Idle Threats

One of the funniest trends in the marketplace are the threats by investment banking heads that they will quit one of the major financial hubs and move their operations elsewhere. They claim that capital and labor are highly mobile, and they can pick up and go to wherever they please. It is true that the factors of production for financial services became much more portable during the past decade with technological advances in communications, data processing and transportation. The rise of Singapore as a major financial center is evidence of the trend. The emergence of regional financial capitals, such as Dubai, Frankfurt and Panama also provide some credence to the argument. Large global financial institutions, such as Goldman Sachs, HSBC and Barclay’s, generate tens of thousands of high paying jobs, thus providing an enormous multiplier to any city or state. They also generate billions of dollars in tax revenues for local and national governments. However, they also depend enormously on the resources, facilities and institutions that are freely provided by these governments.

There are wonderful stories of investment bankers, fund managers and analysts operating in remote and exotic places, such as San Martin de Los Andes, Changmai and Vail. These tend to be small operations, with limited scope and range. However, they lack the institutional framework to sustain large scale operations. Financial centers require good infrastructure, including international airports, reliable energy sources and decent transportation systems. They need world class schools and housing to sustain the family members of bankers, traders, analysts and support staff. However, the two most essential requirements are political stability and a well-honed legal system. Complex financial systems require a predictable political environment that is not prone to dramatic swings. The number of countries that can provide such a political backdrop are limited. Even some of the most highly-developed Continental European governments demonstrated episodes of populist rage in the midst of the recent international credit crunch. Likewise, unbiased and trusted legal systems are the bulwark of a modern financial industry. Even though some of the rising financial centers in Middle East and China are promising, they lack the legal systems needed to referee disputes and enforce financial contracts. The legal system is also the basis of a functional regulatory system, which provides the rules and parameters for all financial operations.

Last of all, a financial capital requires the sovereign capacity to provide assistance in times of need. For all of the bellyaching and complaining by investment bank CEO’s about the U.S. and U.K. governments, it was they who came to their aid, to the tune of hundreds of billions of dollars, when the financial system collapsed. Even Switzerland, one of the most prosperous countries on the globe, is not taking chances. It is forcing its financial institutions to bolster their capitalization in order to prevent a repeat of the global credit crunch. Therefore, the numbers of locations that can adequately serve as hosts for large financial conglomerates are extremely limited. Most countries lack the physical, human, political and legal infrastructure to become a major financial hub. They also lack the immense population pool of highly skilled workers that are the backbone of the financial services industry. Only mega-financial cities, such as New York and London, can provide the range of service providers that allow banks to provide the gamut of sophisticated financial products. Recent attempts to relocate to some of the more promising locations, such as Hong Kong and Singapore, are uncovering new problems. Wages and property prices are soaring, as the limited labor supply is snapped up. The relocation of ex-pats is also putting a strain on home prices, as the finite supply of adequate housing is bid up. The same is happening with schools. We must remember that these two countries are nothing more than small city-states, which are not integrated with its neighbours. Hence, moving into the suburbs or tapping into a wider labor pool are not viable options. Therefore, these idle threats are nothing more than hot air. Government officials, policymakers and regulators should call their bluff and welcome them to walk away—because in reality their places would be immediately assumed by the armies of small foreign banks that are dying to establish a toehold within one of the major financial capitals of the world. In other words, such empty threats are nothing more than risible.