Finance Industry Futures II:

Crisis, Adaptation Failures, Alternatives and Recommendations

By Dave Livingston, Managing Principal, Llinlithgow Associates (www.llinlithgow.com )

Dave is a management consultant primarily focused on improving enterprise performance by coupling strategy with
execution thru the design and implementation of workable, integrated management systems. He blogs on this and
related issues in Economics, Markets & Investments and specific industries and companies at
www.llinlithwo.com/bizzx, his BizzXceleration blog.

Introduction

The metastasis of structural problems in the Finance Industry almost collapsed the world economy. When people talk
about systemic risk, that’s what they are referring to. Here we’ve collected more our of postings that take a deeper dive
into analyzing the Industry and its key players by developing a framework for analyzing the key lines of business, the
critical functions in operating high-performing businesses and relating to the broader social context.

The Finance Industry is a critical component of the health and prosperity of any modern society. In fact the differences
between the modern developed economy and those struggling with achieving takeoff are, partly, due to the lack of
efficient and effective capital markets. In fact throughout history it was the gradual development of sophisticated markets
that led to the modern economic revolution and the rise of modern societies. A point well covered in Niall Ferguson’s
“Ascent of Money”.

Yet, beginning with de-regulation in 1980, profits and compensation in the Industry grew all out of proportion to the
economy and, we argue, to the contributions of the Industry to either the economy or society. Initially the Industry
conceived and implemented many innovations from money market funds to mutual funds to structured finance that were
highly beneficial and did serve a greater purpose, as well as being highly profitable. Beginning in the 1990s though the
chances for profit based on leverage, bad business practice, perverse incentives and terrible risk management led to
increasing risks based on decreasing understanding and control of those risks. In the decade of the naughts those trends
metastasized into a dangerous contagion that eventually threatened the stability of the entire system.

Yet it DID NOT HAVE TO HAPPEN AS IT DID! In the process the Industry not only put us all at risk but nearly destroyed
itself in the pursuit of greater individual gains at the expense of the profitability of individual companies and the health of
the economy. The challenge before the Industry now is to return to its roots, focus on value and service and provide
innovations that are truly value-creating. In the essays collected below you’ll find these challenges discussed from several
different angles that are all focused on what are the proper business models, how should they be translated into
executable operations and what value-creating innovations might be explored.

No enterprise exists for its own sake. It exists if and only if it creates a valuable service for society. The first priority of any
enterprise is to provide value-add, a profit if you will, in both the short- and long-terms. On the whole the Industry failed
miserably with a decade’s worth of profits up in smoke. The second priority of an effective and successful business is to
create a healthy environment; again the Industry is notoriously bad at that. Its final and most important goal is make sure
that the society it depends on is healthy. When self-interested behaviors put the society at risk one can only judge the
results as abysmal. So bad practices served no one well.

The question on the table is what’s next? Will the Industry reform itself, return to performance and justify society’s
tolerance of it? Or will it choose to return to business as usual? A viable strategic option in the short-run but not one that
servers its own best interests in the long-run. The jury is still out but we have to say the early indictors are not favorable.

This collection continues the lines of thinking of two previous collections which are useful background reading:
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Strategy without execution is fantasy. Execution without strategy is thrashing.

Either without a management system is unlikely.
 Finance Industry Futures I: Credit, Leverage, Malfeasance and Broken Business Models
http://www.scribd.com/doc/19011962/The-Broken-Finance-Industry-Credit-Crisis-Collapse-and-Broken-Business-Models

Profit, Social Responsibility and Corporate Performance

http://www.scribd.com/doc/18645321/The-Corporation-vs-Society-Performance-Social-Responsibility-and-the-WinWin

