The economic crisis and the city of London - Essay Example

?A Brief Introduction Developed world is going through one of its harshest economic downturns in history as systematic failure of banks and other financial institutions has shaken the confidence. Over the period of time, what started as a simple subprime mortgage crisis slowly engulfed the whole economy and created the contagion effect on other sectors of economy also. The inter-linked nature of modern economy has created a chain reaction of events in which bad performance in one segment of the economy also affected other segments of the economy also. Credit crunch started at the end of year 2007 when subprime borrowers in US started to default on their commitments. The pace of financial innovation due to de-regulation of financial services industry allowed many financial institutions to actually take risks which should have been avoided under normal circumstances. The relative changing in the banking model and shift in focus on maximizing short term earnings forced bankers and other finance professionals to assume risks which could have an adverse impact on the overall health of institutions. To reduce such risks, most of mortgage lenders and financial institutions repackaged their mortgage portfolio and sold it through mortgage based securities collateralized against subprime housing units. The issuance of mortgage based securities therefore allowed banks to recoup the liquidity which was lost in lending to the subprime borrowers. (GOODHART, 2008). When subprime borrowers, started to default, foreclosure rates increased and caused sharp decline in prices in housing market. London is the first financial hub of the world and carries significant importance in the world of finance because of its historical roots and development of finance as a discipline. (Clark,2002). The presence of almost all international financial institutions as well as other major financial institutions such as Bank of England, Financial Services Authority etc. has given a unique significance to London as a major global financial hub. Historically, this city therefore has played an important role in global finance and must be protected in order to ensure that the financial institutions at the global level are protected. Moran (1993) has argued that the city is more than just the financial market but it is also a hub of extraordinary financial innovation as well as the ability to evolve new ways of life in which society actually flourishes. The current financial crisis therefore has also hit hard the city of London- the first major financial hub of the world. City has remained an active participant in the overall financialization of the British economy and played major part as a market to fill the gap between demand and supply of funds. (Klimecki, 2011). This rise to the fame however, took place gradually due to de-regulation of banking sector which many interest groups are now demanding to be regulated again. The current crisis therefore is not only resulting into loss of jobs but the overall prestige of world’s first financial hub. Banks as important segment of the economy Banks play important role in economy because they serve as the intermediary between savers and consumers. By playing the role of intermediaries, banks actually serve as a link between those who want to save and those who want to borrow. This role therefore has allowed banks to become one of the most important segments of any economy. It is critical to understand that the existence of banks often serve the economic purposes of channeling the savings of those who want to save to those who want to borrow. By doing so, banks actually help other sectors of the economy to access a large pool of funds which can be used for the expansion purpose. Banks therefore serve not only as the creators of money within an economy but also provide essential economic support to other sectors of the economy. (Rubinstein, 1993)  The history of banking in UK is more than 400 years old when first banks started to operate during 17th century. Over the period of time, the sector grew and now forms the basic backbone of the British economy as UK made its transition from an industrial society to a service based society. Before the emergence of current crisis, the UK financial services sector comprised of more than 9% of the GDP of the country it has however, decline to almost 5% after the crisis engulfed the banking sector specially. Such higher percentage of banks and financial services sector therefore outlines the overall importance of the sector in British economy. City of London is important in the sense that it is from here the overall evolution of financial services in UK economy took place. The changes in the landed interests and the split of business sectors into industrial as well as financial capital therefore gave rise to the new interests within the economy. Though initially, the interaction between the city and the government was limited however World War 1 actually increased the overall interaction between the banks in the city and the treasury. This was duly facilitated by Bank of England which is also the central bank of the country. (Roberts, and Kynaston, 1995)  Apart from this, the city of London remained important because it was able to finance the British imperial adventures and it was through the financing from Banks in the city which ultimately provided British Empire a leading competitive advantage in international politics. It is also argued that interests of the city and their integration with the power politics in country made significant influence on the way policy initiatives were undertaken. The nexus between the treasury and finance has translated into something where the interests of city always prevailed over the interests of the nation as a whole.