THE BEAR'S LAIR
UK shows bankers the exit
By Martin Hutchinson
The British budget last Wednesday did very little to rectify that country's
yawning fiscal deficit, but what little it did was almost entirely at the
expense of the country's high-income earners, those making over 150,000 pounds
(US$210,000). The fascinating question is: if British governments return to
their pre-1979 high-tax ways, as seems likely, what will happen to London's
financial services business?
Not content with raising the top marginal income tax rate to 45% from 40% last
November, Chancellor of the Exchequer Alistair Darling raised it again to 50%.
Two tax increases in one year will certainly start to convince affluent Brits
that this has become a habit, as it was with previous Labor governments.
Indeed, yawning future budget deficits, and the accompanying financing
difficulties, are likely to lead to further such increases. Now the European
Union wants to impose a Europe-wide statutory limit on bankers' bonuses.
In the 1930s, you didn't want to own a major Manhattan office building - 40
Wall Street, for example, briefly the world's tallest office building before
being eclipsed by the midtown Chrysler Building and Empire State Building,
leased slowly during the 1930s, for rents about half those projected at the
time of its construction. The building defaulted on its bonds in 1935 and was
still failing to cover even senior debt charges four years later, at which time
it was only 81% occupied.
Brokerage firms, expected to be the building's premier tenants because of its
location next to the stock exchange, went bankrupt or downsized sharply during
the decade, so that even the main office of Merrill Lynch, then as later the
country's largest retail broker, took up only one of its 87 floors. Mind you,
if you were a tenant the fringe benefits were great; remodeling was done at
cost, many repairs were free and the building ran a free shopping service and
provided embryonic information-technology services, fixing tenants' ticker
tapes that seized up. Fortune magazine's superb July 1939 celebration of New
York (timed to coincide with the World's Fair) tried to put a brave face on the
building's fate, and it did much better after World War II, but for a decade or
more the struggle for its owners was grim.
This time around, much of the Manhattan financial services sector has already
migrated to New Jersey, where its absence will be largely hidden from general
view as its offices are adapted to Mafia-run light industry and hazardous waste
disposal. In any case, given the size of the US economy, at least the great
bulk of US financial services will remain domiciled in the country, very
largely in the New York area, so Manhattan real estate should not suffer as it
did in the 1930s.
It is London whose office buildings may suffer the fate of 40 Wall Street, or
much worse. Should the London financial services business relocate, the trading
floors of Canary Wharf, lacking 40 Wall Street's architectural distinction,
adaptability and convenient location, would become cavernous echo-chambers,
home only to bats and rodents feeding off decades-old junk food wrappers. In
the City of London proper, the smaller and older buildings would readily
re-adapt to small-scale mercantile operations, and only the largest and most
opulent offices would lie derelict. Needless to say, petty criminals would
benefit more from such dereliction than the British Exchequer or the staggering
British economy.
It may be objected that the City of London survived tax rates on income far
higher than Darling's current effort, with top rates above 90% for most of the
1939-79 period, and remaining higher than today until (the Conservative Party
chancellor) Nigel Lawson's budget of 1988 (one of Lawson's worst mistakes was
in waiting so long to reduce the top rate to 40% from 60%, thus ensuring that
the City boom of the 1980s occurred in an atmosphere of tax evasion). Indeed,
in one spectacularly awful budget designed by the allegedly moderate Roy
Jenkins in 1968, the top income tax rate was levied at 135%. (Jenkins, in most
respects no fool, recognized the adverse supply-side effect of tax rates above
100%, so imposed the levy retroactively on the previous year's income, legally
and constitutionally disgraceful but economically less self-defeating.)
To optimists pointing out smugly that those four decades of economically
suicidal top tax rates did not destroy Britain's financial services businesses,
I would respond that they came damn close. The jobbers - partnerships that made
markets in British shares - were taxed at top marginal income tax rates on
their profits, while inflation rates of up to 25% eroded their capital base;
consequently by 1980, they were far too undercapitalized to play their proper
role in the capital market, and fell victim to the misguided "big bang" reform
of stock exchange trading.
The merchant banks also had their capital bases halved in real terms by the
1970s' inflation and sterling devaluation, and their partners were no longer
rich enough to inject additional capital. Consequently, they also were too
small to compete with the behemoths of the US and continental Europe when the
"playing field" was so misguidedly "leveled".
