Fell has had a long and distinguished career in Canadian banking, going back to 1959 when he took a job in the research department of Dominion Securities (which eventually became RBC Capital Markets). As a result Fell brings with him a lifetime of wisdom and insider knowledge to the subject of the current meltdown, and it was extremely interesting to hear his frank and candid take on what’s happening right now.

Like many, Fell thinks that what we’re witnessing is the meltdown of a 25-year U.S. dollar-denominated debt super-cycle that began to inflate in the early ’80s. The creation of this giant debt bubble got underway with the ascendancy of Reagan to the presidency and the emergence of Greenspan as head of the Federal Reserve. And the two began a long experiment with de-regulation in the financial services sector in the United States.
As a result prohibitions against lending were rolled back across the financial services, and that allowed credit creation to go ahead at levels that preceded the Great Depression. By the end of this whole process we had continually upped the amount of outstanding debt to the point that investment banks in the U.S. were levered 30-to-1 in terms of assets. But that era, said Fell, “has come to an end. The grand experiment of de-regulation is done.”

What we can expect in the years ahead is a less profitable banking industry as financial service firms focus more on organic growth than growth from off-shoring, de-regulation and credit expansion. The result says Fell is that, “we are going to see a multi-year period of retrenchment in the financial services.”

Fell also said he expects the savings rate of the average U.S. consumer to rise until it returns to its historical average, which means a permanent hit to consumer spending going forward. A chart handed out before his address shows how the personal savings rate of the average U.S. consumer fell from somewhere around 10% in the early ’80s to, basically, zero by 2007. As that number moves back to historical norms, say six or eight percent, we’re going to see that much of a reduction in consumer spending.

Of course, this “new consumer” is what the economy seems to be readjusting to right now. And while it’s likely necessary (we can take some people away from retail and get them working on rehabilitating our decaying infrastructure), it’s going to be painful. Also included on Fell’s handout was a chart showing that over time total U.S. debt as a percentage of GDP rose from a bit over 30% in 1981 to almost 90% in 2007. In terms of lending that represents a spike that mirrors the amazingly rapid increase in lending and credit creation that preceded the Great Depression. No wonder Fell thinks that,  “this could be a longer, deeper recession than many think.”

He also mentioned the recent G30 report on the financial services that was partially authored by Paul Volcker (“the best head of the U.S. Federal Reserve,” he said). Released just a few days ago, it can be found here. The conclusion is that we basically have to “rebuild” our broken financial services sector from the ground up, and that’s going to take a while.

Finally, Fell mentioned some interesting ideas about the way we do our central banking, suggesting that we need to do something about the extended periods of boom and bust we’ve all been subjected to over the past generation. This is a subject we’ll cover off in the next print issue of Canadian Business. We don’t have to run the system the way we do. We can get rid of the big ups and downs. “Instead of one big bubble it would be better to have more and frequent [and therefore less damaging] credit cycles,” said Fell.

Overall his message seemed to be that financial services are going to be in a period of rehabilitation for some time–U.S. banks may still have to be partially nationalized–and that counters some of the stuff we’ve heard from bankers still in the industry. Presumably Fell was able to speak frankly now that he’s retired, and we thank him for taking the opportunity to do so now that he can. I’m trying to get a copy of his whole speech and if we can we’ll paste it here in the weeks ahead for those interested in a really good take on the state of banking in this world credit crisis.

Some other points from Fell:

-Fell suggests banks get away from dealing in complex and expensive derivatives and get back to basic banking. “If it has more than two bells and one whistle,” it’s likely a bit much he said.

-The six largest global banks now have over two trillion in assets, which makes it almost impossible to effectively control those organizations. In terms of size, the Canadian banks are, “plenty big enough…What’s the matter with being the 30th largest bank in the world?”

-Fell also mentioned bond raters and pointed out this is at least the “10th time” they’ve screwed up in their careers. Fell said he never understood what the raters were for. You need to do your own research. Relying on a company that takes money from an issuer for a rating is a conflict of interest that will always leave that model suspect.

So while Canadian banks may seize opportunities in the U.S. market, there is also a risk they could be blindsided by a cooling off of the insatiable demand for metals, minerals, and foodstuffs. Whether or not the commodity boom goes into remission depends upon the extent of the economic downturn now said to be in progress. If it’s severe and spreads to emerging countries, then Canadian bank stocks will find it tough going regardless of the potential for making inroads into the U.S.

All of which is leading to speculation that the Canadian banks could be getting ready to swoop in and buy up some ailing U.S. financial institutions at bargain prices. “I think they’re in a position to really pick over the carcasses,” a portfolio manager with Toronto-based mutual-fund firm CI Investments, Eric Bushell, is reported to have said at a Morningstar Canada investment conference held in Toronto on June 11, 2008.

In other words, as agued in this Canadian Business Online article, the global financial crisis may actually end up benefiting the Canadian banks. They could emerge as bigger and more global players. “Canadian banks are going to be in the driver’s seat for the next decade,” said Dennis Gartman, editor of The Gartman Letter, at the same conference.

Nevertheless, the financial crisis has weighted on the share prices of the Big Five chartered banks in Canada during the past year – most of all CIBC (-48%), followed by Bank of Montreal (-42%), Royal Bank (-28%), TD Bank (-23%) and Bank of Nova Scotia (-13%). CIBC was worse hit because of its exposure to credit derivatives and monoline insurers.

The Bank of Montreal, Royal, and TD are down in large part because their U.S. subsidiaries expose them to U.S. loan defaults. The Bank of Nova Scotia is getting off lightly because it has pursued expansion into overseas markets instead of the U.S. Of the five, I suspect (without having done a great deal of digging) that Royal Bank shares could be the most likely to benefit from the growth opportunities in the U.S market. It has long been the biggest of the Canadian banks and its existing U.S. operations are not as exposed to U.S. loan defaults as the other Canadian banks with a U.S. presence.