Making It Happen: Fred Goodwin, RBS and the men who blew up the British economy

by Iain Martin

  One member of the RBS board was extremely agitated. Steve Robson, the former Treasury mandarin who had had some doubts about the ABN Amro deal and had not spoken out clearly, was more troubled about shortcomings in the risk management processes and apparent flaws in GBM. RBS needed help, Robson concluded. He checked with Tom McKillop and then called Bill Winters, who ran J. P. Morgan’s operations in London. Could they talk? Robson was now gravely concerned about the reckless way the bank had been run under Goodwin. The precise nature of his interest was unclear to Winters, however. Winters wondered whether Robson was scouting for a new chief executive, or a new head of GBM, or just looking for potential advice on what to do. Robson wanted Winters to speak to McKillop and then maybe Goodwin. When McKillop rang Winters he explained the plan would be for him to take over from Johnny Cameron and then, almost certainly, succeed Goodwin. Winters explained he needed some proper guarantees, and not just on the health of RBS. He also had a lot at stake, with a career’s worth of accumulated stock as bonuses that he had built up at J. P. Morgan. That would need to be bought out if McKillop was serious. It could be as much as $30m. They agreed to keep in touch.

  As Christmas approached, those at the top of government were wondering about the true state of the British banking industry. The Chancellor was already in the middle of dealing with the collapse of Northern Rock, which had starkly revealed the inadequacies of the tripartite system of regulation the moment there was a bank-run. The set-up created confused lines of command in a crisis, between the FSA, the Bank of England and the Treasury. And there was no proper resolution mechanism for safely winding up a bank that had run out of money. Now, there were signs of stress in the bigger banks.

  At short notice, a worried Goodwin asked to see Alistair Darling on a Saturday morning in December 2007. The RBS chief executive turned up on the doorstep in Edinburgh’s Merchiston clutching a gift-wrapped panettone from Carluccio’s in Edinburgh’s George Street. It sat on the shelf in the Darlings’ kitchen for several weeks, a reminder of Goodwin’s gloom-laden visit. The RBS chief executive was uptight and agitated. The liquidity problem was making life very difficult, he explained to Darling, and the Governor of the Bank of England had to do something or little Northern Rock would be the least of their problems. But Mervyn King would not listen, said Goodwin. Darling knew this to be true, as he had had similar conversations with King since the beginning of the credit crunch. King’s view was that the banks had got themselves into this mess and that it would introduce ‘moral hazard’ and ‘rewards for failure’ if the taxpayer were to start bailing them out. It was a fine academic theory, Darling felt, but not much use if the banking system ran out of money in the middle of a panic and then crashed the economy.

  Darling was also curious to know why Goodwin had gone ahead and paid so much for ABN Amro, when the signs were that it was overvalued at the top of the market. The global transaction service was worth acquiring, his guest explained. ‘If you ever want to transfer several million pounds across the world in two seconds, now we can do that,’ said Goodwin. Great. In the happy and unlikely event of me needing to transfer several million pounds, I now know where to go, thought Darling. After Goodwin’s visit, Darling quietly ordered his Treasury officials to start thinking about the threat posed by the biggest banks. There existed the tripartite committee, chaired by a Treasury official with representatives of the FSA and the Bank of England, which was supposed to act as an early warning system in the event of a crisis. Mervyn King’s staff had belatedly done some war-gaming. But it was all rather theoretical, slow-moving and ill-focused. Darling discovered to his horror that no one seemed able to provide him with a simple explanation of the condition of each of the major banks. Not the Treasury, the FSA, the Bank of England and most troublingly, not even the banks themselves.

  After Christmas the situation deteriorated as more bad news about ABN Amro’s exposure was uncovered by Crowe and Hourican and reported to Cameron. In public Cameron did his best to sound optimistic and project a sense of confidence. He declared in an interview: ‘I’ve been quite clear that I want RBS’s culture to prevail . . . our concepts of accountability and our focus on getting the job done. I see the RBS culture like a virus and I want to make sure it gets into the veins of ABN Amro.’8 If anything, it was the other way round. RBS, already weakened, was getting a dose from ABN Amro. The basic work of integration rattled along as it usually did when RBS did an acquisition, with departments merged and targets met. Yet that was almost irrelevant when it was now a daily event for Cameron to have to report grim discoveries to an increasingly testy Goodwin. Like RBS, ABN Amro had plenty of exposure to CDOs, and to monoline insurers, the companies with which banks took out insurance on bonds they issued. The monoline insurers had been going bust, cracking under the weight of the credit crisis; the insurance contracts that many banks had were useless.

