Hamilton Financial Index 2012 Teleconference Transcript

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The Partnership for a Secure Financial Future

Release of July 2012 Hamilton Financial Index

July 16, 2012

10:30 am ET

Coordinator: Ladies and gentlemen, thank you for joining the Partnership for a Secure

Financial Future and Hamilton Place Strategies for the release of the Second

Hamilton Financial Index.

The report is released twice annually in advance of the Fed Chairman’s

Humphrey-Hawkins testimony before Congress. On today’s call, our speakers

will release the results of the index report on the current health of the financial

services industry. They will also provide analysis of the European debt crisis

and the impending fiscal cliff.

Before I turn the call over to your host, please note that all telephone

participants are in listen-only mode at this time. Later we will conduct the

question-and-answer session where you will be given the opportunity to ask

questions about today’s discussion. If you have not received the report, please

visit www.ourfinancialfuture.com to download a copy.

If you should require assistance during the call, please press star 0.

http://www.ourfinancialfuture.com/

http://www.ourfinancialfuture.com/



Today’s conference is being recorded. If you do not wish to participate, you

may disconnect at this time.

With that, I will now turn things over to your host, Mr. Steve Bartlett,

President and CEO of the Financial Services Roundtable. Joining Steve are

two of the report authors, Matt McDonald, partner Hamilton Place Strategies,

and Steve McMillin, partner US Policy Metrics.

Mr. Bartlett?

Steve Bartlett: Thank you very much. We are gathered to present the findings of the

Hamilton Financial Index that is a once – every-six-month report on the safety

and strength and soundness of the financial services industry and its effect on

the economy. This also coincides with the second-year anniversary of the

passage of Dodd-Frank.

If you don’t have a copy of the report, you can download it on our Web site,

ourfinancialfuture.com, or just e-mail right now to [email protected], and

we’ll send you a copy of it.

The Partnership for a Secure Financial Future, which is sponsored by The

Financial Services Roundtable and several other trade associates, has

commissioned this report to get the facts to correct myths and to clarify

erroneous assumptions about the industry.

The report - it’s a long report. And we’re going to go into some of the details,

a few of the findings sort of jumped out of me. And then I’ll turn it over to the

authors of the report. And we expect to be concluded by 11 o’clock , including

the questions and answers.



One is that in the financial services industry, safety and soundness is now 22

percent higher than the historical norm as measured by the Hamilton Financial

Index. So that’s Number 1, is the capital levels in safety and soundness are

quite high.

But the second is, we’ve identified a potential risk in the future. It’s not a fact

today, but a risk in the future, and that there’s a tradeoff between capital levels

and lending. That is to say that more is not always better. And in some cases,

too much capital can result in a loss of lending. We don’t find a loss of

lending at this point. But that is a potential negative in the future.

Third, business lending in fact has increased rather dramatically. The current

business loans totaled $2 trillion, which is near an all-time high.

Fourth is we did examine the exposure of the industry in terms of safety and

soundness to Europe and found that US banks have significantly reduced their

exposure to the crisis in Europe.

And then last, and perhaps most important, is we find as we’ve said in the past

that the impending fiscal cliff of the debt limit, tax hikes and sequestration, if

it’s left untended or unresolved, would be the largest fiscal contraction in over

40 years. We find that fiscal cliff, both the reality of it and the threat of it, to

be the highest risk to the economy today by a large amount.

So to discuss those findings in detail, I’m going to turn it over to Matt

McDonald of Hamilton Place Strategies and Steve McMillin of Gramm

Partners, LLC.

Matt?



Matt McDonald: Thank you, Steve. And thank you, everyone, for joining the call today.

The highlights of the HFI, the Hamilton Financial Index, from the fourth

quarter of last year to the first quarter, we saw the index rise. It went up from

1.15 to 1.22. As a reminder, the index is a combination of firm-level risk and

then systemic-level risk. We combine the common capital ratio with the St.

Louis Financial Stress Index to take a look at the whole of the industry to see

how it’s doing. And if you look historically, that index has averaged around 1.

