London Falling

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But now the world is in the grips of a perilous market crunch, the boom is over, and tough times loom. The U.K.'s FTSE-100 stock index has nose-dived and is down about 35% in the past year. Two famous British banks have already imploded--Northern Rock and Bradford & Bingley. And after a dramatic plunge in the stock price of other banks, on Oct. 8 the British government announced an emergency $88 billion recapitalization package that includes partially nationalizing three other banks: Royal Bank of Scotland, HBOS and Lloyds TSB. The City has been through enough slumps to know what to expect next: layoffs, shrinking bonuses for those lucky enough to keep their jobs, and a new frugality regarding expense accounts. This will inevitably have repercussions on housing prices and also on goods and services that boomed along with the City. They range from fancy-restaurant meals to pricey vacations, bespoke suits and aromatherapy massages that the financiers and their legions of support staff could once readily afford.

The coming downturn is already shaping up as different from--and tougher than--some previous ones. That's because the financial crisis is taking place at the same time as a real estate downturn, a conjunction that is unusual; in the past, one has often followed the other, but it's rare for them to happen simultaneously. And the problems are being exacerbated by an explosion of household debt in Britain. Buoyed by rising property prices, households ratcheted up their borrowing to a massive 173% of disposable income, vs. 106% in 1995. That's way above even that paragon of profligacy, the U.S., where household debt amounts to 139% of income.

Oxford Economics, which advises the British government, expects 110,000 jobs to be cut in London between this year and 2010--although if the credit crunch is protracted, that number could rise to almost 150,000 next year alone. Real estate is already reeling. Plans for two huge new skyscrapers in the City have been shelved, and the price of prime houses in central London has dropped 12% so far in 2008, according to the real estate firm Savills, while sales volume is down 50% in some areas like Clapham and Fulham.

As the gloom descends, a question is starting to make the rounds--one that London hasn't really asked itself before: Has London become too reliant on a single industry, putting all its eggs into one volatile basket? "Obviously people see it as a risk, and if there's a prolonged downturn, it will become an issue," says Andrew Goodwin, a senior economist at Oxford Economics, who nonetheless believes that while "there is a concern about dependency, financial services have done well historically."

Move away from London, however, and you get a rather different perspective. Across the English Channel, Thierry Jacquillat, chairman of the Greater Paris Investment Agency, looks at what's happening in world financial markets and says, "The economy of Paris will resist the shock better than London. We're more diversified." And in Brussels, at the European Trade Union Institute, economist Andrew Watt draws some uncomfortable historical parallels. "There was some idea that the financial sector was immune," he says. "It's like pinning your hopes on anything, whether it's textiles in the north of England or the car industry around Birmingham. It expands for a while, and then it takes a nasty knock."