  To Cameron’s horror, another problem manifested itself. Little thought had been given during the bid to what would happen to the deposit base when the two banks were fused together. His team discovered that being an even bigger bank had drawbacks. Says a senior RBS banker: ‘If a company had £100m deposited with us, and £100m with ABN Amro, we just presumed that they would have £200m of deposits with us after the takeover. That’s not how it worked. The corporate customer did not want to have too much money in one place. We were now one bank. So they said no, look, we’re going to have £120m with you and then take the other £80m and put it over here with someone else. We were getting more and more of this.’

  In January the board began to discuss taking emergency action. What might they be able to sell quickly, to strengthen their position? Direct Line, the insurance business, was considered, although selling anything in these market conditions for more than a knock-down price would be difficult. In the midst of this, RBS had to produce its annual results in February 2008. There were more discussions about how much should be accounted for in terms of potential losses from CDOs.9 The matter was debated in meetings of Archie Hunter’s audit committee. The auditor, Deloitte, said that actually it might be prudent to mark down another £200m to £400m, given the uncertainty on valuing CDOs. Joe MacHale, a member of the audit committee, argued that it was immaterial in the light of the size of the balance sheet and the profits they were going to announce.

  On 24 February RBS did declare a record profit, one last time. Before tax it was £10.3bn. Yet Goodwin’s swagger was gone. At the results presentation there were searching questions from analysts representing other banks and investors about CDOs and the state of the balance sheet. What was the true capital position? The exchanges were uncomfortable with Goodwin and McKillop pressed for answers. Goodwin struck his colleagues as being particularly nervous. Guy Whittaker, also looking suddenly way out of his depth, tried to deal with persistent demands that they say, now, precisely what the tier 1 capital number really was because it was difficult to tell with all of ABN Amro loaded on the balance sheet. Analyst Simon Samuels asked: ‘Guy, what is the core equity tier 1 ratio on a look through basis, so excluding the pieces of ABN that you don’t own. Are you saying it’s a number that you know and you don’t want to share with us or it’s not knowable?’

  Whittaker’s response was shaky. ‘Um . . . it’s a number, you can work it out. It’s not a number that we can ever realise because we will never get to that point where we can split it up to do that. Erm . . . it does begin with a four . . . I think that would be as much as we would like to say at this point.’

  It does begin with a four. Samuels had another go. ‘I am sorry, we can work out or you can work out? Can you just tell us what the number is then?’ McKillop stepped in: ‘It’s not a meaningful number in terms of how we operate . . . right now.’ The line in public was that they did not need to raise more capital from shareholders, which means offering existing shareholders the chance to buy new shares at a discount. Such an exercise is known as a ‘rights issue’. The Royal Bank might use the proceeds to strengthen its capita
l position. But Goodwin claimed that RBS did not need to do it. There were, he stressed, ‘no plans for inorganic capital raisings or anything of the sort’.

  Within weeks he was forced to rethink, as it became evident that he would have to try to reassure the markets to withstand the escalating crisis. On 14 March, the Wall Street investment bank Bear Stearns had to be saved by the American authorities. It was sold to J. P. Morgan, with a loan facilitated by the Federal Reserve. In the aftermath, with the markets chaotic, other British banks came under pressure too. Four days after Bear Stearns the share price of HBOS fell 17 per cent. RBS found that liquidity became even more problematic. Cameron was looking at the CDO index, which kept a running score of what they were worth, and he told Goodwin it was a horror show.

  It was obvious to some RBS staff that the senior management had landed them in the soup. After a dinner hosted by the bank in Edinburgh, a drunken RBS investment banker approached Goodwin as he was having a drink with Cameron, Whittaker, Mark Fisher and several others.10 The banker told Goodwin that he would be ‘fucked’ if the ABN Amro deal didn’t work out and that then he would have to resign. A furious Goodwin hit back. ‘This was a deal that justified itself on the basis of GBM. It was done for you guys, by you guys, and you keep fucking it up. Get back to that money-making machine of yours and don’t come moaning to me asking me to raise new capital.’

