The Savings Revolution
By Edward E. Scharff
Moneymen offer investors new ways to keep cash and earn high interest
20% annual interest--Trust Deeds Safely Secured... 18% United States Government Guaranteed Securities ... $3,000 earns 15.086% per year for 26 weeks ... 15% interest on as little as $1,000. No risks. No penalties. No fees.
Those are some of the advertisements that try to attract Americans these days, in newspapers and bank windows, as well as on television and billboards. People are being swamped with offers for investment opportunities, and savvy consumers are now flocking to newly popular savings devices, including negotiable order of withdrawal (NOW) accounts, money-market funds, certificates of deposit, commercial paper and U.S. Treasury bills.
A savings revolution is sweeping the U.S. Only a decade ago, most people were satisfied to put any money left over from the family budget into a savings account at the bank, where it earned 4.5% interest; into a checking account, where it earned no interest at all; and perhaps into a few safe stocks. But today millions of people are taking money out of those traditional savings havens and putting it into accounts that often earn a return of as much as 17%. Says Walter Wriston, chairman of New York's Citibank: "Americans are not stupid. They have been seeking a better return on their money and getting it."
This year $43 billion has poured out of banks, savings and loans, insurance companies and other investments into money-market funds and various new accounts. In the month of April alone, savings and loans had a record $4.6 billion net loss in deposits.
The transfusion of cash into new institutions is putting severe strains on some older ones. An estimated 90% of the 4,560 savings and loans are now losing money. Industry Analyst Jonathan E. Gray of Sanford C. Bernstein & Co. warns that, if interest rates do not abate, perhaps as many as one-third of them will close down in the next five years. Two weeks ago, the Economy Savings and Loan Association of Chicago became the first federally chartered institution to fail in a decade. Many other S and Ls will be forced to merge, as the stronger take over the weak. Last year 142 mergers took place among savings and loans, as compared with only 42 in 1979. Seventy more have occurred so far this year. Says George Salem, an analyst with Bache Halsey Stuart Shields: "S and Ls are in a state of shock from which they may never recover."
The financial jitteriness is even being felt in the Oval Office. American moneymen in past weeks have been voicing skepticism about the Reagan Administration's tax cut plans and consequently bidding up interest rates. Last week the President said that the financial markets were misjudging his plans, adding: "I have never found that Wall Street is a source of good economic advice."
American banks, those stately citadels of stability, are going through an upheaval. A few, like New York's Bankers Trust, have virtually gone out of consumer banking and now lend money almost exclusively to businesses. California's Bank of America and others have instituted heavy minimum deposits and stiff fees on small accounts. Still others, like New York's Citibank, are aggressively trying to win new customers through improved services and bank-at-home computer terminals.
While old savings institutions are struggling to cope, the new money hybrid of the future is rapidly materializing. Neither a simple savings and loan nor a conventional bank, it is a combination bank, insurance company, brokerage firm and credit-card company. The mergers in recent months of the Prudential Insurance Co. with Wall Street's Bache Group Inc. and American Express with the Shearson Loeb Rhoades brokerage firm provide a glimpse of the shape of things to come in finance. With the help of computers, plastic credit cards and toll-free long-distance phone calls, these money supermarkets are carrying out perhaps the most significant change in the way people handle money since Marco Polo discovered the Chinese using paper currency in the 12th century.
No company looms larger in this new arena of financial services than Merrill Lynch & Co., the world's largest brokerage house (1980 sales: $3 billion). As an example of the financial shopping center of the future, Merrill Lynch, in addition to selling its traditional stocks and bonds, will provide customers with money-market funds, sell them life insurance, buy or sell their homes, and lend them money. Says an admiring Samuel H. Armacost, president of Bank of America: "We've already got the nationwide banking of the future. It's called Merrill Lynch."
The reasons for the upheaval in personal finance are not hard to pinpoint: double-digit inflation and high taxes. There are almost no savings instruments that pay interest high enough to offset their ill effects. "When inflation gets into double digits, you have to do something or else lose the race," says George Sullivan, an IBM executive in Denver, who has switched most of his cash from a bank to a money-market fund. Assuming 10% inflation, someone in the 50% tax bracket would now have to get 20% interest on his savings just to break even.
Until the 1970s, an after-taxes annual return of 1% to 2% on passbook savings was considered to be about normal. The trouble began in the mid-1960s, when inflation rose from 1% to 5%. In 1965, when thrifts were paying up to 4 3/4%, a family earning the national average of $7,704 and with a nest egg of about $3,500 in the bank would have realized an annual return of about $80 after inflation and federal taxes were taken into account. By 1967 inflation and taxes had reduced the gain to zero. In the year 1970, that same average family would have lost $110; and in 1979 it would have lost $830. "Just like money in the bank" no longer meant certainty and stability. Now savings were like a sand castle, slowly being washed away by wave after wave of inflation.
