Without a doubt, we have entered one of those “once-in-a-lifetime” events that seems to occur every 20 years or so. To say that the last three months have been an unusual and historic time in the financial services industry and for our economy is an understatement.  The announcement that the U.S. is officially in recession, while perhaps not news to the man or woman on the street, nonetheless puts a cap on the mood of us all. 

What is apparent is a striking lack of confidence on the part of consumers and businesses.  Chart 1 illustrates the decline in consumer confidence since the summer of 2007.  Levels such as this have never been experienced in the 30+ years that this measure has been tracked. 

This is important because consumer confidence is self-perpetuating.  When confidence sinks to increasingly low levels, consumers (and businesses) will delay or curtail spending, which further negatively impacts the business climate, resulting in more layoffs and more economic bad news.  It becomes a perpetuating cycle.  It may be time to dust off the old bromide: “The only thing we have to fear is …”

Chart 1:  Consumer Confidence Sinks to New Lows

 

There is no doubt that we have severe economic problems which are systemic in nature, but are we in the worst economy since the Great Depression?  Chart 2 illustrates the Misery Index, the combination of the rate of unemployment and the rate of inflation, from 1970 up to the present.  Clearly, at least in 2008, we are nowhere near as “miserable” as were in the 1980s and even early in the 1990s. 

Chart 2:  The Worst Economy Since the Depression?

 

However, other factors are leading to the significant lack of confidence that both businesses and consumers are displaying in regard to our economic situation.  On the one hand, homeowners have seen a significant reduction in the wealth that was assumed to be found in their homes.  Moreover, the declines in the stock market since the autumn of 2008 have been precipitous and have contributed to the severe lack of confidence seen by consumers and businesses.  Chart 3 represents the Dow Jones Industrial Average (DJIA) since 2000.  As the chart illustrates, the market has not been kind to the investor in the decade of the 2000s. 

Chart 3:  Trend in DJIA Since 2000

 

While the vagaries of the business cycle clearly have contributed to our current situation, there is also a new reality at play.  What has occurred in the past 10 to 15 years is a fundamental transfer of risk from institutions – such as the government, large employers and financial institutions – to consumers.  This risk transfer is readily seen in two areas: 

• Consumers bear investment risk in ways they never have before.  This is best seen with the impact of stock market values on a consumer’s 401(k).  Prior to the proliferation of 401(k) programs, most retirement programs were defined benefit plans.  In these plans, investment risk – the impact of a declining stock market, for example – were borne by the plan, not the consumer.  In contrast, in a defined contribution plan such as a 401(k), investment risk is borne by the consumer.  The average consumer has not been provided the financial education or tools to effectively manage this risk.
• Consumers are subject to interest rate risk now more than they have been historically.  The simplest example of this is the shift from fixed-rate mortgages to adjustable-rate mortgages.  Adjustable-rate mortgages lead to variability in payment which, when combined with some of the lending practices seen in this decade, lead to significant foreclosure activity.

The simple fact of the matter is that most consumers are not equipped to manage these risks.  And the financial services industry should admit culpability in this regard.  We have fallen down in our role as the customer’s advocate.

So what does the future hold?  The economy will recover, but our business has changed.  The financial service providers who will survive and prosper will be the ones who understand the new realities and adapt.  These new realities fall into three groups:

1.  The financial services industry needs to get back to basics. 

Historically, we have based our lending decisions on the four Cs:  credit-worthiness, capacity to pay, character and collateral.  Unfortunately, in this decade the first three Cs often were forgotten in our belief that collateral would trump all.  Now that collateral has proved not to be such a sure thing, too many financial institutions have retrenched from lending altogether.  We do not need to back away from lending; we simply need to go back to the way in which we did it in the past.  Just as many of us rehired Cobol programmers in the late ’90s to help us with Y2K, now is the time to rehire those lending officers from the 1990s who were far too conservative for the 2000s!

But the back-to-basics message doesn’t just apply to lending.  It also applies to deposit pricing and many other areas.  Rational pricing on products such as CDs has been hard to find recently, but should find a home in well-managed financial institutions in 2009 and beyond.  Too often we simply follow the leader in pricing, often with deleterious impact. 

Similarly, the industry needs to wean itself from its increasing reliance on non-interest income.  Now I’m not suggesting that non-interest income is a bad thing; I am suggesting that an over-reliance on any one source of income could be disadvantageous in the long run.  We need to develop a more balanced approach to how we make money, incorporating margin management, non-interest income generation, expense control and risk management.

2.  The industry needs to prepare for the next generation of consumers.

Part of the reason we experienced such a dramatic decline in real estate values is that there was a fundamental imbalance between supply and demand.  We continued to build new houses and condos even as the number of buyers declined.

Consider the three most recent “generations” of consumers:

Chart 4:  Size of Generational Segments

 

The reality is that in the last decade we continued to build real estate as though Baby-boomers were buying, when the actual home-buyers were the Gen X-ers.  When the size of the buying group declines by over one-third but the number of homes built continues at the same pace, bad things are likely to happen, and they did.  The good news is that the next generation, the Gen Y group, is almost as large as the Baby-boomer segment, and they are beginning to enter the real estate market.  This should in the long term stabilize real estate values. 

However, it is equally important to understand that the Gen Y generation is fundamentally different than its predecessors.  Our research shows less loyalty to financial institutions.  They are more likely to text than call.  They are also more likely than previous generations to want to start their own business.  They express a strong desire for product customization.  And “green” is not just a color – it is an outlook on life.  All of these factors are the new realities that financial service providers need to take into consideration as they position themselves for the future.

3.  Become the customer’s advocate.

This is a simple concept that often devolves into a platitude.  However, those institutions that become the customer’s advocate are the ones that ultimately are successful.  What is the barometer for determining if you are the customer’s advocate? The determination is simple:  If your success as an institution correlates with the financial success of the customer, then you are the customer’s advocate.   

In this environment, this means educating the customer on the increased risks they face and providing them with the tools to manage that risk.  It also requires an investment in staff.  After all, there is nothing more disconcerting to a customer than a lack of knowledge or concern on the part of a member of your staff.  Third, find ways to proactively help your customers through these times.  You may find it necessary to reduce lines of credit on credit cards or home equity lines, but as much as possible involve the customer in the process and work with them to establish new limits that will allow them to avoid even more financial distress.

In short, make the customer the center of your organization. 

We indeed are at a pivotal time.  Consumer confidence has declined more dramatically in the past 18 months than at any point since the inception of this measure in the 1970s.  There is more uncertainty in the eyes of both consumers and businesses about what the future may hold.  Financial institutions have a responsibility to their customers now more than anytime in recent history.  Those institutions that take this obligation to heart are the ones that most likely will emerge stronger on the other side.

Need ideas, recommendations or solutions for putting the customer at the center of your organization?

Contact RFG for our unique blend of strategic foresight, objective intelligence and technology solutions that enables our clients to gain a competitive advantage.  Call 800.827.3500 or email.

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