Table of Contents

1. Rescue, Recover, Re-Design, Re-Build: Finance Industry Futures 3

2. Finance Industry Futures II: Sector Transformations 5

3. Finance Industry Futures III: Cases in Point (C as Exemplar) 7

4. Helmet Laws vs Adult Supervision: Re-Regulation & Finance Industry Futures 8

5. Firestorms, Finance, Futures: From Sociopathic Dysfunction to Value Creation 11

6. About Llinlithgow Associates 15

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January 30, 2009

Rescue, Recover, Re-Design, Re-Build: Finance Industry Futures

http://llinlithgow.com/bizzX/2009/01/rescue_recover_redesign_rebuil.html

Well it'
s time to return to the fray since we' ve "allowed" a natural and necessary focus on the credit and markets crisis and
the coupled economic and markets disruptions and downturns to focus our attention. That means it' s time to re-focus on
business, specifically in our three-part mantra of Economy-Industry-Company that means it' s time to return to discussing
Industries and Companies. But where to start ? Ai...there' s the rub Horatio ! Make no mistake about it, we' re facing radical
changes in each and every industry, deep structural changes (where structural means very long-term changes in how an
industry is put together as opposed to secular changes where an existing structure moves as it would without re-factoring,
or cyclic change which represents normal and natural ups and downs). In shorthand STRUCTURAL = TECTONIC, in
other words we' re facing tectonic shifts in any industry you'd care to name for lots of reasons. The gimmes are Finance
and Autos but include Retail, Technology, Pharma, Mediatainment or any other. For example the Retail is enormously
over-built and between the downturn and consumers changes in structural behavior there' s going to be a lot of
downsizings and BKs ! So if we can start any where let' s begin with Finance.

Four things MUST happen IOHO: 1) Finance will return to it' s roots and no longer absorb the resources and profits it has,
2) the industry will de-leverage, 3) the shadow-banking system will come under the regulatory umbrellas since they can' t
be trusted without adult supervision and 4) there will be an increased emphasis on operational efficacy as opposed to
financial engineering.

But bear in mind two other key short- to intermediate-term major factors: 1) the credit crisis is not over and the industry is
facing a lot more bad debt without the capital to meet the calls and 2) in particular housing is going to have to be written
down to reasonable levels meaning more haircuts for banks/lenders and homeowners. OUCH !!!

Structural Change

The share of national account profits going to the

Finance Industry has historically been significant but
grew much larger in the ' 80s and '
90s but it took a
major jumpshift in this decade. That' s over.
Hopefully you can peek at this composite chart and
readily come to a similar conclusion. Now the
question is, to start, what magic new source of value
did the Industry create to cause such a dramatic
shift around 2000 ? Recent experience would
suggest value-add was large and negative. yet
finance is an integral and essential part of the
modern economy allowing the mobilization of capital
for sundry endeavors that would otherwise lack
funding. So it'll stay but NOT at this level ! So what
happens if it goes back under 20% ? Or, lord forbid,
back to the historic norms that might be guestimated
in the 15-20% range ? What does that say about the
L.T. structural outlook, performance and
value/service requirements?

It'
s a brave new world folks.

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Leverage and Operational
Effectiveness

If you look at that history what you're seeing is

the macro-indicator of lax regulation combined
with a worldwide slushing of funds but most
importantly LEVERAGE run hog wild. That' s
going to stop - which means when you break
down the Industry be major functional sector
and compare each sector by functional
component that instead of 30X leverage banks
will a) have to make money at 10X, b) so will
everybody else and c) they' re going to have to
enormously improve their operational
execution from Marketing to the back office to
Product Development to Service. Pray for the
day.

This chart actually gets to the heart of the

matter and illustrates the huge cliff facing JPM,
Citi and BA, for example. In fact it started as a diagnostic for Citi but turned out to sever well as a way of blueprinting the
strategic requirements and current status of them all. The key enbler will be the management systems - setting objectives
and making sure they come to pass. The cardinal failure of Weill and Prince at Citi. It' s not necessarily that super-market
banks are bad it' s that so far bankers have been bad managers. Given JPM and BA' s acquisitions we'd better hope they
get it right this time !!

Storms, Tsunamis and Quakes

If the credit crisis is turning out to be a never-

ending series of perfect storms with a Cat 5
hurricane thrown in the parallel economic
downturn will keep rippling thru with increased
pressures on consumers and businesses
leading to accelerating defaults, BK' s and other
ugliness. Right now it' s estimated (by Roubini
among others) that most of the major banks are
technically insolvent and have inadequate
capital as it is. If unemployment gets to 10% the
resulting tsunami of defaults will swamp them.
And of course we' ve just finished talking about
the tectonic quakes that will result in huge shifts
in the structure of the Industry. We' re likely to be
facing tight credit for years or longer as a result.
The vicious and viscous positive (meaning
reinforcing) feedback loops we' re about to see
accelerate are illustrated in the accompany
graphic.

That means that getting the bad assets off

the books, re-capitalizing the banks, re-designing the regulatory frameworks and marking to reasonable values
are national strategic imperatives. The question then becomes how will the banks adapt? AND who's
prepared? That's back to our fundamental point last post about looking for blue chips, translated as who's
leadership is up to these challenges. So far there appears to be a real shortfall.
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Strategy without execution is fantasy. Execution without strategy is thrashing.