Until recently, most people had two choices: they could put their money into regular savings accounts, where its value eroded at a frightening rate, or they could spend it. Most chose to spend it. The result: frugal Americans have become spendthrifts. The savings rate dropped from 8% in 1970 to the present 4.7%. By contrast, the West Germans put away 13.5% of their earnings, and the Japanese save 19.5% of theirs. Among major nations, only the Swedes save less than Americans.
Banks and so-called thrift institutions, which are savings and loan associations and savings banks,* have been able to do very little to stop the hemorrhaging of money out of their vaults, because Government regulations do not let them offer interest rates that can keep up with inflation.
Congress first imposed a limit on bank savings interest in the Banking Act of 1933. The great disparity in interest rates offered by various banks had led to sharp fluctuations in deposits and had hastened the failure of many institutions at the beginning of the Depression. In addition, the act was seen as a way of punishing the banking industry, which was held responsible by much of the public for bringing on the collapse of the financial system. The Federal Reserve's Regulation Q gives the Government the authority to fix the level of interest paid by banks. Thrift institutions are permitted to pay 1/4% more as a way of attracting funds for the home mortgages that they normally provide. At present, banks pay 5 1/4% and thrifts 5 1/2% on passbook accounts.
Until this year, federal regulations prevented banks and thrifts from giving interest on checking accounts, and most thrift institutions could not even offer checking. Finally, Government rules do not permit these financial institutions to run full consumer services outside their home states.
Because of the restraints on traditional savings institutions, new financial services have grown up that will pay higher interest while also providing many banking services like savings and checking accounts or loans. The most significant of these: money-market funds. The first of them was started by the mutual-fund firm Reserve Fund Inc. in 1972. The flexible savings accounts now have more than 6 million shareholders and assets of $117.8 billion.
Money-market funds are massive investment pools run by large brokerage houses or mutual-fund firms, which are not subject to the Government's interest-rate laws. The fund managers buy high-interest, short-term money-market instruments, such as U.S. Treasury bills, commercial paper and bank certificates of deposit. Since the securities mature within 30 days to one year, the funds have a dependable flow of cash for paying off investors who want to withdraw their money.
From the consumer's point of view, a money-market fund is not much different from a checking account. In most cases people can write checks for the monthly mortgage payment or for college tuition against an account, though some funds require that checks be written for a minimum of $500. The great attraction, of course, is the high interest, which last week averaged about 16%. Says Houston Attorney Clarence West: "My money-market fund pays three times as much as a savings account would, and I can get my money out with no penalty." Adds Anne Chambers, a New York television producer: "When interest rates hit 13%, I decided to join the money funds."
Some bankers warn that leaving cash in money-market funds is dangerous because, unlike savings accounts, they are not insured by the Federal Government. In fact, money-market funds are quite safe. Their portfolios are usually due to mature in less than one month and include issues from some of the soundest corporations and the Federal Government. Says William Donoghue, author of a bestselling guide to money markets: "Probably the worst possible loss in the highly unlikely event of a problem with a money fund would be 1%. With doubledigit inflation, you've got a guaranteed loss of at least 5% in your passbook. So what are you worried about?"
Many other financial institutions are also moving into areas that once were the private domain of banks and thrifts. Sears, Roebuck, the largest retailer in the U.S., has become one of the largest lenders. The company has more than $7 billion in outstanding consumer credit, and it plans to move even more deeply into finance. It already owns the Allstate Insurance Co., and it has been buying small S and Ls in California to form the Allstate Savings & Loan, which is now the tenth largest in the state, with assets of $3 billion. Within the next few years, it also wants to offer customers tax-counseling services like those of H & R Block, as well as money-market funds and mutual stock funds, as Merrill Lynch does. Says Preston Martin, chairman of Seraco, the Sears real estate financial division: "In order to compete in the '80s, we're going to have to provide all the financial services our customers need."
The automobile industry has long helped consumers bypass the banks by lending money to car buyers through General Motors Acceptance Corp. and the other corporate credit companies. Now others are emulating them. General Electric has become the largest issuer of loans for the purchase of mobile homes. And firms are being established to provide other banking services. Comdata Network, a Nashville firm, has set up a nationwide money transfer service at most gambling casinos and gas stations along interstate highways.
