Britain's Love Affair with Its Banks Must Continue

News that UK fourth-quarter economic growth was revised higher to 0.3 percent will have gone down well with Gordon Brown's government.

Unfortunately for the UK prime minister, by the time he fights a general election in May, data from the first quarter of 2010 could show Britain returning to recession despite unprecedented stimulus spending that has seen the country's national debt balloon.

With more than 800 billion pounds ($1.21 trillion) owed by the government after bailing out the likes of Royal Bank of Scotland and Lloyds Banking Group, Britain faces some very difficult choices.

Stephen Hester, the man chosen to sort out the mess Sir Fred Goodwin made at RBS, finds himself in a position that reflects the wider challenges facing the UK economy.

Having cut losses to a still huge £3.6 billion in 2009, Hester is managing an asset that the British government needs to recover.

With an 84 percent stake that has yet to hit the level that would even see the bailout by Treasury break-even, Hester needs to massively restructure his bank in a market where his major rivals have managed to stay out of government hands.

The likes of HSBC and Barclays have fared better than RBS and despite the huge losses for investment banks globally since 2007, many are now aggressively hiring and paying big money to take entire teams of people on board.

RBS is facing huge pressure amid a public backlash not to pay big bonuses and therefore will struggle to keep and bring in the people Hester needs to maximize shareholder value.

Why The City Is Needed

With an election to be won, none of the UK’s major parties are willing to back Hester to invest in new staff and from April the 50 percent rate of tax that will apply to everyone earning over £150,000 a year will make the City of London a worse place to make money.

This is clearly a dangerous move. Prime Minister Gordon Brown - and Tony Blair before him - borrowed billions to fund spending on schools, hospitals and two wars in the good times the City of London was making billions of pounds for the Treasury via tax receipts. Britain needs those tax receipts to recover urgently.

Whoever forms the next government will have to balance anger about the financial crisis with the reality that getting Britain out of its highly indebted position will need a big effort from RBS and the rest of the City of London.

Because of the relatively small size of the UK manufacturing base, a weaker pound has yet to give Britain the kind of help it needs.

For all the talk of the City needing its wings clipped, without a successful financial services sector, Britain will struggle to either get its money back from RBS and Lloyds or shore up its ailing public finances.

Friday’s reading of GDP growth was heavily supported by government spending, which is clearly not sustainable. Cold weather and its likely impact on spending in the first quarter could well mean the recovery is short-lived.

But failing to walk the line between supporting the bankers and getting elected could have far bigger consequences than two months of heavy snow.