  Actually, raising new capital was exactly what Goodwin was going to have to do. On the evening of Friday 28 March, he rang McKillop at home in Chelsea to explain how big the losses might be on the investment banking side. ‘Tom, the markets are terrible. We’ve rerun all the models and it could even be as bad as £4bn.’ McKillop could not believe it had gone so bad so quickly. ‘I think you should get advisers in over the weekend and start working up a rights issue.’ Goodwin agreed. Whittaker also called McKillop that evening and received a similar message.

  Cameron’s team was asked to prepare a full assessment of what they thought the losses in GBM might amount to, although it was never made clear whether they meant for half a year or the entire year. They came up with the figure of £5.94bn, which was based on where they thought they stood at that point plus some extra allowing for a slight further deterioration in the market in the months ahead. The CDO mark-downs might get worse. The rights issue should be almost £6bn and a bit more as a ‘cushion’. Goodwin took the £5.94bn figure and began discussing with the board and the FSA exactly how big the extra ‘cushion’ should be. ‘We took the view that if we’re going to do one, we needed to do the biggest one we can possibly manage,’ says a board member. The idea was to ‘kitchen sink’ it, or raise more money from investors than the management thought they strictly needed, to err on the side of caution. Such sentiments might have been a good idea several years previously. The regulator was also applying considerable pressure. On Wednesday 9 April, Goodwin was summoned to see Hector Sants, CEO of the FSA, at his office at Canary Wharf. The position on capital was very tight, Goodwin admitted, and at this rate RBS was likely to be in breach of its guidelines. Sants, fearing that Goodwin seemed reluctant and would avoid a rights issue if at all possible, demanded that RBS give him a written commitment that they were pursuing one. They were.

  These are the events on which focus the claims of investors aiming to sue RBS and its directors. In early 2013 one group issued a claim for £3bn in compensation, alleging that the rights issue prospectus published subsequently misled investors and that Goodwin, McKillop, Cameron and others, hid the fact that its capital position was worse than it appeared. This is disputed by RBS, which says that the final figure was based on the best possible assessment of the facts available at the time. Matthew Greenburgh and Merrill Lynch had been called in to help by Goodwin, along with Goldman Sachs and UBS. The three banks acted as underwriters. Says one of Goodwin’s team: ‘They sent in their experts who knew what they were doing, and that was everyone’s best guess of a plausible bad-case scenario.’

  On the evening of Sunday 20 April, McKillop convened a conference call involving the full board. They signed off on a rights issue that would be a then incredible-sounding £12bn. Each board member was asked if they were comfortable with the figure and there was no dissent. It was a shocking, shaming reverse for a bank which just seven months previously had chaired the consortium undertaking the biggest takeover in the history of European banking. Now, on Tuesday 22 April, RBS announced the biggest rights issue in British corporate history. Only weeks after declaring record results, and saying publicly that there were no plans to try to raise any more capital from shareholders, the RBS leadership was asking for £12bn from investors. Ironically, on the day of McKillop and Goodwin’s announcement Fitch downgraded RBS and Moody’s put it on negative watch. Here were two of the ratings agencies, which had rubber-stamped so many of those products such as CDOs, for a fee, now downgrading a bank that had placed faith in the AAA ratings of the agencies.

  In the days after the announcement of the rights issue there was incredulity on the part of the senior executives that Goodwin was not fired on the spot for this. The board discussed the possibility of a swift change at the top but it was decided that Goodwin should stay, at least for six months, to somehow clear up the mess. Says one of McKillop’s colleagues: ‘It was Tom’s third chance to get rid of Fred cleanly and he didn’t. Just as he didn’t when he arrived and then when Fred suggested ABN Amro.’ Goodwin had led the Royal Bank to this but incredibly he was still in post. So deficient had been the succession planning over many years stretching back to Mathewson’s time that there was no one immediately to hand from the existing senior management team who could step up in a crisis even to be a stand-in CEO. McKillop went back to Bill Winters, and took Goodwin to his meeting with the American. It was humiliating for Goodwin, and very difficult.

