Back from the Brink

by Alistair Darling

  Those were dark days. It was a defining moment, too, in my relationship with Gordon. It would never be the same again. Subsequently, I learned that when he was at Southwold, Gordon had decided on an economic strategy that was built around the proposition that the economy would recover over the next six months. I had sensed something was up, since while he was there Gordon had repeatedly been in contact with the Treasury, asking for growth figures and other information. When these hadn’t been immediately forthcoming, he’d rung me to ask whether I was blocking their dissemination – which, of course, I wasn’t. If I had known that Gordon believed that economic recovery lay around the corner – if he’d told me, his Chancellor, this – then we could have had a discussion about it. The problem was that clearly he did not trust my advice, and now he appeared indifferent to what I thought.

  I spoke to Gordon and told him that we knew where the anonymous briefings were coming from. It had to stop. It was damaging the credibility not just of me but of the whole government. He said he was not responsible for it; it was nothing to do with him. Politicians have to be pretty thick-skinned. Criticism from political opponents, either upfront or through anonymous sources, is the stuff of politics the world over. But systematic anonymous briefing from people you have known for years, and who are supposed to be on your side, is deeply unpleasant. Living next door to it – literally – made it all the harder. I was reminded of the words Henry II uttered about Thomas à Becket: ‘Will no one rid me of this turbulent priest?’ He didn’t order his knights to go and kill Becket, but they believed they had his blessing to do so.

  I won’t deny that this episode was deeply hurtful and that it shaped a difficult relationship for the rest of our term in office. But I do have just the faintest sense of gratitude. My fairly accurate prediction of what was to come economically might have been long forgotten but for the inept briefing machine at No. 10. For that I owe them thanks, which is something I am sure they never anticipated.

  5 Crisis: the Collapse of Lehman Brothers

  I returned to London at the beginning of September 2008 rather less than refreshed. Not only had the fallout from the interview undone any good that the Hebridean break might have done me, but our holiday had been interrupted on a daily basis with calls from my private office, which in turn was being bombarded with demands for action from every part of No. 10. I knew only too well that the economy was slowing down fast and was probably heading for recession. I did not need to be convinced of that. What I wanted, though, was to make a coherent announcement, probably in an early pre-Budget report in the autumn. A single big announcement will always have a far bigger impact than a series of small initiatives announced one day and forgotten the next.

  The fallout from the interview continued with a flow of articles by commentators saying that things were not as bad as I had said. Just a few weeks later, however, it was clear that, far from being pessimistic, the picture I had painted was not bleak enough. In that Guardian piece I had also said that people were ‘pissed off’ with us, and that reshuffles of Cabinet positions rarely change anything. In that respect, my prediction was not quite right. People were fed up with us, but in September Gordon decided to reshuffle his Cabinet, this time to good effect. Ed Miliband took charge of a new department of energy and climate change, something I had long believed was needed when I was in charge of energy policy within the large and unwieldy Department of Trade and Industry. Ed was a long-standing protégé of Gordon’s, who had joined him in his early twenties when Gordon became Shadow Chancellor. He was the most personable of Brown’s inner circle, and I found him helpful and straightforward. He worked really hard in this new department and did his level best to make the Copenhagen climate change talks work.

  The big change was the return to government of Peter Mandelson. This was seen as something of a coup. It was totally unexpected and it also suggested a rapprochement between Gordon and the Blair wing of the Labour Party. I was part of a minority who thought that Peter, who at times could be his own worst enemy, was a tremendous asset to the party. He had identified the need to modernize in the 1980s and he had spotted the potential of Gordon and Tony at that time. His influence, and particularly his presentational skills, were instrumental in the transformation of the Labour Party from a creature nostalgic for the past and wary of the future into a body that was confident, optimistic and sure of what it stood for. More importantly, in 2008 I had high hopes that Peter might bring some order and direction into No. 10. We were not close, although we had worked together, particularly when I was at the Department of Trade and Industry. I knew I could work with him, and I desperately needed an ally to argue my case with Gordon. It was also helpful that Peter was in the Department for Business, so that there was now someone involved in managing the economy who shared my outlook. Peter remains something of an enigma, and probably he likes it that way, but politically he is highly sensitive and astute, and he understands the British press. The crucial advantage from my point of view was that after 2008 he was the one person in Cabinet, other than Ed Balls, to whom Gordon would listen. It was to prove to be a good appointment, and we worked well together until the election. I was sorry that Gordon could not persuade Alastair Campbell to return too. I knew that he had approached Alastair, but he felt it would not work. He did return as part of the general election team, but by that time the die was cast.

