by Gordon Brown
On 8 April, the IMF confirmed that losses were spreading from sub-prime mortgage assets to commercial property, consumer credit and company debt. Those additional losses neared $1 trillion, as Ben Bernanke confirmed at the G7 meeting a few days later when he estimated US write-downs alone at $250 billion. It was becoming clear that even if the banks issued new shares to raise more capital, they would not have sufficient resources to lend to businesses and thus keep our economies moving. This was starkly demonstrated when the Royal Bank of Scotland and HBOS issued shares worth £16 billion while Barclays, supported by Qatar and the UAE, issued shares worth £4 billion. Even the biggest rights issues in British history, together worth £20 billion of capital, were simply not big enough to keep them liquid.
On 15 April, as these events were unfolding, I invited British bank leaders to No. 10. All the banks but one – HSBC – were keen for the Bank of England to provide more liquidity; but even if that happened, they seemed unprepared to raise the amount of lending in the economy. They were thinking of their own survival, not of the needs of the wider economy. So, after the banks left, I summoned an impromptu meeting with Yvette Cooper, then Chief Secretary to the Treasury, representing Alistair who was in Washington with the G7 finance ministers, and Shriti Vadera, the permanent secretary to No. 10 Jeremy Heywood, the senior Treasury official Tom Scholar, and the Cabinet Secretary Gus O’Donnell. We approved the terms of a new Special Liquidity Scheme that would provide cash flow to ensure business lending would resume. This allowed banks and building societies to swap some of their illiquid assets, including mortgage debts, for UK Treasury bills for up to three years.
Later that day I flew to the USA to give a lecture at the Kennedy Library. Before travelling to Boston, I invited leading American bankers to sit down with me in New York and quizzed them, without great success, on what measures would be necessary to return lending to the economy. In Boston, I repeated John F. Kennedy’s famous call for a ‘declaration of interdependence among the nations of the world’. It was now more urgent than ever in a globalised world: only on an international basis would we be able to deal properly with the fallout from bank failures and the contagion of recessions spreading from one country to another.
The next day, in Washington, I explored this issue further with Alan Greenspan, the former chairman of the Fed, then with the three leading presidential candidates – Barack Obama, Hillary Clinton and John McCain – and finally that evening with President Bush himself, first in the Oval Office, and again later when our wives joined us for dinner. The next morning I saw Ben Bernanke. Everyone seemed to know there was an impending crisis but there was no consensus on what to do. I flew home to London convinced that Britain had to act right away.
To my disappointment, the Bank of England had been slow to cut interest rates and, even when it did, reduced them only marginally, despite the fact that we were already experiencing a credit crunch and that the funding available for mortgages was now half what it had been. By Easter 2008, confidence in the UK housing market had reached its lowest point in thirty years. America was already in an even worse position: by July the Bush administration had to step in to prevent the collapse of America’s two largest lenders, Fannie Mae and Freddie Mac, who were owners or guarantors of $5 trillion worth of home loans, nearly half of the outstanding mortgages in the US.
Although we could not solve the underlying problem – which had originated in Wall Street – on a purely national basis, we had to try to limit its impact on Britain. The Special Liquidity Scheme now ran to £100 billion. Recalling the damage that had been done to homeowners by the Tories in the previous recession of the 1990s, we also set aside money to help mortgage-holders. But it was not just the mortgage market that was freezing up. I now worried about the entire economy: 850 companies had gone into administration in the first quarter of the year, 54 per cent up on the previous year – with retail and construction the worst affected. The FTSE 100 stock index was already down 20 per cent and the British Chambers of Commerce survey was predicting recession. In fact, between April and July 2008, as the Office of National Statistics would later confirm, the UK economy was at a standstill and we were about to face declines in national economic output in the next two quarters. A recession that had started in summer 2008 would be declared official in January 2009.
