCIAL SERVICES REVOLUTION
The changing nature of money is only one facet of the financial services revolution. In my remarks, I am going to try to paint a larger canvas to cover some of the other areas where change, I believe, is ahead. As with most revolutions, the spark that lights the tinder that creates the flame really only catalyzes forces that are already under way. Technology is similarly just a catalyst at times for fundamental forces already present. Even some of the greatest technology-led revolutions, or allegedly technology-led, really were only made possible because of trends already present. People claim that the printing press helped Martin Luther initiate the Reformation, but, in fact, all the forces were already present.
Forces behind the Financial Services Revolution
So what are those forces in financial services that are already present and that led to the financial services revolution? I'd start with the consumer, and I'd sight two consumer trends in dealing with the financial environment: complexity and self-reliance.
Thirty to 40 years ago, most financial decisions were fairly simple. Consumers saved money and got their financial services from banks and insurance agents. When consumers saved, they put it into the bank. When they wanted a mortgage, they went to the same bank. Products were simple; if consumers wanted to save money, there was one product they could put it in, their passbook savings. If they wanted to get a mortgage, they pretty much had one choice: the 30 year fixed-rate mortgage. When it came to retirement, they depended on Social Security and their private pensions, which could be expected to cover their needs. Life was pretty simple back then. Today, it's totally different.
Today there are a multitude of financial products and services on the market in the United States. There are so many that just counting the number of companies is complex. Mutual funds were created to make investing easy, so consumers wouldn't have to be burdened with picking individual stocks. All consumers would have to do is give their money to a mutual fund and let the fund managers take care of it. Well, today there are more than 7,000 mutual funds alone to choose from, more than the number of listed stocks on the New York Stock Exchange. At least if you buy a company's stock, like Coca Cola, you kind of know what the company makes. But if you buy an aggressive growth fund, you don't have a clue what is involved unless you understand the fund's prospectus, which is written by some lawyer and is usually opaque. And that's just in the investment realm.
On the borrowing side, it's the same thing. There are all types of loan instruments today. Even the once simple home mortgage now has so many flavors and styles and variations that it is difficult for people to make a decision. Indeed, the products are so complex that not even the financial service companies can reliably know what to recommend. Just imagine the situation for us poor consumers. That's complexity.
The second trend in the financial environment is that consumers have become much more self-reliant. There was a time, as I mentioned, when major financial decisions were not so important, or they were taken care of by other parties. It used to be, for example, that people depended on their children for retirement security. Which is why in many earlier societies people had large families. Then there was the move to putting trust in the government or in company pension plans for retirement security. Well, today people have to be self-reliant if they want a secure retirement income. The current institutionally provided retirement plans will not cover people's needs upon retirement. A whole generation of Americans will retire in poverty instead of prosperity, because they simply are not preparing for retirement now. They are not saving enough and investing in the right ways to provide for retirement. By the time you get to 55 or 60, it's too late. This is not just a problem in the United States, it's a global problem.
Today more people believe in UFOs than believe that Social Security will take care of their retirement. People don't place their trust in government or company pension plans; they have to be self-reliant. Yet it is difficult to be self-reliant because things are so complex.
Changes in the Regulatory Climate
Another trend in the financial environment is the change in the financial services industry itself. A trend that is 16 years old in the United States and is happening in other countries as well. And that's the trend to deregulate and free the financial services industry to behave like any other company on the planet.
It is stunning to look back at the way the U.S. government regulated financial services and still regulates them. The unraveling of that regulation began with the Monetary Control Act of 1980. Before 1980, it was basically illegal for U.S. banks to invent new products. Government, not the market, determined how often withdrawals could be made, the minimum deposits, and even the interest rates on deposits. About the only thing left for banks to do was to put their brand names on products and put their ads on the air. That's how hemmed in by regulation the financial services industry was. However, the tide has been turning toward the free market, and the financial services industry is much freer today than in the past.
Who were the losers under the old regulatory regime? Well, consumers, particularly when interest rates were such that banks were not allowed legally to offer consumers a market rate of interest. When inflation increased in the 1970s, the interest-rate ceiling on bank deposits caused a shift of deposits to nonbank institutions. Banks literally could not do anything about it because it was illegal for them to respond. Consumers lost, and ultimately banks lost too. Fortunately, much of this regulation has been stripped away and further reform is on the way.
The Role of Technology
Now that we have considered some of the fundamental underpinnings of the financial services revolution, where does technology come in?
