Till Time's Last Sand

by David Kynaston

  On another topic – the proposed Stock Exchange tape to record transactions – he was pleased to hear my report that market participants are unanimously against such a record. He said he had been arguing this point for some time with U.K. Treasury representatives who claim that it is hard to make the case that a tape record is desirable in the equity market but not in the gilt edge market. It seems to make gilts ‘second class’, they say. As Mr George views it, however, ‘central liquidity’ is very much the essence of the gilt market and revelation of all transactions could inhibit dealers’ willingness to take long and short positions.

  All this was important, technical stuff, of which George was an acknowledged master; and long afterwards, Allen would recall how at that time ‘there weren’t all that many people even in the gilt market itself who really understood how all the parts fitted together’.

  The process was not without controversy. The following summer, the Bank’s Hilary Stonefrost attended as observer an FT Conference on ‘The City Revolution’ – where ‘the atmosphere was by no means relaxed’ – and noted two interventions by the uncompromisingly self-assured senior partner of the broking firm Greenwell & Co:

  Mr Eddie George set out arguments for separate capitalisation of the gilt market makers. Mr Gordon T. Pepper expressed the view that dedicating capital in this way runs counter to the macro interest of the financial sector as a whole. In his view, while high liquidity and abundant capital enable a supervisor to sleep soundly, both hinder the efficient allocation of resources in the financial sector …

  Mr George’s comment that letters of comfort would be requested from major shareholders to their gilt-edged subsidiaries also provoked Mr Pepper. Mr Pepper took the line that if the intention was to prevent contagion of financial difficulties between subsidiaries of the same group, then such letters ‘should be banned by the Bank, not requested’.

  George also gave a keynote address, looking at Big Bang as a whole, in which he ‘commented on the prevailing belief in the benefits of competition to lenders, borrowers and intermediaries, and noted that the burden of proof now rests with those who want to stop the change’. ‘No one,’ recorded Stonefrost, ‘rose to this challenge, but the concerns of the speakers and participants seemed to suggest not so much imminent golden opportunities for the financial sector, but the need to negotiate the change with minimum damage.’23

  That rather apprehensive sense was felt not only in the City. Two months later – in September 1985, just over a year before Big Bang’s due date – Leigh-Pemberton had a revealing conversation with Thatcher, recently back from her summer holiday in Austria with the British honorary consul, a local timber merchant. ‘It became clear,’ noted the governor, ‘that the Prime Minister is much concerned that “the reputation of the City is at a very low ebb. Indeed it was put to me in Austria that the City was my equivalent of the Austrian wine scandal.”’ Unsurprisingly, some governor’s reflection followed the conversation:

  Freedom of competition is very much part of the Government’s philosophy. It must therefore be ready to accept big changes in the markets, especially with the arrival of international operators, financial conglomerates, high salaries, poaching of key staff, and the risk of some failures in the new markets, which are all features which I think we need to put into perspective since the PM connects all this with the low level of the City’s reputation.

  By this time, after significant input from the Bank, a Financial Services Bill was going through Parliament that involved a major shift away from traditional self-regulation, involving as it did the creation of the Securities and Investments Board (SIB) that would closely monitor the City’s handful of main self-regulatory organisations. ‘I believe that the regulatory changes now in preparation are well suited to our great financial centre at a time of continuing change,’ Leigh-Pemberton told the Overseas Bankers’ Club in February 1986. ‘They will help to foster the conditions in which high standards can thrive; and in which the City of London can continue to flourish.’ In retrospect, of course, there are questions to ask. Did that shift away from self-regulation go far enough? Would it have been better to go the whole hog and move towards something like New York’s Securities and Exchange Commission (SEC)? Instinctively, that was not the Bank’s view in the mid-1980s, and it was certainly neither the government’s (notwithstanding Thatcher’s anxieties) nor the City’s at large. ‘There is,’ Walker in 1984 informed the permanent secretary at the Department of Trade and Industry (DTI), ‘a fairly general view that self-regulation should continue to play a major role in the future regulatory structure overall’; and he added that ‘this is, as you know, a view in which the Bank strongly concurs …’