  Goodwin told Winters that they would work as partners, and he would probably be gone by the end of the year. Winters liked McKillop but did not like what he heard about RBS. He asked for a list of assurances on the bank’s ‘risk profile’. In essence, what did they really have on their books? He wanted a full readout on liquidity. It occurred to Winters that it wasn’t that they had this information and were reluctant to divulge it to him, but that they didn’t have it. A few days later Peter Sutherland also asked to see Winters, and made it clear that Winters should forget any ideas of a guaranteed elevation to the post of RBS chief executive if he took over at GBM and replaced Johnny Cameron. They were very happy with Fred, he was told. This seemed weird to Winters. You are the guys in trouble coming to me. Didn’t Sutherland want Goodwin out? Why would Winters give up a career at J. P. Morgan to run something like GBM reporting to Fred Goodwin? What was this really about? He wondered whether RBS were serious operators or not.

  Iain Allan had certainly had enough, and he was signed off sick in May. The strategy director had been sidelined by Goodwin since he had made it clear that he did not like the ABN deal. He had one last conversation with Johnny Cameron about CDOs, the CDOs that Allan had tried to persuade Cameron and Goodwin were extremely dangerous. ‘Iain, you were right,’ the GBM chairman told him. It was not much of a consolation.

  At the June strategy session held for the board and senior management, McKillop went round the table asking for views on their plight. Alan Dickinson, who now ran the UK bank and had been asked to take on retail as well as corporate banking, said he had never seen anything like current market conditions in all his decades as a banker. He had already told his team that spring he was ‘calling the recession’ and that the UK was headed for a serious downturn the following year. Soon this would filter into ‘the real economy’, where RBS like other banks had made a lot of loans in the boom years. Gordon Pell concurred. Larry Fish said the liquidity situation was desperate, much worse than anything he had encountered in his long career.

  Goodwin had never been particularly good at receiving bad news, and now there was hardly ever any other kind. In June when Johnny Cameron was being driven to watch th
e racing at Ascot he received a phone call from Whittaker, the finance director. He and Goodwin had seen Cameron’s forecast for the year ahead and thought it was unnecessarily negative. Whittaker tried to talk Cameron round for forty-five minutes. The GBM chairman insisted: ‘Things are going bad again, they’re going to get worse.’ Eventually Goodwin took the phone from Whittaker and a shouting match ensued. How could Cameron say he might have to mark this stuff, the CDOs for example, down even further when it had already been marked down? Goodwin did not want to have to take Cameron’s forecasts to the board. Cameron argued that it didn’t feel good out there and there would be more write-downs. In the end, Goodwin prevailed and the forecasts were nudged upwards.

  After the announcement of the rights issue there was a brief rallying round. The prospectus was certainly enough to convince a lot of investors and RBS staff to subscribe to the rights issue. Former chairman George Mathewson thought the new shares were a bargain. They were being offered at 200p, when existing shares had closed at 363p on Monday 21 April, the day before the rights issue was announced. It was not only a matter of pride, in sticking by the bank he loved at a difficult moment. Mathewson was convinced that the City and those smart-alec traders he could not stand were wrong. Once again they were underestimating the Royal Bank, as they had done so often in the past. The market would come to its senses, once the excitement had died down about sub-prime mortgages. The Royal Bank was solid. Soon those new shares bought at 200p would be worth a lot more than that, he was sure, so Mathewson resolved to buy as many as he could. The former chief executive and chairman put up his own money, borrowed some more, and loaded up with several million pounds’ worth.

  Early that summer it seemed for a few weeks as though the rights issue had done the trick. All £12bn of shares had been taken up by the time the rights issue closed. The febrile condition of the markets calmed and it was a little easier to get access to funding. They had, Matthew Greenburgh pointed out to Goodwin, replenished an amount equivalent to what they had paid for ABN Amro. But it quickly became apparent it was merely a brief respite, with ABN Amro itself a major complicating factor. Says one of the management team: ‘There were still twice the number of problems but the same number of us, and we were trying to run two banks under two different regulators, yet pretend they were one bank. It was horrendously complicated and time-consuming, dashing to and from Amsterdam. The people there, they were bolshie and didn’t want to do as they were told, and had a long-standing way of doing things differently. At a time when all banks needed their management highly focused on the task in hand, managing their positions, we were trying to integrate a bank.’ On 1 July, for the first time, the share price closed at 199p, below what Mathewson and all those other investors had paid when they signed up to be part of the rights issue.