In the early evening of Thursday 13 September, a meeting of members of each branch of the tripartite authority took place at the Treasury. Chaired by Alistair Darling, it had been convened to finalise the details of the Rock bailout. The intention was for the announcement to be made the following Monday when the markets opened for business at 7 a.m. It was hoped that a low-key technocratic-style statement would be published setting out details of the loan from the Bank of England to Northern Rock. The theory was that the authorities would be seen to be in control and moving in a business-like way to assist a bank experiencing temporary turbulence. As one source put it: ‘The idea was to keep it on the business pages rather than the main news.’ But the plan began to unravel when, from a corner of the room, a Treasury press officer interrupted the proceedings. ‘Robert Peston has been on again and this time he’s asking the right questions’, was the unexpected message. Darling abruptly ended the meeting and moved off swiftly with his advisers.
Robert Peston, then the BBC’s business editor, had started to ask questions on the state of Northern Rock a few weeks earlier. He had been sceptical about the Rock’s financial model for some time and the market crisis of August 9th had rekindled his suspicions. Initially, it had been possible for the Treasury and the Bank to stonewall his enquiries. But Mervyn King’s letter had provided the final piece of the jigsaw. By Thursday evening, Peston was asking directly whether the Bank of England would be providing a loan to Northern Rock and it was impossible to deny. As Darling had feared, the cat was out of the bag. Peston went on the BBC News Channel just after 8p.m. to break the story. Kitty Ussher, who had been at the tripartite meeting, had taken a train to Stockport en route to her Burnley constituency. She got into her car, parked at the station, turned on the radio and was flabbergasted to hear the BBC broadcasting details of a plan which had been discussed only a couple of hours earlier. Ussher had planned as usual a week in the constituency to deal with local issues ahead of the party conference season. It would not be long before the Chancellor summoned her back to London warning that ‘soon none of us may have constituencies to go back to’.
Peston had broadcast his scoop on BBC outlets stressing that while Northern Rock was being provided with emergency liquidity this did not mean there was anything for savers to worry about. In his BBC News blog he said: ‘None of us – not even Northern Rock’s depositors – probably need to panic that the Bank has had to step in’. He pointed out that if the authorities had thought Northern Rock was not a viable bank, they would not have agreed to rescue it. But the news report lit a touchpaper. Within a few hours Northern Rock’s website had crashed. Many of the bank’s savers watching the news on TV that night only had to pick up a laptop, go to the website and move their money out of the Rock. The fact that the website was down created a sense of crisis around the bank from which it never recovered. The IT staff had been caught on the hop – they did not get the website running again until it was too late. More preparation might have kept the site going longer at the outset and avoided the early panic.
Caught on the hop too was the rest of the banking industry. Angela Knight, chief executive of the British Bankers’ Association, was hosting a reception on a passenger boat on the River Thames with many City financiers and others from the markets. She had to move away from the crowd of well-refreshed guests to take a call on her mobile phone. The news about Northern Rock came as a bolt from the blue to Knight and others with her. Stuck on the boat, the event continued but the bankers’ revels were subdued. All the talk was of how the Rock could have got itself in the position of needing a Bank of England lifeline. And there was inevitably speculation about who would be next.
The following morning, Friday 14 September, saw a torrent of media calls directed at Northern Rock, the Treasury and the Bank of England. There were incessant demands for interviews. But the Chancellor and Bank Governor had flown to Portugal for a meeting of European finance ministers – Alistair Darling felt that not showing up would add to the sense of crisis. Adam Applegarth made a few media appearances, arguing that his bank must be sound if the Bank of England was prepared to lend to it. But the stalwart of most media outlets that morning was Angela Knight, doing her best to extol the virtues of the British banking system and reassure audiences their money was safe. She clocked up 19 back-to-back interviews on TV and radio. Her son, travelling in the Far East and for a while out of contact, called later that day to tell his mother he had seen the story on local TV. It was the only cheerful moment in Knight’s day.
