The Republicans did not like TARP, and neither did the Democrats. The politics were compounded by the fact that the US was at the end of the lame-duck presidency of George W. Bush and the election campaign was in its most critical phase. This was a problem not just for the US, but for us as well. If the scheme failed to get through Congress, the blow to confidence on both sides of the Atlantic would be immense. We watched with dismay as the first version of the scheme was voted down. I could see all of its drawbacks, but I could not understand how these US representatives couldn’t see that, like lemmings, they were rushing headlong towards the cliff. I was also struck by the fact that the US president, although frequently described as the most powerful man in the world, cannot automatically get what he wants at home. He has to horse-trade. In contrast, when I effectively wrote a cheque to buy £50 billion of bank shares in the UK, I did not even have to get specific parliamentary authority to do so. We could act overnight. Watching the Americans, I learned another lesson too. It was evident that when the TARP scheme was launched it had not been fully thought through. The original legislative proposal was just three pages long. It was clear to me that whatever happened, we shouldn’t announce a plan until we were absolutely sure how it would work.
Throughout this time, Hank kept in close touch with me and my fellow European finance ministers. Every time I spoke to him I could sense that his fear of meltdown was growing. His frustration with the system within which he had to operate was mounting. I felt that a period of acute watchfulness was coming to an end and it was time for action. The call to arms meant alerting the Treasury to work up contingency plans to halt the collapse of our financial system, with the terrible collateral damage that it would do to our economy. From being an interested spectator, the Treasury had to become a department that delivered. This was to be the Treasury’s war. The social and economic costs of failure were incalculable.
We were still closely monitoring our banks. On 17 September, HBOS reported much higher levels of withdrawals than usual. There were no queues, but customers were fretting and telephone banking was under pressure as people tried to get their money out. A day later, their shares slumped by another 19 per cent. On 25 September, I took a call from my erstwhile visitor, Sir Fred Goodwin of RBS, or ‘Phoenix’ by another name. He said conditions were very bad. The bank had been considering whether or not to stop lending to its customers. What would it take to try to resolve the situation? I asked. What he needed more than anything else, he told me, was long-term funding.
A few days later I had to authorize the Bank of England to provide exceptional funds to keep HBOS going. I told John McFall, chairman of the Treasury select committee, but otherwise the facility was to be kept secret in case it created another wave of panic. RBS also needed exceptional funding, to the tune of around £14 billion, which I had to authorize. The Bank had to agree a swap facility to provide short-term financing of up to £30 billion. And we were coming to the view that, unless they could find a buyer, Bradford and Bingley would fail. I saw that a spokesman for the bank had said: ‘Our funding foundations are solid and we are well capitalized.’ I was reminded of the late Tommy Docherty, who had been manager at many different football clubs. He famously observed: ‘When your chairman gives you a vote of confidence, it’s time to start looking for another job.’
When the dam did burst, though, it happened much more quickly than anyone had predicted, when one of the US’s oldest, and hitherto most respected, banks, Lehman Brothers, got into difficulties. Lehmans’ was very much bigger and more complex than Bear Stearns. Around 50 per cent of its trade came through its London subsidiary, so I was alarmed to hear that the US government was indicating that it might not bail it out were it to fail. Not only did Lehmans’ employ thousands of people in the UK, but the failure of a bank of that size would be bound to have knock-on effects in London.
I was due to fly to Nice on 12 September for another meeting of Ecofin. We were to discuss how the European Union should respond to the looming crisis. Nice is where the English aristocracy used to winter as late as the 1930s, and I was staying, appropriately enough, in a hotel in the rue des Anglais. I reflected on the fact that in those days British Cabinet ministers would retreat to the south of France for weeks on end and no one at home seemed to notice. I wondered how they would have coped with the demands of 24-hour news coverage.
On the Friday evening we were entertained by Christine Lagarde, the French finance minister (now heading the IMF), at an open-air dinner in the gardens of a splendid chateau looking out over a moonlit Mediterranean. It was a brief respite, if not entirely relaxing, as we talked over the international turmoil and my mind was very much on what was happening on the other side of the Atlantic. Christine Lagarde is charming and formidably intelligent, a former partner in an American law firm. She can bridge the intellectual gap in financial thinking between the Europeans and Americans in a way that few other European ministers can. She sought to build consensus, although at the end of the day, like all good French ministers, she always remembered that she spoke for La France. I have often been struck by how, at critical times, the French establishment, right and left, government and business, comes together in the French interest.
I knew the FSA was already drawing up contingency plans to deal with the fallout from a Lehman Brothers collapse, but they could not produce a comprehensive plan until we knew what the Americans were doing. Before dinner, I had spoken to Hank Paulson. He was about to board a flight to New York from Washington and he was anxious both to let me know what was happening and to hear my thoughts. He told me there were three options: a wind-down; purchase by an industry consortium; or a straightforward takeover. His preferred option was for Lehmans to be bought by an industry consortium. This is where we came in. I said that I knew one of the prospective players was a UK bank, Barclays. I made it clear that I was not against a takeover or investment by a British bank in principle, but I would need to be certain that Barclays was not taking on more risk than it could manage. I did not want the British taxpayer to end up standing behind an American bank that was on the verge of collapse. As with all our conversations, it was calm, businesslike, and to the point. Hank accepted this and said that the US government might be prepared to offer some help in the shape of guarantees, if needed. However, at this stage they were not in a position to do so, and we agreed to keep in touch over the weekend.
