The wolf pack finally arrived in the late summer of 2007 while the lambs were still frolicking in the sun. Rachel and I were on holiday with friends in the Lake District when I received a mobile call at the top of a mountain from Sam Fleming, a financial reporter on the Daily Mail. He had been happy to carry my apocalyptic warnings about the banks and the housing market, which conveniently dovetailed with the line of the Mail. The Mail’s financial editor, Alex Brummer, whom I had got to know a little from annual encounters at the Remembrance Day service at Richmond synagogue, had been warning for years about Northern Rock’s dangerous business model and the questionable activities of Mr Adam Applegarth, the chief executive. There were now ugly rumours swirling around Northern Rock, which appeared to be having trouble raising funding, and what did I think? The bank was in difficulty because rapid expansion of lending at the peak of the housing boom had exposed it to excessive dependence on funding through mortgage-backed securities, which were increasingly distrusted in the wake of difficulties in the US sub-prime lending market. My own comments from the mountain top, reiterating innumerable past criticisms of irresponsible lending, no doubt contributed to anxiety around the bank, though I suspect that Robert Peston’s reporting on the BBC had far more impact on the public.
When I returned to London for a few days before the party conference in Brighton, public worries about Northern Rock had reached a tipping point and queues started to form outside branches as Britain began to experience its first run on a bank for almost 150 years. In between media interviews I was called on my mobile phone by Callum McCarthy, the chair of the FSA, who tried to tell me that I was at least partly responsible for the run; that the FSA believed Northern Rock to be a perfectly sound and well-run bank; and that it had a very good loan book, contrary to my assertions. Its problems were to do with irrational worries over access to international borrowing and were not due to mismanagement. It was to be many months before the extent of the FSA’s misreading of the situation became fully apparent, but I kept repeating my rather simple point that any bank lending more than the value of property at what seemed to be the peak of the market was living dangerously. Since it was clear that there was a panic developing, and also that I was being listened to, I was conscious that I was potentially skating on thin ice and so I established a close network of friends with financial knowledge and experience – in particular, Lord (Matthew) Oakeshott – to bounce ideas off and to check facts with before launching into the media. That advice has been absolutely essential as the financial crisis has escalated and grown in complexity. I have been fortunate, too, in having a strong back-up team and a succession of very capable deputies – Chris Huhne, Julia Goldsworthy and most recently Jeremy Browne – who have done the unglamorous heavy lifting in parliament, creating time and space for me to concentrate on the high profile and topical issues.
While it was gratifying to have been able to make what, in retrospect, were good and influential interventions, the political agenda at the three party conferences that year (2007) was dominated by uncertainty over the timing of a general election and, in particular, by the issue of tax. The launch of Lib Dem tax policy was well received: cutting taxes for those on low incomes and financing the cuts by closing tax loopholes and reducing reliefs for the well-off. My team and I, with the help of a specially commissioned public opinion survey, were able to break the taboo on criticizing the tax privileges of the non-doms. Two weeks later, in a remarkable act of chutzpah, George Osborne pinched the policy for the Tories and used an improbably large estimate of tax yield to finance a big cut in inheritance tax, which had become a major issue in the dying frenzy of the housing bubble. I have never rated George’s understanding of financial and economic matters, but he is a political operator of some substance and this was a brilliant move. Together with Cameron’s unremarkable but lionized speech, it changed the whole political dynamic and frightened off Gordon Brown from an early election: a disastrous error from which he never recovered.
It was soon clear that the banking system was the serious battleground, not inheritance tax. In the confused days and weeks that followed the collapse of Northern Rock, few of the key actors seemed to have a clear idea of what was needed: not surprisingly, nobody this side of 1866 had had experience of managing a bank run. The Chancellor, Alistair Darling, had been in the job only a few weeks and was a lawyer without any economic hinterland. After a damaging period of indecision, the government offered a large loan to rescue the bank so as to stop the panic from spreading. It guaranteed the bank’s depositors, apparently without conditions, and also entrusted the management of the bank to Adam Applegarth, whose behaviour had precipitated the collapse. The Governor of the Bank of England, Mervyn King, was clearly uncomfortable with events and upset the banking community by lecturing it on moral hazard – the (entirely sensible) idea that bank bail-outs encourage irresponsible bankers to continue to behave irresponsibly. But he was then required to perform a U-turn and lead the rescue operation. Rushing between fringe meetings in Brighton, I got a strong sense, bumping into journalists, that there was an appetite for a politician who could explain what was going on and offer an alternative to the idea of pouring billions of pounds of taxpayers’ money into a badly run bank. The Conservatives were preoccupied with blaming Gordon Brown for having split the Bank of England and the FSA and, while this criticism had some validity, it was backward-looking and did not address the central issue of what to do next. There was a vacuum waiting to be filled.
I argued that Mervyn King was right about moral hazard but, since a rescue had been launched, it could not possibly proceed on the basis of the taxpayer taking on the risks and losses while the shareholders and managers privatized the profits. The taxpayer must receive any profits in return for the rescue; the shareholders could not expect to have their equity investment protected; and the managers should be sacked. In effect, the bank should be nationalized. Matthew Oakeshott and I debated the pros and cons of embracing full nationalization and I was encouraged to use the ‘N’ word without embarrassment, which became a telling point in the national news coverage.
