28 days that shook the world
Dark days when banks reached brink of oblivion
After Lehman Brothers collapsed a year ago, financial contagion spread like a virus around the world. Here Jill Treanor and Larry Elliott tell the inside story of the manoeuvres to save British banking
- The Observer, Sunday 6 September 2009
Sir Fred Goodwin went white and silent. The terms of the government's plan to rescue the British banking system from systemic collapse were being spelled out, and for the chief executive of the Royal Bank of Scotland it was the equivalent of the unconditional surrender by a defeated power at the end of a lightning war.
At 7am next day, Goodwin was told, the government was buying shares in the Edinburgh-based bank that would leave the group under taxpayer control. The 50-year-old Scotsman would be left without a job - but, as it transpired, with a hefty pension pot.
When he had recovered the gift of speech, Goodwin described the events of Sunday 12 October 2008 as a "drive-by shooting". Lord Myners, one week into his job as Gordon Brown's City minister, was the man holding the gun. An old adversary of Goodwin's from their days together at NatWest, Myners knew that the RBS boss was out of ammunition.
Since the previous Tuesday, RBS had been on "life support" from the Bank of England, according to government sources, ensuring that it received the funds it needed to keep doing business. Goodwin's time was up. With both RBS and HBOS in desperate financial condition, the regulators knew that neither bank could open for business on Monday without a deal being struck.
"HBOS and RBS would not have survived without government intervention. The FSA knew we could not have allowed them to open their doors on the Monday morning without a solution," said Hector Sants, chief executive of the Financial Services Authority. In the circumstances, millions of customers unable to use hole-in-the-wall cash machines was unthinkable. Four weeks had passed since the collapse of US financial firm Lehman Brothers and, as far as the UK authorities were concerned, the impact of that bankruptcy had been to turn a crisis in a specific category of mortgage banks into something systemic.
"What had happened up until Lehman failed was that a specific model had failed. Demutualised building societies had formed a new category of specialised lending banks funded by securitisation. That group of mortgage banks had failed, but the contagion had not fatally affected the core traditional British banks," said Sants.
But that changed after 15 September, the day Lehman filed for Chapter 11 protection. The FSA was already collecting data from the big UK clearers at least once a day, sometimes more regularly. The Treasury had been monitoring the financial health of the big UK clearing banks on a day-by-day basis all summer, following the nationalisation of Northern Rock in the spring, and knew that HBOS - the biggest of the so-called mortgage banks - was having trouble raising funds in the wholesale money markets.
Then, at the start of September, the sense of crisis deepened as Alistair Darling watched his American counterpart, Hank Paulson, effectively nationalise the two biggest US mortgage providers, Freddie Mac and Fannie Mae. While this made the refusal of the US authorities to intervene in Lehman more surprising, there was no time for UK regulators to dwell on the decision. Sants rang all the chief executives of the major banks on the day Lehman fell. Goodwin was one of them and knew that the pressure was building.
Andy Hornby, chief executive of HBOS, had been the first bank boss to feel the heat. Within 48 hours of Lehman's collapse, the government had cleared the way for Lloyds TSB to swallow up HBOS, owner of Halifax, by waiving competition rules that would ordinarily have prevented the move. The enlarged bank was to dominate mortgages and current accounts, with market shares of more than 30%. "After Lehman Brothers went down, the search was on for who else was in trouble," one government source said. "HBOS was an obvious target."
Darling was acutely aware of the competition issues involved in securing a Lloyds-HBOS marriage, but the chancellor decided they were dwarfed by the threat that a failed HBOS would pose to the entire banking system.
Even before the collapse of Lehman, the FSA had held discussions with every obvious bidder for HBOS - Santander, HSBC and Lloyds, which had already been interested in the bank but were deterred by the competition issues. The regulators were not going to force a takeover and wanted a willing partner. Lloyds was ready to conduct a deal.
But if ministers thought that finding a white knight (or a black horse) to salvage HBOS would be the turning point of the crisis, they were mistaken.
In the week Lehman collapsed, the Bush administration propped up insurance giant AIG. As the days passed, European banks came under pressure. Dutch Belgian finance group Fortis was on the brink. The Icelandic banking system crashed and, barely a fortnight after the collapse of Lehman Brothers, Treasury civil servants were burning the midnight oil again to save Bradford & Bingley, Britain's leading buy-to-let lender. The nationalisation of B&B was announced on Monday 29 October, the first day of the Conservative party conference in Birmingham. That evening, the speech by shadow chancellor George Osborne was overshadowed when Congress rejected Paulson's $750bn plan to buy up toxic assets from the US banks. Predictably, shares on Wall Street collapsed.
By this stage, it was clear to the Treasury that piecemeal solutions were pointless. Since the early autumn, plans for a general recapitalisation of the banks were being worked up by the Treasury, the Bank of England and the FSA. Myners and Treasury mandarins John Kingman and Tom Scholar were involved, along with Baroness Vadera and an array of bankers from big City firms and with lawyers from Slaughter & May.
Naguib Kheraj, a veteran dealmaker and ex-Barclays banker, was just a day into his new job as chief executive of JP Morgan Cazenoze when his help was prevailed upon, along with David Soanes and Robin Budenberg, big names at Swiss bank UBS. Sir John Gieve, the deputy governor from the Bank of England responsible for financial stability, and Sants were also in key roles.
The work was supposed to be conducted in the utmost secrecy but it leaked out in an interview with Osborne. The Treasury believes that Bank of England governor Mervyn King had let the cat out of the bag in a private briefing, although the shadow chancellor has always denied this. "King talked too much," one source insisted.