By the end of the decade, banks, savings and loans, insurance companies, investment firms and credit cards will have gone through so wide-ranging a transformation that they will be hard to recognize. Says Merrill Lynch Chairman Roger E. Birk: "Sooner or later, somebody may have to redefine the word banking."
Whether or not they change their names, banks will be under tremendous pressure during the next few years. While a majority of individuals and businesses still do more of their financial transactions at a bank than at any other money institution, the role of banks is quickly eroding. About 30 years ago, banks held 57% of American financial assets; now they hold 37%. Ten years ago, six of the ten largest banks in the world were American. Only the Citibank and Bank of America companies are still among the biggest.
Some consumers are undoubtedly abandoning their local banks because of what they consider to be rude or indifferent service or hard-to-correct computer errors. In California, class-action suits have been filed against six leading banks on the grounds that they are gouging customers by charging up to $10 for handling checks drawn on insufficient funds. Some claim that the service actually costs the banks less than $1 a check. Many bank customers have learned that the old financial catchall, "The check is in the mail," has been replaced by a new one, "The computer lost your deposit."
The first reaction in banking circles to the new competition has been greater specialization. Says James Alef, a vice president of the First National Bank of Chicago: "It is increasingly difficult for a bank to be all things to all people." Many of the larger banks have decided to reduce their consumer business. The $50.6 billion Morgan Guaranty Trust Co. did not abandon its retail clients completely; it simply instituted a $60 monthly fee on checking accounts with balances of less than $5,000, a quick way of brushing aside all but the well off.
Some banks, on the other hand, have decided to go after consumer business and de-emphasize the corporate side of finance. The most innovative of these is Citibank, which has sunk $225 million into new consumer technology. It has installed 468 automated-teller machines that now dot the streets of New York City like so many telephone booths. The new tellers can take deposits, issue cash and transfer funds from a savings account to checking. The machines already handle about 30% of the bank's consumer business at one-half the cost of transactions handled by human tellers. Says Bank Chairman Wriston: "People love them. The machines are polite, bilingual in English and Spanish, and are available 24 hours a day, without coffee breaks."
Citibank's foray into the future goes beyond automatic tellers. This month a hundred Citibank customers in the New York City borough of Queens will give up their checkbooks in favor of small computer terminals installed by the bank in their homes. These desktop devices will enable customers to electronically pay their bills or rent, stop payment on a previously paid bill, take out a loan, open a new savings account or check on the balance of an existing one.
The bank is also promoting a new way of making a cash withdrawal. Customers telephone a designated number, give a code word like "hot dog," and traveler's checks with a perfect electronic copy of the customer's signature are sent out. The checks are insured against loss or theft, and the bank believes that they will soon be as popular as cash.
Such innovations are not limited to the major financial centers. The United American Bank in Knoxville, Tenn., in a joint venture with Radio Shack, is offering home banking as part of a private computer service. Customers can pay bills, study current interest rates and apply for a loan from their living room or den. Under one option, checks are no longer mailed back to people but are classified by family-budget category and then stored. At the end of the year the bank provides a handy accounting of all money spent for mortgage payments, education, charitable contributions and other budget items.
Many bankers argue, however, that they will not be able to survive the tough new competition from other financial institutions unless the Government lifts the regulations that limit the amount of interest they can pay and the areas where they can do business. Says Bruce M. Rockwell, chairman of the Colorado National Bank in Denver: "If the banks are not given more freedom, there will be a serious erosion in the industry. We can't go on this way without major consequences."
The Depository Institutions Deregulation and Monetary Control Act of 1980 has already started removing some of these constraints. During the next five years, the ceilings on interest that banks can pay on savings accounts will be abolished. The act has also permitted the nationwide establishment this year of NOW accounts, which pay 5 1/4% interest on checking. Some $48.5 billion has been deposited in the NOW accounts since Dec. 31,1980.
Even before these reforms, banks were trying to attract new savers with a variety of high-yielding time deposits and money-market certificates. These give much more interest than a passbook account; last week a six-month certificate paid 15.9%. But they usually require that the depositor keep his money in an account for six months or longer in order to earn the full interest.
A more controversial proposal would permit banks and thrift institutions to do business in more than one state. The U.S. has more banks (14,500) than all the rest of the world combined. The tradition of many small, local banks goes back to frontier days, when a bank was one of the pillars of a new community. Bankers say, though, that regulations limiting them to one state are now an anachronism.