What we see today is that that is up to 1.22. During the worst of the crisis, that

index was down to 0.46.

So what you really see is a dramatic improvement in terms of the safety and

soundness of the industry as demonstrated through the index. And what we

found is that that is actually being driven by higher capital levels at the banks.

So we did a little bit of sense-testing. And in the report, you can read about

this. But we wanted to see given events in Europe, given systemic risks and

what’s out there, what would happen to the index today, the highest point of

Quarter 2 systemic risk, the index would still be at 1.15.

And what we actually found is that for the index to dip below that historical

average of 1 is that financial stress would have to be five times higher than it

was during the second-quarter high. So really we’re looking at a situation

where the systemic risk gets so much lower than what you would need to see,

to see the index dip below its long-term average.

Another piece that we go into is the fact that the high index is being driven by

the higher capital levels raises a question of choice, both for the industry and

for regulators and policymakers. And that choice is the fact that higher capital

levels are not necessarily always a good bank.



So a bank that has 100 percent capital level is not a bank; it is a pile of money

sitting there. And effectively, the capital should be used to balance the risk to

the institutions with the need to grow the economy. And if that balance is out

of whack, if the capital levels are too high, then the banking system won’t be

supporting the economy the way that it needs it.

In the value section of the report, we actually explore whether that is the case

or not. And what we find, as Steve alluded at the beginning, is that loans are

up. We see total loans up to $6.8 trillion and then business loans at $2 trillion.

The loan availability is up. People are getting the loans that they need. But theimportant thing to note is that this is in a context of reduced demand because

of the soft economy.

So the question is that we have higher capital levels now that are helping to

protect the industry, protect our economy from risks that are out there. But as

the economy returns to growth, is that those higher capital levels can actually

hold back the economy if the demand for loans increases. And that’s the

choice and the challenge that we explore in there. And I think that the

headline from that is simply that higher capital levels are not always a good

thing.

And then the final piece that I’ll touch on in the safety and soundness section

is the question of European exposure. And that is driving some of the systemic

risk that we see out there. It’s obviously a major problem for Europe, a major

problem for the global economy, and the knock-on effects that the US could

be substantial as well. We wanted to dive in a little bit to what US financial

services firms are doing to prepare for any potential problems from Europe.



What we found is that the exposure to the EU has actually decreased 16

percent. And a lot of that exposure reduction is being driven by exposure to

the periphery.

So when you look at the countries where that’s actually focused, is there’s

been massive reduction in exposure to Greece, to Spain, to Ireland, to

Portugal. We even have reduction in risk exposure to Germany. The two most

notable where there’s exposure to debt by US institutions is the increase in the

UK and in Switzerland; notably, neither of which are actually part of the

Monetary Union, which is, I think, where a lot of the concern is focusedaround.

So, broadly, what we see is a financial services industry that continues to

repair itself beyond where we saw it in the crisis that is acting to deal with

challenges that are outstanding, including the EU. And for policymakers, I

think the question is that as the economy returns to growth, when that

happens, is the financial services sector and are the regulators and

policymakers going to be positioned best to support that growth going

forward? And that’s the question that people have to have their eye on as they

think about the future.

And now to Steve McMillin.

Steve McMillin: Thank you.

The basic points of the fiscal cliff section of this report are first of all, the

fiscal cliff, if it does occur, would be the largest fiscal contraction in four

decades, which would put significant stress on an already weak economic

recovery. The magnitude of the fiscal cliff, just to remind everyone, put it all



in front of you there, would be $607 billion in one year, equivalent to 5

percent of GDP.

And an important thing to understand here is the fiscal cliff is not a policy

outcome that anyone in political life is advocating or favoring. The policy

choices are in fact much narrower between the two parties. But because of the

way fiscal policy decisions have been put off or time-limited in recent years,

you have all of these policies coming due in one fell swoop.

So this deadline was meant to have such catastrophic consequences that itwould force politicians to act. The risk here, of course, is that they do not act.

And we have that significant fiscal contraction which will then do substantial

damage to our economy especially in the first half of next year.

