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How (and Why) the Big Banks Will Destroy Themselves

The big banks have been destroying themselves as we speak. Otherwise they would be on track to take over the world.

This is not a conspiracy theory or anything of that sort. Rather, it is a logical application of the laws of compound interest.

Around 1970, people posited that if IBM continued to grow at its historical (20%) rate, its sales would represent all of the U.S. GDP in X years. Meaning that IBM COULDN'T continue to grow at those rates. Similar things could be have been said about Walmart around 1980, Microsoft in 1990, or Berkshire Hathaway in 1995.

This time its the banks that have become "victims" of their own compounding. But not before victimizing most of the rest of us.

The banks got into the catbird seat because they have an easier task of reinvestment than most other firms. That's because their "inventory," money, is highly fungible. They don't have to worry about product obsolescence like manufacturers, or clothes going out of fashion like retailers.

Even so, things were fine as long as banks stayed within their social role as the handmaiden to other forms of commerce, until perhaps the late 1980s or early 1990s. But this becomes more and more tenuous when, through continuous reinvestment, banks become "too large" a part of the economy (20% of the value of the S&P 500 index and 40% of the U.S. corporate profits) after counting those of "captive" finance subidiaries such as GMAC and GE Capital.

So where did the banks go wrong? They did so when they got to a size where they forsaked their main business (lending money after checking the credit of others), in order to engage in "new" businesses (like telling homebuilders and home buyers how to conduct themselves, and providing the money for foolish invesments. What HAD been a credit check culture became a credit granting culture.

The banks are going to lose money on the bad loans. But before they do, the bankers would have paid themselves more than they are worth. Thereby decapitalizing the banks.

When the banks have brought themslves down to size, the typical banker will become an "aw shucks," Jimmy Stewart type character, and standard industrialists, who is selling "toasters" for deposits, rather than straight money. (In "A Wonderful Life," the main character did forego his dreams of during the "grand tour" because his community needed a community banker.