Citibank is already preparing for nationwide banking. It has put its VISA and MasterCard into the pockets of 5 million customers throughout the U.S. and is moving its credit-card operation to Sioux Falls, S. Dak., where it is free from any restrictions on what interest rate it can charge. Regional banks, such as North Carolina National, and Citizens & Southern in Atlanta, also want the right to expand across state boundaries and are promoting a law that would permit them to do banking in nearby states.
Many banks, however, do not want outsiders in their markets. Says Charles N. Brewer, president of Dallas' Reunion Bank: "When the large East and West Coast banks get down here, they might drain off our resources to make their international loans."
The fear that the giants will put all small banks out of business may be unfounded. Small bankers in New York State were troubled in 1976, when New York City banks were allowed to establish branches upstate. But most of the small banks easily stood up to the guys from the big city because they knew their community and clients far better than someone from outside. In Sioux Falls, Citibank will offer other banking services besides its credit cards, but the local First National Bank is not worried, even though it has assets of only $172 million, compared with Citibank's $116.5 billion. First National Chairman William S. Baker III says confidently, "The ace up our sleeve is customer loyalty, and we have greater flexibility than the big corporate banks."
Sam C. Smith, 33, president of the $ 15 million Bartow County Bank in Cartersville, Ga., says he is not concerned that big money managers will take away his business. Like many small, rural bankers, Smith borrows low and lends low to customers he knows. He can keep his rate below the rate of other banks because 35% of his deposits are in non-interest-bearing checking accounts, and 10% are in 5 1/4%-interest passbook accounts. Last winter another nearby bank installed an automated-teller machine, but Smith notes that it is hardly ever used. Says he: "What all this is telling me is that you can do a lot of things to push around figures, but you can't change human nature that easily."
Most banks remain relatively stable because of their large amount of business lending, which is normally tied to the fluctuating prime rate. But savings and loans and other institutions specializing in fixed-rate mortgages are in serious trouble. Two-thirds of all home loans on the books of S and Ls carry rates of 10% or less, though the thrifts have to pay 15% and more for new money. Says Analyst Gray: "In New York the thrifts are 20 feet under water; in other states it might be only five feet. But they're all under water."
Congress and the financial community are currently considering a variety of ways to help thrift institutions. The result, in any case, will certainly be a reduction in their number during the next few years. The lucky savings and loans may be like the Count of Sieyes, who, when asked what he did during the French Revolution's Reign of Terror, gave the legendary reply: "I survived."
Once freed from the burden of regulations, the more prosperous thrift institutions are likely to emerge as full-service family financial centers, offering everything from money-market funds to credit cards. The best-run savings and loan associations are financially very sound and will prosper in the new, freer money market. Says Richard H. Deihl, president of Home Savings & Loan in Los Angeles, the largest in the U.S.: "There will always be room for a variety of financial institutions. Some will make loans to industrialize the forests of Brazil; others will lend money to people to buy houses."
One of the cornerstones of personal financial planning used to be a life insurance policy, but it, too, is changing under the battering of inflation. The meager 4% annual interest such policies can pay is even lower than the 5 1/4% earned on a bank savings account. Millions of Americans have now shied away from so-called whole life policies that combine insurance with savings. Instead, they are taking out less expensive term policies that have no investment value and provide death benefits for only a limited time.
In addition, consumers have discovered that they can recover part of the money they have spent on life insurance in the past by borrowing against the cash value of those policies at bargain interest rates as low as 5%. The borrowed funds can then be reinvested in a money-market fund, Treasury bills or six-month bank certificates at far higher yields. The amount of funds borrowed against old insurance policies has now swelled to $43 billion.
The $432 billion life insurance industry is trying to fight back with a host of new financial services. Many firms have introduced a variety of new policies with greater investment flexibility and higher interest rates. Equitable Life Assurance, for example, is now offering a money-market fund for policy holders. Earlier this year, Prudential Insurance Co. jumped to set up its own broad-based financial firm by buying Wall Street's Bache Group, the sixth largest American brokerage house, for $385 million. The companies are already working on new financial products that can be sold jointly by insurance agents and stockbrokers. Says Prudential Chairman Robert A. Beck: "Acquiring Bache is a significant step in our plan to offer a broad range of financial services."
While banks, savings and loan associations and insurance companies have been retreating, brokerage houses like Merrill Lynch, Bache, and Shearson have assumed unprecedented importance in personal finance, and are now leading the drive toward new forms of saving. Unhindered by the restrictions on the amount of interest they can pay or where they can do business, brokerage houses operate many of the largest money-market funds.
