Executive Speeches

Robert P. Kelly, Chairman and Chief Executive Officer, BNY Mellon

Address to the 14th Annual Wharton Leadership Conference

Good morning, and it's a real pleasure to be here.

What I'll do is talk a little bit about BNY Mellon and the global economy — and the U.S., in particular.

Let me start by giving you a bit of background on BNY Mellon.

We're the oldest bank in the United States, started by the guy on the ten dollar bill, Alexander Hamilton. The Bank of New York, our predecessor company, came into existence because of Philadelphia. In 1784, when the company was founded, there were no banks in New York, but Philadelphia had two, and one of them existed to pay U.S. troops during the Revolutionary War. At the time, Philadelphia was much larger than New York, and one of its competitive advantages was that it had a bank and New York didn't. So Alexander Hamilton created The Bank of New York.

Of course, he was also the first secretary of the Treasury, which we're all very proud of. At our company headquarters, we actually have displayed a letter from George Washington announcing the establishment of the Treasury Department. Right next to that is an agreement for the first loan ever made to the United States Government by The Bank of New York, and it was signed by Alexander Hamilton six days after the Treasury Department was created, and before you know it, 13 colonies consolidated their debt into this new entity at a six percent interest rate, which was pretty impressive.

We're also one of the healthiest banks in the United States. One of the reasons for that is our business model. It's different than most traditional banks, in that we're essentially in only two businesses:

• We're in the asset management business, where we have a trillion dollars in assets under management, which makes us #7 in the United States or #10 globally.
• And, secondly, we're in the securities processing business. There was some McKinsey data last year that essentially said there is about $100 trillion dollars of equities and bonds on the planet. We are custodian or processor for about 23 percent or $23 trillion of those securities, making us the largest processor of securities in the world, and that's good business to be in.

In fact, both businesses tend to provide higher returns on capital and they don't involve a significant amount of lending, a good thing these days.

BNY Mellon has the strongest debt ratings of the large U.S. banks, as rated by both S&P and Moody's. And when we issued debt in 5-, 10- year periods, we had the tightest spreads over treasuries of the major U.S. banks, which is a competitive advantage in terms of the cost of our debt. More importantly, our clients want to deal with us because we're viewed as one of the stronger financial institutions in the world.

We're in 34 countries and have 42,000 employees. We have a strong reputation and have weathered the recession, which hopefully we're finally through and are going to see some growth. We've been around for 226 years; the lesson is that you can survive economic downturns and other crises so long as your company is well-managed.

Because we're relatively healthy, we're finding good opportunities to buy businesses around the world at really good prices, and we're taking advantage of that with our excess capital. For example, we have a couple acquisitions that are closing this summer.

• One of them — a securities servicing acquisition — closes in a couple of weeks. We're adding 5,000 people, and over a thousand of those people are here in Philadelphia (we had over a thousand here already). In total, we're adding 5,000 people in the U.S., Ireland and Poland.
• We're also doing another acquisition, scheduled to close on August 1, in Germany, where we will go from being the #15 processor in Germany to #2.

We hope to continue to make acquisitions, subject to regulatory reform and available capital, but in the meantime, we're trying to expand organically in this environment.

I want to talk about the economy a bit, and I'll divide my thoughts into two categories: good news and areas of concern.

First, the good news, which is that the global economy is expanding, and we expect to have reasonable GDP growth around the planet this year, and it looks like that's going to continue.

The risk of a double-dip is possible, and it feels like the market has priced in a 10 or 20 percent chance of a double-dip U.S. recession; whereas, say, a month ago, the likelihood of that was probably at one percent.

It's really a tale of three different world economies:

• There's Asia/Pacific, plus Brazil where we're looking at growth from 6 to 10 percent per annum, and that's going to continue, I think, for many years.
• There is North America — the U.S. and Canada — which is expected to grow at two or three percent.
• And then there's Europe, which is feeling it a little bit like Japan, where we expect very low growth for a very long time.

The overall story is a positive one, in that we are looking at growth in all three of those economies, and that should continue, although it's three very different growth stories.

Focusing on the U.S., we came extraordinarily close to causing a global depression back in the fourth quarter of 2008; we came right to the very edge of the abyss and our toes were actually over the edge. The Treasury and the Fed did some incredibly aggressive things. Not all of them worked, but most of them did, and they were courageous and it worked. That included TARP, stimulus spending and stress tests on the nation's largest banks, as well as the various liquidity programs that were put into place. It's astonishing how quickly the financial markets improved thereafter.