Either without a management system is unlikely.
January 31, 2009

Finance Industry Futures II: Sector Transformations (Hedgies, M&A)

http://llinlithgow.com/bizzX/2009/01/finance_industry_futures_ii_se.html

Currently the Davos World Economic Forum is underway,

and having watched several of the online videos which are
available to you (SB: a great resource which you should
invest some time and thought in - for example Putin and
Wen' s critiques of the financial system breakdown were
small parts of their speeches, despite headlines, far less
harsh than the Westerners themselves and their call for a
new integrated economic and financial framework
commonly shared very widespread) online.

Several recurring themes/memes were (1) find and hang

the guilty, (2) re-engineer the system, (3) the downturn' s
going to be worse than we think so far and (4) the geo-
political strains immense (all of which we' ve been
trumpeting for some time) are running thruout the sessions.
There' s no better horse' s mouth sources about on-coming
events, trends and changes than this stuff and the
reporting is just flat getting it wrong. The vidclip graphic
takes you to a session that' s among the many you should
listen and it's on "What Went Wrong" (click to see if the
graphic doesn' t work) and is hosted by the Money Honey
and includes folks like Stiglitz, Shiller and Blinder as well as
many leading luminaries. Listening to ought to scare you because the folks who are at the forefront and were at ground
zero basically confirm all our arguments from the previous post (Rescue, Recover, Re-Design, Re-Build: Finance Industry
Futures). Sorry if the graphic doesn' t look as appealing as it does running :) ! But listen to it anyway (after the start you
need to scroll to about 40 min but especially listen to the end. The
discussions are the real meat though).

Brave New World and Confidence

The relevance for us is that we will see new national and international
regulatory frameworks and the best thinking is that the Finance Industry
as we knew it and are still extrapolating forward from will undergo deep
structural changes. This is NOT a cyclic downturn it is a structural one and
what comes out will look nothing like what we' ve seen. The readings after
the break start by speaking to some of these strategic contexts and trends
and then focus on two sectors which will undergo some of the most radical
change as de-leveraging proceeds and risk is re-priced and regulatory
mechanisms tighten up in new forms. Those sectors are Hedge Funds
and M&A. In the last post we talked about the big picture trends and put
up a graphic illustrating which sectors were in what kinds of trouble.

The key to remember is that the more they relied on over-leverage, under-
priced risk and bad operational practices the more vulnerable they are, the
harsher the changes will be and the less the new will resemble the old.
From that same conference it turns out that our coterie of flat-footed
business executives are loosing confidence rapidly and the rest of the
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world is loosing it even faster in them. How'
s that going to play in Peoria ? Or more importantly among the stakeholders
who went chasing returns in the alternate investment "brave new world" that' s dying ?

No More Quoth the Maven, No More

Well one way to judge that is by looking at long-term finance industry stock prices, here proxied by the XLF industry ETF,
as a proxy for what people think of the industry. Not surprisingly not much at all, as shown by the literally abysmal drop
into the depths of loss. Go look up Laurentian Abysmal on Wikipedia sometime, or better/worse read about the Challenger
Deep. Let' s hope we stay Laurentian instead of further challenged (there' s several puns there...look it up as they say :) ).
Meanwhile look more carefully at the chart, the top of which shows the 10Yr weeklies for XLF along with the 20Wk MA
and the bottom two sections show technical indicators (Volume and a MA difference which shows momentum). Now really
look at it carefully. From 02 to early/mid 07 finance went up 100% - a pretty good exemplar of a fantasy bubble in a week
economy IOHO. So what differential, unique and new huge value add was brought to the table to so far exceed historical
performance norms ? Well judging by the 50% drop since then BELOW the 10Yr zero point NONE. And it turns out that
the industry lied to us AND itself - these are after all "the smartest guys in the room". Turns out that subsituting financial
engineering and loosing sight of fundamentls looks more like the early rockets than Saturn V.

The Devil's Details

Let's consider that down another level of

granularity to bring it home. The accompanying
graphic provides a list of key bellweather financial
stocks showing their status as of mid-day
yesterday, relative to their 50Day MAs and 52WK
High/Lows. Take a careful look and tell us who you
think has turned in an exemplary performance ?
Even the best investor of our lifetimes is down
almost 40%. Which is a tad better than Jaime
Dimon at JPM and enormously better than Lewis at
BAC, the architects of the two new megabanks. On
the other hand People' s Bank of CT is down 24% -
a stunning out-performance in this environment. So
what does that tell us ? Well PBCT has been
conservative, run a good bank and picked it' s
opportunities. Things Dimon and Warren are
known for as well.

We come full circle (Survivor: Search for the Next

"Blue Chips" (UPDATE))back to our key themes -
good Strategy, great Execution on operational
fundamentals, sound Management Systems and
Leadership.

And if you don't think it makes any differences then work out what yearly return you got by buying XLF at the end
of '02 and buying the inverse in early '07. Hints: try a 2 handle for the first and a 4 handle for the second !