An hour later I spoke to Hector Sants, the chief executive of the FSA and someone whose judgement I trust. He and the chairman, Callum McCarthy, had been talking to Barclays; but they too wanted to know what support would be offered by the US Treasury. Both Callum and Hector wanted to be reassured that the deal was sufficiently watertight to cope with any worst-case scenario, including Lehmans’ assets turning out to be worse than expected – as, in the end, they turned out to be. All of this was being done in what seemed to me to be undue haste.
Throughout the following day, Saturday, I was kept informed of what was going on. There were two prospective buyers: Bank of America and Barclays. The consortium idea never got off the ground, primarily because the other banks were in an increasingly precarious position themselves. Also, it was not clear why they would want to bail out one of their competitors. The alternative was a wind-down or, to put it bluntly, bankruptcy. What was worrying was that it was becoming more evident that the US Treasury was reluctant to provide the financial support to make the deal work. I was not entirely surprised, having watched Hank Paulson struggle with his TARP scheme. I didn’t think he had enough political capital to persuade the Republicans to nationalize another bank. I could not see how Barclays could buy Lehmans without financial help from the US government; but, on the other hand, US legislators might well baulk at subsidising a British bank. On the Saturday evening I flew back to Edinburgh, where I was rung up to be told that Bank of America, whom we had assumed were the front-run-ners, might be pulling out. That was when I felt that my doubts about the deal were justified. The Americans wou
ld not pull out of a good deal and allow the Brits to get it instead. If Bank of America was walking away, something was wrong. What we did not know at the time, but learned shortly afterwards, was that Bank of America had decided to buy Merrill Lynch instead.
My private secretary told me that Callum McCarthy could not get the information he needed from the US side. He wanted to speak to Tim Geithner, who at that time was President of the New York Fed, which, with its responsibility for Wall Street, is second only to the US Treasury in terms of influence. Any bail-out for Lehmans or help with a takeover had to come from them. Callum was unable to reach him, however. Tim, who later became President Obama’s Treasury Secretary, was, like Hank Paulson, open and upfront. We saw eye to eye on most of the big issues we had to confront. Here, though, he was doing his job for the United States. He did eventually speak to Callum McCarthy, who made it very clear that we simply did not know enough about what was being proposed. It looked as if the sale to Barclays had been cobbled together too quickly and that our regulators simply did not have full sight of what was being proposed.
On Sunday afternoon, my private secretary told me that the Americans felt we were being obstructive. One of the key issues that had arisen was whether or not the British government would be prepared to waive a legal requirement for Barclays shareholders to approve any deal before it went through. This, for me, illustrated the fundamental weakness in the proposed sale. Not only would we have to stand behind Barclays, as increasingly we were doing for the rest of the banking system, but we would be overriding the rights of millions of shareholders who might get cleaned out. Midway through the afternoon, John Varley, chief executive of Barclays, asked to speak to me. I came to value John’s advice over the next few difficult weeks. He was candid and wanted to know if the British government would give its blessing to this deal. I pointed out that no deal as such had been put to us. It was all very vague, but, since he asked, I said I did not see how we could be asked to stand behind something that was so risky. Hank Paulson had talked about US financial help, but nothing was on the table. I got the impression that the Barclays board itself was divided over whether to buy Lehmans, given the risks involved and the lack of US government support. John Varley said he would understand if we decided not to support the deal and, if that was the case, Barclays would not proceed. The negotiations were being conducted on Barclays’ behalf by Bob Diamond, head of their investment bank, who was in New York. I told John that we would keep in touch, but I was relieved that there did not seem to me to be any great determination on Barclays’ part to acquire Lehmans that day.
I then spoke to Hank Paulson. He was exasperated. He had spoken to Callum McCarthy, who had, in Hank’s view, hit the final nail into the coffn of the deal. Hank said Callum had raised some twenty objections but had not unequivocally said no. I told Hank that Callum had raised legitimate objections, because we still did not know what was being proposed. I said that I had also spoken to John Varley at Barclays and explained to him that we could not stand behind any deal until we knew precisely what were the risks. In any case, I added, as far as we could see, there was no deal on the table. In any event, we could not stand behind a US bank that was clearly in trouble.
Throughout that weekend we got a real sense that the US administration was in a state of panic. And perhaps because of that, no one in New York appeared to have thought about telling their UK counterparts what they were trying to do. Nor did they explain why Bank of America had suddenly pulled out of a deal to buy Lehmans, buying Merrill Lynch instead. We were deeply suspicious: why were the Americans prepared to hand over what they claimed was a good deal to the Brits?