( Michie, and Williamson,2004)  It is also critical to understand that even during Industrial revolution; London was able to maintain its economic superiority. It is argued that London was able to keep itself away from the industrial progress in North of the country as wealthy in London even were not ready to finance such expansion. London therefore was able to maintain its ability to finance the overseas expeditions of the government while still retaining its separate and distinctive economic power at the domestic level also. Historically when the word city is mentioned, it is not normally meant as city of London but rather it refers to the banks in London city. Such significance of banking therefore outlines that London as a city was famous for its banks and their dominance over the economy and society of London city. Organization of Banks The traditional organization of banks in any economy is based upon their links with the central banks and other regulatory organizations. In a highly de-regulated environment, banks therefore tend to focus on organizing themselves in such a manner which can give them an opportunity to develop significant influence over the policy making issues. Studies suggest that over the period of time, corporate sector as a whole, in UK, has been able to develop the influence and public significance to have an impact on any policy initiative. (Davis, 2000) Banking industry as such in UK is mostly represented by BBA or British Bankers’ Association which is a leading trade association of banks in the country. It is mostly through BBA that the overall legislative and policy making process within the country is influenced. By engaging with the regulators, central banks, EU institutions and Media, BBA not only promote the industry but also attempt to influence different policy outcomes. BBA therefore also serves as a platform for banks to show their collective response to any changes in the regulatory environment which may not be in favor of the banking sector as a whole. BBA has more than 200 local as well as international banks as its members thus making it one of the strongest trade associations for banks in global financial environment. It is also important to understand that corporate Public Relations as a whole has also significant impact over media and public opinion. Over the period of time, corporate sector including banks have developed itself to a point where it can directly influence the media as well as the public opinion. This therefore has resulted into significant gains for the banks as well as other corporate entities within the city. Davis (2000) argue that the use of PR has been effectively used by the corporate sector as a mean of controlling the mind of the general public and the same has been utilized in making gains out of it. Some therefore argue that Banks has become so influential politically that they were able to make FSA to keep a soft touch on them rather than pushing them hard to make decisions which effectively safeguard the national interests of the country. Inability of British regulators to keep a check over banks like RBS is therefore considered as a shining example of how banks continued to dominate even regulatory institutions. Politics and City It is argued that the flourishing of mortgage markets in UK and the importance of high street banks in London emerged as a result of what is called property owning democracy. City under the Thatcher administration flourished as there was a clear shift from the Keynesian economics to monetary economics. This shift towards adapting monetarism therefore increased the overall importance of banks and proved as the starting point of a deepening relationship between the banks and the politics of the city. The pace of relationships between the politics and the finance in city quickened specially during 1980s when Britain government went on to deregulate the financial services industry and potentially gave more power to the banks and financial institutions to dominate. This was however, done on the premise of achieving efficiency through free markets. (Baijal, 2000). It has also been argued that in long term the overall priorities of the banking sector may also become the priorities of government. The nexus between the politics and the city also resulted into the actions which gave regulatory preference to the city also. The de-regulation of the city’s banks during Thatcher era is considered as one of the important indications of making regulatory changes out of the pressure from banks and other financial institutions. The systematic decline of building societies and passing of regulations to reduce their role is also viewed as a regulatory step towards increasing the power of high street banks in city. The links between the Conservative Party and City are probably best known as there have been clear establishment of the fact that most of the Tory funding comes from city. Some reports suggest that donations from financial services firms have increased greatly since David Cameron became the leader of Conservative Party. (Wright, 2011)  Studies also revealed that those bankers who are considered as directly responsible for the failure of the banks in city have donated much and increasingly the reliance of Tory party on city funding has increased. Angela Knight, the Chairman of British Bankers’ Association is former MP from Conservative Party thus suggesting that the relationship between politics and banks in city are deeper. Many argue that policies like reduction in the corporation taxes as well as a commitment to resist EU wide financial transaction tax are considered as some of the steps which may be coming as a direct result of the funding made to political parties in return for the political