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Strategy without execution is fantasy. Execution without strategy is thrashing.

Either without a management system is unlikely.
February 20, 2009

Finance Industry Futures III: Cases in Point (C as Exemplar)

It'
s time to dive back into Part III of our extended round of
dissection of the Finance Industry, a dissection which, btw,
we have taken several passes at. So much so that there' s
an extended archive of previous postings looking at the
Industry as a whole and particular companies. And course
there' s the prior two posts in this current series (Rescue,
Recover, Re-Design, Re-Build: Finance Industry
Futures,Finance Industry Futures II: Sector Transformations
(Hedgies, M&A)) which follow along our revised mantra of
Policy-Economy - Industry-Company. In those archives
you'll find us arguing rather early in '
08 and extending back
to mid-' 07 that the Finance Industry had become a vastly
disproportionate share of earnings, market indices and
corporate profits. And also arguing that that displacement
was a recent phenomenon, since ' 00, but having roots
stretching back.

Our argument was/is that the displacement was based on

mis-priced risk, leverage and liquidity, not on innovation or
value-creation. Yet at the same time we MUST recognize
that the Finance Industry plays a vital role in a modern economy and is essential to prosperity.

What that all boils down to is that a re-factored industry will, and should, be with us for a long time but that the necessary
re-factoring will take many years. What we' d really like to see is new service and product innovation, on the same order as
money market funds, discount brokers and all the other major breakthrus that made the industry of the ' 80s so
contributory. The jury is way out on that but at the end of the day it all boils down to the individual companies and their
leadership. Hence this post.

Citi as Exemplar

In a set of prior company specific posts (Poster-child II:

s Potential Turn-around as Performance Exemplar) we
Citi'
dissected Citi and Pandit' s reform and re-structuring
efforts. Our bottomline conclusions were that he was
trying to do the right things, that he was in danger of
being swamped both by systemic problems AND the
legacies of bad management systems. Our final
argument was that, given a multi-step strategy of
arrest, recovery, re-design and re-build and then re-
energize that the critical key was, and is, the
implementation of a management system that set
clear, simple and reality-based objectives and then
implemented them with the appropriate resource
commitments and measured them with the right
accountabilities and controls.

The presence or absence of a Management System

will make or break Pandit'
s efforts; it will also make or
break the huge new financial conglomerates create by
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Lewis at BAC or Dimon at JPM.

Citi, Management System and the Finance Industry

What do we mean by that ? Well the accompanying graphic tries to sketch it out conceptually, based on our approach to
assessing and re-building "total enterprise performance" using the Management System as the driving engine of
controlled adaptation and resilience. First you have to have a blueprint that lays out the Vision and Strategy, which have
to be based on current or reachable Operational capabilities in critical functions. Then you have to develop the right
implementation, operating plans and controls for each of those functions, both as a stand-alone capability and as part of a
whole who' s performance is more than the accidental sum of the parts. A point central to our last several postings on
business performance (Let the Triage Begin: Business Performance vs "Stupid Is",Survivor: Search for the Next "Blue
Chips" (UPDATE),Time, and Past to Play Bizzball: Economy to Business Performance (UPDATEs)).

Finally a proper management system sets objectives and goals, establishes resource commitments judging the tradeoffs
and then puts measurements in place for which each manager is held accountability and reponsible for delivering against.

It Ain't Just About Citi

In the readings you' ll find an extended set of excerpts that

trace C' s trials and tribulations from last Fall to now. One of
the scariest thing is, despite our earlier applause, is how
oblivious they were to all these macro and management
issues. But it' s not just about Citi. The rest of the readings
point to other examples, good and bad, of financial firms
either adapting to the moment or not; and in the latter case
dying as a result (cf. "The Last Days of Lehman"). The
readings also start off with two context defining excerpts.
One that reiterates and reinforces our fundamental point by
pointing to a recent Booz study about how flat-footed, shell-
shocked and non-adaptive leadership is on a worldwide
basis. The other, a very recent Jubak column, is the only
balanced assessment of the Geithner plan that integrates
the politics with the policies we' re aware of. The recent spate
of policy announcements are, IOHO, much better and much
better crafted in light of circumstances, than anybody yet grasps. (Miracles on Pennsylvannia Ave: Make it So, No. 1 !) Nor
are the talking heads and pundiocracies getting to the heart of the matter - something constructive is better than standing
pat, there' s no time for more screwing around and you do the best you can with what you can lay your hands on. What' s
required is a cool head and a steady hand on the tiller, plus some communication skills. On the whole our public policy
makers are doing enormously better than our private decision makers. Let' s hope that changes and rapidly !

