If you were looking for someone to weigh in on bank regulators' ability to keep up with advances in technology, you'd have trouble finding anyone better informed, and holding clearer opinions, than Eugene Ludwig.
"We already know where the direction of the world is going — it's going to be more tech, more tech, more tech," said Ludwig, who was Comptroller of the Currency under President Bill Clinton. "So at this point, there's no excuse for the bank regulators not to have top people in their organizations that are well versed in tech. And they've got to get them from the private sector."
Further, banking agencies ought to be paying up for senior talent, he said. "They've got to get people who come from industry who are knowledgeable and top notch and they've got to pay for it," he said.
Ludwig wears many hats. He was a founder of the compliance consultancy Promontory. He is CEO of Ludwig Advisors, chair of the Ludwig Institute for Shared Economic Prosperity, author of the book "The Vanishing American Dream" and co-founder of Canapi Ventures, which he runs with Chip Mahan, CEO of Live Oak.
In an interview just before the new year started, Ludwig reflected on the struggles fintechs have had in the past year and what lies ahead for banks and fintechs in 2024.
A lot of people feel that the past year was pretty difficult for fintechs in general. Certainly the online lenders had a difficult time as interest rates rose and it was harder for them to sell their loans. Some of the consumer-facing fintechs had a challenging time also with rising interest rates and the need to get to profitability and prove profitability. Do you have any thoughts on how you think 2023 went for the fintech community?
EUGENE LUDWIG: What you've said I think holds true for fintechs generally and techs generally. You've gone from an interest rate environment of essentially, let's just call it zero, to over the past 18 months, considerable raises in interest rates and that's affected the market. And then the financial markets generally have been choppy and so that this has been a challenging year, 2023. But as you know, the fintechs that we invest in at Canapi, we're kind of a mission-driven fund in this sense. Our fintechs support and tend to improve the operation of our banking system. So it's a different cohort than the fintech market as it's generally understood and broadly applied. Now in that regard, there has been a movement, a change in terms of the things that banks care about and are focused on over the last 18 months, and I think that change we'll see continue into 2024.
A lot of people are putting out predictions at this time of year. Do you have any thoughts about the coming year and which kinds of fintechs might do well in the coming year and which might again have a difficult time?
Yes, I think there are two buckets you can put fintech startups when you're looking at them as entities in which to invest. Because banks are more careful with their budgets now, the fintechs that are creating tools that are nice to have but are less must-have are going to have a much harder time of succeeding. This is more of a "must have" environment and there are a couple of reasons for that. It's not just the budgets, but banks have to ingest these new technologies and that takes time and effort so that there's much more focus on the bank's part in terms of, what do we need to have. Now the second part of this is the general environment for banking, and the environment is one of increased regulatory scrutiny challenges somewhat on the safety and soundness side of the house, a lot of it emanating from the SVB debacle of last spring and the run on several banks triggered by the SVB debacle. So it is more attractive for fintechs that produce back-office products and services, particularly in the safety and sound compliance area to be taken up by banks. And there's always been a need, but we get more enthusiasm I think, and there will be more enthusiasm about taking these new products and services on. But again, these are ones that have to make a difference in the bank's overall operations. So there are those two changes. There's one sort of additional overlay on all of this, and that is there's so much excitement in the marketplace about artificial intelligence, anything that is coming forth, everybody claims to have their crown of an artificial intelligence-driven product, they'll stamp AI on everything, but what we'll also be seeing in 2024 is true AI.
Those are interesting points. So on risk management, when you think about what some of the banks that failed went through this spring, Silicon Valley Bank and Signature Bank and so forth, is there any one technology that you think could have saved them?