The 1986 Financial Services Act in the UK was a bureaucratic nightmare, which
left investors far worse protected than they had been under the previous
"gentlemanly capitalism", and together with "big bang", delivered the
British-owned houses trussed up as victims to foreign predators. However,
because of the decimation of British wealth caused by the taxes and economic
ineptitude of previous decades, this may well have been inevitable, if Britain
was not to fall behind entirely in the race for internationally sourced
business.
The merchant banks, brokers and jobbers of 1939-79 were deeply attached to
British-domiciled institutions and deeply rooted in British society; they and
their senior staff had very little alternative but to remain passively in place
for the Exchequer to loot. Those controlling the limited international
corporate and capital markets business of those highly protectionist and
unglobalized decades also had very little alternative but to transact their
business in London. Even so, much investment management business migrated to
Switzerland, not historically a major home for global private wealth and
investment management but free from the capital controls and intrusive
regulations and taxes of London.
New York, the principal potential competitor to London, was artificially split
between commercial and investment banking, and the investment banks were
undercapitalized and focused almost entirely on the gigantic US domestic
market. Hence, with a considerable amount of wobbling by the late 1970s and
early 1980s, London finance houses were able with difficulty to maintain their
position, and even to regain some of the capabilities that had been destroyed
by World War II and the decades of exchange controls.
Since the destruction of almost all the historic British financial institutions
in 1986-2000, the picture is very different. A high proportion of the
participants in the London market are foreigners, and even British participants
are much more securely members of the international moneyed elite than of the
decayed British aristocracy or impoverished middle class. The significant
London financial institutions are almost all headquartered outside Britain, and
their London staff have caused the head offices endless cost and risk over the
last few years by their careless attitude to the parent institution's risks and
insatiable appetite for their own rewards.
Potential clients are themselves global, with corporations manufacturing
worldwide and run by rootless MBA management, while the wealthy are almost
entirely from non-UK cultures, possibly effectively without any domicile at all
if their home country has been taken over by crooks, thugs or Marxists. In any
international business, London is no longer without serious competition; for
one thing, most owners of London financial houses have taken good care to
install equivalent capabilities in their home country headquarters.
In such an environment, the government appears to believe that by turning a
blind eye to foreigners' tax evasion, it can preserve London's capabilities.
However, this is probably wrong (although imposing full British taxes on
foreigners would kill the City even faster.)
British bankers will not wish to continue forever as impoverished valets to
their wealthy foreign overlords; they will migrate to some non-UK jurisdiction
where they are not grotesquely discriminated against by the local tax
authorities. Their employers, finding London an expensive place in which to do
business, no longer with any great advantages in terms of local expertise, will
move their London operations back to their headquarters, or to third-country
tax havens. Foreign staff, finding themselves far from home in a declining
business environment where their wealth is fiercely resented by the
impoverished overtaxed locals, will seek some alternative low-tax domicile.
If the EU caps bankers' bonuses (at a level that after the next few years of
inevitable inflation will seem laughably inadequate), this will merely ensure
that the international financial business moves to New York, Shanghai, Dubai,
the Caymans or (my guess) Singapore, rather than to Frankfurt, Paris or even
Dublin.
Much of the financial glory of the past two decades is one with Nineveh and
Tyre in any case; no regulator will ever again believe in bank self-management
of risk. Hedge funds, the obvious alternative homes for the financially
adventurous, will find it impossible to attract either equity capital from
newly suspicious institutions or debt finance from newly cautious banks.
However, even within this duller, diminished universe, London's market share is
almost certain to shrink, as successive British governments seek to finance
their overspending habits and close the resulting deficits from the resources
of the ever-dwindling number of rich.
The British economy may not quite experience the traumas of the United States
in the 1930s (though Britain's gross domestic product has already fallen as
much as in the better-managed Britain of the 1930s, without much hope of
subsequent vigorous recovery as in 1932-37.) However, the London office market,
particularly that in the isolated and unreusable Docklands, will almost
certainly suffer a downturn that will make the grim New York 1930s market seem
the epitome of prosperity.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-2009 David W Tice & Associates.)
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