But as we wend our ways thru these minefields understanding how adaptive and resilient
leadership is will be a critical factor to evaluating the future.

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March 30, 2009

Helmet Laws vs Adult Supervision: Re-Regulation & Finance Industry Futures

http://llinlithgow.com/bizzX/2009/03/helmet_laws_vs_adult_supervisi.html

Well last week should have been another stunner,

beginning as it did with the biggest extension of the
biggest bailout since the GD and ending with the largest
regulatory re-thinking since the cumulative total of GD
and intervening decades legislation and regulation.
REALLY stop and think about that for a moment - almost
EIGHT DECADES of incremental change has been
compressed into sixty days. Or being slightly more fair
120 going back to Sept and the TARP kickoff.

Five weeks ago everybody wanted to hang Geithner for

malfeasance and lack of detail, now he' s a genius and a
hero. Be careful what you ask for too ! Pundits and
interests on the left, right, up and down are all choking,
albeit more quietly, on these details. Yet nothing should
be a surprise since there' s a clear pathway from Bush
Administration decisions and recommendations, including
Paulson' s tentative plan from last spring (btw on of the key readings is a FT oped by Henry supporting a regulatory
overhaul that looks like this one on a worldwide basis).

Of this set of initiative what'

s most important - the economics, the financial technicalities, the politics or the popular
reaction ? Actually all of them !! What's still missing is a context to help organize, categorize and organize our thinking
about these myriad complexities so we' re going to take our best shot at explaining what' s going on. And make no mistake
- these are enormous changes, mostly for the better IOHO, long over-due and the Finance Industry and it' s role will never
be the same again. The last three decades of business models, strategies and profit/performance relationships are gone
forever ! We ended the last post with the accompanying cartoon to capture the popular reactions to date and so we start
there. Now lets dig into the strategic context.

Helmet Laws and the Public Good

My personal reaction to seatbelt laws was they were

unnecessary interferences in private decisions; as we used to
say in the rock climbing game when the tourists went round the
back side of difficult climbs, started down ravines and went splat
in the parking lot that's how you sort out the riffraff and
wannabees from the folks who belonged there. Ditto for
motorcycle helmet laws and cellphone laws. All of which have
become widely adopted. Now for anyone who' s almost been run
over by some weekend shopper chattering away (in our case
one nice lady looked us directly in the eye and then almost ran
us over and didn' t even notice !) these laws begin to make more
sense.

Take at look at this YouTube clip and ask yourself what level of
responsibility was displayed by the rider. Then ask whether or
not the law made sense. Without a helmet this guy would have been history. Here' s the policy implication - if the only
person to be hurt had been the rider then sobeit. And if irresponsible riders had to post insurance for the bucket and mop
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brigades required for cleanup as well the public costs would have been balanced out. The realities are lots of folks
continued, continue and will continue to act irresponsibly and the costs are not restricted just to them but impact the
general public. There' s the general principle - when the costs to society greatly exceed the cost to private individuals
regulation is our only recourse.

Keep On Breathing: the Financial

Circulatory/Respiratory System

What does that say about the Financial System ? If you

go back to the Congressional testimony in the summer of
'07 on executive compensation one can only characterize
the responses of the boards, chairmen and compensation
committees as being beyond tone deaf. And as publicly
irresponsible as a drunken motorcyclist driving thru
streets full of school children.

We have at least $180B invested in AIG to date trying not

to save the company but save the world economy;
literally. (If you check out several of the last posts that
show the credit and equity markets and economic data
that should now be beyond challenge we hope !!!). The
credit breakdowns and crisis is often compare to a terrible
plumbing problem with rusted and clogged pipes, frozen
values, and bad water. A fair analogy if you consider that
it's not just a house but the whole neighborhood and
town.

A better analogy we think, that represents the complexity and inter-connections is how your circulatory system takes
oxygen and energy and gets it into your system until it reaches the cellular level where a complex and inter-connected set
of metabolic and bio-chemical reactions keeps you going. Credit has been called the lifeblood of the economy and, in
some senses, that' s almost literally true. It'
s pervasive, systemic and systematic involving inter-actions at the most minute
and granular levels on up to grand flows of macro-systems. To tell that story we' ve composited a graphic that traces thru
the flows of the circulatory system as a model and metaphor.

