On Sunday afternoon, after hours of negotiation and much discussion between the Treasury, the FSA and the Bank, not to mention meetings with Gordon, Santander agreed to buy Bradford and Bingley. By early on Monday, 29 September 2008, we were able to announce that we had saved as much of Bradford and Bingley as we could. The bank was open for business on Monday morning. Sadly, jobs did go, particularly in Yorkshire. But had the bank collapsed, many more would have been lost.
I did the now familiar round of media interviews as soon as the markets opened, and was back at my desk in the Treasury in time for the next crisis. There was a torrent of bad news all day. A financial geyser was bursting in Iceland as the government there had to bail out one of its banks, Glitnir. Its largest shareholder, Stodir, had been due to buy a huge stake in the House of Fraser and Hamley’s owner, Baugur. The deal was halted at the eleventh hour as Stodir went into administration. At this stage, Iceland’s other two banks, Kaupthing and Landsbanki, were still open for business, but it looked to be only a matter of time.
Iceland’s population is about the same as that of the English midland city of Wolverhampton. Yet by 2008 the country boasted no less than three banks that had grown way beyond the wildest dreams of their founders. Much of their activity centred on the UK, and London in particular. They bankrolled a lot of property development, high-street investments, and the English football premiership. They offered attractive rates of interest and attracted billions of pounds of savers’ money. The largest, Landsbanki, although based in Reykjavik, had branches in London, trading under the name Icesave.
This was a disaster waiting to happen. In a nutshell, all the action was in London but the regulation and detailed supervision of what was going on was supposed to be carried out over a thousand miles away in Iceland. The problem was that Landsbanki had come to London to attract volumes of money it could simply never have got from a population of 340,000 people back in Iceland. Over the years it funded a range of investments, many of which are, in 2011, being investigated by the criminal authorities. Along the way, quite a few Icelandic citizens seemed to get very rich. Some were even able to make handsome donations to the British Conservative Party. By 2008 it was clear, too, that Iceland itself was rapidly becoming insolvent. Earlier in the year Gordon had spoken to the Icelandic prime minister, who had formerly been governor of their central bank, and urged him to go to the IMF. He was reluctant to do so, preferring to seek out Russian loans to tide the country over.
Although the FSA had been concerned about Icelandic banks, it was only in early September that it was brought to my attention. I was told that there was a delegation from Iceland, headed by their trade minister, who wanted to see me as a matter of urgency. The FSA was anxious that I should meet with them because they were making no headway in trying to persuade Landsbanki to put more money into its activities in the UK. But if the FSA thought the Icelandic delegation had come to show some contrition and eagerness to respond to the British regulators, it was in for a rude shock.
I was struck, as the minister and his colleagues entered the Treasury, at what seemed an unusually large delegation. The minister, his private secretary, Icelandic Treasury civil servants, representatives from their regulators and assorted others all trooped into my room. The minister spoke at some length, complaining about the attitude of the FSA. He seemed to believe that Iceland was being picked on. The Icelandic regulator spoke volubly, again at considerable length, about the strength of the bank and how we were being unreasonable. I was told that considerable national pride was invested in Landsbanki. It occurred to me that if they did not realize just how bad a state Landsbanki was in, they did not know what they were doing. Alternatively, they did know.
They were not helping matters by trying to pretend to us that everything was well. This meeting coloured my subsequent dealings with Icelandic ministers. I have been involved in talks with many ministers from different countries. You expect them to stick up for their country when their interests and ours diverge. However, you do expect their dealings to be straightforward – and this simply was not the case, as we were soon to find out. Two years later, a different Icelandic government established a ‘truth commission’. It examined the relationship between politicians, bankers and business people. Its report makes grim reading.
Icelandic banks were a relatively small part of the problems I had to deal with, but they illustrate the bigger problem when banks become too big for their home countries to manage or ultimately to finance. Iceland, along with Ireland, was part of what Scotland’s nationalist first minister, Alex Salmond, liked to refer to as an ‘arc of prosperity’, to which he yearned to attach Scotland. It was now an arc of insolvency.
Ireland has three banks, all of which got into trouble. Eventually, Irish bank debt effectively became Ireland’s own debt, forcing the country to seek an international bail-out. No one visiting Dublin in the ten years before the crash could have failed to notice the extraordinary number of tower cranes above office blocks which had yet to find tenants. The Irish banks had got into property lending like there was no tomorrow, along with HBOS and RBS, which had a great deal at risk, mainly through its Ulsterbank. The Irish banks had lent heavily into the British property market too and got badly burned. I was most concerned about the healthiest of the three Irish banks, the Bank of Ireland. I wondered just how many people knew that the Post Office Bank in the UK is in fact the Bank of Ireland. The closeness of the Irish banking system to the UK was to cause huge problems for us just two weeks later. In the good times, this profusion of banks is good for an economy, but that is only so if the banks are built on firm foundations. There is potentially a huge problem for any country when foreign banks have a significant presence but their regulation is carried out overseas and largely out of sight.