It feels like unemployment has bottomed, and is perhaps starting to improve a little bit. What's a little concerning is that we're not going to have a huge job recovery. My daughter just graduated undergrad a couple of weeks ago. I read yesterday that only 27 percent of undergrad graduates are going to get jobs this spring! It was 24 percent last year, so it's improving a little bit, but not much. It's a real tragedy, in my view, because a lot of this was avoidable. But it looks like employment is going to improve. What's concerning is that, even the Fed, which tends to be a little bit optimistic, is saying that the unemployment rate by the end of this year is going to be around 9.25 percent or even higher. Let's face it, the average American is not used to that sort of number. It's going to be hard work to get Americans back to work, and it's going to be even tougher in Europe, which I'll come back to in a bit.

You have to remember that this was not a business recession. This was a consumer recession. The consumer is 70 percent of GDP in the U.S. Business was in pretty good shape with the exception of the autos and a few banks. Consumers took on way too much debt, and they stopped saving. The savings rate in the United States from the '50s through the '80s was eight or nine percent per year, and it basically went to zero or negative. The average American is now saving money again. That's a good thing. They need to do that. The bad news, of course, is that there's going to be less spending, which is going to make it harder to achieve GDP growth.

Housing finally appears to be stabilizing. Looking at the most recent Case-Schiller Index, 12 of the 20 cities measured are actually up a year now, which is good. The three cities that are having the toughest time still are Las Vegas, Detroit and Orlando. Philadelphia is still down a little bit, but not much. It's low single-digits, which is good.

The U.S. banking system is healthy again. The big banks are all basically healthy. They went through a stress test last year, which was, indeed, stressful, and they raised a lot of new capital — in some cases, they were forced to sell pieces of their business to generate capital — and they wrote off a lot of loans and securities. In terms of TARP, all the money given to banks has been repaid. The large banks are making money again. Some are continuing to take a lot of write-offs, but it feels like we've passed the peak, and we're basically going to get through the big write-offs over the next three or four quarters, and the big banks should be able to remain profitable, which means that capitalization will continue to strengthen.

The other side of the story is small U.S. banks. We used to have 20,000 banks here in the nation. Now we have 8,000. Over time, that will decrease because the small banks have a lot of competitive disadvantages. Small banks in the southeast and the southwest are going bankrupt, and we could see 100 this year and will probably have a few hundred more before this is over. It's basically all about putting all your eggs in one basket and, in the case of those banks, that basket was commercial real estate. There were many banks that built up their entire franchise on one product: commercial real estate lending. The problems with those small banks are not expected to really hurt our economic expansion, and it's already been priced into the market.

Of course, in the U.S. we're continuing to work through regulatory reform. Lawmakers in DC are going through a reconciliation process right now between the Senate and House bills, and we're hearing that that process should be largely concluded within the next 10 to 14 days, and I understand the President hopes to sign the financial reform bill around July 4th.

There are three primary benefits in the current regulatory legislation:

• The first one, and by far the most important, is there's now a provision in law to prevent another Lehman-type collapse. When Lehman got into trouble, there was no mechanism to take it over and slowly wind it down. It just basically collapsed and caused a global liquidity crisis, which was solved by the Fed and the Treasury through their various programs. We can't let an investment bank collapse like that again. That was way too scary and risky. We already have a good mechanism for banks in which the FDIC can come in and take them over and sell off the assets in an orderly way. Now we will have the ability to be able to wind down any large financial institution.
• The second thing that's good about the regulatory reform is it will create a consumer protection agency. Oversight will extend to anyone who lends, including auto lenders, mortgage lenders and payday lenders. That's a really good thing for the average consumer.
• The legislation also addresses the lack of accountability that exists in our current regulatory framework, which is a competitive disadvantage for the U.S. We have way too many regulators and no one is in charge overall, with the ability to see the big picture of everything that's happening. The bill will create a systemic risk council, and the chair will be accountable for the big picture.

On the global side, the Bank for International Settlements in Basel is working on creating new capital and liquidity rules that are expected to be introduced globally later in the year. Generally speaking, it's going to require banks to have more capital than they did in the past, and also have more liquidity or cash on hand. An awful lot of banks, particularly the investment banks, basically had no capital compared to the size of the assets on their balance sheets, were way too leveraged and, basically, they were funding themselves overnight versus having term funding. With the investment banks and brokerage companies that ran into problems during the crisis, it wasn't because they lacked capital; they just ran out of cash and no one was willing to lend to them, and it's because all of their funding was very short term. So it's important to require them to have more capital and liquidity.

Putting all those positive aside, I have two major concerns.

• First is the situation in Europe, which is pretty worrisome. And there's no easy, short-term solution here.
  
  The so-called Club Med countries of southern Europe have a pretty concerning mix of very high debt to GDP and, worse, very high deficits to GDP. It's a combination that can lead to serious financial consequences, as we've seen in Greece, which required a massive bailout. Spain, Portugal and Italy are also a concern. There's a lot of budget cutting that has to take place.
  