Whatever was being said by broadcasters and their guests, Northern Rock customers began to make their way to branches. Small clutches of people gathered outside a few outlets, waiting patiently to get inside to speak to staff and withdraw their money. For BBC News and other TV channels there was a dilemma – show the pictures and risk the accusation of inciting people to queue or keep the pictures off the air and face the charge of suppressing information. But by lunchtime it was clear there were queues at every branch. Northern Rock’s second major misfortune, after the shutdown of its website, was that it did not have a large number of branches – just 70 around the UK, few of which were in the populous South East of England. As a result, there were fewer locations than at other high street banks at which customers could go and withdraw cash, hence the larger number of them appearing at each one.
Northern Rock staff had not been briefed on how to handle the flow of customers building up outside branches – there had not been time because of the unexpected revelation of the emergency loan. There was no grasp of how to organise the queues and to get as many people as possible in and out of the branches with their money. At the same time, at Northern Rock headquarters in Newcastle there seemed to be a lack of recognition of the scale of the impending disaster as hundreds of millions of pounds were withdrawn by depositors. The website had slowed to a crawl because of the volume of traffic attempting to get money out, yet the bank’s IT experts appeared unable to resort to contingency measures, if indeed there were any back-up plans in place. The press office was overwhelmed with calls yet offers of help from the British Bankers’ Association and other sources were rejected. It was hard, however, to blame the beleaguered Rock management and staff, as there was no template on how to deal with a bank run.
If there was no template for the Rock’s executives, there was no certainly no emergency plan stored away in the Treasury for the Chancellor to dust down and enact. Alistair Darling flew back from the meeting in Portugal, in his own words, jammed in the back seats of a small chartered plane with Mervyn King. There was time to get to know each other a bit better on the flight, whiling away the time with talk of football as well discussing how to deal with the Rock. They had seen TV footage of the queues on rolling news channels, highly and embarrassingly visible on screens around the conference hall. But there was nothing in the Treasury or Bank of England playbook that could be deployed. No Chancellor or Governor had been confronted with a run on a bank since the nineteenth century.
Back at the Bank of England that day, senior officials were coming to the conclusion that the only way to reassure customers and stop the queues was to offer a blanket guarantee of all deposits. That had to come from the government because while Threadneedle Street could manage a £20 billion loan to the struggling bank, it could not afford to underwrite £80 billion of Northern Rock deposits on its balance sheet. It was the logical, though unpalatable, next step once the taxpayer, through the Bank of England, had offered to pump in enough cash to save the bank. The emergency loan had been announced but the fact that savers were not reassured and were demanding their money necessitated further action, so the Bank’s thinking went. It was inconceivable that Northern Rock would be allowed to fail once the decision to save it had been made. Sir John Gieve’s view was that ‘it was double or quits – we had already decided not to quit, we had already decided to save this bank so we had to get on and save it – this seemed an absolute no-brainer’. The Bank’s view that a blanket guarantee of deposits was required was conveyed to the Treasury late on the Friday. But from then right through the weekend until the Monday, the government did not take the advice. Gieve later concluded that the failure to offer the guarantee while the queues built up for another three days was ‘cack-handed’.
On Friday and over the weekend, either in physical withdrawals from branches or via the bank website, it is thought that about £2 billion was taken out by customers. The queues continued at some branches through Monday and late that afternoon Alistair Darling announced that the government would guarantee all Northern Rock deposits, including those by local authorities and commercial lenders. Over the weekend, the Chancellor had revisited the Lloyds takeover idea, supported by a Bank of England loan guarantee. But it had not gone anywhere. Lloyds’ bosses were contacted again and insisted on the same official backstop if any deal was to go ahead. There were concerns in the Treasury about using the government’s balance sheet to underpin a struggling bank. Guaranteeing one bank’s deposits might prompt questions about others. Ministers and officials wondered whether the rot might not be stopped and whether customers of Alliance & Leicester and other banks seen to be vulnerable might start pulling out their money. Darling was not convinced that underwriting all deposits on the Friday or Saturday would have made much difference. The government guarantee was finally announced by the Chancellor in the bizarre setting of a press conference with US Treasury Secretary Hank Paulson, who was visiting London at the time. That did the trick as far as the queues were concerned. It looked more like business as usual at Northern Rock branches by the following morning.
