Vanderlei Silva sits squarely in the middle of the global financial crisis. A Brazilian by birth, he immigrated to the United Kingdom eight years ago to work for a Dutch retailer. Now, aftershocks from a credit crunch that began in the United States are clouding his future.
In 2005, when the global boom looked set to run indefinitely, European retailer Mexx signed a 20-year lease on a prime Oxford Street location. Now that the company wants to retrench, it can't find anyone to take over its pricey storefront. "With the credit crunch, nobody's interested in investing in stores. That's why we're still here," says Silva, 33, a floor manager. "I'm worried a lot. … I will lose my job. I just don't know when."
Last fall, the British government's aggressive response to cleaning up its troubled banks was cited as a model by critics who accused U.S. Treasury Secretary Henry Paulson of giving American bankers overly generous bailout terms. But today, deep problems with the flow of credit are choking the British economy, enfeebling retail stores, darkened factories and the housing market alike.
The financial ailments — and their troubling implications for the overall economy — mirror the ills afflicting the United States' banking sector. But here, they may prove even more difficult to resolve. Britain's global banks, once a source of pride for this financial capital, now carry potential liabilities that dwarf the nation's total economic output. The loans and other assets on the balance sheet of a single bank — the Royal Bank of Scotland — are greater than the U.K.'s entire $2.1 trillion economy.
"The British are in a deeper hole. … They specialized in finance in a way that may prove unsustainable," says Simon Johnson, former chief economist of the International Monetary Fund.
The British government launched its second banking system rescue Monday, when it extended new aid to troubled institutions on the specific condition that they boost lending. Lenders in recent weeks had reduced the amount of credit for households and businesses by an unexpectedly large amount while planning further cuts in the months ahead, according to the Bank of England. To jump-start the collapsing economy, the bank on Jan. 8 cut interest rates to their lowest level since 1694. No one thinks that will be sufficient to thaw the credit freeze.
To date, the government has committed about $885 billion to save the banks — an amount equal to more than 40% of the country's gross domestic product. The United States' Troubled Asset Relief Program, for all its controversy, is about 5% of the nation's output. Yet, some prominent experts say credit channels are so impaired that only outright nationalization of the banks would guarantee new lending.
Given the outsize role of the financial industry in the U.K., the nation's economy seems certain to become a major casualty of the global crisis. This year, total output is likely to shrink by 3%, according to BNP Paribas. That would be a greater decline than is expected in the United States and would be the steepest one-year plunge since 1946.
"The U.K. has the worst of all worlds. … (It is) at the beginning of an adjustment that is going to weigh on growth for a protracted period," said Malcolm Barr, an economist at JPMorgan Chase.
If the British must brace for an even steeper downturn than Americans, it's largely because they enjoyed an even more inflated housing bubble. From 1995 through 2007, U.K. home prices roughly doubled. At the frenzy's peak, banks were routinely giving mortgages worth almost six times an individual's income.
At the Hampstead office of real estate agent Knight Frank, Grant Alexson, 46, anticipates a difficult 2009. This quaint north London village of narrow streets and stately homes, adjacent to an enormous wooded park, was home to figures such as Sigmund Freud and Charles Dickens. Today, it is a major draw for high-end clients, notably the vanishing investment bankers from the City of London. Homes here customarily bear multimillion-pound price tags.
The boom was good to Alexson, who pulled in a six-figure salary and an annual bonus that could be three times his paycheck. This year, he says, he'll be lucky to earn half as much as last year. "The market was there, I had to take advantage of it," he says, sipping a glass of red wine in a local pub. "We then ran into a brick wall."
Cash-rich still buying
Mortgage applications in the U.K. are down by about three-quarters from their bubble peak. Cash-rich buyers, such as the Russian businessman Alexson squired around the village today, continue to keep him busy. But with banks requiring larger down payments and being far choosier in granting mortgages, Alexson has been forced to lay off four of his 17 employees. They were the first job cuts in 15 years and, with a companywide review looming in early February, they may not be the last. "Everything's being rethought at the moment. … People are under pressure, no question," he says.
January is the traditional month for sales along Oxford Street, London's premier shopping district, where major department stores such as John Lewis and Debenhams share space with smaller shops touting mobile phones, clothes and tourist memorabilia. But this year's storefront ads touting price cuts up to 70% carry an undertone of desperation.
