The Green Sheet Online Edition
February 11, 2013 • Issue 13:02:01
Surveying the financial landscape in 2013
In previous articles, I've compared and contrasted aspects of the local Sonoma County wine industry to the payments industry. Now that winter is here and the vines are napping, I will continue in that vein. About this season, Oded Shakked, the winemaker at Longboard Vineyards, said "Once the grapes are picked, it's really more about having the patience to let the wine develop in the barrel. ... Making balanced wines requires patience and calmness. ... Behind the scenes as a winemaker, there is a good amount of napping."
Big developments in payments
Napping may be a crucial component of winemaking, but in today's payments industry, napping is, unfortunately, not an option for ISOs and merchant level salespeople. For starters, there are so many different developments that you can't tell the players without a scorecard. Key developments include:
- The November 2012 "preliminary settlement" of antitrust litigation against Visa Inc. and Mastercard Worldwide. The legal fight isn't over, as of Jan. 27, 2013, retailers are now permitted to tack on a surcharge for credit card transactions in states where that is legal.
It is not legal in states that, collectively, represent about 40 percent of all retail sales, but you never know: I pay an ATM surcharge when I pump my gas even though California is a no-surcharge state.
- The adoption of global chip and PIN standards for U.S.-based merchants. Adoption of the Europay/MasterCard/Visa (EMV) standard for debit transactions is stalled by major technical issues that will not likely be resolved for a long time, probably beyond the 2015 "deadline" for a shift in fraud liability to merchants.
- The adoption of near field communication (NFC). If EMV is delayed indefinitely, there is no urgency for merchants to adopt NFC because they won't have the terminals to support it.
- The almost constant noise about mobile payments and mobile wallets. Retailers must be wondering which vendors and products will become commercially viable, but the technical infrastructure is not yet in place for consumers to pay with smart phones quickly and easily - as easily as swiping a card.
- The continual prediction that prepaid cards are the next big thing. ISOs tend to forget that 85 percent of the world's transactions are still cash, and that a quarter of U.S. consumers are unbanked. However, Mercator Advisory Group predicted that consumers will load over $100 billion dollars onto prepaid cards this year.
New products such as Liquid and Bluebird (from JPMorgan Chase & Co., American Express Co., and Wal-Mart Stores Inc.) might change the landscape, but I am not sure that there will be a play for ISOs here.
The role of big banks
However, there is another factor that I believe is a more compelling subject for everyone in the payments industry: the current state of the American banking system and how technology can fix problems and create economic growth. Recently, I saw an article about how a Bank of England spokesman explained the economic crisis to Queen Elizabeth. He made the following points:
- Financial crises are like earthquakes - rare and difficult to predict.
- People didn't realize how interconnected the financial system had become.
- There was a growing complacency among players that fostered an attitude that regulation wasn't necessary.
Folks, you can't make this stuff up, but here's a better explanation. A new book by Alan Blinder, After the Music Stopped: the Financial Crisis, the Response, and the Work Ahead, concisely identified the real causes as inflated asset prices, excessive leverage, lax financial regulation, disgraceful banking practices, the crazy-quilt of unregulated securities and derivatives, abysmal rating agencies, and perverse compensation schemes.
Blinder is right on the money here, unlike his Bank of England counterpart.
This points to the real issue: the inability of anyone - government, Wall Street or anyone else - to understand what risks the largest banks have on their balance sheets.
It turned out that the largest banks deliberately and willingly misled clients; packaged and sold hybrid securities that in some cases they knew were inferior credits; and even in some cases, via hedging, bet against their own securities to profit when the market turned.
As a result of the lack of transparency, many observers don't trust the financial statements of the largest banks. Some have even called these banks "complete black boxes."
A recent study by Barclays Capital found that more than half of the institutional investors surveyed did not trust how banks measure the riskiness of their assets. This includes such basics of financial analysis as how banks report loans and mark them to market, and what risks are generated by complex investments and trading.
The large banks derive an outsized amount of their income from trading activity, as opposed to the conventional business of just lending money. Trading is risky business; it is placing a bet, and it is placing a bet with borrowed money.
Even hedges don't always perform as expected, and in spite of complex math and mainframe-level modeling, they can go south. When the bank has a trading position measured in trillions of dollars, it is virtually impossible for a financial analyst to figure it out.
I point this out because while in the last crisis these banks were deemed to be "too big to fail," that may not be the case next time. If this comes to pass, and it happens to be your acquiring bank that fails, what will you do?
In the credit card world, banks also generate credit, and in so doing create money. In fact, a large part of the growth in the post-war period was directly due to the emergence of the credit card.
My friend Chuck, the chief executive officer of a large payment processor, always takes me to task when I criticize the monopolistic and anti-competitive posture of Visa, and in some respects, he has a point.
To understand, I suggest you read a good book by columnist Joe Nocera, written way back in 1994, called A Piece of the Action: How the Middle Class Joined the Money Class. From 1945 to 1960, consumer credit grew from roughly $3 billion to $45 billion; it then grew to $105 billion by 1970, when more than half of all U.S. families had at least one credit card.
Back then, only about 22 percent of all cardholders carried a balance, compared with 56 percent today. When banks create money, it has a multiplier effect, and it had an amazing effect on post-war America. Per capita income, even adjusted for inflation, has doubled since 1960.
The next game changer
And this brings us to the point of the story: how a new, game-changing technology enabled all this to happen. Everybody who works in the credit card business knows who Frank McNamara was, but do you know about Joe Williams?
As Nocera wrote, it all began in 1958, when a Bank of America middle manager named Joe Williams decided to mail a credit card, unsolicited, to all 60,000 households in Fresno, Calif. This is referred to as the famous "Fresno Drop." Remember, in 1958, only wealthy people had an AmEx or Diners Club card. Credit cards were not for the middle class, not yet. Williams' drop wasn't a disaster, but it wasn't an immediate success either.
Even by 1970, some observers were predicting that banks would abandon the notion of credit cards for the middle class, but then technology intervened in the form of the mag stripe and the Visa BASE I authorization system. That changed the game, because it changed the merchant experience, and that changed the customer experience.
In 1972, the first bank-issued mag stripe Bankamericard was issued, and the BASE I electronic authorization system debuted the next year.
This technology, which enabled the mass usage of the credit card by the middle class, was a big engine of economic growth for the following 30 years. Now, the question is, which one of the emerging technologies I mentioned at the beginning of this article will have a similar effect, or will it be something that hasn't been invented yet?
We are in the "napping" stage now. The "grapes" (technologies) are "ripening." We will have to wait to see results, but as the growers know, the harvest can come early, or it can come late; you can never predict when, or what, the result will be. Place your bets.
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at firstname.lastname@example.org.
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