When the 4,500 people who used to work for Lehman Brothers in London showed up at the investment bank's plush office on Canary Wharf on Sept. 15, only to be told that the firm was out of business and that they should look for another job, some of them did what any number of their colleagues around town have been doing for years: they threw a party. On the equity-trading floor, the internal PA system known as the "hoot" blared out the R.E.M. song "It's the End of the World as We Know It." And then, after collecting up their personal possessions, dozens of the Lehmanites crossed the concourse to the pub just opposite, All Bar One, where they drowned their sorrows in style, accompanied by friends from other banks in the area. "People were spending five or six hundred pounds on champagne," recalls a member of the bar staff.
It was a fitting end to what has been a remarkably bubbly period for London. Over the past decade and a half, ever since its last protracted downturn, the British capital has transformed itself into Europe's indispensable financial center. Leaving Frankfurt and Paris in the dust and encouraged by the policies of Gordon Brown, the current British Prime Minister, it has become a magnet for people, jobs and investment from around the world. The big U.S. banks made London their international hub, and the major continental European banks moved much of their trading and investment banking operations there. About 70% of international bonds, one-third of the world's foreign exchange and almost half the total volume of international equities are traded in London, more even than New York, its only remaining rival as the world's financial capital. Hedge funds piled into Mayfair on the heels of private-equity players. Any self-respecting Russian oligarch has a Knightsbridge mansion, sends his kids to élite private schools and has listed his company on the London Stock Exchange. Affluent Chinese, Indians, Middle Easterners and many others are not far behind.
All this activity has made the City — the square mile around St. Paul's Cathedral that is the heart of the old financial district, and the gleaming towers of the new financial district in the docklands area — a powerful motor not just for London but for British prosperity. In 2007, financial services accounted for 10.1% of the U.K.'s gross domestic product, up from 5.5% in 2001. Add in professional services linked to finance, such as accounting, law and management consultancy, and the total rises to 14%. And that's for Britain as a whole. For London, finance has been even more important: It now accounts for almost one-fifth of the city's total output, and perhaps as much as one-third if professional services are included. That's far more even than New York, where financial services are about 15% of the local economy.
But now the world is in the grips of a perilous market crunch, the boom is over and tough times loom. The U.K.'s FTSE-100 stock index has nosedived in recent days and is down about 35% in the past year. Three famous British banks have already imploded — Northern Rock, HBOS and Bradford & Bingley. And after a dramatic plunge in the stock price of other banks, the deeply rattled British government came to the rescue on Oct. 8, announcing an emergency $88 billion recapitalization package. The City has been through enough slumps to know what to expect next: layoffs, shrinking bonuses for those lucky enough to keep their jobs, and a new frugality over expenses. This will inevitably have repercussions on housing prices, but also on other types of consumer spending that boomed along with the City. They range from fancy restaurants and overpriced cappuccino bars to pricey vacations, bespoke suits and aromatherapy massages that the financiers and their legions of support staff could once readily afford.
The coming downturn is already shaping up as different — and tougher — than some previous ones. That's because the financial crisis is taking place at the same time as a real estate downturn, a conjunction that is unusual; in the past, one has often followed the other, but it's rare for them to happen simultaneously. And the problems are being exacerbated by an explosion of household debt in Britain over the past decade, which now leaves people especially vulnerable. Buoyed by rising property prices, households ratcheted up their borrowing to a massive 173% of disposable income, vs. 106% in 1995. That's way above even that paragon of profligacy, the U.S., where household debt amounts to 139% of income.
Oxford Economics, which specializes in regional forecasts and advises the British government, expects 110,000 jobs to be cut in London between this year and 2010 as the city's economy contracts — although if the credit crunch is protracted, it predicts that the number could rise to almost 150,000 next year alone. Real estate is already reeling. Plans for two huge new skyscrapers in the City have been shelved, and the price of prime residential houses in central London has dropped by 12% so far in 2008, according to realtors Savills, while sales volume is down by 50% in some areas like Clapham and Fulham. That's just the start. Vincent Tchenguiz, one of the biggest property moguls in the U.K., believes the real estate downturn will last five to seven years. "It's obvious that with a crippled financial sector the consequences won't be too good," he says. "London was helped by strong international markets, but as they're now gone, we'll see some stress."
As the gloom descends, one question is starting to make the rounds — a question that London hasn't really asked itself before: Did the City become too successful for its own good? The increasing dependence on financial services has brought in fabulous wealth in the past 15 years, but it has also left the British capital at the mercy of the ups and downs of the moneymen. As finance has soared as a proportion of the local economy, it has eclipsed other sectors. London was once a major center for industry, for example, but manufacturing now accounts for just 6% of the city's output, half the proportion of two decades ago. Has London become too reliant on a single industry, putting all of its eggs into one volatile basket? "Obviously people see it as a risk, and if there's a prolonged downturn, it will become an issue," says Andrew Goodwin, a senior economist at Oxford Economics, who nonetheless
believes that while "there is a concern about dependency, financial services have done well historically." At the Guildhall, which is where the City administration is based, policy head Stuart Fraser is bracing for a slump as severe as the one in the early '90s, when house prices collapsed and unemployment soared. Still, he adds, "It's like the aircraft industry. A plane will crash occasionally but what you don't do is stop flying."