  Although I was not consulted – nor, in the circumstances, would I have expected to have been, such were the difficulties between us – I was optimistic that these changes would help get us back on our feet. The only appointment on which I was consulted was whether or not I would take Shriti Vadera into the Treasury. Shriti had been a special adviser to Gordon since the late 1990s. She had come to him from an investment bank, to advise him on development in Africa in particular, and was a huge contributor to the debt-relief initiative. When Gordon moved into No. 10, he needed an economic adviser full-time, a position that had previously been occupied by Ed Balls and, to a certain extent, Ed Miliband. I didn’t want her to come into the Treasury, not only because she had a difficult working relationship with civil servants there, but more importantly I wasn’t having a spy in the cab, which is what Gordon wanted her there for. That would’ve provided even greater dysfunction and I wasn’t having that in the Treasury. So I told Gordon that I wouldn’t have her. Instead, I happily took Paul Myners. Gordon’s response was to put Shriti into the Department for Business; but she constantly sought to be a presence at the Treasury, undoubtedly at Gordon’s behest. I was happy to let her be around, but only on my own terms.

  The reshuffle was well received, but already the whole developed world was on a slope that would take the banking system to the brink. The debacle of the summer was about to be overshadowed by the worst banking crisis – not in sixty or a hundred years, but in history. A foretaste of what was to come had been seen in the US, the day after my Budget the previous March. Bear Stearns was one of the oldest and most well-established investment banks in the US. Burdened with a huge amount of securities based on sub-prime mortgages, the bank had collapsed. The US government rightly believed that they could not let it fail, so they engineered, and largely financed, its takeover by another stalwart of Wall Street, J P Morgan Chase. On that occasion, as a result of the prompt action by the US authorities, a crisis was averted.

  Any hope that banks could put an accurate valuation on their potential losses had come to nothing. Worse, the whole thing became self-fulfilling: as each bank disclosed its losses, the markets, and other banks, further downgraded the value of the assets they held. In the US, the Federal Reserve had made $200 billion available to the banks a few days before the collapse of Bear Stearns, but its attempt to stave off collapse by providing emergency lending to the bank had failed.

  The housing market in the US was in desperate straits. Millions of Americans on low incomes – and in some cases no income – had been persuaded to buy houses on the back of historically low interest rates. Many had been
sold mortgages that had incredibly low rates of interest and no repayments for the first few years – so-called ‘tasters’ – which then reverted to a much higher rate thereafter. All this was predicated on house prices continuing to soar, so that the value of the homes would quickly outstrip the size of the loans made against them. Then house prices began to plateau and to fall; and on top of that, when interest rates went up, millions of people found they could not meet the repayments on their loans. The sale of mortgages in the US was largely unregulated which meant that the very people whom the state should have protected, by insisting that they be told precisely what they had let themselves in for, found themselves completely exposed. Interestingly, in the UK, the Tories had proposed similar deregulation the previous autumn, just before the crash.

  All of this had two effects that proved disastrous for the US. First, defaulting loans turned into securities and held by American banks changed from assets into massive liabilities. Secondly, in the US, unlike the UK, a property owner can simply hand back the keys to their house and walk away. That meant that the US housing market crashed, leaving empty and half-completed homes dotted across the country. Some people had made money exploiting the needs of the poorest and most vulnerable of their fellow Americans, and now the whole country would have to pay for it.

  In the UK, private sector house-building had virtually stopped and new mortgage approvals were at their lowest level since records began. I was always less worried about Britain’s housing market. I knew it would fall, that was inevitable, but in the long run Britain’s problem is that the demand for housing exceeds supply. There are many people chasing too few houses and, until the country’s planning laws change, houses are likely to rise in price over time. Ironically, the spectacular failure of successive British governments to deliver increased house-building proved to be a blessing for the housing market, which did not fall by anywhere near as much as people feared, although in parts of the country the falls that did occur will take some time to recover.

  However, confidence in the banking system was slowly seeping away. In April, RBS had announced a plan to raise the money it desperately needed from its shareholders through a £12 billion rights issue, the biggest in UK corporate history. In May, the Swiss bank UBS launched a £16 billion rights issue to cover some of its losses on assets tied up in US mortgage debt. In June, Barclays said it was planning to raise £4.5 billion in the Gulf and from its shareholder the China Development Bank.

  At the beginning of July, a big US mortgage lender known as IndyMac collapsed, and the government was forced to shore up the country’s two largest mortgage finance companies, known as Freddie Mac and Fannie Mae. Freddie and Fannie own or guarantee almost half of all US home loans. This makes mortgages cheaper to obtain, but now it resulted in the US government effectively backing more than $5 trillion of debt. Belatedly, the American authorities had woken up to the fact that what was happening in the housing market amounted to criminal behaviour in some quarters. The FBI had arrested 406 people, including brokers and housing developers, in a crackdown on alleged mortgage fraud worth $1 billion. The guarantee for Freddie Mac and Fannie Mae was welcomed when it was announced. Hank Paulson called the G7 finance ministers to keep us informed, and for a time it seemed as if the rescue measures would work. But that was the summer. By the autumn it had proved to be a false dawn.

  It was in July that alarm bells really began to ring around HBOS. The bank had first appeared on the Treasury watch list when the problems with Northern Rock surfaced. The FSA was concerned about its exposure to the housing market. It too had sold mortgages aggressively, offering amazing deals, to the point that it was not making any money out of them. Although this wasn’t so obvious at the time, the bank had tried to compensate for that by making commercial loans, especially on property, which were to result in colossal losses. HBOS was becoming increasingly desperate and needed to raise capital, which it started to do that summer through a rights issue. But it experienced real difficulty in raising money by issuing these new shares, for it was evident that investors – rightly – took the view that the bank was in deep trouble. At the end of July, HBOS profits had halved. Bad debts, as more customers failed to repay loans, were up by a third. There was a whiff of death surrounding the whole operation. Two once solid institutions, the Halifax Building Society and the Bank of Scotland, were heading for the rocks.