At Mexx, which Liz Claiborne acquired in 2001, red-and-black signs promising "up to 50% off" dot the displays of men's and women's clothing. Rock music blares from overhead speakers as midday shoppers prowl for deals. The ads are having some effect. "Oxford Street traffic is still quite high," says Silva. "They're coming and looking for bargains."
Still, December was a brutal month for U.K. retailers. Same-store sales fell 3.3% from the same month one year earlier. Purchases by visitors from the continent, attracted by the pound's weakness, represent a rare bright spot amid the gloom.
"We're seeing more European customers than in the past because there are more bargains," says Kizzi Abdessadiq, 46, manager at Barratts, a shoe store. Large window signs blare "SALE — up to 70% off original price."
Away from the prime tourist areas, a number of vacant storefronts are evident. Financing woes are causing bankruptcies in the retail sector to mount unusually early in the recession cycle, says Barr. Venerable companies such as Woolworths — a fixture here for more than a decade after its U.S. demise — already have disappeared, while even a traditional powerhouse such as Marks & Spencer is closing stores. And with British consumers even more heavily indebted than their American cousins, a retail upturn isn't likely any time soon.
Retailers' prospects also will be chilled by the worsening employment picture. Job cuts, especially in the country's factories, are becoming a near-daily occurrence. Unemployment reached 1.8 million individuals in November, the highest mark in 11 years, in an economy about one-fifth the size of the USA's.
London's financial heart, "the city," will lose 62,000 jobs by the end of this year, the Center for Economics and Business Research said last fall. Barclays Bank last week announced 2,100 job cuts just a day after revealing an additional 2,500 layoffs.
The bloodletting isn't confined to financial services. Heavy equipment maker JCB, a British Caterpillar, let go 684 workers earlier this month. That came after an initial round of 1,000 pink slips last year and a vote by the remaining workers to reduce hours in hopes of avoiding further layoffs. "Customers are still struggling to buy machines because of a lack of available credit," said CEO Matthew Taylor.
JPMorgan's Barr says the economy will be hit with "a tidal wave of job losses" in the next few months.
Those credit woes were the target of the government's first attempt to rehabilitate the battered banking sector last fall. The British treasury in October pumped more than $54 billion of fresh capital into the banks and offered to aid their efforts to raise private capital by guaranteeing almost $370 billion in new bonds.
It didn't work. Earlier this week, responding to increasingly panicked market calls, Prime Minister Gordon Brown announced a new insurance program that, in return for a fee, will protect banks from most losses on ill-conceived loans. A separate nearly $75 billion government fund will be used to purchase from banks some of their riskiest assets. The aim is to make the banks feel sufficiently protected from potentially bottomless future losses to resume normal lending.
The banks' need for additional help was illustrated Monday by the announcement that Royal Bank of Scotland may report next month a 2008 financial loss of more than $41 billion — the largest single-year loss ever by a British corporation. The government now owns 70% of the bank, founded in 1727 under a royal charter.
After months of hoping that the use of public funds would reignite bank lending, the government's newest initiative requires the banks to sign agreements with "specific and quantified lending commitments."
It's less that traditional credit pipelines are broken as much as that they're frozen. The Bank of England has lowered interest rates to 1.5% from 5% in October, but the wider economy has seen little benefit. Bankers, already saddled with billions of dollars in losses from asset-backed securities, are reluctant to extend new loans when a weakening economy imperils borrowers' ability to repay them. U.K. banks are sitting on a cash hoard of almost $60 billion vs. a historical average of less than $400 million, according to UBS.
Dead banks walking
Even the banks that refused the government's initial offer of capital, HSBC and Barclays, are "dead banks walking" because of their exposure to now-tottering emerging-markets borrowers, says Willem Buiter, a former member of the Bank of England's monetary policy committee. U.K. bank lending to emerging markets is equal to about 24% of the country's gross domestic product, vs. just 4% for U.S. banks, says Morgan Stanley. As the global recession causes borrowers in those developing nations difficulty repaying those loans, potentially fatal losses will mount.
The bankers' hesitancy to lend is being made worse by British regulators' insistence that banks boost capital reserves, says Buiter. Only the politically unpalatable step of "wholesale nationalization" may succeed in restoring normal credit flows, says Buiter, a professor of political economy at the London School of Economics.
"They will probably do it quite soon, because the situation is getting pretty bad," says Buiter. "We must get credit going again."