  Importantly, Leigh-Pemberton in his speech to the overseas bankers was not just referring to the Financial Services Bill; he also had in mind, he told his audience, ‘the Bill to amend the 1979 Banking Act which the Chancellor intends to introduce in the next parliamentary session’.24 Three words formed the essential backdrop for that other legislative initiative: Johnson Matthey Bankers (JMB) – the Bank’s most difficult single episode of the entire decade.25

  Since the 1979 Banking Act, there had existed a two-tier system of authorisation: recognised banks and licensed deposit takers, with the former category subject to a less onerous range of statutory requirements. Naturally, the recognised banks were keen that the Bank should not lose sight of their superior status. As early as April 1980, at a meeting between the governor and the chairmen of the clearers, Morse of Lloyds made ‘a plea for flexibility in relation to capital adequacy and foreign currency exposure’, to which Richardson responded by assuring them that, in its general approach to supervision in the new era of the statutory framework, ‘the Bank intended to be flexible’. Among the recognised banks was JMB; and almost certainly it was that status that contributed to the Bank failing to realise earlier than September 1984 that it was in a seriously bad way – poor management, inadequate controls and most immediately two highly questionable loans to Third World borrowers standing at the equivalent of 115 per cent of its capital. Crucially, JMB was one of the five London banks authorised to deal in the London gold market. That fact determined much that ensued.

  The archival trail begins on Wednesday, 26 September, when McMahon – with Leigh-Pemberton away at the IMF’s annual meeting in Washington – called on the Treasury’s permanent secretary Sir Peter Middleton to tell him ‘something of the Johnson Matthey developments’: specifically, that ‘a large part (but not all) of the bank’s capital had been lost’ and that the Bank was ‘exploring ways of putting the situation right before news breaks and a run develops’. The deputy governor’s note for record included a revealing rider: ‘I thought it appropriate to tell him this much because Johnson Matthey is a recognised bank and because things might develop in such a way as to call for a Bank of England guarantee. Fortunately, however, he did not raise this last question in any guise. Nor did I.’ Next day, following a meeting with the senior general managers of the clearers, McMahon was back at the Treasury to see the permanent secretary:

  I told him that while we were still working for a clean solution which would probably involve the purchase of the bank from the Group [the parent group Johnson Matthey] against warranties, we could not be sure that we would have achieved this before the weekend (or of course even later). If the news broke, we needed to be in a position to stop a run on the bank. To this end we were putting together a standby facility with the clearers, backed by some form of indemnity from the Group. The terms of this standby would be those hallowed by the lifeboat [a reference to the secondary banking crisis]: i.e. the clearers would be involved in proportion to their eligible liabilities as to 90% and the Bank of England would be in for 10% of a total of £200 million.

  To this, noted McMahon, the response from Middleton was that the Bank was ‘doing the right thing’.26

  Then, over the next few days and with rumours inevitably starting to circulate, the focus was on who might be JM
B’s new owners, with the main hope being that the Bank of Nova Scotia would put in a bid, against certain indemnities from other banks; on the morning of Saturday, 29 September, representatives of Rothschilds and Kleinworts – two of the other four banks authorised to deal in the London gold market, the latter through Sharps Pixley – made it clear to McMahon that there was a real danger to the London gold market, and possibly even the London inter-bank market, if JMB was allowed to go. Nor was that all: another of the banks dealing in the gold market was Midland (through Samuel Montagu), and McMahon was well aware of its seriously weakened financial state as a result of its ill-advised purchase three years earlier of the American bank Crocker, an awareness that made him fear a possible domino effect if JMB went. In the course of Sunday the 30th, with the Bank by that evening full of representatives from all possible interested parties (including London’s clearing banks), it emerged eventually that the Bank of Nova Scotia was not willing to take on JMB, having failed to receive adequate indemnification from other banks against potential lawsuits; and at some point before midnight, McMahon took the decision that systemic risk was involved and that therefore there was no alternative to the Bank itself acquiring JMB.

