Of course, the City will never be the same again. It is going to shrink. Earlier this year, JP Morgan was predicting 40,000 jobs would go in the square mile—a number that will surely rise following the autumn meltdown. Once lucrative activities such as securitisation and credit derivatives are being slashed; many hedge funds, private equity groups and other businesses that depend on debt will disappear. Meanwhile, traditional City deal-making will grind to a halt as the recessionary effects of global deleveraging start to bite.
But these problems are not unique to London, and nor will they determine whether the City can hang on to its status as one of the world's leading financial centres. Politics will determine London's future status—both at a domestic and global level.
At home, the big unknown is the severity of any backlash against the City. "Light-touch—bordering on non-existent—regulation has been at the heart of the City's renaissance since the 1960s, which began with the growth of the Eurobond market," says City historian David Kynaston. "That made it into, as one American banker put it, 'a warm place to do business,' and that continued with big bang and Thatcher's reforms in the 1980s. Since the ERM crisis in 1992, the City has been virtually politically untouchable. But who now is going to speak up for the City? Not David Cameron."
Kynaston may be a little too pessimistic. True, popular resentment towards the City has been brewing for years—spilling over into last year's rows over private equity and non-doms. With taxpayers having to pick up the bill for bankers' losses, there are bound to be calls for punitive action. But while tougher regulation is inevitable, neither Gordon Brown nor the Tories seem keen on heavy-handed intervention that might drive bankers away. And given Britain's dependence on financial services, the political imperative must surely be to nurse this golden goose back to health.
The bigger risk exists at a global level in the form of rising protectionism. London owed its recent success to two major trends. The first was the development after 1945 of an international rules-based trading system under the umbrella of US security. When that expanded eastwards after 1989, London, with its geographical, linguistic, legal and institutional advantages, was the biggest beneficiary. The second trend was EU expansion and currency union. The growth of a European trading bloc and capital pool created a hugely lucrative market for financial services. A global recession could put both trends at risk.
Protectionist sentiment has been on the rise for several years and contributed to the collapse of the Doha round of world trade talks. Although all major world leaders remain publicly committed to open markets, the financial crisis has put strain on international relations—especially in the financial arena. When banks fail, and governments have to bail them out, they understandably put the interests of their own citizens first. For all the talk of co-ordination during this crisis, only national governments have the chequebooks. They have shown little enthusiasm for rescuing foreign creditors. Britain discovered this to its cost when Lehman Brothers was found to have drained its UK subsidiary of $8bn on the eve of its bankruptcy, leaving its British creditors with no assets to claim. That may explain why Gordon Brown used anti-terrorist legislation to freeze the British assets of Icelandic banks when some went under. The idea of cross-border banks operating anywhere is being questioned by regulators—and investors. "We shouldn't see an unravelling of financial globalisation, but the fact that nation states will want more control over big international banks operating in their territory will introduce some friction into the system," says economist Charles Goodhart. Banks may need more capital to operate internationally and profitability may come down. If so, the City (as a big international hub) will be affected.
But London's future success will also depend on it retaining one essential ingredient: the ability to innovate and take risks. Thankfully, that still looks to be abundant supply, judging by the way that London came up with the bailout plan that finally stemmed the panic—succeeding where the US and the EU had failed. That's a huge feather in the cap for the City and British policymakers—and underlines London's claim to have overtaken New York as the world's leading financial centre. If that confidence survives, this crisis need not be the breaking of the City—but could yet be its making.