For Darling, the leak was unfortunate. He was due to give a statement to the Commons and was not ready to go public. The lack of detail triggered a sharp loss of confidence in the banking sector. Darling, who promised to do "whatever it takes", was not ready to give details of what the government was planning, but his hand was forced when the bland statement to the Commons on its return from recess sent the markets into fresh turmoil. Other countries in Europe - Ireland in particular - were making explicit promises to guarantee all bank deposits. Darling made no similar pledge.
With the crisis deepening at RBS and HBOS, the bank bosses were summoned to the Treasury on Tuesday 7 October to receive an outline of the government's plan to inject £50bn to bolster the banks' capital cushions. Darling, realising that he was in for a long night, rang one of his favourite restaurants, Gandhi's in Kennington, south London, to order £245 worth of rice, karahi lamb, tandoori chicken, vegetable curry and aloo gobi.
But seven banks and one building society were lukewarm about the need to raise so much cash. The assembled bankers went into a huddle. One of the officials who was present said that they insisted there was only a shortfall of £25bn, and even at this late stage were reluctant to admit they needed cash.
By the end of the week this looked like a blatant case of denial. But reputations were at stake and, as one senior government source said: "It was humiliating for them to admit they had their foot on the accelerator when they went over the cliff."
Gordon Brown and Darling announced the recapitalisation plan on Wednesday 8 October, but confidence would not come back to the sector even though the Bank of England took part in a co-ordinated cut in interest rates in an attempt to boost confidence in febrile markets. On Thursday of that week, King and Darling left for Washington for the annual meeting of the International Monetary Fund in crisis mode.
With the pressure on the banks refusing to abate, the strain on the two men was evident. King felt it was the moment of truth for the international financial community. The banking system was on the brink. In London, the stock market was in freefall. Shares in RBS could not find a floor. By the close that Friday night the stockmarket value of Lloyds, HBOS, RBS and Barclays was less than £45bn. The year before, RBS alone was valued at more than £60bn.
The Edinburgh-based bank had once been regarded as such a stalwart of the system that it enjoyed huge deposits from big companies and other banks for overnight money. This slush of funds had disappeared slowly as Lehman collapsed and during this second week of October only a lifeline from the Bank of England was keeping the bank afloat.
On the Friday night, the G7 finance ministers and central bank governors, who always meet at IMF gatherings, responded with a terse five-point plan to shore up confidence. They warned "the current situation calls for urgent and exceptional action".
Back in London, the Treasury was indeed on a war footing. Darling flew back from Washington early and on arrival back at Heathrow on the Sunday morning, was plunged straight into negotiations with the leaders of the UK banks on the price that would be paid for unprecedented taxpayer support.
He found the second floor of the Treasury building overlooking St James's Park littered with pizza boxes. Every desk was occupied and lawyers, bankers and mandarins jostled for a square inch of floor space to work on a blueprint to save the British financial system from collapse. One of those present said that the sight of so many members of the City's elite scrawling on pieces of paper gave Darling's ministry the feel of a particularly crowded kindergarten during art class.
The mood was sombre. Those present knew that the hours were ticking away to 7am the next day when the chancellor would have to announce to the stock exchange the government's plans to inject billions of pounds into the UK banks. Agreement was still to be reached. Myners was delegated to tell the bank bosses of their fate. Vadera was charged with securing lending commitments from the bailed-out banks to appease the Bank of England, which was concerned that a lack of lending could hurl the UK even deeper into recession. Gordon Brown was being kept informed.
Hornby and his chairman, Lord Stevenson, were said to be stunned by the amount of capital HBOS was deemed to need, and put up a bit of a fight. Stevenson, who was to have lost his job once the Lloyds deal went through, is thought to have considered his resignation when confronted by the numbers compiled by the regulators.
Eric Daniels, the quiet American who heads Lloyds TSB, was also summoned, along with the avuncular chairman Sir Victor Blank, who had become the public face of the HBOS deal. Even without HBOS it was apparent they would be forced to take government funds and decided to press on with the rescue takeover, although they negotiated down the price and eased out Hornby, who had originally been expecting a seat at the boardroom table. Daniels said the banks were being "over capitalised" and intended to be "bullet-proof".
Goodwin, whose pension pot has overshadowed much of the historic events of that weekend, was flanked by his chairman Sir Tom McKillop, who has since fallen on his sword.
Called before Myners, they bowed to their fate. One bank, though, declined its summons to appear before the City minister. John Varley, chief executive of Barclays, remained at the bank's Canary Wharf headquarters, determined to ensure that the taxpayer would not end up with shares in the bank.
While promising to raise fresh funds, he managed to convince a reluctant Myners that it could be done without the taxpayer and without a face-to-face meeting. According to Gieve: "It was a great moment for British state. It really was an excellent operation."
But it dragged far into the night. Darling went to bed at 12.30am aware that it was only a matter of hours before he would be in the public eye. He rose at 5am to be confronted by one bank pitching for last-minute changes. "It was so exasperating," said one source.
But at 7am on Monday 13 October the string of announcements hit the stock exchange news service. Brown and Darling took to the airwaves. Darling also presented his plan to the Commons. "If on that Monday I had gone to the House with nothing to say, I think the banking system would have collapsed," he said
For that day, at least, the financial system breathed a collective sigh of relief. Share prices soared in London and on Wall Street, and in parts along the lines outlined by Darling.
But, it was not to last. Less than three months later, the chancellor and his officials were again fighting a crisis of confidence in the banking sector, working on emergency plans to remove the toxic assets and bad loans from banks' balance sheets. The agreements are still to be finalised. As the first anniversary of the collapse of Lehman Brothers approaches, attempts to clean up the financial system remain incomplete.
- guardian.co.uk © Guardian News and Media Limited 2009
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