Move away from London, however, and you get a rather different perspective. Across the English Channel, Thierry Jacquillat, chairman of the Greater Paris Investment Agency, looks at what's happening in world financial markets and says: "The economy of Paris will resist the shock better than London. We're more diversified." And in Brussels, at the European Trade Union Institute, economist Andrew Watt draws some uncomfortable historical parallels. "There was some idea that the financial sector was immune," he says. "It's like pinning your hopes on anything, whether it's textiles in the north of England or the car industry around Birmingham. It expands for a while and then it takes a nasty knock."
Boris Johnson, London's charismatic, mop-haired mayor, takes issue with the notion of overdependence, saying that the city's economy has "a very, very wide base." But he tells TIME: "The strength of the financial sector is obviously pretty important in acting as a flywheel to spin those other wheels. And I'm going to be fighting very hard to make sure that we don't in any way gum up that machine."
River of Gold
To see how finance has reshaped the British capital, take a trip to Greenwich, about 3 1⁄2 miles (6 km) downstream from Tower Bridge and home to the Royal Observatory, which dates back to 1675. It's the birthplace of Greenwich Mean Time, but for years the area was as well known for its mean streets: 19 Greenwich neighborhoods rank among the most deprived in England. Since 2001, the local council has pursued a major state-funded regeneration program aimed at cutting crime and unemployment, and improving the decaying public housing stock. But these days, coexisting with the urban blight, are plenty of new, well-heeled residents in new, well-appointed residences: bankers and others who work at Canary Wharf, the docklands development where Barclays, Morgan Stanley, Credit Suisse and many others have their offices. Greenwich is just a short hop from the wharf, thanks to the Docklands Light Railway, which linked up parts of once dilapidated east London in the '90s. Liam Bailey, head of residential research at realtor Knight Frank, says the gentrification started a decade or so ago, and has accelerated in the past five years. Knight Frank is currently offering plush one-bedroom apartments with river views there starting at about $500,000 apiece.
Local businesses have caught on. At one end of Greenwich's High Street is the Green Baby store, which sells Earth Friendly Baby organic chamomile shampoo and diaper balm made from sweet almond oil and shea butter. A short walk away is the Greenwich Park Bar & Grill, where a burger made from "Kobe" beef raised at a farm in north Wales will set you back $33. Some of these upmarket places have already been feeling the pain. At the Nevada Street Deli, which serves up smoky cheese from County Cork and freshly made poached-salmon sandwiches, owner Laura Heap says she's already noticed a downturn in business: "I get a lot of local mums, and they're spending less. Whereas they used to buy their eggs and bread, now they're just buying a cup of tea." Heap, who opened the shop less than a year ago, has dropped her prices by 25% and let some staff go. She remains upbeat about the future, but with Canary Wharf on her doorstep, she concedes, "I do feel a slight wave of fear."
She has every reason to be scared because financial services have a record of retrenching fast in a crisis. And the business in some sectors has evaporated. The volume of mergers and acquisitions, for example, is down by about two-thirds from its peak in 2006, while the public stock offerings that made the London Stock Exchange a shooting international star have fizzled. Given the role played by arcane financial engineering in triggering the current crisis — the troubles at AIG, for example, stem largely from its freewheeling London financial-products division — the future looks especially bleak for people working in structured finance and complex derivatives. No surprise, then, that HSBC, Citigroup, Credit Suisse and others have started cutting staff.
The Alternative Investment Market (AIM) is a good example of how London got so big in the first place, and how it's starting to pay the price. Launched in the mid-'90s as part of the London Stock Exchange, this market for small companies deliberately set out to cut the paperwork for listing firms to an absolute minimum. There's no need, say, for bulky official prospectuses before a stock is listed on AIM, and the market is overseen not by official regulators but by brokerage firms called "nomads," which are responsible for the new issues. For years, AIM was a fabulous growth story, attracting more than 2,500 companies from around the globe — and brickbats from jealous rivals, especially in the U.S. One top official at the Securities and Exchange Commission in Washington, Roel Campos, even likened it to "a casino." But in the first eight months of this year, only 85 companies listed on AIM, compared with 201 in the same period a year ago — and almost twice as many have dropped off it. "Capacity is massively down," says Tom Nicholls, a partner at London law firm LG who specializes in matters related to AIM. The nomads themselves are now under financial pressure — their number has dropped from 80 to 69 — and the remaining ones are pessimistic; at a June conference, they were asked how long they thought it would take before the market for new listings bounces back. The overwhelming consensus: not before the end of next year. "There'll certainly be an 18-month lull," says Nicholls.