The success of the brokerage houses in popularizing these new financial products has made them a tempting target for takeover. American Express acquired Shearson, the second largest American brokerage firm, in order to establish its one-stop financial shopping center. American Express Chairman James D. Robinson III and Shearson Chairman Sanford I. Weill are already drawing up plans to introduce accounts modeled after Merrill Lynch's popular interest-bearing checking accounts.
Although the brokerage houses are now some of the most attractive players in the money game, less than a decade ago they were in disarray. After the stock market collapse of the early '70s, more than 5 million investors left Wall Street, and brokerage-house profits tumbled from $915 million in 1971 to $43 million in 1973. The result was a vast merger of firms, as poorly managed houses were taken over by stronger ones. The number of brokerage firms belonging to the New York Stock Exchange decreased by 18% between 1971 and 1977. Fixed-rate stock commissions were eliminated in 1975. The resulting competition led brokers to offer other services, including real estate, money-market funds and tax shelters. It was their very weakness in the 1970s that has led to their strength today.
Mutual-fund companies like T. Rowe Price Associates in Baltimore and Fidelity Management & Research in Boston have also played an important role in the growth of financial services. These firms have long given moderate-income families the possibility of investing small amounts to buy shares of companies doing business in anything from natural resources to high technology. Now the mutual-fund companies have also become a major source of money-market funds, which they often offer with minimum deposits of $1,000.
Meanwhile, the passion for plastic money continues to grow, and the credit-card firms are moving to expand their range of products. Some 125 million Americans now have MasterCard, VISA or both. These little cards can be used to buy a tank of gasoline or to help make a down payment on a house. Both MasterCard and VISA have introduced the debit card, which operates much like a check. Instead of being billed for the cost of purchases, the customer has the amount automatically deducted from his bank account.
American Express is the blue chip of the credit-card industry; some 6.7 million people in the U.S. pay an annual $35 fee in order to carry its card in their wallets or purses. The company also owns Fireman's Fund Insurance (1980 sales: $3 billion) and has a 50% interest in a cable-television subsidiary of Warner Communications, which it plans to use for experiments in home banking. The merger with Shearson may give American Express a range of financial products second only to Merrill Lynch's.
American Express's bold deal on Wall Street has spurred rival VISA to new money ventures. The company is reportedly planning to pay interest to people who deposit money in their card accounts. It is uncertain, though, whether the Federal Reserve will allow that, since it would be a savings account in all but name. Says VISA Chairman Dee W. Hock: "We're going head-to-head with American Express. They've got a virtual monopoly in some areas, and we're going to take them on."
American financial institutions from the neighborhood savings and loan to Wall Street stock brokerage firms have now entered a battle for the $1.1 trillion that consumers currently have on deposit. And the fight will be fierce. Says Merrill Lynch Chairman Birk: "We are now competing against major securities firms, banks, credit-card companies and insurance companies. This is going to be one big, competitive assault. The pace of change will become even more rapid in the next five years, and the lines between the various financial institutions more blurred."
As money-market funds and other high-interest accounts have grown, there has been strong political pressure to control their expansion as a means of helping the beleaguered banks and thrift institutions. Several bills have already been introduced in Congress to regulate the money-market funds as though they were banks. Such attempts have failed, so far, to win much support.
The far better approach to helping the troubled financial institutions is to remove the remaining sinews of regulation so that all money managers can compete equally. This would open the way for strong nationwide banking and healthy competitive savings and loans. Says George LeMaistre, a former chairman of the Federal Deposit Insurance Corporation and now a professor of banking at the University of Alabama: "Congress shouldn't put the clamps on Merrill Lynch. The only logical answer is to free up the banks."
Savings are a vital part of the healthy functioning of an economy. The money deposited in a savings, checking or money-market fund account provides the capital that permits companies to build new factories, create new jobs and foster new prosperity. Recent inflation has undoubtedly created an attitude of buy today and save tomorrow. But the very low American level of saving has also been caused by backward financial institutions and restrictive Government regulation.
Ultimately, the clear winner of the financial revolution will be the public. Americans have not really forgotten the lessons of thrift and hard work; rather, they have learned that 5 1/4% interest at a time of 10% inflation is simply a bad deal. Merrill Lynch and the other innovative leaders of personal finance have shown that people will still put money aside when they are given a real reward for saving.
--By EdwardE. Scharff.
Reported by Michael Moritz/Los Angeles, Frederick Ungeheuer/New York and other U.S. bureaus
*The 459 mutual savings banks in the U.S. are located mainly in the Northeastern states, and they, like savings and loan associations, specialize in home-finance lending.
With reporting by Reported by Michael Moritz/Los Angeles, Frederick Ungeheuer/New York, other U.S. bureaus
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