Both Iceland and subsequently Ireland were brought down by their banks. Meanwhile, Belgian-Dutch bank Fortis was bailed out by Holland, Belgium and Luxembourg. The German commercial property lender Hypo Real Estate Holding AG had to be rescued, and shares in the Franco-Belgian bank Dexia plummeted. It was obvious that across Europe they were hitting the same problems as we were. Twelve months before, during the collapse of Northern Rock, I had sensed more than a little Schadenfreude when I went to that first Ecofin meeting. I did say to them then that I suspected they had the same problem, if they cared to look.
The problem of toxic loans had spread like wildfire through the banking system. It did not recognize national borders. It was inflamed by the fact that far too many people at senior levels in the banking industry were happy to look the other way when the going seemed good. In the US the fires were still raging, with frantic talks in Washington to agree a $700 billion rescue package for the country’s beleaguered financial institutions. The only positive thing was that the Republicans were now giving support to the bill in Congress, as Wachovia, the country’s fourth-largest retail bank, was on the verge of collapse.
It was apparent to us in the Treasury that, unless we put some sort of firebreak in place, we would see one bank after another collapse in the UK. Mervyn King and Adair Turner had met and reached the same conclusion. We were now deep in uncharted waters. There was the smell of fear in the air. Those who believed they were still all right, mainly because their business was in the Far East, were afraid of becoming contaminated, as investors and traders dumped the institution they thought weakest and most likely to collapse next.
For much of the previous year, the banks’ problem had been lack of liquidity. The introduction of the special liquidity scheme in April had eased the pressure, but the problem now was lack of capital. On 26 September, Mervyn King asked to see me and Adair Turner privately at the end of one of our formal meetings. He said that unless the banking system as a whole was recapitalized, further failures were inevitable. Adair Turner agreed. The only realistic source for that capital was unfortunately the government. My concern was not about the principle of recapitalizing, but the practicalities of undertaking it. The Governor
said that the key was to require banks to raise capital. He wanted it to be a compulsory scheme, with the banks obliged to take taxpayers’ money and to meet the conditions that came with it. They should be given no option if the FSA were to allow them to continue to operate.
The key was to get capital into the banks that needed it – primarily RBS and HBOS, which was now part of the Lloyds group – but at the same time to persuade a bank like HSBC, which had no obvious need for more capital, to join in the scheme. This was necessary because unless we could show that action was being taken across the board, the risk was that the markets, satisfied that, say, RBS was adequately capitalized, would turn their attention to, say, Barclays, if it had not raised more capital. If they did not stand together, they would be picked off one by one. In other words, we had to show that we had dealt with the systemic problem across all our major banks. We had to convince the still solvent banks to come into the scheme, something they would be very wary of doing.
We were also concerned about the legal and financial implications of overruling shareholders and forcing banks to take government money, not to mention explaining to the public what we were doing. On the other hand, a voluntary scheme had the obvious drawback that it would not be seen as a complete solution and would stigmatize the participating banks. The key might be to persuade those banks who could do so to raise the required capital themselves. It was important, in the interest of stability and confidence, to get those banks that did not need capital signed up to the scheme without fuss.
We would be providing billions of pounds – money the government would have to raise in the financial markets by selling government bonds – to banks that, until now, had been owned entirely by their shareholders. In return, the government would acquire shares in the banks, which would subsequently be resold. Depending on how bad the situation was, we could end up owning all the banks in Britain. Perhaps not surprisingly, the Treasury was very reluctant, and in some quarters downright hostile, to what we were proposing. Nevertheless, I told officials to work up an emergency plan to inject new capital into the banks. They were to work closely with the Bank of England and the FSA. But failure to head off the crisis was not an option. The first piece of written advice that I received from Treasury officials was, in effect, perhaps we should wait and see because the crisis wasn’t here just yet. That advice was consigned to where it belonged, and once the initial scepticism was overcome Treasury officials worked day and night to come up with a plan. There were continual meetings at No. 10 too, but they focused on the actual delivery of the package, not the principle.
We were fast reaching a situation where a big British bank could go down. HBOS was having to borrow £16 billion overnight to keep going. Even HSBC was struggling to fund itself beyond the very short term. Normally, banks can borrow for long periods, six months or a year or even longer. Here we were with the biggest banks in the world in a position where no one was prepared to risk lending them money they could not count on getting back the next day, never mind next week.
So why not let the banks fail?
In normal times, provided it is handled carefully, a bank can fail. It happened with Barings in the 1990s and BCCI in 1992, and there had been smaller bank failures in the 1970s. In the US, bank failures are commonplace. Provided savers’ money can be guaranteed, and provided investors can be reconciled to losing money, then it is all manageable. But I was in no doubt that these were not normal times. The risk of one bank collapsing and taking all the others with it was acute. I suppose it could have been tried, but I would not have wanted to be responsible for the economic and social catastrophe that might follow. Banks and their boards had made catastrophic errors of judgement and in some cases they did not even know what they were doing. The regulators had not understood the pressures building up, and neither had central banks nor governments. There were lessons that needed to be learned, but they were for later. What was vital now was to prevent a complete collapse of the financial system.