The global economy was under stress in other ways too. One of the great ironies of 2008 was that even as the western economy was slowing and faced collapse, oil prices were still rocketing because of high levels of demand from Asia. I spent an inordinate amount of time trying to help prices to fall. It may have been a detour from the bigger business of the day – preventing a world depression – but it mattered. We called in experts from the industry and beyond and carried out an examination of all obstacles to supply that, if alleviated, could bring the oil price down. Then, on my initiative, the king of Saudi Arabia called the Jeddah oil summit where it was agreed that they would pump more oil. As a result, oil prices peaked at $148 a barrel and two weeks later began to fall. Soon they were to collapse as world economic activity ground to a halt. By December they were down by 75 per cent.
Throughout the early months of 2008 we struggled to persuade the banks that their problems demanded radical surgery. Bankers kept telling me that their problem was one of liquidity, but it was becoming clear that the real issue was solvency. When HBOS had issued shares to raise capital, they had failed to sell two-thirds of them: the markets were telling HBOS to come clean on the toxicity of its assets. Even Barclays faced a similar problem before they were rescued by cash injections from the Qatari government.
The collapse in credit and its consequences for the global economy were the questions on my mind throughout the short holiday I took that summer. As always, it was great to spend some private time with Sarah and the boys. Sarah had chosen Suffolk so that our children could spend time playing with some of their friends who would also be there that summer. I took some time out to get fit. The personal trainer I hired locally would come to regret taking on a client who brought with him such press attention, which swiftly turned its focus on her colourful private life: yet another individual was to learn a lesson about the pitfalls of entering the political orbit. And of course the usual summer political gossip started up when David Miliband wrote an article hinting he was ready for a leadership coup.
As usual I tried to use the holidays to read widely in a way that wasn’t possible when faced with a daily diary of back-to-back meetings. I picked up Ben Bernanke’s essays on the Great Depression. I could see the parallels: the swift withdrawal of credit worldwide could drag Britain into recession or even depression. I also invited Shriti to join us. We talked about Bernanke’s ideas for quantitative easing and I made a mental note to talk to Gavyn Davies when we were all back in London. In fact, Gavyn was the first to suggest to me that the Bank should buy bonds outright and that it should finance part of the budget deficit by expanding the monetary base. I then talked to Mervyn King, who in January was to announce the Bank’s Asset Purchase Facility and then in March the Bank’s first purchase – £75 billion of assets.
In 2008, we had started thinking the previously unthinkable. Quantitative easing would be £200 billion by November 2009. It was to be a central element of the recovery programme in 2009 and, after the 2010 election, the only element of the recovery programme. A further £175 billion would be added by the coalition government after November 2011 – required to compensate for austerity and the loss of the fiscal stimulus.
That summer, however, our primary focus was on the banks. We studied Japan’s experience with what were now called ‘zombie’ banks – those that had no actual worth but continued to operate because they were propped up by the government. Shriti, who always thought far into the future, gave me her bleak assessment: poisoned by bad sub-prime assets, some banks might now fail. If they were to stay afloat, then an even bigger injection of capital would be needed than the one provided by their recent share issues. Where
would it come from? Might sovereign wealth funds step in? Might there be other sources of private capital around the world? Could we in Britain do what the US had done in the case of JP Morgan and Bear Stearns, with the stronger banks taking over the weaker? Or would governments have to step in?
Jeremy Heywood arrived in Suffolk to discuss these crucial questions and we agreed that a Civil Service team would explore both how banks might be incentivised to resume lending, and how they might be recapitalised if this was deemed necessary. Shriti sent me a long set of email exchanges in which she had been exploring the options ahead with a group of hand-picked experts: they were bluntly entitled ‘is it capital?’ And the more I explored the lessons of the past and applied them to the data of the present, the more it became clear that a massive amount of capital was indeed needed to strengthen the banks, but that even then both additional government spending (a fiscal stimulus) and lowering interest rates or printing money (a monetary boost) were essential to restore the economy to decent levels of growth. It was also clear to me that all of this would work best if the rest of the world joined in. Indeed, when I started to examine the cumulative benefit that would come from all countries taking similar action along these lines, I quickly found that joint action would achieve twice the impact.