Supreme Truth and Systemic Poisonings

Back in 1995 the Aum Shinrikyou cult put Sarin gas into
the Tokyo subway systems to purify things and bring on
the new world, since they were an elect and spiritual elite
who had deeper insights into the mysteries of the
Universe. Now there are many good people in the
Finance Industry but the leadership, perverse incentives
and lack of controls combined with the "deeper grasp of
the mysteries" of financial engineering led the Finance
Industry as a whole to effectively mimic the cult' s actions.
Only instead of 5,000 people who were affected locally
we had six billion who are effected globally. For nearly
three decades the Industry has argued that it was capable
of self-responsible adult supervision, that is it wouldn't
drive recklessly, didn'
t need to wear helmets and was
performing both a privately profitable and public good
service. That turns outs out to be entirely false to fact. And, judging by the shell-shocked lack of leadership in response to
these disasters the industry isn' t stepping up to the plate to help re-formulate the proper "helmet laws" so society is going
to do it for them. Which is truly unfortunate on many levels and in several ways. First off we truly do need a finance
industry to help mobilize and allocate capital; much of human progress is built on the gradual evolution of capital markets,

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at least indirectly. And there's still going to be huge profit potentials for well-constructed, designed and operated financial
institutions as a result. The question really becomes which ones.

Can You Hear the People Singing ?

As Peter Drucker pointed out almost forty years ago

businesses are social institutions and cannot survive or
prosper if the societies of which they are a part are not also
healthy and prosperous. Enlightened self-interest would,
for a responsible adult, motivate businesses to encourage
the welfare of the broader society. Or at least not damage
it. Drucker identifies three major goals or responsibilities of
the effectively managed business: 1) deliver an effective
service that creates value - in the case of businesses this
means making a profit that is sustainable in the long-run,
i.e. balances short- and long-run decisions. Then, 2)
operates efficiently and effectively by making work
productive and the worker achieving. In other words by
making sure that work is logically designed but also
recognizing that people are social animals and to be
effective one has to account for the non-economic
dimensions of the business as a social institution. Finally, 3) act in a socially responsible manner to ensure that society is
doing well (or as we put in an earlier post make sure that the prey populations are sustainable and self-renewing). Social
responsibility requires two things - first when the activities of your business impact the broader society move to reduce the
harm. For example when you create a pollutant act to clean it up before society forces you to do it. Second, identify
broader social problems that are connected to your business and act proactively to eliminate them before they become so
bad that society has to. The classic example is the Auto companies and Healthcare, which they' ve known is a competitive
problem for six decades yet failed to pursue the social remedies of regulatory and insurance overhauls required.

Farther and Farther Behind the Curve

In particular Drucker points out that denial and fighting rear-guard

actions to prevent regulation when it' s in the interests of society and
your company is a management failure, grossly counter-productive and
irrational in the long-run. Paraphrased, either change the regulations or
change the regulations!

Let me translate that: if business operations create a

problem that individual businesses cannot solve because of the profit impacts and therefore
require general regulation it is the fundamental responsibility of management to proactively
engage in working with other institutions to craft the legislation and regulation. To fail to do
so is irresponsible, malfeasant and a gross failure of managerial leadership.

The Finance Industry would never be the same again after testing their engineering skills to destruction. But after the
social damage they' ve done society cannot allow them to self-supervise. Something they should have been addressing for
the last thirty years; there have been plenty of warning signals. Instead they chose to pursue the path of lobbying for
greater and greater freedom which led to greater and greater risk-taking. Pursuing the analogy it' s as if the Aum cult kept
making more sarin.

The question is what happens now ? We' ll take that up in another post but here' s a hint: get out in front and help shape
things or get run over by the Juggernaut. Two more: you won' t like the alternatives AND if it gets out of control nobody will
win.

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Either without a management system is unlikely.
April 07, 2009

Firestorms, Finance, Futures: From Sociopathic Dysfunction to Value Creation

(UPDATE2)
http://llinlithgow.com/bizzX/2009/04/firestorms_finance_futures_fro.html

We' ve been plowing thru various aspects of the Finance

Industry and it's outlook as well as the broader socio-
political context since the end of January. Starting with a
broad overview and then tunneling down into specific
sectors outlook. The AIG firestorm led to or was associated
with a look at the broader context. No business or other
institution can exist other than on the sufferance of society,
and if it does not contribute value to that society it will be
changed - one way or another. That makes it a
fundamental management responsibility of any business to
be aware of broader socio-political trends and problems
and to act proactively to intercept or correct them. If
nothing else by anticipating problems and acting to support
broader policy responses to problems beyond the
industry' s immediate ability to cope with. Judging from the
remarks of the new Citi CEO the Finance Industry gives
new meaning to phrase tone-deaf.

Now that some of the details are leaking out we've found out that in the President' s recent meeting with key CEOs he
basically said, "we'
re the last thing between you and the pitchforks". We' re tempted to put up the "Can You Hear the People
Sing" graphic and URL again but hopefully the point is still relatively fresh in your minds, as it appears not to be in the
minds of the industry.

