LONDON, U.K. — I have lived in the British capital on and off since the early 1970s. I have been here permanently since 1985. In the Two-Thousand Noughties, London changed beyond recognition.
It became the most ethnically diverse city on earth and there is a veneer of wealth and comfort here that was unthinkable in the year 2000. It would be churlish to say the changes have all been bad. On the other hand, most of that surface wealth was built on two fictions: that bankers/financiers/speculators knew what they were doing and house prices would always go up.
I could take you about four miles from my front door to Canary Wharf and show you block after block of high rise apartment buildings 80 percent empty. "Why were they built?" you would be right to ask. The demand for housing in London is for family homes. These vacant towers are mostly studio, one- and two-bedroom apartments, not suitable for families. So, why were they built? Each of them represents a young banker’s bonus.
For most of this low, dishonest decade property in the U.K. increased in value 18 to 20 percent per annum. Beats the hell out of t-bills or virtually any stock. No other investment did as well. If you got a mid-six figure bonus, as so many in the financial services industry did, every year the simplest way to invest the money was to buy an apartment "off-plan," just from the blue prints.
You didn’t have to live in the monstrosity (and they really are butt-ugly these buildings) just hold on to the flat for a year or two and sell it on. Did I mention there is no capital gains tax on home sales in Britain? That kind of sweet tax regime is just one more reason why London has become the world’s financial capital. And why as this low, dishonest decade ends, Britain remains in recession, the longest slump since the 1930s, while London’s bankers prepare to pay themselves bonuses larger than those before the crash.
More than Iraq or Afghanistan, it was the madness of high-finance and the attendant bubble in the housing market that will define this decade in history. And one man will be at the center of the histories written about it. That is British Prime Minister Gordon Brown. For most of the decade he was Chancellor of the Exchequer, Britain’s equivalent to America’s Treasury Secretary. But Timothy Geithner can only dream about wielding the kind of power that Brown had. Brown as Chancellor was something like Britain’s Prime Minister for domestic affairs. While Tony Blair was busy solving (or creating, depending on your point of view) the world’s problems, Brown was counting the pennies for domestic programs. He oversaw the tax regime and how the taxes were spent. He did not advise. He made the executive decisions.
The story really begins back in the 1990s, as Blair and Brown embraced the Third Way, the British Labour Party’s adaptation of the American Democrats’ political philosophy of triangulation. It was a brilliant method for winning elections via the big tent. Everyone could feel there was something for them inside. Heading into the 1997 election the Labour election machine re-branded itself "New Labour" and reached out to the financiers of the City of London, Britain’s Wall Street.
We are a different party, was the message. No more high taxes and subsidizing old industries. Blair and Brown’s chief electoral strategist, Peter Mandelson, today Lord Mandelson, told financiers that New Labour "was intensely relaxed about people being stinking rich."
And so it turned out. The City already had a very light touch of regulation. Once Labour got into power it became less than featherweight. London became the world’s financial center. Money flowed in, tax revenue did not flow out. Soon financial services accounted for 20 percent of the British GDP. All the money being generated in a few square miles of London needed some place to go … and so was born the property boom.
It worked at first. Britain has no tradition of renting homes. People buy long-term leases on properties instead. As a bubble formed in the housing market even people without real jobs living in the former industrial heartland of Britain found their dwellings had become an asset to trade or borrow on. Daytime TV and primetime TV was filled with programs about improving and flipping properties, buying abroad, living the dream. The same mad mortgage practices that attended America’s housing bubble turned up in Britain. Self-certified, or "liar’s mortgages," were given to people with virtually no income, sometimes in the amount of 125 percent of the value of the property they were planning to buy and flip. The tax man didn’t get a whiff of the profits in this mania.
When I say this was a low, dishonest decade, I’m not referring just to the big players … everyone has to shoulder some blame for the mess.
Meanwhile, back in London, hedge funds and the investment wings of the big banks were buying into CDO’s from the American housing bubble. When, inevitably, the sub-prime mortgage crisis hit, the bubble burst.
By now, Gordon Brown was prime minister. He is not incompetent. He actually understood how the whole system worked and what needed to be done to shore it up. The U.S. was about to have an election and its leaders were otherwise engaged, so Brown, to his credit, led the international effort to shore up the banking system via a massive state intervention. To the prime minister’s discredit he was unwilling to step away from the city and put strong regulations in place to make sure this sort of thing never happened again.
As the decade ended, the city of London was back to its old tricks: Making money not by investment but by playing casino on the movements of markets. There are fewer players now, so those left in the game are making more money than before as Britain endures its worst economic downturn since the 1930s.
But the Third Way is a deeply ingrained ideology — and Brown simply couldn’t do what everyone knew was necessary: regulate and tax speculators. That might drive them outside the big tent. It took Lord Turner, head of Britain’s Financial Services Authority and former director of McKinsey & Co and vice-chairman of Merrill Lynch in Europe, to state the obvious, too much of the city’s activities were spent on investing in "socially useless" projects.
This autumn, when Royal Bank of Scotland, about 70 percent owned by British taxpayers now, announced huge bonuses for its investment bankers, Brown finally put his foot down. The government will put a special one-time only 50-percent tax on all banking bonuses.
But it is too late. As the low, dishonest decade ends Britain is still in recession, the only one of the major economies still contracting. Unemployment is approaching the level it was when Labour came to power in 1997 with more to come. Public sector workers have avoided the worst of layoffs, in the new year that will change as the government starts cutting back programs. Meanwhile, banks refuse to make "socially useful" loans to small businesses and first time home-buyers looking to actually live in a house rather than flip it in 90 days.
Yet no matter how grim the picture, the "bankers" attitude doesn’t change. They pout and keep threatening to leave London altogether if they get taxed. It has got so bad that the Bank of England’s head of Financial Stability, told the BBC that bankers leaving Britain "may be a price worth paying."
The lessons of this decade have been hard. Down in the city they clearly haven’t been learned. Gordon Brown has figured it out but his time is limited. He must call an election next spring and the odds are against his winning. And as for the rest of the country:
I can take you around the corner from where I live and show you a semi-derelict row house or a terraced house, as the Brits call them. Three beds, one bath, small garden at the back. A year ago it came on the market. It had no central heating, no working kitchen, half the floor boards had rotted away and the roof needed replacing. It had been the home of a poor family for decades.
It sold a few months ago in this run-down condition for around $600,000. A minimum of $150,000 was required to make it habitable. Three-fourths of a million dollars to live in an ordinary neighborhood adjacent to some of the poorest areas in the capital, with mediocre public transport.
Who would pay so much for such a thing? A lawyer for the financial services industry who had developed a little sidelight in property flipping, that’s who. New habits die hard.
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