What's interesting is that the financial services industry is perhaps the largest industry today where the product is already marvelously automated. Now that has not always been true. Fifty years ago wealth was stored and transmitted physically through gold bars, stock certificates, bank notes, and coins. Large physical distribution networks were required to collect and distribute the means of exchange. Today, the financial services industry is digital. Wealth is no longer stored in physical means, it's stored as bits on mainframe disk drives and transferred electronically. In fact, the largest consumers of mainframe computing power in the world have always been financial institutions. And that's because the factory for financial institutions is essentially the mainframe computer. That's where they make their product.
Now what's interesting is that even though the back ends of financial institutions are wonderfully automated, the front ends are not. The consumer interface is not. Instead, computers and consumers are insulated from each other and separated from each other by a layer of old stuff. The old stuff being physical branches with tellers, telephones, and managers. Personal contact is very good, but consumers often have no direct access to their accounts. What's amazing is that you often have people looking at computer screens and telling the person on the phone what's on the screen. But why should we have bank employees looking at computer screens when bank customers could do the same thing at home and at lower cost?
Here's another interesting observation. If you survey Americans and ask them when they most want to buy financial products and make financial decisions--such as refinancing their mortgages and investing in mutual funds--most working Americans will say at night and on weekends. Indeed, mutual funds that operate 24 hours a day, 7 days a week are finding that the majority of their business comes in during nights and weekends. But when are banks closed? Nights and weekends, with some exceptions on Saturday. Isn't it odd that we have an immensely expensive distribution structure in this country that is closed the very hours customers most want to buy things? Now, it's not that bankers are bad, it's just that the branch system of distribution is so expensive that if banks were to stay open for two shifts, they would go out of business. Again, this illustrates the mismatch between the nature of the product and the nature of consumer demand, and the old stuff in the middle.
Another example of inefficiency is business use of the U.S. postal system. Businesses still use that system heavily for marketing their products. In 1996, there were more than two billion credit card solicitations sent in the mail, even though the response rate on most direct mail pieces is only about 2 percent. A response rate of 3 percent is considered a success. But a 3 percent response rate means 97 percent waste! Can you believe that U.S. businesses spend billions of dollars in mass marketing every year for something that fails 97 percent of the time? The explanation is simple. Mass marketing is when the marketer sells what the marketer wants, when and where the marketer wants to. What's left out is the consumer. So of course it's mostly waste, because most of the time businesses are selling products that consumers don't want.
Technology can make tremendous changes in slashing the costs of marketing and distribution. Technology will make it far more efficient and far more convenient for the consumer. Instead of finding out weeks later that there was an overcharge or some mischarge on your credit card, you can find out within hours if you wish to. Similarly, computer technology will lower costs and increase convenience, allowing people to shop 24 hours a day, 7 days a week from their homes.
But the benefits of technology go beyond just lowering costs and increasing convenience. Let's take the retirement planning problem, for example. Today only a small percentage of Americans can actually afford a real live, unbiased, fair financial planner to help with retirement. Less than 4 percent of the population will pay the thousands of dollars that it takes for a real financial planner to do the job right. So, instead, most people rely on either books or on persons whose business cards say financial planner but who are actually paid through commissions from insurance companies or brokers. In fact, the most frequently consulted financial experts in the country are insurance agents. And while many of those individuals are straightforward, honest, square-shooting people who are looking out for their customers' best interests, there are some who are merely trying to maximize their commissions or win a trip. Unfortunately, consumers often cannot tell which type of person they are dealing with. Moreover, retirement planning is so complex that most people can't do it out of a book. There has to be a better way.
Banks and others have tried to hire legitimate financial planners to help their customers, but the costs are murderous. What Intuit and other companies are doing is trying to use computer technology to lower the costs of financial planning and help consumers. Intuit's Quicken Financial Planner, which we started selling in 1995, guides our customers through a two-hour interview. The program asks questions intended to build an understanding of our customers' financial situations. Quicken asks people about their income, age, retirement plans, expenses, investments, and current retirement benefits. Quicken then presents a graphic analysis of our customers' financial situations and indicates whether they have enough money or whether in some year in the future, before they are likely to die, their money runs out. Our customers can then play ``what-ifs'' to see what they have to change to become financially secure in their retirement. Quicken also helps customers figure out how to invest their money. Intuit doesn't make specific recommendations, that's not our job. What we help with is portfolio allocation so that people can get the types of returns that they are going to need over a long period.
