At times like this you need the still quite voice of calm, a little reflection and perspective. I would like to offer that, though after the seismic events of the past few days, it is harder than usual.

When Britain’s biggest mortgage lender can be thrust into the waiting arms of a rival by a crisis of market confidence, America has nationalised one of the world’s biggest insurance companies and the chances are diminishing fast of any investment bank surviving the carnage as an independent entity, we are talking about world-changing financial events.

If Britain and other advanced economies were facing a mild “technical” recession before, it would seem that now something deeper and nastier is in store. This looks like one of those “if the facts change, I change my mind” series of events, to quote Keynes, who knew a bit about times of dramatic economic change.

There have been several phases to the crunch. The first was in August and September of last year and claimed the scalp of Northern Rock, after which things calmed down and optimism briefly returned.

The second phase came at the end of last year, when a scramble by banks for liquidity resulted in another sharp rise in money-market interest rates, forcing central banks to pump money into the markets, as they did again last week.

Calm returned again in the early part of this year but, again, it was a false dawn. In March, not only did Bear Stearns have to be helped into the arms of JP Morgan but Britain’s lenders, realising the crunch was not going away, began to clamp down hard, particularly on mortgages. Finance suddenly became very scarce. This gave us the biggest slump in mortgage lending on record.

Until a fortnight ago it was possible to detect signs that the third phase was drawing to an end. The strains in the money markets had eased noticeably and rates available to borrowers had begun to fall.

Then, of course, came the American government’s rescue of Fannie Mae and Fred-die Mac, initially but only briefly regarded as good news, followed last weekend by Lehman’s bankruptcy, the forced sale of Merrill, the AIG rescue, the stock-market run that forced HBOS into the arms of Lloyds TSB and the pressure on Morgan Stanley and Goldman Sachs, only eased by news of the US crisis plan on Thursday night.

There are two ways of looking at this. One is that the nasty third phase of the crunch has come to an end, only to give way to an even nastier fourth phase, in which credit will be even more expensive and harder to obtain.

If that is the case, then consensus forecasts for the economy, 1.2% growth this year, 0.5% in 2009, are going to be optimistic. A ratcheting up of the credit crunch at this stage will mean an outright recession not a technical one, something we have not seen since the 1990s.

The other possibility is that the fast-paced sequence of events of recent days will prove cathartic, and signal the beginning of the end of the financial phase of the crunch. The US government rescue plan has improved the chances of this being the case.

As a young economist I was taught an important rule of thumb by my then boss, the late James Morrell, which is that financial events happen quickly but real economic changes take time.

In one respect, that is reassuring. Economies do not fall off a cliff as stock markets sometimes do. In another respect it is disturbing, for it means that the consequences of current events could be with us for years to come.

Either way, there is something lacking in the response to this. Growth is either going to be very weak or worse. Inflation should peak soon and then fall, as noted by Bank of England governor Mervyn King last week in his letter to the chancellor. Surely, interest rates have to be cut and, if necessary, cut hard?

The Bank of England cut rates aggressively in the wake of the September 11 attacks on America seven years ago. What we have seen in recent days is a kind of financial 9/11, to which a rate-cutting response is even more appropriate. The upside risks to growth or the housing market are minimal. Unemployment is rising, up 32,500 last month on the claimant count and by 81,000 over the latest three months according to the Labour Force Survey.

This is what worries the monetary policy committee’s (MPC’s) David Blanchflower who, alone among his colleagues, voted for a half-point cut in Bank rate earlier this month, and I think he is right on this one.

The banking system is vital because without it the economy stops functioning, which is why it was right to waive competition concerns over the Lloyds-HBOS deal. But what are the direct consequences for the economy of this intense consolidation in financial services we are seeing?

Merrill Lynch will always have a unique place in the City of London’s history. More than two decades ago, rumours emerged that “the Thundering Herd” intended to take full advantage of the Big Bang liberali-sation of the Square Mile and was waving a very large chequebook around. It duly arrived along with its American and international rivals, and a new era was born. Now the Thundering Herd has been cor-ralled into Bank of America.

Lehman Brothers, resplendent until last weekend in its gleaming European HQ in Canary Wharf, is no more. The City, by which I also mean its Docklands branch, will be a very different place.

The other day I heard an eminent businessman on the radio suggesting the City accounted for perhaps 20% of Britain’s economy. He was not even close. According to International Financial Services London, using official statistics, the financial sector accounts for just under 9% of the economy, measured by gross value-added.

The City’s share of that is no more than half, perhaps 4% on a generous estimate. That is consistent with the City’s small share of employment, 300,000 out of total employment of 30m, or 1%.

But while financial services are not as big or important as often supposed, the sector’s growth rate in recent years has been stunning. Over the past five years the economy has expanded by 13%, while financial services have grown by almost 50%. The party may now be over but it was a hell of a one while it lasted.

The question now is whether we will see a permanently smaller City or one that is going through one of its periodic and painful bouts of evolution, of the kind seen in the 1990-92 recession, 1994, 1997-98 and the early part of this century. It looks worse than three of those, though not necessarily the early 1990s. Either way, for the time being, a shrinking City will weigh down on an already weak economy. PS: Mervyn King has suggested in the past that if you want a cheerier picture of the economy, you should get out of London. He has a point, with the City and Canary Wharf being scary places right now.

I have been taking his advice and getting out, including to the Black Country, where he and I come from.

For those unfamiliar with it, it is the part of the Midlands that was the cradle of the industrial revolution whose main towns are Wolverhampton, Walsall, West Bromwich and Dudley. The Black Country Chamber of Commerce has been working to put the area on the map and the first Black Country Ordnance Survey map will be published soon.

So was the mood different? Yes. Though there are worries about the banking system, Peter Mathews, president of the Black Country Chamber, said he refuses to use the R word.

Firms in the region, still dominated by manufacturing, are optimistic about the effects of a lower pound on exports. The direct effects on business of the credit crunch appear limited. Nobody is pretending things are easy. But for areas like this, used to tough times, nobody is throwing in the towel.

Financial engineering is now public enemy No 1. Could real engineering and areas like the Black Country make a comeback?

david.smith@sunday-times.co.uk

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