  And unlike in prior periods — say, at the end of the second World War, where the were extremely high debt-to-GDP ratios — markets weren't efficient then, and countries could either grow out of it or inflate out of it or default out of it. And they could take their time. Not anymore. If nations don't do the right thing, the markets will respond negatively, and we've definitely seen evidence of that in Greece, and their real cost to debt is just going to skyrocket.
  
  It feels like there's a longer-term process that has to happen in Europe to become more competitive, balance their books and start to bring those debt levels down, but it's not going to happen overnight.
  
  It doesn't feel like what's happening in Europe is going to have a major impact on the global economy. Only 17 percent of our exports are in Europe, and a lot of it is food stuff and staples, that I don't think they're going to be greatly impacted. The real thing I worry about is the confidence factor. If people see what's happening in Europe, they get worried about the potential impact in the rest of the world, which could cause them to reduce their spending, hiring and capital expenditures. So I do worry about confidence contagion, versus real economic impact to the world.
• My other concern is the U.S. mortgage system. It was the core problem that led to the financial crisis, yet it's not addressed in the financial reform legislation. The U.S. has the world's worst residential mortgage product, and it's now owned by the federal government. There were so many abuses. For example, I was told about 18 months ago that in Ohio, 18 percent of the mortgage brokers had criminal backgrounds. Think about that. There were no national standards for licensing. That's not good for the consumer.
  
  There are about 100 million homes in the United States; about 50 million of those have mortgages on them. Of that, some 12 million are expected to default by the end of 2012.
  
  We need the basics, like requiring a down payment, verifying employment, demanding an appraisal of what the house is really worth and requiring banks to put the loan on their balance sheets instead of just selling it through one of the GSEs. Instead, we made it too easy for the average person to borrow, and it created a gigantic systemic risk for the country.
  
  I recently read that the U.S. has a lower rate of home ownership than the UK, Canada and Australia. It should have the highest, but that will require a mortgage product that makes sense for the consumer the financial system.

But the good news is that corporate America is generally in good shape, consumers are doing a better job of saving more and paying down debt and we've transferred enormous amount of risk through stimulus spending by government. But now the federal and state governments have huge debt and deficit issues. That's a dangerous combination, and the U.S. has to address it. If not, we're heading toward a train wreck. I don't know when that's going to occur — maybe a year from now, three years, five years, seven years? I don't know the answer to that.

A senior administration official in Washington told me something recently — it's really technical, but it's worth remembering. He said foreigners will keep buying our bonds until they stop, and isn't that the truth? We don't know when that will be, but it's very alarming to think about.

There are two things we could do to address the problem: rein in spending and/or raise taxes.

If you think about raising taxes on corporations, consider this: until about two years ago, the United States had the second highest corporate tax rate in the world. Two years ago, we went to the highest corporate tax rate. So we have a higher tax rate than Japan, and I don't really want to emulate the Japanese economy right now. Our all-in tax rate is about 41 percent here in the United States. In the UK, the tax rate is 28 percent and Ireland is 12 percent.

We're in a global economy now. Companies are going to tend to create jobs in places with some competitive advantages, including big schools like Wharton. They also look at the tax rates. And the U.S. does not have a competitive tax rate, so it can't afford to increase it further. If the U.S. does, it will lose jobs.

Looking at the personal income tax rate — and keeping in mind that half of Americans already don't pay personal income taxes at the federal level — I'm not sure if you could actually expand the basis enough to pay for these deficits.

So, in the end, the U.S. has to cut costs, and the question is, do we have the will to do it? With an election coming up in November, I hope the average American understands what's at stake. If we don't take action, the world will force us to do it at some point in the future.

There are two critical spending issues: healthcare and retirement spending.

• In terms of healthcare, before the healthcare package was signed, our healthcare cost as a percentage of GDP was about 16 percent. It's probably 17 or 18 percent now. Compare that to the rest of the developed world, where it's 10 or 11 percent. The cost to deliver healthcare in the U.S. is uncompetitive with the rest of the planet. It's about efficiency, it's about our legal system and it's also about access, and at some point, we're going to have to deal with it, and I hope soon.
• In terms of retirement, the federal retirement age here in the United States is 65. As background, the first country to introduce a retirement program was Germany. Bismarck did it in the 1860s or '70s, and he set the age at 65, the same as the U.S. today. I don't know what the average life expectancy was in those times, but it wasn't 65. So let's think about the United States. We introduced 65 as the retirement age in 1935. Does anyone know what the average life expectancy was in 1935? It was 61.7 years. Today, the average life expectancy is 79, so we have to figure out how to support our aging population.

A few countries are starting to raise their federal retirement age. Germany just raised theirs to 68. In Greece, it's 55 or 50, depending upon if you're male or female, but they're now raising it. France just increased theirs from 60 to 62.

The good news is we're living a lot longer; the bad news is, we've got to deal with the cost of that.

I hope the U.S. has the fortitude and political will to take the necessary actions.

Thank you.