Which way now when the world has shifted? | Observer
Which way now when the world has shifted? | Business | The Observer
Ruth Sunderland looks at the causes and consequences of a 10-year boom imploding, leaving Britain at a dangerous economic crossroads
The Observer,
- Sunday December 23 2007
If
you landed in London from another planet this month and picked up the
Financial Times's glossy How to Spend It magazine, you would not
suspect for a nanosecond that there was a crisis on the world money
markets. In 120 pages of unabashed haute consumerism, ads for Tiffany
ran alongside features on record couture sales at Christian Dior, with
scarcely a hint at harsh realities such as multibillion-pound bank
write-offs, smaller bonuses and lost City jobs.
The truth,
however, is that in 2007 the financial world was turned upside down:
the credit crunch has toppled a golden decade of extraordinary
prosperity in the UK and accelerated a shift in the global balance of
economic power. One consequence is that banks in the City and Wall
Street, the engine rooms of capitalism, have been so desperate for cash
that they have sold large chunks of their equity to China or Middle
Eastern states.
The credit crunch has spawned plenty of soul
searching about financial regulation, debt risks and the like. But more
thoughtful financiers acknowledge it has also prompted broader
reflection on the City's role in modern Britain.
David Buik of
spread betting firm Cantor Index says: 'The day the queues formed
outside Northern Rock branches marked a sea change. It was the end of
the illusion that we - individuals, companies and governments - could
go on running up debt with impunity. It was a wake-up call,
particularly for a younger generation which has never known financial
hardship, negative equity, high unemployment, never known the economy
to be less than benign. It also revealed the truth about our system of
financial regulation, that was supposed to be so brilliant, but did not
work when put to the test.'
With hindsight, the first signs of
a gathering financial storm came early in the year, when HSBC, which
owns the former Midland Bank in the UK, admitted that it had written
off $10.5bn of bad debts, a large chunk of it on home loans to poor
borrowers in America. The bank came in for a huge lashing from its
shareholders, but few, at that stage, made the leap to realising it was
a much wider problem.
Loans made to cash-strapped American
homebuyers had been packaged up into fancy investment vehicles and sold
to investors around the world; banks are unsure of the extent of their
rivals' - even possibly their own - exposure, and therefore are
unwilling to lend to each other.
That matters because it has
hit our high-street banks: Northern Rock is being supported by the
taxpayer to the tune of £55bn and looks to be heading for
nationalisation. It could also hit the wider economy. Mervyn King,
governor of the Bank of England, who prides himself on being calm and
understated, warned last week of a 'palpable sense of fear' that could
send the economy into free fall.
The City has in the past
decade turned itself from a comparative backwater into a genuine rival
to Wall Street. But the credit crunch means jobs will be lost and
bonuses smaller. In Covent Garden, Portland Place and Berkeley Square,
the private equity barons, who menaced FTSE 100 companies with
audacious takeover bids in the first part of the year, have watched
their flood of deals dry to a trickle. On the high street, tills will
not be ringing so loudly and, on Acacia Avenue, homeowners are worrying
about their mortgages.
Some will see the crisis as an overdue
humbling of City arrogance. The past 10 years have been stunningly good
for the super-rich. The wealth of high-net-worth individuals (Henwis) -
those with at least $1m at their disposal, not counting their main home
- increased by 11.4 per cent last year to $37trn worldwide. In the UK,
the number of Henwis rose from 448,000 to 485,000; you now need £70m to
get into the 'Rich List' of the 1,000 wealthiest people. Much of that
wealth inflation has come from the City, with a record 155 financiers
making it into the table.
That has fuelled middle-class envy of
the very rich, or what Harvard economist Martin Feldstein calls
'spiteful egalitarianism' - the idea that the increasing fortunes of
the uber-wealthy are bad, because it makes others feel poor.
The
middle classes are resentful because they are being priced out of
things they consider their birthright, including homes in desirable
areas and good schooling. Private fees, for example, have soared by 41
per cent in five years, taking the average costs of a day school to
more than £9,600 a year. The rising costs of education and home
ownership, coupled with the urge to consume, has driven record numbers
into insolvency (see chart).
Robert and Lisa, a professional
couple in their late forties living in London with two sons, are
typical of the families caught in the middle-class squeeze. Although
prosperous by most standards, they are beset by financial anxieties.
'We
live in a five-bedroom terraced house in north London and it has shot
up in value since we bought it in 1996,' says Robert. 'But our elder
son will soon go to secondary school. To get him into a good one, we'd
have to move a short distance and pay an extra £250,000 for the
same-sized property near the school. We're thinking seriously about
sending both boys to an independent school because the fees are about
the same as moving.
'Foolishly, I failed to join company
pension schemes in my twenties and thirties and now regret it. We're
wondering how we are going to juggle all these financial
responsibilities at our age. My parents were not enormously wealthy,
but my dad had a good job in an accountancy firm and was always home
for supper at 6.30 in time to read us stories. I can't do that with my
kids because I have to work such long hours. He lived in London all his
life after retiring at 65 on a generous final salary pension scheme - I
will have nothing like that.'