The damage had been done. The government had the daunting task of working out a way forward for Northern Rock and juggling the need to find a private sector buyer while ensuring that the taxpayer’s interest was protected. But hanging over the tripartite group and, ultimately, Downing Street, was the whiff of incompetence. The run on the Rock was a humiliation for a government and banking industry which sought to ensure the UK was globally respected as a financial centre. The recriminations were swift. Mervyn King and Sir John Gieve were summoned to account for themselves before the Treasury Select Committee of MPs. In a bruising session, Gieve took many of the punches. The committee chairman John McFall accused him of being ‘asleep in the back shop while there was a mugging out the front’. King was asked at one point which of the members of the tripartite had been in charge during the weeks before the run on Northern Rock. The Governor, to the surprise of MPs, answered ‘it depends what you mean by in charge’.
One of the areas probed by the Treasury Select Committee was the state of readiness of the government and other regulators before the market crisis flared up in August 2007. Their investigation and subsequent revelations revealed major shortcomings in what might charitably be termed the UK’s defences in the event of a financial hurricane. No regulator or government in any leading economy had anticipated anything like the severity of the credit market freeze which developed. To suggest that the Treasury, Bank of England or Financial Services Authority should have had comprehensive contingency plans in place would have been unfair. But it transpired that the UK was, in some key respects, the least well protected of any of the major industrialised nations. And one of the most exposed areas was deposit protection.
To expect customers of high street banks to assess the financial health of institutions as they decide where to deposit their money is unrealistic. A deposit protection scheme exists to ensure that in the event of a bank failure, most ordinary customers are left with the bulk of their savings. But any such scheme can offer protection only up to a certain threshold as otherwise it would be unaffordable. Wealthier savers are expected to know that their money is not protected above that threshold – it is assumed that better-off customers should be financially literate enough to spread their savings around different institutions. The UK scheme at the time of the Northern Rock collapse ensured that 100 per cent of the first £2,000 of deposits was fully protected, then 90 per cent of the next £33,000. The theory was that many customers would be fully protected and that those with £35,000 would get most of their money back in the event of a failure. The 90 per cent rather than 100 per cent had an element of ‘moral hazard’ about it – an incentive for customers to do some homework on the banks they were entrusting with their money.
The British deposit protection scheme, as it happened, was one of the least generous of leading economies. Run by the Financial Services Compensation Scheme, an independent body funded by a levy on financial services firms, it covered a relatively low level of savings in the event of a bank default. The US had a higher level of protection following the toppling of the savings and loans institutions in the previous decade. There had been lengthy debates about deposit protection inside the European Union in the 1990s. A baseline safety net was agreed with member states allowed to ‘gold-plate’ if they wished. The UK chose to remain at the harsher end of the scale with depositors expected to take a small chunk of risk should a bank collapse. The thinking was that it was unhealthy if savers did not care how strong or weak their banks were. But as one senior government source put it subsequently ‘in stress conditions it’s a dangerous set up and was a mistaken judgement’. It seems to have been a judgement by officials rather than a political one by ministers. But it resulted in a flaw which made Northern Rock’s problems a lot worse than they might have been.
The stark reality was that if you had more than £2,000 in an account at Northern Rock, there was every incentive to queue to get the money out. 90 per cent protection above that level might have sounded reasonable before September 2007. But when a bank was unstable enough to need a Bank of England loan and there seemed plenty of alternative homes on the high street, depositors reasoned that instead of potentially losing 10 per cent of some of their savings it was better to withdraw the money and secure the full 100 per cent elsewhere. This explains Mervyn King’s comment to Alistair Darling as they watched TV pictures of the Northern Rock queues in the margins of the Portugal meeting: ‘They’re behaving perfectly rationally, you know.’ Darling later reflected ruefully that ‘it was helpful advice, which you come to value’. But King was stating the obvious truth given the low level of deposit protection in the UK – there was no compelling reason to leave money in the Rock during the first couple of days of the run.