Well, there is no technology I think that we will have in our professional lifetimes that will obviate the need for management judgment. In other words, there's no substitute for management judgment and hands-on banks are big important ships and they take real, as everybody knows, top people to manage. But the fact is that I think we can do better in terms of technologies that identify and send up signals in the tail risk area and technologies that also are better data managers. You can imagine a technology that manages the bank's data and has a tail risk component that would send up a flare that, hey, you're out of balance here or there. And there's nothing on the market that I know that is good at that. I believe there will be, I think artificial intelligence will be used in this area. I think it will make a big difference in alerting institutions for certain tail risk developments. The interesting thing about tail risk, and to some degree the Silicon Valley issue is a tail risk issue, the combination of the internet, short selling, misuse of the internet, the shortening of payment system happening all at once as you have an interest rate spike, coming together created a witches brew of risk, particularly for entities that were concentrated in terms of their liability side that helped trigger the SVB matter as well as that asset liability mismatch to a degree. But you can imagine technology helping in that area quite a bit. There is no product that I'm aware of that is doing that vigorously, but there's opportunity there.
You also mentioned that a lot of companies are stamping their products with AI branding and AI language. As a venture capitalist and as a former Comptroller of the Currency and someone who's been in the industry, how do you think company banks can determine the difference between those that really, truly are making the best use of AI and those that are just kind of using the terms and not necessarily doing anything particularly advanced?
Well, we're lucky enough at Canapi to have investors, about 70 banks and trade association participation as well. So we have a deep pool of banks that we talk to and learn from, and most of those banks, the vast majority, do have a very good due diligence effort that is quite capable and they have good tech departments, differentiating between those folks who are talking the talk but don't walk the walk, you might say, in AI. Some do not. But that is, I think, a big differentiator for banks that has developed over the last 20, 30 years. There's a lot that goes into running a good bank, one can hardly replace the human factor here. On the other hand, a good tech department that is part of a due diligence effort and the ingesting of the new technologies that are appropriate for the bank is going to be increasingly important and that kind of vigorous due diligence and thoughtfulness will make a big difference on success or failure and, over time, a bigger difference for these institutions.
Has anything changed for you in the way that you look at and choose fintechs to talk to or companies you might invest in, especially since the banking crisis and with all this noise about AI? Or do you look for the same things you always have?
Well, it's a matter of degree. In evaluating companies, we obviously do an enormous amount of due diligence as to strategy, quality of product, product fit for the banks, the quality of management, and I want to say a word about that. At the end of the day, the most important thing in terms of creating a really first-class company is the quality of management. The technology, of course, is important. These are technology companies. But the quality of management we look at very closely. We interview them, we visit them, being hands-on there is, I think, number one, two and three of investing. Understanding the technology, I think, is also very important, both from a product fit in terms of whether banks are going to take this up. And we've been lucky enough because of our bank investors and our own backgrounds, to interact as an investor with the products and how they fit in the banks and talk to the banks and have an insight that is critically important but is hard to get.
I can't imagine investing in this space successfully without that. So that's a big part of our due diligence because there's a lot out there in the marketplace. There is an immense amount of new ideas and companies coming on stream. They add value, but the managers are weak. Some of the products are weak. We've certainly seen companies that fit both silos in the wrong way: pretty good product, but very badly managed and a very good management team, but their first product out of the box doesn't ring the bell and you've just got to be able to differentiate. Now, the one thing that is changing that we're quite focused on is that the degree of governmental supervision, the vendor management area, etc., of any company the bank does business with, including financial and, importantly, financial technology companies, is tough and getting tougher. And the entities we invest in, we want to try to help them meet and exceed regulatory standards as they should because they're part of the banking environment. And that's a big part of what I think we can help with and also what we demand.
One thing I hear a lot is that the regulators really struggle to understand technology and to sometimes give kind of a green light to banks' purchases of new technology because they struggle to hire top tech talent themselves because a regulator can only pay a fraction of what a tech company can pay. What do you think, based on your experience, can the regulators have the needed understanding and be able to assist?
You and I have occasionally talked about this and many of your predecessors and I have talked about it a lot. I am strongly of the view that the banking agencies in particular, but government as a general rule, should be a champion of the revolving door, not negative to it. And we've really got to educate the Congress on this. Banks ingest people from industry with different talents and skills including tech, but the agencies have been reluctant to bring people in from industry. And part of that is this anti-revolving-door sentiment, which I think is crazy, on the part of some in Congress. As banking regulators get into any space, they always lag the marketplace and there's good in that it allows for innovation, but the banking regulators are always playing a little bit catch-up ball here.
