Brexitg – It’s a Matter of Trust

By Sean McMahon – SmartBrief Director

Readers of a certain age might recall a tune from Billy Joel entitled “A Matter of Trust.” Those wondering why British voters chose to leave the EU might want to consider that song title. The voters who opted to leave no longer trust their leaders — elected or appointed — to fix what they believe ails the UK. Worse yet, many of them no longer trust their leaders to tell the truth about pretty much anything. However, it would be a mistake to think the trust deficit was born and nurtured just during the controversial Brexit campaigning. The lack of trust has some of its roots in the financial crisis of 2008. Those roots are still growing and stand to make an impact on markets and politics beyond the shores of the UK.

The Leave campaign performed exceedingly well in regions of the UK that have never fully recovered from the financial crisis. Voters in those regions simply weren’t buying what Remain campaigners were selling. In 2010, UK leaders said austerity measures were the path to recovery. Austerity measures were initiated, the pain was felt and yet the recovery never materialized in wide swaths of mostly rural areas. Contrast that with the recovery that powered the city of London, and rural voters had plenty of motivation to take to the ballot box to voice their displeasure.

Voting for change was one manifestation of the trust deficit, but another was the choice by voters to abstain from voting. When voters feel like their vote doesn’t matter, they stop participating in the process altogether. This empowers those who turn out on election day, regardless of whether their views represent a true depiction of overall sentiment.

Politics is, indeed, a matter of trust. If voters around the world don’t trust their leaders or trust that their vote matters, then Brexit might just be the first of many ballot box shocks.

How Did Brexit Happen?

Education was a factor, but not as much as age
Pundits the world over have pointed to education, or rather the lack of education, as a reason the Brexit vote happened, because voter data found that a strong majority of the Leave supporters don’t possess a university degree. The inference seems to be that a more formally educated electorate wouldn’t have voted to Leave. However, that data can be misleading, because the age of Leave supporters skews so heavily toward older voters. Nowadays a university degree is a common marker used to determine if someone is “educated.” However, that wasn’t the case in 1956 — which is when today’s 80-year-old Leave supporter was the age of a normal university student. Many pensioners in the Leave camp don’t have university degrees because they simply didn’t need one to live a comfortable life.

It is also worth noting that pensioners are old enough to remember a time before the EU existed, so it is not surprising they might hark back to the days before Brussels held so much sway over British life.

As for younger voters, many are crying over what the Brexit vote means for their future and pointing accusatory fingers at pensioners. Those fingers should be pointed at their contemporaries, because only 36% of those ages 18 to 24 even bothered to vote.

What’s Next for the Finance Industry in London?

Jobs … jobs … jobs
London’s financial center (aka The City), is scrambling to determine what Brexit means for the thousands of jobs in the English capital. Even before the vote took place, cities like Paris and Frankfurt, Germany, made it clear they would welcome any bankers jettisoned from the once-warm embrace of The City.

This might seem like some kind of parlor game that only interests senior banking executives, but the end result will have an impact on consumers. Any costs financial firms incur dealing with Brexit will likely be passed on to consumers. And from an investment standpoint, anyone holding shares in the affected financial firms will see earnings take a hit.

Paris and Frankfurt still make the most sense, but Dublin is also likely to attract numerous firms. Some have suggested Amsterdam, but that seems incredibly short-sighted considering the “Nexit” noise Dutch politicians like Geert Wilders are making.

Milan is another contender, but banks should exercise caution, because Prime Minister Matteo Renzi is reacting to Brexit by pushing for a $44 billion bailout for the country’s banks. Such a move is likely to prove unpopular amid the populism that is sweeping the continent.

One long-shot location that can’t be overlooked is, well … London. Leaders in Brussels are full of harsh words now, but the actual Brexit process will take years. Once all the bluster dies down, the current EU solidarity is likely to fracture when the leaders of countries like Estonia, Hungary and Latvia realize it is not in their best interest to make it difficult for banks to operate in their country. Plus, The City is extremely savvy when it comes to lobbying for regulatory carve-outs and legal exemptions for itself. Some financial services jobs are certain to Leave London, but don’t be surprised if most actually Remain.

What Does Brexit Mean for the US?

It is all about event risk
Brexit isn’t likely to have a long-term, dramatic impact on the US economy. However, the UK does not have a monopoly on the electorate trust deficit that has some roots in the financial crisis. Remember when then-Federal Reserve Chairman Ben Bernanke said the US would see 10% unemployment if the Troubled Asset Relief Program was not approved to combat the financial crisis? Bernanke and the Wall Street banks got their TARP money, but unemployment climbed to 10% anyway. That 10%, along with millions more who escaped unemployment but still felt the pain of the Great Recession, haven’t forgotten what the financial crisis wrought.