Deposit protection was improved considerably after the Northern Rock queues had ebbed away. On 1 October it was extended to cover all of the first £35,000 of a customer deposit. A year later, at the height of the banking crisis, it went up to £50,000 and then from early 2011, the threshold rose again to £85,000. That brought protection in line with where the United States had been in 2007 but the American threshold protection has since been raised to $250,000. The Bank of England had examined the question of deposit protection some years before the run on the Rock. Mervyn King had argued during these Bank discussions for more extensive protection after the Asian-owned bank BCCI had collapsed in the early 1990s, also prompting queues outside some of the UK branches. He had made the case for 100 per cent insurance up to a higher level – 90 per cent, he felt, was simply an invitation for depositors to try to get their money out of a stricken bank. The issue was never pursued and the UK was left with what many acknowledged was inadequate protection once the Rock foundered. In September 2007, full coverage up to something closer to £85,000 – and properly publicised – might well have reassured savers and prevented the queues.
Senior policymakers who had to handle the Rock debacle are clear that in another vital area the British regulatory system’s readiness for a bank run was woeful. The UK, unlike most other members of the G7 group of leading industrialised economies, did not have a resolution regime – in other words, a toolbox allowing a doomed bank to be wound up rapidly and efficiently. There was no legal framework which would allow regulators to seize control of a bank, and to ‘resolve’ its future by selling off parts to other institutions and winding down others. Yet the lack of a resolution regime was well known to policymakers before the Rock’s collapse – it had been identified in ‘war games’ carried out by the tripartite authority in 2006.
These preparatory exercises were designed to identify weaknesses in regulation and contingency planning. They were carried out in conjunction with American regulators who wanted to test their own systems with a scenario involving a crisis and banks toppling. The exercises identified what turned out to be a central problem in dealing with Northern Rock – the absence of legal authority to sort out a bank’s problems over a weekend, away from the gaze of the markets and not in conflict with rules on disclosure to shareholders. In 2006, a senior regulator at the Financial Services Authority had written to other members of the tripartite authority pointing out the flaws in both the resolution capability and the deposit protection scheme. However, the recommendations after the ‘war games’ seem to have sat in the Treasury’s in-tray and got no further. When Alistair Darling arrived in the Chancellor’s office in June 2007, he found no recommendations for action or legislation and the need for a resolution regime was nowhere near the top of the list of priorities presented to him by civil servants. He later reflected that the contingency planning ‘might as well not have been done for all the help it was to us’, while acknowledging that in the summer of 2007 the prospect of a bank crash seemed remote and not worthy of extensive consideration. Darling, though, recalled a planning exercise on London Underground when he was Secretary of State for Transport which identified a host of problems for emergency services, including oxygen supplies not working. Better equipment was procured and training modified so that by the time of the bombings in July 2005, the response was much more effective than it would otherwise have been.
Ironically, further ‘war games’ had been planned for October 2007. Ministers and civil servants had been asked to clear diaries for a few days that month. A scenario had been planned with the Americans that involved a bank going under and telephone calls being handled in a mock ‘bunker’ at the Treasury. It never happened. By October, Whitehall had been confronted with the real thing and been found wanting.
A resolution regime was created in February 2008. Legislation at that time covered the nationalisation of Northern Rock and provided for regulators to take control of fatally wounded banks in similar situations. It was used to good effect on Bradford & Bingley in September 2008. In February 2009, an updated version became law and this was swiftly put into practice with the Dunfermline Building Society in March of that year. There was a simple but effective sequence of events each time. The Financial Services Authority would announce the institutions were no longer fit to take depositors’ cash at the beginning of a weekend. By the end of it, regulators had stripped out whatever was impossible to sell and shunted it on to the government’s balance sheet. A buyer was found for the marketable part and the transaction was executed swiftly. Repeated messages that depositors’ cash was safe were broadcast. Every leading policymaker involved in fighting the fires at Northern Rock in September 2007 agrees that the resolution regime in place after February 2008 would have made a big difference if it had been on the statute book six months earlier. It is conceivable that if those tools had been available to regulators, the bank could have been ‘resolved’ over the weekend before the fateful events of Thursday 13 September. Lloyds could have taken on the ‘good’ parts of Northern Rock and the queues would never have happened.