Middle-class financial woes could
be dismissed as the bleatings of the privileged but, at the bottom end
of the economic scale, things are also arguably worse. The rich have
become richer, but the poor are still relatively poor. The Institute
for Fiscal Studies reported this year that relative poverty has risen
for the first time since Labour came to power, with 12.7 million people
- more than a fifth of the population - living in households with
incomes lower than 60 per cent of the median after housing costs. A
shocking 3.8 million children are classed as living in poverty.
Schadenfreude
may be satisfying, but a downturn in the City hurts us all, because of
the massive increase in its influence on the UK economy as a whole
during the golden decade. Financial services has grown from 5.5 per
cent of the economy to more than 9 per cent last year and, over the
past three years, it has been responsible for a third of overall GDP
growth. Manufacturing has gone in the opposite direction, declining as
a proportion of the total economy from 23 per cent in 1990 to 14 per
cent in 2005. Employment in industry has plunged by more than a
million, while financial service sector jobs have grown (see chart).
A
report by the Ernst & Young Item Club this year described the City
as a 'cuckoo in the nest', crowding out manufacturing and other
industries. While it is good to specialise, the report said, this
process should be carefully managed. David Frost, director-general of
the British Chambers of Commerce, says: 'The government has no option
but to nurture the City because it is a huge economic driver. But
manufacturing is still important. It is not an either/or situation. You
should be able to have both, as they do in Germany, where they still
have world-class manufacturers. The economy is like a tripod: you need
strong services, strong manufacturing and a strong public sector. Ours
is unbalanced, with manufacturing the poor relation.'
The credit
crunch has also prompted more soul searching about our high-consumption
lifestyle. Edward Bonham Carter, of fund manager Jupiter Asset
Management, says: 'In every economic cycle, there are excesses on a
local level. People have been much better off in the previous decade,
but are they happier? Material accumulation does not improve our sense
of well-being, and that is intersecting with the climate change debate,
where people realise that they have to consume less. It is part of the
zeitgeist.'
Not that he is advocating a hair-shirt backlash: 'The
more redistributive you are, the less incentive people have for
creating wealth. On the other hand, if you have a rampant capitalist
state and do not redistribute it at all, you get rich ghettos and
ultimately revolution.'
The other great upheaval of 2007 is the
shift in the balance of power from the West to the developing world,
seen in the rise of sovereign funds investing trillions of dollars of
excess savings from China and the Middle East, a trend that accelerated
strongly due to the credit crisis. While Northern Rock was bailed out
by the government via the Bank of England, others courted rescue from
the Chinese state. Morgan Stanley, for example, received a $5bn
injection from the China Investment Corp in return for securities that
will convert into as much as 9.9 per cent of its stock. Abu Dhabi's
sovereign wealth fund invested $7.5bn in Citigroup last month, and the
Singapore government and an unnamed Middle Eastern investor has
ploughed SFr13bn (£5.7bn) into Swiss bank UBS.
'When you have a
sector that is bombed out but with high growth potential, the smart
money piles in,' says one chief executive. 'I think it is a healthy
part of globalisation, but there will be more protectionist noise in
America about it, which could be harmful.'
Chagrined though they
are, leading bankers don't believe their game is up. The same chief
executive adds: 'If you take a 10-year view, there is every reason to
believe the financial services sector will be one of the fastest
growing. Nothing that has happened in the past six months will change
some of the big long-term trends, such as the privatisation of the
welfare state, or the demographic drivers, such as people living
longer. These are behind the development of the financial services
industry.'
He goes on: 'The conditions we have now were created
by the pursuit for yield by investors in a low-interest, low-inflation
environment. Some of the opaque instruments have gone, but the quest
for yield has not vanished and that will drive innovation. The
performance of markets over time is being pushed by those very big
demographic drivers - it is completely unstoppable.'
In the
past 10 years, the City has sealed its transformation from a soporific
club for paunchy Old Etonians to a magnet for brilliant young talent.
It has unleashed innovations on an uncomprehending world and the pace
of financial evolution has far outstripped ability of the relatively
underpaid, and sometimes intellectually underpowered, financial
regulators to keep up.
Sober critics have been questioning the
vertiginous rise of the City for some time. During the good times, this
was brushed aside by practitioners and politicians, content to bask in
the reflected glory of London's rise as a financial centre. After
Northern Rock, those inconvenient voices have grown to a clamour that
must be heard.
Are we prepared to live in a less equal and more
divided society if that is the price of a booming financial sector? Is
it OK for the City to play such an overweening role in our economy,
while manufacturing struggles? How else, other than in financial
services, might Britain compete in a global economy against emerging
nations with cheaper labour and raw materials? Is it desirable for the
sovereign funds of sometimes undemocratic foreign governments to gain
more control over the levers of capital? All of these are issues for
2008 as we ponder how best to move forward in this chastened new world.
December 23, 2007 at 06:00 PM in Business Models | Permalink
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