Hank acknowledged that everyone had to do what they thought right. He believed we might have got round some of the concerns raised by Callum if he had raised them sooner. Callum was later adamant that they had been raised a considerable time before. My conversation with Hank was brief and to the point, and there was no rancour at its conclusion. We were both doing our jobs. He was trying to fix a big broken bank. I was determined that UK taxpayers would not end up having to bail out a US bank. I asked him if the only option now was administration. He said he needed to discuss that with others, but both of us knew that was where they were heading. He said, ‘You’ll be the first person I call.’ Two hours later, at 11 p.m. our time, he kept his word. His chief of staff spoke to my private secretary, Dan Rosenfield. He confirmed that Lehmans was going into administration and forwarded the draft of Hank’s statement which would be released before the markets opened in Asia that morning.
Throughout the weekend, I had kept Gordon in touch. We were agreed that there was no way our government could effectively bankroll an American bank that was in trouble, when the US authorities wouldn’t and when other US banks were running a mile. For me, this was one of the most profound decisions made during the course of the entire banking crisis. Lehmans collapsed that night.
It was not the cause of the virtual collapse of the world’s banking system a month later, but did precipitate it. The problem was that the US had sent a clear signal: it would not step in to save a failed bank. The markets therefore assumed that if Lehmans was allowed to collapse, the same could happen to other banks. My guess is that if the US authorities were to have their time over again, they would act to prevent the near-chaos that ensued less than a month later. Saving Lehmans, or at least salvaging something of it, would not have stopped the collapse of confidence, but I have no doubt it would have been far easier to manage.
Even at this late stage, there was no sense that America and Europe would ever work to a single plan. There was not, as yet, the widespread sense of panic that would eventually force more progress in five days than had been achieved in the previous five months. On Monday, 16 September, the world watched police cordon off Lehman Brothers’ headquarters in New York as staff carried their working lives out of the building in cardboard boxes. The bank, 158 years old, had filed for bankruptcy. Lehman mementoes turned up for sale on eBay.
Lehmans’ collapse, and the sale of Merrill Lynch to Bank of America a few days earlier, meant that there were now only two big independent firms left on Wall Street, Goldman Sachs and Morgan Stanley. Even they had to raise huge amounts of capital – Morgan Stanley from Mitsubishi, Goldman Sachs from Warren Buffett. They even had to change their status, from being investment banks to taking some deposits as well, so that they became retail banks, which come under US government protection and regulation, and can borrow money from the Federal Reserve. The face of Wall Street had changed.
When Lehmans went down, it was believed that it held around $60 billion in toxic debts. It was an investment bank and its clients were institutions, not individuals. Its collapse exposed the vulnerability of the entire international banking sector. A small number of people in the UK held shares, and their investments were now worthless. For most people, though, the effects of the collapse would be felt indirectly. It meant that other banks would be reluctant to lend not only to each other, but also to individuals.
In London, on the Monday morning, five thousand Lehmans staff cleared their desks, amid extraordinary scenes. It was the country’s biggest single loss of jobs since the collapse of Rover in 2005. I had known it was coming all weekend, but to see people carrying their boxes out of the building at Canary Wharf like refugees was a startling sight. It was almost like the grainy black and white footage from the Wall Street Crash of 1929. What terrified me was the obvious question: how many more banks were heading this way? Would there soon be people pouring out of British banks? The FTSE 100 Index tumbled over 200 points that day. Investors were panicky. There was no frenzy in the Treasury, however. Teams were calmly working around the clock to devise a plan not just to deal with the fallout from Lehmans but, more pressingly, to decide what to do about Bradford and Bingley. At the same time, we were working on the pre-Budget report, and I met Gordon for breakfast early on the Monday morning to discuss it. The conversation was dominated by the fallout from Lehmans
and, in particular, by the plight of HBOS, which was beginning to crack.
As Hank Paulson had said a year earlier, I do have a high pain threshold, but I was reaching its outer limits. Lehman’s collapse was to prove catastrophic. British bankruptcy rules meant that the administrator here in the UK froze Lehman Brothers’ assets. He did so with good reason, because he suspected that $6 billion had been taken out of the London office on the Friday evening and had not come back. This demonstrates just how interlinked the banks are, and how quickly money can be moved from one jurisdiction to another. Because of the administrator’s vigilance, the US banks became fearful that they would not get their money out of the US arm of Lehman Brothers. They, in turn, refused to settle with other banks. Although these problems were later resolved, it was another jolt to the system. Stock prices plunged in Europe, the US and across Asia. Ironically, that meant Barclays were able to pick up the American end of Lehmans at a bargain-basement price. Had they had bought it on the Sunday, they would have paid a huge amount more. I wondered why they hadn’t just waited, as any sensible vulture would.
Commentators and Wall Street were in a frenzy of speculation, some of it well founded, some prompted by panic. Throughout that week I met with Callum McCarthy and Mervyn King, who were monitoring events in the US, where household names like Morgan Stanley and Goldman Sachs were under severe pressure. The Federal Reserve tried to calm the markets by announcing plans to loosen its lending restrictions to the banks. A hastily convened consortium of banks agreed a $70 billion fund for financial firms that might need it. The ECB said it would pump 42 billion euros into the money markets. The Bank of England offered nearly £9 billion in a three-day auction.
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