The real question is now what ? Mike Mayo (cf. the readings) as well as Meredith Whitney came out yesterday and said in
effect to short the Financials. Advice we heartily agree with because there is no function or aspect of the industry that
doesn' t appear to be broken. From internal execution capabilities to strategy to broader socionomic positionings. The
really sad thing is that it doesn't have to be this way. During the 1980s we were all the beneficiaries of major value-
creating innovations from money market funds to reasonable de-regulation to discount brokers to mutual funds. In the ' 90s
that innovation evolved into internal financial engineering rather than value-creation and in this decade it clearly
metastasized into value-destroying, on both the business, industry and social levels, "innovation". To survive, recover,
return to profitability and restore it'
s place as a valued part of the system the Industry needs to realize these firestorms will
rage and change everything.

Drucker Principles and Finance Futures

As we' ve worked our way thru an analysis and

assessment of the broader impacts and consequences of
the finance industry we' ve ended up depending quite a bit
on Peter Drucker' s insights on the major performance
criteria for business value creation. The graphic at right is
a summary of one interpretation combined with our earlier
framework of the major sectors of the industry. But let' s
start by quoting Drucker (p. 369, "Management: Tasks,
Responsibilities, Practices"):
"Essentially being a member of a leadership group is what
traditionally has been meant by the term "professional".
...as a member of leadership group a manager stands
under the demands of professional ethics - the demands
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of an ethic of responsibility. [A professional] is public in the sense that the welfare of his client sets limits to his deeds and
words. And Primum no nocere, "not knowingly to do harm," is the the basic rule of professional ethics.

There are important areas where managers still do not realize they have to impose on themselves the responsibilities of
the professional ethic. The manager ho fails to think through the and work for the appropriate solution to an impact of his
business because it makes him "unpopular in the club" knowingly does harm. That this is stupid has been said. That this
always in the end hurts the business or industry more than a little temporary "unpleasantness" would have hurt has been
said too. But it is also gross violation of professional ethics".

We trust Prof. Drucker' s points are crystalline ? Just to compress and paraphrase them the actions of the industry are
harmful, counter-productive and are going to lead to a massive social backlash that' s entirely justified by the facts of the
situation and the necessities of society. Remember if you do not create value society has NO reason to tolerate you. If in
fact you destroy value and massively harm society it cannot even afford to tolerate you. In the graphic we' ve tried to depict
the relative performance on the Drucker Principles of each of the major lines of business with the caveat that there is no
multiple-red color to properly represent the behavior of the securities related business and the damage caused.

The Theory of the Case

When a logician or lawyer is looking for the core,

fundamental argument that drives the entire rest of a
complex chain of argument they talk about the "Theory of
the Case". We' ve come to think that's a nice, powerful,
description of how to think about a business. That is to ask
"what is the theory of the case ?". In other words what' s
really going on here, what are you going to do about it and
why are you convinced and convincing that value-creating
performance will result. So far all we've heard from the
Industry has been denial, rear-guard defensive actions and
what can only be described as "forlorn hope" attacks.
Nowhere have we seen anybody stepping up to present
the theory of the case for the immediate crisis let alone for
the necessary future timeframes. Instead they' re leaving
leadership to Washington, speaking for society. And
Washington is indeed stepping in to fill the vacuum. But the policy-makers and politicians know they aren'
t experts and
would more than likely welcome constructive engagement that looked to the greater good of society as well as the
industry. Not just continuing defenses of egregarious compensation packages.

Observations, Suggestions and Opportunities

We aren' t so bold ourselves as to make detailed

suggestions just yet but we would like to make some
observations and suggest some trial balloons. Across the
entire spectrum of banking and financial services,
including banking per se, consumer finance, SMB
finance, financial companies, investment services and
advisory services we think the basic business model and
strategies of the future will have to deal with several key
factors:

1. The industry will be significantly de-leveraged.

2. A focus on customer service, putting the customer' s
interests ahead of the firm' s, will create value and
ultimately a differentiating competitive advantage.
3. Fairness and value for compensation need to be fundamental principles of operation.
4. Innovation in new value-creating services and capabilities needs to be the driving strategic mantra of the new industry.
5. Survival, recovery and effective innovation need to be based on effective and principled management systems.
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Which leads to some strawmen suggestions for financial innovations just to get the ball rolling:

1. Hedge-like funds for small investors to be able to cope with a low-return, topsy-turvey world.
2. Non-opportunistic (i.e. non-exploitative and with non-exorbitant interest rate) consumer finance and
credit cards.
3. Securitized business finance based on deep understandings of fundamentals AND loanee re-payment
capabilities. For example trade finance could be greatly expanded and help out the growth of the global
economy.
4. Micro-finance in the inner city.
5. Ratings mechanism reforms coupled with performance insurance and/or bonding.
6. Localization of financial services where branch offices and staff truly return to being local in their
knowledge and connections. This could be coupled with a "franchising" approach to combine the
economies of scale of large institutions along with superb local knowledge.
7. Merchant banking for small companies in the best, "ye olde English" sense of informed investment in
serious business opportunities. For example in green energy, bio-tech, etc.
8. Operations-based investing based on business fundamentals for the Private Equity sector.
9. Macro-monitoring and advisory services to help with budgeting, capital planning, expense control and
general business planning.