Second point, for the long-term strength of our economy, while it’s important

to avoid the immediate impact of the fiscal cliff, this needs to be accompanied

by action to reduce our current historically large deficit. If you look at the US

Government debt held by the public, by the end of the decade, that’s going to

be approaching 100 percent, which is a level that economist (unintelligible)

was posing a significant danger to our economy. Our debt load is already

higher than the European Zone as a whole, higher than some of the countries

in Europe that are already experiencing economic crises. And that debt load is

getting worse and more burdensome every day.

Thirdly, in addition to the direct effects of this fiscal policy, we have

additional detrimental effects that come from uncertainty about government

fiscal policy. The debt ceiling crisis last summer was perhaps the most

celebrated example of this, where even though at the end of the day, the debt

ceiling was increased, the federal government never defaulted on a single

dime of debt or interest payments or any other obligation, the uncertainty



about where the government will go caused a reaction in the real economy.

And that had real and negative economic consequences.

The magnitude of the policies expiring at the end of this year is even greater.

You have another debt ceiling expiration, which will come at probably late

calendar year or early in 2013. And you have the potential for a one-year

$400-billion tax increase and a cut of $100 billion in spending again in a very

compressed time-saving.

Just the risk of that shock is naturally going to have an impact on people whoare trying to plan their investment, to plan their hiring, plan what their tax

burden is going to be next year, and when people in the private economy are

shrinking back, hedging their bets, holding onto things, waiting on

Washington, that has a drag on the potential for our economy to grow.

Steve Bartlett: So with that, this is Steve Bartlett again. We are prepared for questions for any

of the three of us or all three.

First question please?

Coordinator: Thank you.

And our first question will come from Tamara Keith of NPR.

Your line is open.

Tamara Keith: Hi there. This is a question about the fiscal cliff. And I don’t know if you’ve

looked at this. But you talked about just the concern about the fiscal cliff

having an impact on decision-making and investment and hiring. Has that

already started to have an effect? I mean is there a point beyond which



avoiding the fiscal cliff doesn’t matter in a way that avoiding the debt ceiling

didn’t really resolve the economic impacts?

Steve McMillin: Well, there’s always going to be a benefit to avoiding the fiscal cliff. What we

saw in looking at how uncertainty around last year’s debt crisis had feedback

effects in the economy, it was something that grew as public attention began

to focus on those very contentious negotiations and the potential negative

consequences if the deal weren’t reached.

So I don’t think we’ve seen anything quantitative at this point. We certainlysee anecdotal evidence of layoffs and hiring freezes. That’s starting in

particular -- you see reports about defense contractor worried about cutbacks

in military spending. But as we get closer and closer to the December 31st

deadline, we expect we’ll see that show up in a variety of both anecdotal

evidence and in statistical trends.

Tamara Keith: Thank you.

Coordinator: Once again, if you would like to ask a question, please press star 1.

Steve Bartlett: This is Steve Bartlett.

To put another way is there’re really two requirements here I think in the near

term. Remember that it was in July of 2011 that the markets in the economy

and in private businesses and consumers began to notice that the debt limit

was uncertain as to whether they would be extended. And that’s, as everyone

recalls, when the economy hit a major bump in the road, a major dip. That was

a year ago.



So that was one major dip, bump in the road. This is five major bumps in the

road. – We have no hard evidence of this. It seems to me though that the

business decisions and consumer decisions are essentially beginning to hold

their breath at this point to wait to see if the Congress and the Administration

are going to agree.

There’re two challenges for the policymakers. One is for both bodies, the

House and the Senate and the President to agree. But they don’t have to agree

on the terms of what to do about the fiscal cliff until the end of the year. But

the second one, I think, the near term and just as important is to agree toagree, is to agree with each other that at the end of the day, they will reach

agreement to avoid this financial catastrophe because it would be an economic

catastrophe of epic proportions.

Other questions?

Coordinator: We show no further questions.

Steve Bartlett: Matt, do you have anything to add to it?