This financial service will expand the ability of many Americans to plan for their future. Roughly a third of U.S. households already have computers, and Quicken runs on any standard personal computer with Windows. Interestingly, if people get stuck, or want advice, Intuit has included video clips of financial columnist Jane Bryant Quinn, which appear at each point where a customer might have a question. Quinn will explain the topic and give her opinion on what makes sense. In this way computers can help people improve their decision making so that they can deal with the complexity of the financial system, become self-reliant, and achieve good results instead of disappointment and failure.
Quicken is just the start of a flourishing of using the computer to help people make smarter decisions about their finances, whether planning for retirement or financing their children's college education. There are many people working on this new financial software. What Intuit is doing is not unique. We have a lot of competition from firms of all sorts. Competition is fierce, and both the consumer and the efficiency of the marketplace will benefit.
The Role of Government
Another issue related to the financial services revolution is the issue of government involvement in the industry as there is greater acceptance and demand for electronic commerce. A set of governmental consumer safeguards is now in place, but over time those regulations and laws will need updating to deal with an environment that now has a computer link as opposed to just a paper link. And this process is already occurring.
The Federal Reserve Board recently proposed amendments to Regulation E that would permit financial institutions to give, to those consumers who desired it, the required documentation and advice documents electronically, instead of by paper. This regulatory change is not only better because it lowers costs and increases convenience, it's better because businesses can get their messages to customers faster. This increased efficiency, in fact, should be the sole goal of regulation.
In addition, the Fed has proposed changes to preauthorized electronic funds transfers, and the SEC has just recently modified its rules to allow electronic delivery of some of the disclosure documents such as prospectuses. Intuit's Web site is using that rule to allow mutual fund companies to sell mutual funds and distribute prospectuses electronically on-line. Consumers benefit because they can gather information more easily on mutual funds and mutual-fund alternatives.
The Future of Financial Services
Let me now address the topic of money. All of the financial services that I have already discussed work within the existing system of money and banking. In fact, I am reasonably happy with banks running the payments system. Intuit makes heavy use of the existing payments system and is not trying to invent a new one. That's not our business. Instead, we're trying to improve consumers' access to the financial system by allowing them more freedom to move their own money around.
Although money and payment systems embody technology, they are first and foremost social conventions. When Marco Polo visited China, he was most amazed by the widespread use of paper money. In the West, however, it was unimaginable that anyone would trust slips of paper to be valuable. There was a social convention in China that was absent in the West. Today there is a global social convention that causes most people to believe that chunks of plastic and pieces of check paper are valuable. This change only reinforces the idea that payment systems, like languages, are methods of communication between large groups of people.
As a result of being a social convention, payment systems have great inertia; they do not change rapidly. This slowness of change is not due to technical reasons but to human inertia. For example, even after using electronic payments technology for decades, people still pay for the bulk of things with paper checks. (Over the 1994-95 period, the increase in the number of checks written each year was greater than the total number of consumer electronic bill payments in 1995.) I believe that new payment systems not only emerge slowly, but only when certain, rather strict, conditions exist.
Innovation in the payments system often occurs in small steps rather than in radical leaps. If an existing payments system can be modified so that it can deliver new benefits sought by consumers, it will likely be the winning form of providing the new benefits. So perhaps the best place to look for many of the new payment systems is to look at the existing system and consider how it can be modified to deliver benefits that people sometimes think can only be delivered through radically new systems. I would point here to the modifications being made to the credit-card system (led by Visa, MasterCard, Microsoft, AmEx, and Netscape) that will allow people to secure on-line credit card transactions. Once that system is in place, I think it will become very popular and become the predominant payments system. In part, because it doesn't have to solve the chicken-and-egg problem that bedevils new payment systems.
In conclusion, the biggest benefit of the new technology is that it will improve efficiency in the current payments system. It will do so by lowering costs, increasing convenience, and allowing people to use their current financial products and services more wisely and more conveniently. Electronification, all the way to the consumer and small business, will enable the invention of new kinds of financial services that have never been comprehended before--things that could not exist without the ubiquitous electronic channel. I do not know what those products will be, but I do know that they will be forthcoming and of true value to consumers.
Intuit is working with other companies to push for those innovations, which will be as important as credit cards and money market funds were when they first appeared in the marketplace. I believe we are entering a period of one or two decades of marvelous invention and creativity that will change the financial services universe.