The Bankwatch

Tracking the consumer evolution of financial services

“Addicted to consumption” | where does that leave Banks

Umair writes some great stuff, but this post is a classic, and a keeper.  “We’re addicted to consumption”, and “Do we need razors with ten blades – or a single blade that never dulls?” are classic quotes that reverberate. 

The key backdrop in this piece [for me] is the comment on the financial system.

America’s Addiction and the New Economics of Strategy – Umair Haque

Let’s re-examine the house of cards that is the global financial system. Emerging markets seek export-led growth: they undervalue their currencies, so their exports are more competitive purely in terms of price. That’s essentially a subsidy to consumers on the other side of the table – those in the developed world.

As emerging markets accumulate surpluses, they recycle them: they lend them back to the US and UK in the form of government and mortgage debt, stabilizing their economies, and amplifying the existing consumption subsidy through leverage.

Its hard to argue with anything in here.  You can resist, offer other causes of todays malaise, yet its hard to argue with the seductively simple arguments. 

The key in the argument is the notion of artificial cheapness that is otherwise known as offshoring.  Umair argues that the costs associated with the consequences of our consumption; human, social, and environmental consequences, are far beyond anything we anticipated, and are driving us to something deeper and more consequential.

I buy this argument.  Banks are complicit.  The financial system is awash with cash, and Banks as the intermediaries that manage that cash are seeking any available outlet that offers enough return that covers their costs, plus provide a decent margin.  Ergo the subprime debacle.  What rational banker would say that investing in real estate to 100% loan to value ratio, with expectation of repayment from people with high probability of default was a good idea.

Yet that is not the whole story.  Banks have been living off the consumer consumption binge, which was funded by loans against appreciating real estate values.  Real estate values are now down in the western economies.  They will not rise soon.  In the UK the voice of reason is taking over and the expectation is that house prices must adapt to the new expectation; that is much lower than the bubble times we have just seen. 

Relevance to Bankwatch:

The Banking system is in trouble for many reasons, and it goes beyond the subprime crisis.  Banks are complicit in the subprime crisis, and are paying the cost.   Yet who is paying the cost?  Certainly not the senior management of the Banks during this period.  In previous recessions, or economic downturns,  the consumer and business services charges and interest pulled the Banks back out.   Yet if we accept the premise that the consumption overload is over, then the associated lending spree is over too.

Banks cannot count on the traditional way out of a recession by expanded consumer borrowing supported by home buying and related increasing home values.  We are entering a different scenario now, and these are uncharted waters.

Written by Colin Henderson

July 30, 2008 at 02:32

Posted in Business Models

One Response

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  1. I gots the subprime mortgage crisis blues!

    Kinda like Schoolhouse Rock, only better.

    This little ditty must be seen to be believed.

    Morriss Partee

    July 30, 2008 at 09:11

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