I think the main problem that others have pointed out, is that you typically have a persona that you reveal to different groups of people and you typically only want those groups to have a specific view into your life:
* Family - you are an upright person that loves grandma's pumpkin pie.
* Distant friends (coworkers) - you are a hard worker that occasionally is interested in backyard BBQs.
* Close friends - they know you are really a drunk.
* Intimate friends - they know you are really just a big kid.
* Internet friends - know you really have a thing for fishnets.
Point is, a social network really needs to successfully tackle this issue. If they can do that, then they'll be able to fold facebook, linkedin, twitter, et al all into one site.
The Windsoc Social Client aggregates activities and includes the concepts of Circles and Channels. Circles are collections of people just as you described, actually, while Channels work to split contacts and services (and someday individual activities) into separate subject areas. This is because usually I'm on startup mode, but when I'm relaxing I like to change over to my other interests.
And that is exactly why it is such a hard problem to solve. Any naive UI that attempts to solve this problem will putt too much cognitive load on the user.
Internet is more and more shaping like human life, because well it only exist if humans contribute. When internet was young it acted like a teenager: want to be anonymous and talk crap, spam, troll, now this is like a 20years old growing up man -- wants to put his real identity upfront, upload real pictures, organize and connect with real-life friends, etc.
Facebook lacks next layer, next growing up stage, that is everyone has multiple identities and act accordingly to situation: work, home, friends, family, lovers, etc. This is pretty much what you said already -- I think Facebook failed with "groups" -- they should put more effort into literally enforcing users to organize everyone into real-life "groups", so once this is done you can give options to modify feeds from each person. Now, my wall is equally crapped by people I dont want to hear everyday, and my closest family. Its a mess; like well-build Geocites with nice logo on the top...
IF Facebook wont put more focus on enforcing people to get into groups, I agree that sooner or later they will start declining. I dont really "buy" that whole "everyone is in so I am not going anywhere" point; looks at MySpace -- everyone was there. Fast forward 3 years later everyone is somewhere else. The point is, once a website goes viral, friend of friends and their friends start joining, you won't stop migration of users from one website to another -- but obviously first islander need to see benefits and reasons to move on. Once this start, it will NOT be cool anymore to have a Facebook profile. I cant wait for these days.. not really that I wish bad to someone -- but I want to see how CEO of Facebook will act to save his sinking ship. Oh, I also don't buy the fact that "entire website is using facebook features, such as "like" and forum etc". Trust me, once a new network kicks in, it is obviously will be #1 goal of every webmaster and administrator to attach a new&cool thing to their website. You will see that new widget everywhere within weeks, if not days!!
Fair argument, sensationalist title.