Wednesday, October 15, 2008

Inflation and Stupidity

Jeremy Lang of Liontrust provides a very clear explanation of the reasons for the credit crunch in the UK Telegraph. He contrasts the old boring banking model with the new flashy one.

The modern banking model is broken. But first the old model; how did it work? Banks should be conservative ventures. They rely on trust and permanence to work. Banks persuade enormous numbers of people to trust them with their cash. They then lend that cash to other people, trusting them to pay them back. They earn money by charging more to lend than it costs for them to borrow. Simple.

.......So the old banking model relied on two things. First, successful banks made sure they had a comfortable buffer of their own cash for the inevitable times of stress. Second, successful banks made sure they lent carefully, so most people who borrowed from them would eventually pay them back. So far so boring.

Investment banking is not boring. Investment banking is deal making and product innovation and high risk taking. Investment banking built the modern banking model.
Read the full article here.

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