We already know where the direction of the world is going. It's going to be more tech, more tech, more tech. So at this point, there's no excuse for the bank regulators not to have top people in their organizations that are in tech. And in that regard they've got to get them from the private sector. So that's point number one. Point number two is in terms of pay, the banking regulators are exempt really from the restrictions that are placed on most government agencies in terms of pay so they can pay more. As a general rule, banking agencies ought to be paying up for senior talent. At the OCC, at the head of the agency, we restricted ourselves to very low pay. I remember Alan Greenspan and I used to talk about it, and we'd take a very low pay, I think the very lowest or equivalent to lower pay at the large government departments. But for the professional staff, we made a point in my day of paying up and they always are advancing more than we did. That's critically important because we need top people at the agencies. In fact, given the amount of pay we have provided these people, the agencies are lucky to have the extraordinarily good people they do have, but in the tech area in particular, they've got to get people who come from industry who are knowledgeable and top notch and they've got to pay for it.
Well, just to go back to your revolving door point, I think about that period where we had a lot of Wall Street firms sending top people to the Treasury Department and other regulatory agencies, and it almost felt like it was a job requirement. You'll work at the bank for X number of years and then you'll go to Washington and then you'll come back. And it seemed like there was a conflict of interest there. Am I wrong about that?
Well, I think that there is always a tendency in all of us to be a little skeptical and to be wary of motivation. But in my experience in government, I think this is true in the vast degree in the history of the United States, people serve in government out of a sense of purpose, noble purpose. They may have different points of view from their backgrounds, but without exception, during my time in office, the people who came to do service in government who came from the private sector, for example Bob Rubin, were exceptional people and they were there to serve the nation. And it was part of what they viewed as a civic responsibility, particularly people who have been fortunate enough to have the intelligence to go into private sector financial jobs and make a great deal of money. It seems we almost have a responsibility to go into government and share the skills that they've been able to gain in service of their country.
And I think we do ourselves a huge disservice by assuming that there's some misuse here. The government has strict ethics rules, there's extreme penalties for abusing one's governmental position. And I think as a country we are much better off sucking in the talents and experience of people from the private sector into government to serve the country. And then I go back to the private sector. If you look at our Founding Fathers, virtually every Founding Father had been in business. If you look at the 1930s, the New Deal, same thing: a large percentage of the people who were helping Roosevelt out had been in the private sector. I think we've got to allow that, not criticize it, and I think we ought to be encouraging it to a very great degree right now.
The key question that I wanted to ask you today was about the whole fintech movement, which to me started with BankSimple and Moven and a few of these challenger banks that came out about 15 years ago. Certainly the word fintech encompasses much, much more than that and there's a lot of financial technology companies out there. But when you think about that challenger movement — we're going to make people's financial lives better, we're going to charge less fees, we're going to make financial services affordable and convenient and accessible to more people — do you think that the fintech revolution has done any of that?
The fintech revolution has, but I think it's done more by taking steps that are synergistic with banks than confrontational. As you know, we have not seen a fintech movement that has been successful in terms of replacing the banks in and of themselves. And banks have powerful franchises, part of it actually is regulation that they're places of trust. And the keystone of banking, I think, is trust. But the fact that banks have become more technologically savvy and have become more efficient does, I think, translate into significant benefits for consumers. And to be fair, I think there's a degree to which the challenger banks got that movement going. Improvement in the operation of the banking system is generally faster and bigger than would've been the case if they didn't have that competition. Now, a number of banks and a number of companies have put that effort into service, particularly service for low- and moderate-income citizens. And I think that's commendable.