Matt McDonald: On the fiscal cliff itself, I mean I think that anyone who pays attention to

Washington, to the fiscal cliff, to the political environment so far, sees a great

deal of uncertainty. And on a practical level is that if you are sitting as the

leader of a company or a small business or making decisions and looking at

what’s happening, is that now is not the time that, if I were in that position, I

would be placing big bets on actions for my business.

I think that there’s enough outstanding out ther e from Washington, from

Europe, et cetera, that the uncertainty is weighing heavily on business

decisions.



Steve Bartlett: Okay.

Do we have another question?

Coordinator: And our next question comes from Kent Hoover of American City Business

Journals.

Your line is open.

Kent Hoover: Yes. Back on the fiscal cliff, I understand that Senator Patty Murray is making

a speech today at the Brookings Institution, basically saying that it’s so

important to not continue the higher income tax cuts, that Democrats are

saying they’re willing to let all of the income tax cuts expire, if necessary, and

then start over.

What do you think about that strategy? Do you think that’s just more of a

negotiating ploy or do you think that, you know, when talking about that it’s

important to agree to agree, that you think that’s a sign that maybe there’s not

an agreement to agree?

Steve Bartlett: Steve?

Steve McMillin: This is Steve McMillin.

Just a quick reaction there; I think both parties recognize at this stage that the

prospect for near-term agreement is low and that it’s important for them to set

up a negotiation in December in a way that’s most likely for their position to

prevail.



Two years ago in December of 2010, there was a lot of discussion that that

was going to be the time that those upper-income Bush tax cuts would be

allowed to expire. But at the end of the day, there was agreement to allow

everything to go forward.

Similarly, last year, we had a lot of concern on one side of the aisle about

extension of the payroll tax holiday. At the end of the day, when confronted

with a soft economy that really can’t handle too many more hits like that, the

parties came together and avoided that near-term hit to the economy.

So it’s probably important to, you know, to certainly take those statements

seriously, but to recognize that everyone is involved in what they plan to be a

month-long negotiation. And they would like to prevail (unintelligible).

Steve Bartlett: And this is Steve Bartlett.

Without saying anything about an individual Senator, but I will say that

brinksmanship in this case is not only not the best strategy; it’s highly risk y

for the American people. We’re faced with failure to reach an agr eement that

results in the -- I’ll choose my words carefully, but this was right out of the

Hamilton report -- results in the largest contraction of the American economy

in 40 years. Those are very significant.

And further, failure to even appear to reach an agreement, that is failure to let

the American public know that they’re going to reach an agreement, will also

begin that large contraction.

So I think that for any party or any policymaker in Washington, a “my way or

the highway” approach, is dangerous for the American people and will not

necessarily end up with a better deal. There are half a dozen issues that have



to be resolved. Everyone in Washington has a different opinion about how to

resolve each one of them from alternative minimum tax to the state taxes, to

individual tax rates, to long-term debt, to the debt limit, to capital gains and

dividends, to sequestration, and to a long-term fiscal agreement for reduction

of the debt.

So each of those has to be resolved and have different opinions on how to

resolve them. But they’re not resolved until Congress passes a piece of

legislation, sends it to the President and the President signs it. So I don’t think

any one individual or party or caucus is going to get their way on everything.And I think the brinksmanship is not a way of securing that; it just merely

tanks the economy.

Matt McDonald: To augment what Steve said, the fiscal contraction -- meaning the impact of

government spending on the economy -- would be the largest decrease in 40

years. Practically, what would happen is that it would almost certainly drive

the economy into recession in the first half of next year.

And so the idea that, you know, wherever the politics lay is that if we drive up

the fiscal cliff, it will be Washington hurting the economy at a time when it

desperately needs help.

Steve Bartlett: Thank you all very much. My name is Steve Bartlett, President of the

Financial Services Roundtable. If anyone has any additional questions you

want to ask me directly or our two authors, you can contact me directly or you

can contact me through Richard Fawal at the Roundtable. And that’s

[email protected].

With no further questions, thank you very much.



Coordinator: Thank you for participating in the conference today. You may now

disconnect.

END

Hamilton Financial Index 2012 Teleconference Transcript

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Transcript of Hamilton Financial Index 2012 Teleconference Transcript