As recriminations reverberated and the blame game began, attention focussed on the Bank of England’s handling of the crisis. Much of the criticism was aimed at the Governor. The heat was turned up on Mervyn King by many in the City of London, indignant at what they saw as his failure to support the needs of the financial sector. One prominent commentator, reflecting the views of banking boardrooms, predicted at the height of the row that King would be gone within 24 hours. But the Governor’s reign continued. Battered by the storm of briefings against him, King soldiered on. He was determined not to follow some other central banks and, as he saw it, pander to the needs of reckless investment bankers. The banking industry, in turn, believed that King had failed a fundamental requirement of central bankers – to provide succour to sclerotic financial markets at a time of crisis.
The central criticism of the Bank of England was that it had failed to follow the European Central Bank and the US Federal Reserve in providing funds in exchange for a wide range of collateral once the credit markets had stalled in August. The Frankfurt- and Washington-based central banks had offered loans to banks and taken as collateral mortgages and other loans. The Bank of England stuck to its existing arrangements, offered liquidity in exchange only for high quality collateral, UK government bonds (gilts) and for relatively short periods. King’s reasoning was that these facilities would provide any struggling bank with the money it needed without appearing to make life easier for an institution which was the author of its own plight. Senior Bank sources believed that the ECB had over-reacted and created a sense of panic simply by the act of dramatically upping its support for the markets. But bank chiefs could not understand what they saw as King’s overly academic stance, seemingly infused with a cogently argued but impractical concept of moral hazard. The Bank’s facilities, some argued, were designed with the narrow aim of helping control inflation by ensuring a stable overnight interest rate and had underplayed the need to provide liquidity insurance.
Inside the Bank there was not unanimity behind King’s position. Some senior officials believed that a central bank’s role, as originally set out by the nineteenth-century constitutional expert Walter Bagehot, was to bail out struggling banks at penalty interest rates but also to provide blanket funding for the market as a whole. A bank on the verge of failure could go to the central bank and be bailed out under cover of an industry wide scheme. In that way there would be no stigma if recipients of Bank of England loans were revealed. Healthy banks could access funds temporarily at rates of interest comparable to others in the market so there would be an incentive for them to do so. The Bank of England could even persuade a range of banks to take funding through this route even though they did not need it – a ruse to give the impression of a market-wide solution. A bank desperate for Bank of England cash to survive, meanwhile, would pay a penalty rate which was kept confidential – that was necessary to underline the point that banks in trouble because of their own recklessness could not expect easy money as a lifeline. The Financial Services Authority pressed hard for the Bank to adopt such measures, arguing it was the central bank’s responsibility to oil the wheels when normal market mechanisms were grinding to a halt.
Allies of King maintain that the Bank of England’s existing liquidity facilities in August 2007 were adequate. These operations were described in a set of rules codified in a Bank of England ‘bible’ known as the Red Book. It had been updated by Paul Tucker the previous year and was considered to meet the needs of modern banks. The commercial banks could choose what reserves they held at the Bank of England and could access a ‘liquidity window’ at regular intervals topping up their reserves in exchange for top-notch collateral. King’s reasoning was that there was no point in forcing liquidity on banks which did not ask for it. Commercial bank chiefs did not want to use the window because doing so they feared might suggest they were having problems. But it was suspected in the Bank of England that the bank bosses did not understand how the system worked, leaving such apparently mundane matters as money market dealings with Threadneedle Street to more junior staff.
Those close to King argued that liquidity was provided under the radar even if there was not a high-profile scheme such as that announced by the European Central Bank. The billions lent to Northern Rock flowed out into the wider banking market. By early September the Bank of England had expanded its balance sheet commitments, yet the ECB’s net position, after repayments are taken into account, was the same as at the start of the previous month. At senior levels of the Bank there was a suspicion that the banks that had been briefing against the Governor to the press were the very banks struggling to raise funding. HSBC, by contrast, was awash with liquidity as investors sought to deposit their cash in what was seen as safe haven in a crisis. A leading Bank of England official later reflected that coping with hostile briefings in the City and othe sources were ‘far and away the hardest part’ of tackling the crisis.
