The City and the current financial crisis About London’s financial centre The financial centre of London, or ‘The City’ as it is known, is the world’s most important financial centre and houses the headquarters of many banking and insurance institutions. “The London Stock Exchange (shares and bonds), Lloyd's of London (insurance) and the Bank of England are all based in the City. Over 500 banks have offices in the City, and the City is an established leader in trading in Eurobonds, foreign exchange, energy futures and global insurance. The Alternative Investment Market, a market for trades in equities of smaller firms, is a recent development. In 2008, the City of London accounted for 4% of UK GDP.” “London is the world's greatest foreign exchange market, with much of the trade conducted in the City of London. Of the $3.98 trillion daily global turnover, as measured in 2007, trading in London accounted for around $1.36 trillion, or 34.1% of the total. The Pound Sterling is globally the fourth most traded currency and the third most held reserve currency.” “Since 1991 Canary Wharf, a few miles east of the City in Tower Hamlets, has become a second centre for London's financial services industry and houses many banks and other institutions formerly located in the Square Mile. Although growth has continued in both locations, the Corporation has come to realise that obstructive planning policies were causing financial firms to increasingly choose Canary Wharf as a location.” (Wikipedia, 2011) Though the City has always been London’s financial centre, it was only until 1986, when its regulations were relaxed, that it started to grow to its current level of importance. This is explained on the legacy from the empire, the use of English, its location in a time zone half way between the USA and Asia, and favourable legal system. 25 years later the City attracts professionals from all over the world who are paid very large salaries and bonuses. Associated services like law, accountancy and consulting prosper alongside the financial services.
The current financial crisis The current financial crisis was triggered by the drop of houses prices in the USA. This originated when poorer households took out mortgages they could barely afford. Normally, if they had struggled to pay they would have simply lost their properties; banks would have charged interest rates accordingly to the level of risk. These would have been considered fairly risky mortgages. However, for a long time, lending it had seemed as a good business to both these families and the banks, because house prices were relentlessly increasing, so when the families got stuck with their payments, they sold their houses for a profit and everyone was happy. These risky mortgages, or sub-prime mortgages, were sold on by the banks as ‘low risk’ investments. However, the property boom could only go on for so long , and eventually the ‘bubble’ burst. When it did, the financial sector realised that they had bought these mortgages as a low-risk asset, when in reality they were not. Banks started losing money, and more seriously, they felt they could no trust each other. Banks all over the world, in particular in the UK, had become very dependent on these strange financial tricks by which banks would sell-on their loans to third parties, so a financial problem in one part of the market had repercussions all over the world. Banks had moved away from what banks do: put money away from savers, and lend money to those who need it, to finance their business or buy a house. Banks were lending money they did not have in their coffers!
Banks were far more interested in strange monetary somersaults that seemed to give better returns. Banks like Northern Rock had very little of their ‘own’ money to lend, and would lend money using these strange tricks. Banks also mixed their risky business (known as ‘casino banking’), with their more conventional “high street” banking. When some banks went broke, many other banks lost confidence in the process and stopped lending each other money, because the connections between them were so complex. However, the crisis deepened a lot when ‘Lehman Brothers’ collapsed. This sent the whole financial services into disarray. It looked like financial meltdown. Some banks would have truly gone broke, meaning that many people would have lost their savings, whilst others would have lost their means to borrow money. Governments all over the world stepped in to prevent what could have been a disaster. They lent money to the banks or they even ended up buying (nationalising) the banks. To do this they sold government bonds or even printed more money (this is called Quantitative Easing), and the central banks dropped their interest rates as low as possible. This averted a disaster, for a while, at least. Tax-payers had picked-up the pieces that reckless bankers had left behind. Though most tax-payers agree that something had to be done, they feel angry that the City employees and bosses still receive large salaries and bonuses, when everyone else has felt the pinch or have lost their jobs. Tax-payers dislike that the profits are privatised, but losses are nationalised. In the UK, nationalised banks have been caught in the conflict between making the banks profitable again, lending to businesses and creating a cushion of capital to help banks rely more on their own money. Many tax-payers want to see the City more heavily regulated and taxed. Defenders of the City argue that it is an important source of exports, and a unique British strength (though manufacturing still employs more people and generates more exports, it has been weakening for so long that it has been frequently overlooked). The defenders of the City argue that if they become too heavily regulated or taxed they will go elsewhere in the World.
The unfolding crisis It seems now that the problem has moved to the governments as the financial markets are worried that the governments are too far in debt. When everything was going well prior to the crisis, governments could get away with spending foolishly, as everyone thought they could pay their debts as they could raise more taxes. Now that the economy has slowed down, governments have less means to raise taxes, so they go into deficit. As lenders worry more about the financial health of whole governments, they lend money at much higher interest rates, which makes it harder for them to pay, and the whole situation starts to snow-ball. Governments are like a business, they need to borrow money to get by. In the UK, we entered the recession with several factors against us:
The government was already running up a big debt, We are very dependent on the financial services, We have very big household debts, Our banks hold very little capital, We have a weakened manufacturing (exporting) sector,
This has made the whole situation here very difficult. The government has to stop getting further in debt, and must try to reduce its debt. If it doesn’t, international lenders will charge even higher interests. On the other hand, if the government stops spending too quickly and too much, lots of people could lose their jobs and therefore stop spending, and in doing so they will slow down the economy. If the economy slows down too much, we could be in a recession again and the government would raise less taxes and so forth…