Alistair too saw problems ahead: in an interview with the Guardian from his holiday cottage in the Outer Hebrides, under the headline ‘Storm Warning’, he said the economic times would be the worst for sixty years. He was absolutely right, but it wrong-footed us because he was interpreted as singling out a peculiarly British problem. When we later talked by the phone, he and I were agreed that we had to emphasise the reality that the roots and failures were worldwide.
By now the Treasury was acting – and intervening – far faster than the Bank of England. Alistair announced a temporary boost to the housing market – exempting stamp duty on purchases at £175,000 or below. But I found it difficult to understand the Bank of England decision to keep interest rates at 5 per cent. Even though all the signs were there that the economy was now entering recession – later confirmed by the official statistics – the Bank was holding back on the monetary stimulus the economy clearly needed and maintaining its position that intervening to save distressed banks should be resisted because of the moral hazard involved. Rates would still be at 4.5 per cent at the start of October 2008 – a whole year after the Federal Reserve had cut rates from 5 per cent to 1.25 per cent. They would come down to 1.5 per cent only in January 2009 and then to 1 per cent in February, four months after the Fed cut rates to 1.25 per cent and two months after reducing them to 0.5 per cent. I was right not to criticise the Bank publicly for keeping rates high for so long – that would have reopened the whole question of Bank independence – but it is obvious now that we needed far earlier and far more proactive monetary intervention.
Things had to change. If the Bank was going slow, governments had to do more in Britain and Europe. But even then, we already knew it would not be enough. America – where the problems had started – had to act. I talked to President Bush by phone on 11 September. Four days earlier Fannie Mae and Freddie Mac had been nationalised, and after posting a three-month loss of $3.9 billion, Lehman Brothers was on its deathbed. A later report showed that Lehman had removed liabilities from its balance sheet to create a materially misleading picture of its financial position. By now Hank Paulson was in touch asking for British support for a rescue operation. He enquired if Barclays could buy Lehman’s US operations – something Barclays, keen to become a global bank with a strong investment banking arm, were interested in. But the US conditions attached were impossible: Hank wanted to transfer to Britain the responsibility for providing Lehman with liquidity, and he wanted Barclays to be able to ignore the legal requirement to put the acquisition to their shareholders for approval. So, the deal would have left the UK taxpayer footing the bill for the collapse. We could not offer such an open-ended guarantee. There was another issue. By the Sunday when we rejected the proposal it was becoming clear that despite their ambitions to enter the top tier of investment banking, Barclays did not have the funds to mount the Lehman rescue.
The next day, 15 September, Lehman filed for bankruptcy, and a Wall Street institution that had survived two world wars and the Great Depression was no more. Previously there were four big independent Wall Street firms; by that Monday morning, there were two. That same day the Fed bailed out AIG to the tune of an astonishing $85 billion.
Barclays were saved from themselves when we blocked their Lehman deal – they would have taken over $60 billion of losses – and were now able to pick up Lehman’s US investment banking and trading assets for $2.5 billion. To cover their outlay, they successfully placed 750 million shares for £700 million and raised the capital necessary for the acquisition.
HBOS appeared to be the bank in most trouble. Fortunately, one of our options, a private sector solution, seemed doable. Lloyds had been interested in acquiring HBOS for many years, but competition issues had blocked any merger. When each of them made separate approaches to us, asking for a waiver, we agreed. I talked directly to Victor Blank, then Lloyds chairman, who was to be unfairly criticised for his role in the Lloyds–HBOS link-up, mainly by Lloyds shareholders who would have to endure hefty losses. I found him straightforward, a man of integrity, and in my view he behaved in a way that was beyond reproach.