  We were also concerned about the condition of Bradford and Bingley. Now a bank, it had been a well-run building society based in Yorkshire. However, fuelled by what seemed an endless supply of cheap credit, it had got into the buy-to-let market. People who had previously never thought of buying property in order to let it saw this as a new way to boost the value of their savings. Buying to let is risky, however. Added to that, Bradford and Bingley seemed to have a large number of customers who ‘self-certified’ their circumstances. The result was that as property values began to fall, borrowers began to default. Its share price was falling as investors decided that Bradford and Bingley had gone bad.

  The only good news was that, after months of agonizing, the directors of Alliance and Leicester, another former building society, had decided to sell the company to Abbey, which was itself a subsidiary of the Spanish bank Santander. We had been worried about Alliance and Leicester – not because it had done anything wrong, but after the collapse of Northern Rock there was a general suspicion that, if all these former building societies were in trouble, why should Alliance and Leicester be any different? They had no alternative but to sell if they were to avoid the fate of the others. For us, it was one less bank to worry about.

  Throughout that summer, as the dismal picture developed, we at the Treasury were reflecting on what to do. It was obvious that far too many banks were short of capital to fall back on as their losses began to mount. Whereas in the first half of the year we had been worried about liquidity, or cash flow, by midsummer another problem was apparent: the banks needed more capital behind them. They needed more funds to fall back on, because it now seemed inevitable that they would face growing losses as borrowers got into difficulties.

  The position in the UK was nothing like that in the US, but because of the size of the housing market here, some of our banks were very exposed. Home ownership in the UK is much wider than it is in Europe. That means that whatever happens in the housing market not only affects the banking system but also the wider economy, including the business sector, since if house prices fall home owners spend less money.

  In the Treasury we drew up a list of banks that we thought needed close monitoring. Reports were given to me on a daily basis. They became known as the ‘animal and planet reports’. Such was their sensitivity that a well-meaning official devised code names for each of the banks. My private secretary would give me a note telling me how Jupiter was faring, that Lapwing was failing, or that Badger was in a bad way. It got frustrating trying to remember which was which. An apprentice spy might not have had much trouble breaking the code. When bankers came to meetings, the minutes discreetly recorded them by their code names: ‘Elvis left the room.’ A cursory glance at a report would show that ‘Elvis’ had headquarters in Newcastle and sponsored Newcastle United FC.

  At that stage there was no worked-up rescue plan. That came later. We were dealing with a moving target. It still was not clear how deep the problem was, and because of that it was difficult to know how to treat it. The only thing that was clear was that the situation was getting steadily worse. Looking back at my engagements for early September that year, I see that when I addressed the TUC (the first and only occasion on which I did so) I spoke on the risk of inflation, rather than on the situation relating to the banks. I was concerned about the return of inflation, but it turned out to be the least of our worries that autumn.

  The US government’s attempt to shore up Freddie Mac and Fannie Mae was short-lived. Their financial position was far worse than had been thought. So, on 7 September 2008, the US government decided it would nationaliz
e the two insurance entities. Hank Paulson arranged a teleconference for the G7 finance ministers and explained the decision to us. The private sector was not going to help with a rescue, and they saw no alternative way to maintain confidence. It was not called ‘nationalization’ but rather ‘conservatorship’. Presumably that was designed to go down better with Republican politicians.

  Whatever it was called, $5 trillion of American housing debt now belonged to US taxpayers. Despite that, it was well received both in the US and especially in Europe. This was interesting: in a country where the state – or big government as it’s often called – is viewed with suspicion not just on the right but even in some Democratic quarters, the US government action was seen as positive. As in the case of Bear Stearns the previous March, the US had used the power of government to stabilize the situation and avoid panic. Hank Paulson, having worked in financial markets all his life, knew what needed to be done, although, as he has subsequently admitted, he found the politics much more difficult to understand. It was, however, a watershed for a Republican administration.

  Paulson was also working on a more ambitious scheme to deal with what he had correctly identified as the core of the problem in the US. He wanted to use taxpayers’ money to buy the bad assets that banks held and that were effectively crippling their ability to borrow and lend. The idea was that these ‘assets’ would be sold off at distressed prices to anyone who would buy them. The plan was known as the Troubled Assets Relief Programme, or TARP. From the time of its announcement, it was the subject of a rising chorus of criticism inside Congress and from leading economists. The main objection was that the US taxpayer was taking on the bad assets, while the banks, whose recklessness had caused the problem in the first place, would keep the good bits. The real problem, as many commentators saw it, was that American banks needed more capital. From this side of the Atlantic, we watched the TARP proposal with foreboding. I could see the attraction of the principle, but I could not understand why any private sector body would buy these toxic assets. If their original owners could not sell them, how would the new buyers?