All of this amounts to a particularly tricky issue for one man who has played a key role in the City's growth: Prime Minister Gordon Brown. As Chancellor of the Exchequer for 10 years, his support for financial services was especially notable because his Labour Party had a history of antagonism with the City. Brown sought to convince the financial community that New Labour would be probusiness, pro-enterprise, noninterventionist and keen to cosset the rich, believing their wealth would trickle down into the wider economy. Brown also led the way for Britain to put in place a new governance system for financial services that he and other politicians like to refer to as "light-touch" regulation (although bankers and regulators cringe at that phrase; they prefer to call it "appropriate" regulation). In June 2007, just days before he replaced Tony Blair as Prime Minister, Brown gave a rousing speech at the traditional black-tie dinner in Mansion House, the residence of the Lord Mayor of the City, brashly predicting "an era that history will record as the beginning of a new golden age for the City of London."
It's been downhill ever since. First came the run on Northern Rock, the stricken bank that the government ended up nationalizing and whose near failure raised serious questions about the effectiveness of U.K. banking regulation. Then came a damaging political storm over the taxing of "non-doms" — wealthy foreigners who move to Britain and are taxed only on their U.K. income. Following last month's rescues of HBOS and Bradford & Bingley, the big question now is what sort of new regulatory measures will be put in place as a result of the current market meltdown. Fraser, the City's policy head, is hoping that any changes will be peripheral. "We'd be in much greater danger if financial services accounted for just 3% of the economy," he says. "Politicians recognize it as an important industry and are sensitive to the issues."
But at the annual Labour Party conference last month in Manchester, delegates adopted a new vocabulary. In fringe meetings, speakers inveighed against "the spivs" who caused the mess, while union leaders and politicians raised cheers by bashing the rich. Brown's keynote speech talked of a new era that demands heavier regulation, an era in which the rich will "be able to look after themselves." That sort of talk sets off alarm bells. "There is a risk that a mood could emerge, an anti-City mood," says Douglas McWilliams, chief executive of London's Centre for Economics and Business Research. "You sense that now with the Labour Party in a rather weak state, there could be a bit of populism that could actually do some damage."
Braced for Pain
This isn't the first crisis London has lived through, and it won't be the last. At his Guildhall office, policy chief Fraser talks about his 45 years of experience in the City and says, "You just have to sit it out. It recovers." But he acknowledges that "it's a painful process and we are only at the beginning." The impact won't be felt across the board, either. Barring a financial cataclysm, London will retain its position as Europe's preeminent financial center for players from around the world. Some wealth management may migrate to Singapore or Dubai, rapidly emerging regional centers, and some of the back-office jobs that are cut may never come back. "As in any business there will be more pressure to take more support roles out of London, to Asia or just to cheaper places in Britain," says Owen Jelf, who heads the U.K. capital markets practice at consultancy Accenture. But nowhere other than New York boasts the combination of specially tailored office space and clustered expertise to challenge London's status. "I don't see how what is happening will upset London's position as the fulcrum of finance in Europe," says Marc Lhermitte, a partner at Ernst & Young in Paris who specializes in foreign-investment issues. And even in the worst-case scenario of continued market turbulence and a deep recession, the London economy has one crutch that won't be knocked down: huge government spending on preparations for the 2012 Olympic Games.
The bigger question is whether the risk-taking, hard-charging, high-living times will give way to a quieter, duller, less profitable and far more regulated era — not so much a golden age as a golden cage. The debt-fueled days are almost certainly history, and households across the capital will have to tighten their belts and live with a lot less leverage; the banking crisis has already made it considerably harder for house buyers to get mortgages of any sort, let alone ones requiring only a tiny down payment. Jon Lloyd, joint head of LG's real estate practice, points out that the investment-banking mentality of the past few years — ever bigger fees for ever more complex transactions — has spread to all sorts of businesses, from law to real estate. He wonders whether that's all about to change. "Will we as advisers fall back to where we were 10 to 15 years ago?" he asks. "The question is whether we are now entering a more frugal world."
Lloyd already knows the answer, and so do thousands of others who have thrived off the good times in the City. Yes, London is heading for a fall. Yes, the excesses are about to be wrung out of the system. Yes, it will hurt. But he remains sure of one thing. "We've got a city we are proud of," he says. "There's a feeling that London is a good place, and that hasn't changed." At troubled times like these, a stiff upper lip may be just what's needed.
With reporting by Eben Harrell, Catherine Mayer and Adam Smith / London
6 months ago