For example, Nova Credit, which I know you've written about, is an entity we've invested in that provides a technological solution for immigrants whose credit history is really abroad and should be able to borrow in a safe and sound manner if their credit history were made available to a domestic lender. Another not only low- and moderate-income oriented, but another rather civic fintech we've invested in is Greenlight debit cards for kids utilizing modern financial tools and learning from them is tremendous in terms of improving their financial literacy, which will serve them well in life. So those are two examples of where technology is not just advancing the well-being and the efficiency of consumers generally, but folks can take advantage of new technologies in a special way.
Speaking of lower income people, one of your jobs is with the Ludwig Institute for Shared Economic Prosperity. And I know that you and your team there look at how the economy is working for lower income neighborhoods and people who are living paycheck to paycheck and all of the people in our society who are not thriving financially. What are some of the latest things you're seeing there? Are you seeing any improvement or do you have any hope for improvement in the coming year?
Yes, I think there is a hope for improvement in the coming years. And let me explain largely what LISEP is doing and why I think we're part of the wave to improve. Interestingly enough, when I wrote the book or really wrote part of the book and edited other chapters which were contributed by other folks in policy, "The Vanishing American Dream" reflected a sense I had that there was a decline happening for middle- and low-income Americans. I felt that decline because I grew up in a small industrial and farm town called York, Pennsylvania, on the edges of Amish country in Pennsylvania, and I've seen a town that was once prosperous and on the rise to a town that I visit now that has struggled with the loss of jobs, major businesses leaving, etc., and a decline that's really affected middle- and low-income Americans in that area.
So we got a symposium together and asked the question number one, how bad is it? Is it as bad as I think it is? The symposium came to the conclusion that there was a decline, that the problem for middle or low-income Americans in the decline was serious and then came up with prescriptions that one could follow on the national level and local levels and make a difference. When I listened to what was going on in the symposium, one thing that struck me was that people had anecdotes as I did from York. They were anecdotal and personal and there was relatively thin data in terms of how bad the situation is, where it was going.
Furthermore, later after the symposium, what seemed odd to me was that the headline statistics were not telling that story. If you looked at the headline statistics, supposedly wages were growing. GDP is growing if not as robustly as we want, but still growing consistently. Inflation is under control. So how could this be, things ought to be getting better for middle- and low-income Americans. And I formed this institute called the Ludwig Institute for Shared Economic Prosperity. And I hired young people out of school and graduate school who were top economists, and we began to look into the headline statistics, the unemployment numbers, the inflation numbers, GDP wage data. And we found consistently this problem. And the problem is that these headline statistics are based on definitions that were locked in place in the 1930s that come out of concepts of the 1880s, believe it or not.
And therefore, the world that these definitions were created in is a very different world than the gig economy in which we live. And over time, they have become increasingly misleading. For example, let's take inflation. Inflation for the period of 20 years prior to today. I'm talking about the last couple of years where inflation was supposed to be near zero. It was not near zero for middle- and low-income Americans. Why? Because the consumer price index, which is the generally accepted measure, is based on a basket of 80,000 goods and services, but middle- and low-income Americans live and die on a much smaller basket of goods and services: food, housing, medical care, transportation to get to work. And if you look at the basket of services that most matters to middle- and low-income Americans, one finds that in fact it's been inflating much more rapidly than the CPI.
So it's masked what is in fact a decline for middle- and low-income Americans over a period of 20 years. I think it actually goes longer than that, but that's the era of good data to look back en masse at the decline, not the increase. If you look at the wage data, supposedly middle-income Americans have increased their wages net of inflation over the last 20 years, but in fact, that's not true. If you use the right number for inflation, that affects them, that's been declining. I think official Washington is becoming more aware of this difference. Certainly we're beating the drum to try to make them aware. And that awareness, I think, will have an impact on policy because unfortunately, we've been lulled into a false sense of security that things were getting better for middle- and low-income Americans, and not getting worse. The anecdotal evidence has been worrisome: increased drug use, increased death rates in this area, violence, gang violence, use of guns, etc. All of which would suggest that something economically is going wrong in middle and low-income America. And what our institute has done is prove that that is in fact the case. And as I say, I'm very hopeful that the work we've done will lead to better policy focus.
