The storm that couldn’t be weathered

The riches that flowed from the City and into the state's coffers are gone for good. Britain is going to have to reinvent itself, says Matthew Lynn.

The news from the City just gets bleaker. Jobs are being cut continuously. Bonuses are evaporating. Mergers and acquisitions work has dried up and new listings land about as regularly as planes in a snow storm at Heathrow. As Anne Hathaway observes in Fantine's big number in Les Misrables, there "are some storms that cannot be weathered".

It now looks as if the financial crisis of 2008 was a storm that couldn't be weathered for the capital markets and the good times are not coming back.

That matters for every country that hosts a major financial centre. But it matters for Britain more than most. Britain had got used to the jobs, wealth and taxes the City provided. If the City is going to be a lot smaller from now on, then Britain will have to find some way of replacing that income, or get used to being a lot poorer.

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The evidence keeps mounting that the financial markets aren't just going through a temporary downturn, but a permanent reduction in profitability and size. Rather like retailing, or newspapers, the world has moved on, and finance is not going to be the huge industry it once was.

The Confederation of British Industry, a lobby group, forecasts this week that another 43,000 jobs would be lost in the sector this year. At the peak of the market in 2008, finance employed a million people in this country: 132,000 of those jobs have already gone and more are being lost all the time.

According to recruitment firm Morgan McKinley, job vacancies in the City fell by 24% in the last year and it's forecasting no growth this year. City salaries may still be huge by the standards of most ordinary people, but they're flat-lining, with no significant increases over the past 12 months.

The same is true across all financial markets. American banks are shedding staff and pay. A survey by Bloomberg found that job cuts at global financial firms totalled 115,000 in 2012. MorganStanley said this week it planned to cut 1,600 jobs in the next few weeks. Citigroup said in December it would cut 11,000 jobs.

Meanwhile, Morgan Stanley recently announced that bonuses over $350,000 would be deferred and paid out over three years rather than the year they were earned. In short, there are fewer people, and they are earning less. The quarter-century expansion of the finance industry has come to an end.

It is not hard to figure out why. For much of the last 25 years the developed world was borrowing more and more. Big banks are basically machines for manufacturing debt. Just as the tobacco industry went into irreversible long-term decline once people started giving up smoking, so the banks will go the same way now that the limits of debt have been reached.

There is another reason too; much of the profitability of banks has turned out to be bogus. Say a trading desk makes a profit of £10m a year for five years. That looks great, and the traders can expect to make a lot of money. But if it then loses £50m in the sixth year, it doesn't look so good. Over the six years, it made nothing and the traders are a lot less valuable.

Most major banks are starting to realise that most of their profits came from a good run at the casino table rather than from creating any real wealth. Many, like UBS, are starting to withdraw completely. Others are winding down their trading or being forced to do so by regulators who have come to realise it is governments that will be picking up the tab. So finance is going to keep get smaller. The trouble is, Britain depends more on the capital markets than most other major economies.

Wall Street is important to New York, but not that important to the US. Switzerland has plenty of other big export industries (pharmaceuticals, food, engineering and private banking). Hong Kong and Singapore are business rather than purely financial centres and hubs for fast-growing regions.

But Britain, and London in particular, is critically dependent on finance. Five years ago the City paid £70bn in taxes to the government. That was around 15% of the total take. Now that's down to £40bn, or around 8% of the total. The City was the source of wealth that flowed into the London property markets, and also propped up markets in smaller centres, such as Edinburgh. All that is likely to go into reverse.

Meanwhile, its foreign earnings kept the trade deficit from ballooning out of control. Financial services contributed a net £46bn to the trade balance in 2011, the latest year for which figures are available. But by the second quarter of 2012 the quarterly surpluses were starting to fall. As that continues, as it almost certainly will, sterling will come under more long-term pressure.

There may be some scope for the City to reinvent itself. It is carving out a niche in Russian and eastern European flotations. It may find a market in currency trading if smaller states start to peel away from the eurozone. Those, however, are unlikely to replicate the huge growth and profits of the last 30 years.

Over the next decade, finance is going to contribute less and less to the British economy. Other sectors might take up the slack but if they can't, get set for a very tough decade for Britain.

Matthew Lynn

Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years. 

He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.