Sunday, The New York Times featured a story on how the housing crisis that many leaders seem to have forgotten is still ravaging American families. The Times seems to indicate that the continued pain is due to “missteps” by the private equity groups that took the place of banks in the housing market. The Americans who are suffering would likely argue that those “missteps” have been intentional.

Some of the sentiments currently circulating around the US are strikingly similar to those expressed by the Leave campaign the UK. Voters in the UK hoping for a return to the days of British glory are mirrored in the US by voters who want to “Make America Great Again.” They prefer the past over the present, and they aren’t convinced the US is on a path that will take them back to the future.

The financial crisis hurt millions of Americans. Policymakers prescribed the medicine. The electorate swallowed the medicine. But millions aren’t feeling any better. Those millions represent significant event risk throughout the summer and into the 2016 election.

Reading the Tea Leaves

Tons of instant analyses have popped up regarding Brexit. Here are 8 smart takes on what it all means for the markets and the political future of the UK.

Deloitte: UK’s departure from the EU is a trip into the unknown
Because no country has ever pulled out of the EU, it is impossible to say with certainty what the impact of Brexit will be for the UK or the EU, although the negative economic consequences will hit Britain harder than the EU. Guiding and managing the complex process of executing the withdrawal will be an enormous challenge for a British civil service that is smaller than it has been at any other time in the past 75 years. Deloitte (6/25)  LinkedIn Facebook Twitter Email this Story

The Economist: Brexit vote will bring years of costly, wasteful turmoil
Despite any good reasons for the leaving the EU, the UK’s vote leaves the country and its major political parties divided, according to The Economist. “The economy will suffer, as will the political establishment,” the magazine notes. The Economist (tiered subscription model) (6/25)  LinkedIn Facebook Twitter Email this Story

Nasdaq: How US investors would be wise to respond to the Brexit vote
Given the uncertainty unleashed by the Brexit vote, US investors should probably stick with US markets. Dividend payers, including telecom and utility stocks, real estate investment trusts and master limited partnerships, are likely to outperform the broad equity markets. (6/24)  LinkedIn Facebook Twitter Email this Story

Morgan Stanley: Brexit to depress UK investment and consumption
Investors can expect Britain’s decision to leave the EU and the uncertainty it has created to reduce domestic investment and consumer spending for a prolonged period. Over the longer term, the reduced openness of the economy is likely to diminish Britain’s rate of potential growth. Morgan Stanley (6/2016)  LinkedIn Facebook Twitter Email this Story

CME Group: UK’s exit from EU heightens political risk
The UK’s vote to leave the EU prompted an expected rally in gold and sell-off of the pound. The move will leave lingering tensions among the 27 remaining EU nations and even within the UK, especially since a majority of voters in Scotland and Northern Ireland wanted to stay in the EU. CME Group (6/24)  LinkedIn Facebook Twitter Email this Story

Charles Schwab: Diversified asset allocation the best response to Brexit vote
Investors with short investment horizons should be ready to ride out Brexit-driven market losses for the next three to six months. For investors pursuing longer investment horizons, standing by their existing diversified asset allocations may be the best course of action. Charles Schwab (6/27)  LinkedIn Facebook Twitter Email this Story

Franklin Templeton: Brexit an unquestioned negative for the UK economy
By putting its valuable trade agreement with the EU in doubt and restricting labor mobility, Brexit is a major setback for the UK economy and its important London-based financial sector. If the vote is an early indicator of a broader European nationalism, it will be a negative for the EU as well, although the effects on the EU won’t be felt for some time. Franklin Templeton Investments (6/2016)  LinkedIn Facebook Twitter Email this Story

Harvard Business Review: Brexit a major setback for US strategic interests
The implications of Britain’s departure from the EU for the US and the world are enormous, primarily because it greatly increases the likelihood of the Scotland leaving the UK. Without Scotland, what is left of the UK will be unable to maintain its present role supporting US strategic interests and the NATO alliance. Harvard Business Review online (tiered subscription model) (6/24)  LinkedIn Facebook Twitter Email this Story

SmartBrief Director of Content for Finance Sean McMahon edits newsletters on global financial markets, fintech and retirement.

Brexitg – It’s a Matter of Trust
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