The first reactions were not encouraging. I had a flood of angry emails and telephone calls from shareholders who blamed me for the collapse in the share price. I became public enemy number one in the North-East for casting aspersions on the competence and integrity of Mr Applegarth and his team. They were civic heroes in Newcastle and were shortly to be given the freedom of the city by the council. Geordie pride was deeply offended. The problem was made worse by the fact that Newcastle was a flag-ship Lib Dem council which was doing well under an impressive group leader, John Shipley. Council leaders are important people, running big budgets, and normally do not take kindly to MPs parking tanks on their lawn. But John understood the wider picture and skilfully defused any conflict. Then I was contacted by an old friend from my days in East Africa, Alistair Balls, who ran the Northern Rock Foundation, which had done a great deal to support the arts and other good causes in the region but which was now threatened. Somehow, the Foundation had to be protected.
There was also, however, strong and encouraging support. Some was from old lefties who were bowled over to see the Liberal Democrats arguing for nationalization. A lot of Labour MPs could not understand why we were making the case rather than their own ministers. The case for public ownership in this rather special set of circumstances was also taken up by the Economist, the FT and the Evening Standard – none of them obviously lefty – and it was the Conservatives, who opposed the idea, who seemed excessively ideological and irrelevant. My own party activists and MPs were delighted that I had got us on to the front foot after months of painful coverage at the end of the Ming dynasty.
But the government was determined to press ahead with a ‘private sector solution’, and among the front runners was a proposal to let Richard Branson buy the bank, albeit with government loan guarantees. My team and I opposed this proposed sell-off as the privatization of profits and the social
ization of losses. In the process, I seriously antagonized Richard Branson, whom I had hitherto rather admired as a buccaneering entrepreneur. But our questioning of his suitability to run a high-street bank and criticism of his recourse to Caribbean tax havens provoked a stream of angry, threatening faxes. The doubts that we raised about the Branson bid contributed, I am sure, to its eventual demise.
The government was extraordinarily maladroit and appeared to have neither political antennae nor economic sense, but a rather ludicrously optimistic faith in the expensive advice of investment bankers, self-interested sharks masquerading as national saviours, and the failed managers and directors of Northern Rock, who were prised out far too late. When Matthew Oakeshott asked Northern Rock about the availability of 125 per cent mortgages and was offered one without conditions, we were able to demonstrate that, three months after the bank had collapsed, its managers had apparently learned nothing and were building up big future losses for the taxpayer. Eventually, after several months of fruitless and expensive negotiations for a private sector solution, the government announced in February 2008 that the bank had to be nationalized.
The next few days were among the most frantic in a very frantic year. The drama started with a weekend in Twickenham at a local Lib Dem fund-raiser being interrupted by a Sky camera crew and Five Live radio car wanting comments on fat cats’ pay. No mention of Northern Rock. On Sunday morning, my wife and I were supervising the preparations for an onslaught by builders on the lounge wall and my grandson Charlie was playing in my Aladdin’s cave of toy cars. A call from the press office alerted me to the decision and I was summoned to the BBC studios in west London, while other media outlets sent crews to Twickenham. The drama continued long into the night and at 6 a.m. next morning it was –5°C and GMTV was outside the front door for an interview with Kate Garraway. Then, after another round of interviews, a visit to the Chancellor, and a parliamentary statement, the government decided that it planned to pass the nationalization legislation in a day. We supported the government and the Commons debate went well until, about 11 p.m., it became clear that ministers did not understand the significance of Granite, an offshore entity originally set up as part of the complex securitization process.
I finally arrived home at around 2 a.m. The media frenzy continued and I was drafted in to Question Time in Newcastle to confront confused and angry Geordies. But, as became clear from the press coverage, in the space of a few days there had been a quantum leap in the Lib Dems’ and my own economic credibility. The government had been forced under pressure of events to accede to a radical policy that we had advocated. We had to defend Alistair Darling against criticism from the Conservative side that there were other viable options, and I had the satisfaction of being credited with having got the issue right: the first time since the start of the Iraq War that the Lib Dems had successfully led the public debate on a major issue.
In the months after the nationalization of Northern Rock my team continued to worry that there were dangers from bank lending practices, particularly in the domestic and commercial property markets, where it was clear that there was a market downturn already under way. The global financial crisis was also building up in intensity with the collapse and rescue of Bear Sterns and large-scale intervention by the Bush administration in saving the US mortgage-lending industry. The Bear Stearns crisis occurred when Rachel and I were enjoying a week’s skiing with the Oakeshott family, with whom I had learned to ski the year before. I was able to piece together only fragments of the drama in France and returned with a sense of foreboding not dissimilar to that which I had brought back from holiday in India after 9/11. A financial crash was on the way.