concessions. (Holt, 2011)  Conflicting Interests The current financial crisis has resulted into widespread challenges for the banks as many now reckon to lessen the influence of banks on the policy making issues. There has been increasing calls for regulating the bank’s environment by putting restrictions on what they can do and what they cannot. The current coalition government has been able to bankroll compensation regulations for the bankers but still many believe that enough has not been done to restrict banks from paying with tax payers’ money. The overall public opinion therefore is against the way banks operate and the impact of bank operations on the society. Increasingly, it has been highlighted that rather than helping society to progress ahead, banks are eating away tax payers’ money and are becoming burden on the public treasury. In the aftermath of the crisis, UK unveiled different regulatory initiatives aimed at reshaping the overall banking sector in country. As a result of this, FSA was abolished and Bank of England was given powers to supervise the banking sector of the country also. Policies were initiated to restrict the banks from taking on risky businesses besides putting pressure on banks to reduce executive compensation. (The Telegraph, 2009)  There has been a renewed drive to occupy Wall Street also where many, at global level, believe that banks are directly responsible for the current economic crisis. There is therefore an increasing pressure and public agitation on the role of banks and the failure of government in further controlling the behavior of banks in their overall conduct. Issues such as executive compensation as well as the rationing of capital for banks are some of the key issues which are being exploited by other interest groups against Banks. Moran (1983) has argued that the banks have been able to flourish despite all the opposition because they have been able to create a bureaucratic clout within government. They have drafted people on paid salaries to ensure that their interests are served through lobbying and developing close contacts with the civil servants thus virtually making themselves immune from any Government pressure. Conclusion London is still considered as the financial hub of the world and its importance is mostly due to economic reasons. By facilitating the global financial system, London has played an important role in ensuring that the global financial system operates at reasonably efficient level. History of banking in city dates back to 1700s and over the period of time, banks have developed themselves to a certain degree of sophistication. This sophistication however, has been mostly due to political connections of the city’s financial district with the ruling class. Historically, there have been established links between the two and banks in city have influenced largely the overall policy making process at government level. The current Conservative Government and Party are considered as one of the biggest beneficiaries of the link between the two as most of its funding comes from the financial institutions and private equity firms. Such reliance on funding from city’s financial institutions therefore makes the government more vulnerable to the demands of banks. It is also because of this link that UK has vigorously opposed the implementation of financial tax on EU wide level as it is believed that it may hurt the banking sector of the country. References 1. Baijal, P. (2000) From Nationalisation to Privatisation: UK and Japan, Economic and Political Weekly, 35(13), p.1101-1106. 2. Clark, G. (2002) London in the European financial services industry: locational advantage and product complementarities, Journal of Economic Geography, 2(4), p.433-453.. 3. Davis, A. (2000) Public relations, business news and the reproduction corporate elite power, Journalism, 1(3), p.282-304. . 4. GOODHART, C (2008) The Regulatory Response to the Financial Crisis, [online] Available at: http://www.ifo.de/pls/guestci/download/CESifo%20Working%20Papers%202008/CESifo%20Working%20Papers%20March%202008/cesifo1_wp2257.pdf [Accessed: 12th Dec 2011]. 5. HODSO, D (2009) UK Economic Policy and the Global Financial Crisis: Paradigm Lost?, [online] Available at: http://onlinelibrary.wiley.com/doi/10.1111/j.1468-5965.2009.02034.x/pdf [Accessed: 12th Dec 2011]. 6. Holt, N (2011) EU treaty letter calls for common framework on financial regulation,[online] Available at: http://www.moneymarketing.co.uk/regulation/eu-treaty-letter-calls-for-common-framework-on-financial-regulation/1042922.article [Accessed: 12th Dec 2011]. 7. Klimecki, R (2011) UK Mortgage Market Financialization and the Political, [online] Available at: http://www.organizzazione.unina.it/cms7/proceedings/proceedings_stream_24/Klimecki.pdf [Accessed: 12th Dec 2011]. 8. Michie, R. and Williamson, P. (2004) The British government and the city of London in the twentieth century, Cambridge: Cambridge University Press,. 9. M. Moran (1983) "Power, Policy and the City of London" from King, Roger, Capital and Politics pp.49-68, London,: Routledge & Kegan Paul.  10. Roberts, R. and Kynaston, D. (1995) The Bank of England: money, power, and influence 1694-1994, London: Clarendon Press. 11. Rubinstein, W. (1993) Capitalism, culture, and decline in Britain, 1750-1990, London: Routledge,. 12. The Telegraph (2009) Government gives regulators power to curb bankers' pay, [online] Available at: http://www.telegraph.co.uk/finance/financialcrisis/5777947/Government-gives-regulators-power-to-curb-bankers-pay.html [Accessed: 12 Dec 2011]. 13. Wright, O (2011) Revealed: how the City bankrolls Tory party, [online] Available at: http://www.independent.co.uk/news/uk/politics/revealed-how-the-city-bankrolls-tory-party-2208668.html [Accessed: 11th Dec 2011]. Read More