Thursday, January 17, 2008

Western Banking in Melt Down

Dear Colleagues

The banking rot set in some time in the 1980s, maybe even before. The banking or the financial system is a fundamental part of a "monetized" economy ... but is not, however, a productive part of the economic system ... it is merely a key piece of the system that helps to make the productive parts of the economic system function efficiently and smoothly.

Costs and profits in the banking and financial services sector are overhead costs in the productive sectors of the economy.

There are two sources of revenue in the banking and financial services sector: (1) payments for the use of money, that is interest; and, (2) fees for services, mainly fees for advice and fees for carrying out transactions, whether it is ATM fees, closing fees for mortgages or closing fees for multi-billion M&A transactions. None of this adds value for the client but is a cost for the client in the productive sector ... the banking and financial services sector can charge these fees as long as the productive sector has profit opportunity and these costs are modest compared to the profit opportunities.

For the last two or three decades the banking and financial services sector has been feeding at a very rich trough of global economic opportunity. Science and technology has created new industries ... notably (1) the technology of the knowledge economy, biotechnology and very much improved engineering systems and (2) the opening up of new cost effective sources of product and services, primarily in China and India.

But the signs of Western financial stupidity have been around for a very long time. The Western banks made more and more money on less and less capital ... a formula that increased their return on investment (capital employed) but also made them more and more vulnerable ... and they have been "over the cliff and in mid-air" for years now ... a crisis waiting to happen.

The scale of this crisis is not yet fully apparent. The idea that the big name American banks are soon to be financed by large scale investment from countries all over the world is thought provoking ... but it was obviously going to happen at some point in time. The impact of this over the next year and the next century are not particularly likely to be good from the American and Western perspective.

Frankly, I am ashamed that my generation of leadership has got the West into this mess. My impression is that most of the Western leadership community thinks that they can "window dress" and come out of this with the public not understanding what has happened. I believe they are mistaken ... and the best solution is to do some hard rethinking about what the function of the banking and financial sector should be, and get to work doing this well.


Peter Burgess
The Tr-Ac-Net Organization