By now the chaos in the United States was at the forefront of everyone’s minds. In Downing Street, we were all watching the markets anxiously, and around me I could feel the growing tension in the air. Every time Jeremy Heywood said he wanted to update me on something, I expected another banking collapse.
The Lehman bankruptcy marked a turning point; from then on not just mortgage markets but all markets froze across the world. The Lehman case revealed that right at the heart of the world’s banking system, which prided itself on and indeed advertised its prudence, there had been a reckless culture of excessive risk-taking. For a century and more Lehman had been a brokerage firm. For the most part, it did not use its balance sheets to acquire assets to make its own investments. But in 2005 it made a strategic shift: it was risking money it did not have to speculate in commercial real estate through leveraged lending and private equity. It was a change in business model that had now had devastating consequences.
The Royal Bank of Scotland had made similar mistakes. On paper, it had been making huge profits, paying high dividends, acquiring new assets and, as one of the first banks to enter China, seemed to be on its way to becoming the world’s biggest bank. To the public in Britain it was a dynamic retail and commercial bank with branches all over the country, backed by some of Britain’s most famous names. At least that was how RBS presented itself on advertising boards round the country.
I had known the bank from my early days as an MP. The Fife constituency I served was just across the Forth from the bank’s headquarters in Edinburgh, and I remember visiting their new offices before they were officially opened. Their plush £350 million headquarters, which were opened by the Queen, were the size of a small village, with shops, cafés, auditoriums, a swimming pool and even space at the rear for a proposed golf course.
The RBS chief executive, Fred Goodwin, was a self-made man. I first came across him as one of the accountants involved in privatising Rosyth Dockyard. Over the years I saw him change. By the time the bank collapsed he had from his company a private suite in the Savoy costing £700,000 a year, a fleet of twelve chauffeur-driven Mercedes limousines with RBS emblazoned all over them, and regularly used a private jet at the weekend – whether for hunting in Spain or following the glamorous F1 circuit around the world. Every year £1 million was paid out to each of RBS’s ‘global ambassadors’, including Sir Jackie Stewart, Jack Nicklaus (whose image was on one of the bank’s commemorative £5 notes), and Andy Murray (who, to his credit, would volunteer a cut in his payment) as part of an estimated £200 million sponsorship budget. Large five-year contracts, including f
or cricketer Sachin Tendulkar, were to be signed just weeks before the bank crashed. Millions of pounds were simply wasted.
Fred and I spoke only rarely, but I do recall one conversation with him. While I was still chancellor I met Fred at his Edinburgh office and asked about what were called ‘orphan assets’. These were assets held on banks’ balance sheets belonging to customers who had died without leaving any instruction as to where the money should go. In some cases, these customers had passed away a century ago or more, but their savings were still held by the bank and accruing interest. The banks estimated them at £400 million. We thought they were in excess of £1 billion. Once the unclaimed assets of insurance companies were added, the figure exceeded £2 billion. I told him that this was money that the institutions did not own and that, according to a plan drawn up by the Commission on Unclaimed Assets – led by the philanthropic venture capitalist Sir Ronald Cohen, who proved masterful in raising money for social purposes – it should be put to community uses. One was building new youth centres, another was funding education in financial literacy. I was planning to introduce a policy that would bring this plan into effect, and in my discussions with other banks had found them, if not overjoyed, at least receptive. Goodwin was resistant, the odd man out, and for reasons that at the time I couldn’t work out. I can only now imagine how delicate his bank’s position must have been.
RBS did indeed have an unusually low capital base, but we did not know quite how vulnerable it was. And when RBS proceeded in 2007 with a leveraged and risk-laden $60 billion bid to take over the Dutch bank ABN Amro, they did not do the checks necessary to discover it was riddled with sub-prime and impaired assets. The information made available to RBS by ABN Amro in April 2007, the FSA later reported, amounted to ‘two lever arch folders and a CD’. I was later told of the crucial email that gave the order to go ahead: they would deal with the assets and liabilities later.