In May, with Nick Clegg, I launched a New Deal for the City which set out some proposed reforms – to curb the bonus culture, reduce boom and bust cycles through bank capital requirements, and regulate the shadow banking system. The recommendations were not wildly revolutionary. But we received some credit in the City for addressing these issues ahead of, rather than after, the main crisis broke and in terms that were moderate and liberal, though very firmly directed towards stopping abuses in the Square Mile.
In the same month I and my colleagues launched an opposition day debate in the House, which would have been unremarkable but for the minister’s responses, which are now something of a collector’s item. I warned, I think in guarded terms, of the consequences of a falling housing market combined with an economic slowdown, probably a recession: that is, negative equity and growing repossessions. The two ministers, Angela Eagle and Jane Kennedy, had been briefed by the Treasury to swat aside these ridiculous, hysterical assertions and absurd Lib Dem fantasies about recession. I have long since learned to enjoy jokes at my expense and not to be fazed by parliamentary banter. But I was truly alarmed to see that the Treasury apparently believed in its fairy tale of booms without busts and ever-rising house prices. Outside, in the real world, there was growing alarm about the economy.
But at this stage of the economic crisis, economic policy thinking was still located within the framework of monetary independence and Gordon Brown’s fiscal rules (however fractured). I had been asked to give the Institute of Fiscal Studies’ annual lecture in June and devoted a lot of time to it as a means of thinking through new approaches to economic policy, and in particular how to incorporate asset prices into inflation targeting. I was conscious, too, that a decade of constituency surgeries and press releases had not done much for my professional skills and reputation as an economist, and was determined to get up to speed (and to impress).
The daily news from the financial markets, and especially from the USA, spoke of a gathering storm, perhaps a hurricane. But as the summer advanced, there was a strange feeling: a sulphurous, threatening gloom, but only a few spots of rain. I took up an invitation from Toby Mundy of Atlantic Books to produce a book on the crisis and Rachel offered to help me by forgoing a summer holiday and instead bashing out typed drafts as I wrote, and rewrote. August was spent on a mixture of constituency duties and writing in Rachel’s luxurious garden shed. My task was to make myself understand a complex, multi-layered, global and still evolving crisis, absorbing a large amount of contemporary and historical literature. I had learned to write long scripts very quickly. But this exercise also involved some difficult practical and theoretical issues: like putting together a big jigsaw puzzle and with only half the pieces. I had assembled a rough draft a few days before our party conference started in September, and as the conference gathered the storm finally burst with Lehman Brothers facing collapse and shares in British banks falling through the floor. As with Northern Rock the year before, the party conference coincided with a major financial drama. My job, as in 2007, was to try to compose a distinctive, audible Liberal Democrat response to the crisis, rather than letting ourselves be drowned out by it.
I realized that, in the wake of Northern Rock and my wider comments on the banking crisis, the media were coming to me rather than the Tories for comment. It was important to maintain credibility and to have a distinct, forward-looking line. When Bradford & Bingley collapsed the government did not prevaricate but decided on a partial disposal and nationalization of the rest. I did not demur. What I and my team did was to focus on short-selling of bank shares by hedge funds. I called for a ban and a few days later the government introduced one, temporarily as it transpired. The call for a short-selling ban was controversial and I seriously alienated people in the City, including prospective party donors. But the case had to be made. The problem related to the way in which short-selling had destabilized banks that depend on government guarantees, implicit and explicit. And while there is an entirely legitimate role for speculative activity in markets, there are good reasons to question it when speculators are using borrowed money rather than their own.
With the banking system in a tailspin and the prospect looming of a serious recession – perhaps a slump – there was a cross-cutting issue that led to considerable confusion over the directio
n of economic policy. Oil prices had been rising steadily since before the Iraq War, from a low of $25 per barrel to an astronomic $140 at the end of last summer. There was inexorable pressure from rising demand in China and India on the one hand, and rigidity of supply on the other, caused by underinvestment by state-owned and private-sector oil companies, deepening economic nationalism (in Iran, Russia, Mexico and Venezuela), and disruption due to violence (in Nigeria and Iraq). Spare capacity had dwindled to virtually nil and speculative pressures pushed the price up to extraordinary levels. Headlines were dominated by the oil price spike, and on a short visit to Shetland I saw the crisis graphically illustrated, with unleaded petrol costing £1.40 per litre and cars being parked at country crossroads so that drivers could share.
Economically, the oil shock had the disastrous effect of diverting the Monetary Policy Committee from the consequences of the market crash and causing it to stall over interest rates when the rapidly deteriorating economy demanded a deep cut. At the end of September the position of the banks was critical and this threatened to spill over into the wider economy. I wrote an article for the Sunday Times calling for a deep, 2 per cent interest rate cut as well as recapitalization of the banks. I did so with some heart-searching because I had been a strong supporter and advocate of Bank of England policy independence and had made my maiden speech on the subject in 1997. I was compromising that independence, albeit from the opposition benches, by shouting at the Monetary Policy Committee to wake up to the gravity of the crisis. A former member of the MPC, ‘Danny’ Blanchflower, has since confirmed that serious tensions existed within the committee at that time, the first time in its ten-year history that a deep division over strategy had arisen. In the event, the 2 per cent cut occurred at the following meeting.
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