  The governor himself was present by midnight, following a weekend in Kent, and ‘at about 3.00 am’ he rang the chairmen of the clearing banks ‘to ask for their co-operation in agreeing to indemnify the Bank for part of the JM bank loan book’, saying that he was ‘looking for a £70mn contribution’. If he was anticipating a smooth relaunch of that celebrated Lifeboat, he was in for a shock:

  Lord Boardman [NatWest]. Very reluctant to participate because of difficulty in justifying it to shareholders. But would stand their corner if all the other clearers took their share.

  Sir Donald Barron [Midland]. Knew very little about Johnson Matthey. But provided there were no open-ended commitments on the gold market, would reluctantly come in – again provided that the others did likewise.

  Sir Jeremy Morse [Lloyds]. More banks should come in – e.g. Standard Chartered and the Scottish clearers. Lloyds in a weak position, but would come in to a maximum of £5mn on public duty grounds provided that the list of contributors was widened. Meanwhile, the Bank of England should carry the extra load.

  Sir Timothy Bevan [Barclays]. Initially refused to contribute – impossible to justify to shareholders. After much persuasion agreed to £5mn.

  Soon afterwards, at about 4 am, ‘the Governors and those Executive Directors still in the Bank rang all the other Members of Court that could be contacted’. They explained the state of play since the Court meeting the previous evening – no outside buyer of JMB; instead, the Bank to acquire JMB ‘for a nominal sum’; the parent group Johnson Matthey to ‘put £50mn into the bank’ – and noted circumspectly that ‘indemnities were being sought from the gold market and the clearing banks against a proportion of the remaining loan book’.27 Why were those banks proving so recalcitrant? Perhaps because, contrary to Morse’s warm words at the time, they really did feel let down three years earlier by Richardson’s failure to prevent the draconian one-off levy; but perhaps more because, when it came to it, the Bank could no longer, for a mixture of personal and institutional reasons in the new City that was so rapidly taking shape, realistically expect to exercise its familiar powers of moral suasion.

  Once day had broken, there were three significant moments that Monday morning. The first was Leigh-Pemberton and McMahon going to No. 11 at 7.30 and putting Lawson (who had also been in Washington the previous week) in the JMB picture – very belatedly, as Lawson felt it, though with his retrospective account not discussing whether his permanent secretary should have mentioned something already. The chancellor was also told that an announcement would have to be made by the time the London market opened at 8 o’clock. ‘As a result,’ recalled Lawson, ‘I was being given only a few minutes to decide whether or not to give an open-ended guarantee of taxpayers’ money in support of a rescue about whose wisdom – as I made clear to Robin and Kit at the time, and subsequently in a minute to Margaret – I was far from convinced. I had to make up my mind with no time to secure the information on which to base a considered decision. In the circumstances, I had no option but to rely on the Bank’s judgement.’ The second moment was the announcement itself: a blandly drafted press release, about the Bank ‘acquiring’ JMB consequent on ‘problems’ in the latter’s commercial lending book, that was received reasonably calmly. And the third was an awkward telephone call from Morse to Leigh-Pemberton:

  He had seen the Press Notice that the Bank had put out and he wondered how much had been arranged in terms of indemnities and standby facilities.

  The Governor explained that the clearing banks were committed for indemnities totalling £20mn, with £5mn from both Barclays and Lloyds; the gold market were providing £30mn and Johnson Matthey PLC £50mn …

  Sir Jeremy’s response was that he had thought that there would be a wider circle of banks involved in providing indemnities and that, as the picture was not as he expected it to be, he could not yet commit the bank even to £5mn, although he was not actually withdrawing the offer he had made. The Governor made it clear that he regarded Lloyds as fully committed for £5mn, as the other clearers had all agreed to play their part in providing support.

  Even so, £20 million from the clearers: that, to put it mildly, was well short of the £70 million that the Bank had hoped for.