Within a few days of the Northern Rock embarrassment, King announced that he was letting the liquidity taps flow more freely. The Bank agreed to supply funds over a three-month time period and accept mortgages as collateral, though at a higher rate of interest than prevailing in the money market. A £10 billion tender would take place at weekly intervals. It looked like a U-turn but King defended it, arguing that circumstances had changed in the markets since the run on the Rock and the liquidity made available to individual banks was not large. But when the banks were invited to tender for the Bank’s cash there were no takers. The penal rate of interest was unattractive to those banks which were not struggling to raise funds and those who badly needed the cash were worried about their reputations if the markets knew they had to resort to the Bank’s offer.
Some inside the Bank continued to be sceptical about King’s position. They recall a very difficult autumn with demands for more action by the Treasury and Financial Services Authority intensifying. There was a feeling that at the highest level of Threadneedle Street there was a failure to absorb how serious the situation had become even with the relative calm after the Northern Rock bailout. But the Bank’s thinking did eventually change. By the following spring, it had launched a bigger and more ambitious lending plan, called the Special Liquidity Scheme (SLS). A wider range of collateral, including credit cards loans as well as a range of mortgage debt, would be acceptable at the Bank in exchange for funding in the shape of liquid assets easily tradeable in markets and over a three-year period. Over a period of less than a year, £185 billion was lent to banks. SLS was hailed as a great success and precisely the sort of initiative that a central bank should be pursuing during times of stress in the markets.
Looking back, and accepting the wisdom of hindsight, King’s critics are clear that if a bold policy based on the same thinking as SLS had been adopted in late August or early September, Northern Rock could have been saved. The scheme would have dealt with the Rock’s immediate funding needs – others would have found it attractive enough to take part too so it would not have looked like a rescue of one troubled institution. Northern Rock would probably not have survived as an independent bank but, with another six months’ breathing space, the authorities could have pushed it into a merger or takeover by another player, as was to be the case with Alliance & Leicester. Instead, Northern Rock hit the buffers and UK policymakers had to live with the consequences.
Some see Northern Rock as an important wake-up call for regulators and ministers. The lack of preparedness and weaknesses in the banking system’s defences had been painfully exposed. Lessons would be learned, procedures tightened and the financial watchdogs put on high alert for the next crisis. The Northern Rock experience paved the way for the post-Lehman Brothers response in September and October 2008. Kitty Ussher’s view is that vital lessons were learned:
‘Mervyn did not get his head round the responsibilities of a central bank, we at the Treasury did not get our heads round the responsibilities of government and in particular the need to act very quickly. However it made us realise the enormity of the situation we were in – our neurological pathways were opened up to act much faster second time round when the order of magnitude was so much greater.’
Ussher believes that if a Bank of England window had been opened in July or even August, offering liquidity to any bank that wanted it, most obviously Northern Rock, the run would have been avoided. And, with hindsight, she concedes the Treasury should have announced that all Northern Rock deposits would be guaranteed as soon as the news broke that Thursday night.
On a mundane level, government staff around the UK were sent on scouting missions to banks and building societies in their local areas. Their mission was to check whether there were attics and cellars which could be used by customers to wait in the event of another panic instead of queuing on the streets. Regulators ordered Northern Rock to change the layout of branches to allow for more customer space. It was evocative of air-raid preparations for the Second World War and little did they know that the financial equivalent of an attack on the UK was only a year away. The Treasury, meanwhile, summoned back any staff who were out on attachment to other departments to bolster the defences for what they saw would be a long period on a war footing.
Other banks, though, seemed too ready to accept that Northern Rock might be a one-off, brought down by its mismanagement. Rock staff reported that Alliance & Leicester employees were seen walking up and down queues during the run trying to entice new customers. HBOS continued expanding its loan book after September 2007. Every pound withdrawn by a Northern Rock customer had to go somewhere and many went to other banks, perhaps giving them a false sense of security. There was no sense that the Northern Rock collapse was the canary in the coal mine.
Northern Rock would seem like a prelude rather than the main drama by the time the crisis erupted in the global markets in September 2008. But it had damaged the UK’s reputation. Sir John Gieve’s view is that the impact was severe and would have lasting consequences: ‘Right at the beginning of the crisis we had the public humbling of the UK authorities and we put a big flag on British banks saying “these look dodgy” which was very unhelpful – it drew attention to the weakness of British banks in a way we need not have done.’