SEE CHANGES: Glimmers of Hope, Honesty and Re-Thinking

The industry is faced with some very stark choices: Cooperate (go
along with unavoidable policy changes just to survive), Collaborate
(become pro-actively involved in shaping that policy) or Cave (be
plowed under and constrained for decades by the popular anger at
the violations of the public trust). The financial firms you want to be
investigating and investing in are the ones that satisfy the Drucker
principles AND have clear responses on the "Theory of the Case" on
all timeframes for all lines of business.
So far we haven' t seen any. Let's hope that that' s just our lack of
information access and not the reality. Otherwise a vital and
important industry will do itself and us irreparable harm !

UPDATES: Nothing like good timing. As we were putting up this post

it turns out Lloyd Blankfein was giving a truly stunning speech in
Washington that finally acknowledges the public responsibilities of
the Finance Industry, in detail. In particular he supports almost point
by point the major elements of the Geithner Plan as well as the call
for greater worldwide regulatory over-sight coming from the G-20
meeting. His speech got widespread, rapid and, dare on say, shocked coverage from a wide range of the commentariats.
You can find some of this in the readings as well as a a valuable assessment from Steve Perlstein of the WaPo
highlighting the need for fundamental cultural change. Our collective bottomline is that we consider all the points we've
been making in this post and it' s predecessors to have been supported by perhaps the leading executive in the Industry !
There is, btw, an enormous collection of readings after the break that we highly recommend you at least skim. Judging
from the readership stats that hasn' t been the case but there'
s quite a collection surveying the evidence behind the points
we' re making !

UPDATE2: Just ran across a fabulous oped from the WSJ on Wall St. cultural breakdowns that both fits nicely with our
overall theme and serves as the perfect counter-point to Blankfein'
s Mea Culpa.

The point being this - external and internal structural changes are vital but UNLESS THE STREET CHANGES IT'S
CULTURE....IT'S CULTURE WILL BE CHANGED.

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Strategy without execution is fantasy. Execution without strategy is thrashing.

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About Llinlithgow Associates Customer Problem
• Value Proposition
• Business Model
Llinlithgow Assoc. is a management consultancy • Strategy
focused on evaluating businesses to reduce risk,
leverage under-developed opportunities in
operations and increase overall enterprise
performance to improve investment return. Management System
Marketing, Sales &
•Budgeting system Service
Our approach is based on BizzXceleration, a •Management Controls • Customer value focus
proprietary framework with 25 years of •Operating Plans • Process Discipline
development, to review and analyze Business •Resource Development • Business-driven
Models and Strategy, key operating functions and
supporting infrastructure and management
systems. From there we develop comprehensive,
integrated operating plans that tie all the Core Operating
Functions
components of the business into a high- • Functional Efficiency
performance enterprise. • Inter-function
Integration
Several years ago Michael Lewis published an •Value Alignment

interesting book on how the Oakland A’s took a

systematic look at how the game really works, and what investments in players, strategies and tactics were most likely to
result in the most wins for the lowest cost. Our approaches are similar in taking a systematic look at the whole business,
each of the major components and the best way to tie everything together into a high-performance system.

We start by looking at the basic core value proposition and it’s translation into the Business Model and Strategy. Typically
we next examine Marketing and Sales operations, where it is possible to reduce operating costs by 30%, shorten the
sales cycle by 30% and increase the closure rate by 30%. This is primarily the result of establishing good processes and
discipline.

BizzXceleration is comprehensive but integrated across the total reach and range of business activities and issues. And
emphasizes a pragmatic, workable approach that results in a stepwise path to performance improvement. We believe that
our approach mitigates business risks, improves operational performance and can lay the groundwork for 10-30%
EBITDA improvements in post-deal execution.

If you would be interested in further discussions, more detailed descriptions or the review and testing of specific
opportunities we would enjoy hearing from you. We can be reached at contact@llinlithgow.com .

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Strategy without execution is fantasy. Execution without strategy is thrashing.

Either without a management system is unlikely.