In the aftermath of this crisis there have been many who have claimed authorship of what proved to be a highly successful plan. Gordon and I had earlier discussed the idea of forcing banks to raise capital, and of us providing it if necessary. He was immediately open to the idea and he did tell me, when I outlined it to him, that he and his advisers had been thinking along similar lines. It really doesn’t matter who thought of the scheme first. What matters is that it worked. What I know for certain is that the Treasury, the Bank and the FSA started this work on 26 September, under my instruction.
At 4 o’clock on the Monday afternoon I met with Gordon in Downing Street to take stock. I was about to head back to the Treasury when I got a text from Anna, our daughter, who was travelling in South America with a friend. It opened with the perennially hair-raising line: ‘Hey, Dad, no worries but . . .’ They were stranded on the border between Bolivia and Peru. Her friend Catriona’s passport, money and credit cards had been stolen. Less worrying, I suppose, than the previous week’s text in which she had described watching a gunfight outside her hostel in Bolivia. The border guard wanted a bribe to let them into Peru to reach the nearest British embassy and was that OK? No, it wasn’t; but I was thousands of miles away. Just because you’re Chancellor doesn’t mean you’re not still a father.
At 6 o’clock on Tuesday, 30 September, I awoke to the news on the BBC Today programme that the Irish government had decided to guarantee all savers’ money held in Irish banks. This was the first we had heard of it. It meant the Irish government was effectively underwriting its banks in a way that no other country in the world had done. We had guaranteed savings in the special circumstances of Northern Rock, but I had been careful not to do the same elsewhere. I knew full well that if the Irish government’s bluff was called they would be bankrupt. It was a promise on which they could never deliver. My immediate thought was that in the current climate savers in British banks would shift their money into branches of Irish banks in the UK. As it turned out, that is exactly what was crossing the minds of finance ministers around Europe. We were all hearing this for the first time on the BBC news. Despite frequent undertakings that everyone would keep everyone else informed before taking action, this had been a unilateral declaration. It was the last thing we needed.
I did know that for some weeks there had been disagreements within the Irish government and between the prime minister and his finance minister, Brian Lenihan, about what to do. Their central bank was becoming increasingly frustrated. I spoke to Brian Lenihan shortly after 9 o’clock that morning. We knew each other well and had a good working relationship. I knew sometime after that that Brian had been diagnosed with cancer, to which he succumbed three years later. He worked tirelessly for his country in difficult circumstances. Then, when we spoke, I said that what he had announced put us in an impossible position. The implication for savers was that if they put their money in an Irish bank, it was safe. If it was in a British bank, with no such guarantee, it wasn’t. I didn’t say that it might occur to some savers that if the guarantees were called, Ireland would be in no position to honour them. I told him in no uncertain terms that the FSA would have to take action if it became clear that funds were flowing from Britain to Irish banks. Brian apologized. He said the decision had been taken very late at night and that there had been no opportunity to tell us, or anybody else, about it. I did later find out that it had been taken at something like 2 a.m., which smacks of panic rather than a plan, although I understood Brian’s predicament.
I spent the rest of the morning on the phone: to Neelie Kroes, the European commissioner for competition, to Christine Lagarde, and to Wouter Bos, the Dutch finance minister. We were all deeply concerned at the implications of the Irish announcement. A day later, we heard reports that Germany had announced that they would guarantee all their bank deposits. This was extraordinary from a government that kept telling the world that they saw no need to intervene in the German banking system. It was even more surprising because the Germans se
t much store on announcements being made by Europe as a whole, rather than by individual member states. Unfortunately, it took some considerable time to find out that Chancellor Merkel had made a general statement that no depositors would lose out, in the context of a bail-out of one of their banks, rather than promising to guarantee all bank deposits.
Sadly, whereas I had a good working relationship with Christine Lagarde, the same could not be said of my German counterpart, Peer Steinbrück. He refused to return my calls that day, and eventually I had to ask David Miliband, the Foreign Secretary, to call his German counterpart to find out what was happening. I would like to think that Peer’s problem was that he didn’t know what was going on either. These things can happen in a coalition government.
Throughout the day, the FSA monitored the flow of savings between banks. There was some movement, but it was not as bad as it might have been. Our Northern Rock explicit guarantee that no saver would lose money had translated into an implicit guarantee for the rest of the banking system. Confidence is a very fragile thing and in those days any shiver could make it collapse. I knew that if collapse did come, it would happen very quickly.
I had met the main bank chief executives individually and sometimes as a group, as over Bradford and Bingley, to discuss specific problems. Fred Goodwin had been in touch a few days earlier to say that the banks were increasingly worried about both liquidity and capital. They wanted to know what we were thinking. I thought it best to try to meet them all in the same room once more. In my experience, it is very easy when you talk to one chief executive for the conversation soon to move to everyone else’s problems. It is a classic defensive position and a bit of displacement activity. We needed to get the banks to work with us, but these were commercial companies, always ready to stand on their dignity, and culturally resentful of any suggestion that they might need to ask the government for help, let alone that government might actually tell them what to do. I was also conscious that relationships between the banks and the Bank of England had not improved since the previous autumn; if anything they had got worse. There was a general feeling that the Governor had not acted quickly enough to put more money into the system.
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