  ‘All the various hitches have been overcome,’ an exhausted McMahon was relieved to tell the governor and senior colleagues on Tuesday, 2 October, ‘and we have now bought the bank (out of IFD’s petty cash!).’ IFD was the Industrial Finance Division, with its petty cash box being conveniently at hand to be raided by Walker for a pound coin as a somewhat theatrical gesture. Within days, the Bank’s Rodney Galpin was ensconced as executive chairman at JMB, where in his obituary’s words he ‘swiftly sacked the top three executives, recruited their replacements and steadied the ship’ – so successfully that the Bank would finally lose only about £30 million as a result of its acquisition. This was little thanks to the clearers, who remained in entrenched, unhelpful mode, not least when the governor and his deputy summoned Bevan and Boardman to the Bank on the 11th. After Leigh-Pemberton had told them that he wanted the clearers to double their proposed contribution of £20 million, McMahon explained that the Bank had received £10 million from the merchant banks and ‘probably’ £10 million ‘from the Scots and Standard Chartered’, and then ‘went on to spell out for them the consequences of an ultimate very large loss for the Bank of England, viz either or both inability to play a credible role in future banking crises, or calling for a retrospective Treasury bail-out which would put the Treasury in the driving seat of banking rescues forever afterwards’. Unfortunately, reflected McMahon in his note, ‘none of this seemed to make much impression’. That meeting was of course below the public radar, but a week later the governor gave an altogether more harmonious impression at the lord mayor’s dinner for the City’s bankers. It had been, he emphasised, ‘a collective operation’ in which ‘a large number of banks came together and quickly subordinated their direct and immediate interests to those of the wider system’ – in short, ‘the rescue operation was characteristic of the City of London’.28

  Very soon afterwards, the political dimension began to come into play. ‘Treasury ministers,’ reported the Financial Times on 22 October, ‘have made known their major reservations about the Bank’s handling of the events leading up to JMB’s collapse and of the rescue itself’; while at a luncheon meeting that day Lawson told Leigh-Pemberton that he was ‘concerned’ that some of the governor’s remarks in his recent speech ‘might be interpreted as giving too liberal an approach to Bank rescue policy’. Next day saw an improbable alliance working together. The left-wing Labour MP Dennis Skinner, motivated by what he saw as the hypocrisy of public funds being used for unprofitable banks but not for unprofitable coal mines, asked Lawson in the Commons if public money had be
en employed in the JMB rescue; and the leader of the Social Democratic Party, David Owen, in a letter to the chancellor, not only pursued that tack, but argued that the danger to the gold market had been seriously overestimated and that the Bank’s decision to take over JMB was mistaken, especially as ‘such treatment has not been accorded to a number of other and much larger industrial and commercial companies which have also collapsed in recent years’. Lawson, already irked by being left in the dark in late September, dead-batted as best he could, but over the next few weeks Owen continued his campaign, amid gathering talk of an establishment cover-up. By mid-December, moreover, the ominous word from the Financial Times’s Peter Riddell to a member of McMahon’s office was that ministers felt that the Bank had ‘acted too much on its own’ and presented them with ‘a fait accompli’. Lawson himself tried to take the political heat out of the situation by announcing to the Commons on 17 December that he was setting up a joint Bank/Treasury inquiry into the system of banking supervision. By a cruel stroke for the Bank, he was asked by the Labour backbencher Robert Sheldon (seventeen years after his costly question to Callaghan) what exactly the Bank’s liability was. Wrongly believing that the Bank’s only significant liability with regard to JMB was its half-share of a £150 million indemnity, and not having been told that on 22 November the Bank had transferred to it £100 million of liquid (sterling) reserves as working capital, Lawson gave a reply that inadvertently misled the House. When that emerged he understandably (if mistakenly) ‘felt badly let down, as I made clear when I learned about it’. As every so often at that time of year, festive cheer and goodwill did not abound, as spotted by Christopher Fildes at the Stock Exchange’s Christmas lunch: ‘The Chancellor showered Sir Nicholas [Goodison] with praise, said not a word about the Bank or the Governor who was sitting by his side, and then left, pleading an engagement at Westminster.’29