As the small group from the Treasury and 10 Downing Street, backed by the FSA, continued to try to pull together the threads on recapitalisation that had been developed in Suffolk and Whitehall, they were confronted with a potential problem in the shape of the American response. In the face of a market maelstrom after the collapse of Lehman, the US Treasury Secretary Hank Paulson was battling to come up with a comprehensive plan to restore confidence in American banks. He told his aides it was ‘the economic equivalent of war’ and the market was ready to collapse.
Paulson’s approach was to use hundreds of billions of US government dollars to pump into the banks while sucking out the toxic material which was troubling the markets. The Troubled Asset Relief Program (TARP) was planned as a government-funded vehicle to purchase rancid loans from banks. Removing these stressed assets from the system, it was envisaged, would allow the banks to lend more freely without the fear of future losses from the loans which had soured. But this was not the route the British Prime Minister wished to go down. Contacts between the Treasury and its American counterparts to try to discuss a joint approach had not got far.
Brown believed that a TARP-style approach would not work in the UK. It would be inefficient and probably unaffordable for the Exchequer. But if he embarked on a different plan to support the financial infrastructure, doubts might be raised about the UK’s credibility. Why, sceptics might ask, does the British government know better than the titans of Washington, those at the heart of the world’s biggest economy? One insider guessed the likely reaction of the markets: ‘They would essentially believe we were “Reykjavik-on-Thames” and had a specific UK problem.’ Reykjavik-on-Thames was a term coined by former Bank of England policymaker Willem Buiter. He highlighted the risks of economies with large banking sectors which had borrowed in foreign currencies and would struggle to repay them if their own currency tumbled. Brown and his advisers were convinced that a universal banking solution on both sides of the Atlantic was the best way forward. And the only way to achieve this, he reasoned, was go to the US to make the case.
Brown and a British delegation were due in New York the following week for the start of the annual UN General Assembly. This, he reasoned, offered a chance to pursue the urgent financial agenda both covertly, in the margins of the Assembly, and if necessary overtly at the White House. One immediate dilemma was how to include Shriti Vadera, who at this time was officially a minister at the Department of Business and did not hold a brief with any relevance to the UN agenda. Brown wanted her to undertake a secret mission on Wall Street, testing opinions on Paulson’s plan and exploring support for the logic of boosting capital throughout the banking system. It was decided she would travel on the same flight as the Prime Minister and his wife as a friend of Sarah Brown. Vadera even paid for her own airfare. With the media still reacting to Brown’s party conference speech in Manchester, framed very much in terms of his response to potential Labour rebels, the Premier and his party took off for New York.
The main talking points at the UN did not get much of the Prime Minister’s attention during his time in New York. He embarked on an intensive round of discussions on the financial crisis with different sets of political leaders and economic experts. One such was a meeting with Tim Geithner, then President of the Federal Reserve Bank of New York and a key player in attempts by the US authorities to put out the fires blazing across Wall Street. It took place around the dining table at the apartment of of Sir John Sawers, UK representative at the United Nations. Brown was careful not to give too much away about British intentions but pressed the issue of the US government injecting capital directly into the banks. Geithner made the point that the TARP legislation would allow direct purchases of bank shares if required. The New York Fed chief indicated that he agreed with Brown’s analysis on the need for capital but warned that President Bush would not. He suggested Brown might like to raise the issue with the President. There were no clues given on whether it was likely the US administration would back recapitalisation but Brown left the meeting reassured that it remained a possibility.
Vadera meanwhile was pressing the flesh on Wall Street. Her task was to find out whether the major banks backed TARP and whether they thought recapitalisation might be better. At most of the meetings, including a larger gathering with investors attended by Brown, the message was clear. The American institutions confirmed that the banks were under-capitalised and that the TARP approach would not work effectively. Banks that feared an injection of government funding were against the idea of raising capital – most others seemed in favour. For Brown this was heartening and confirmed that he was on the right track with his thinking on a UK plan.
The British Prime Minister managed to convene a meeting of leaders from G20 economies at the UN building in what he described in Beyond the Crash as ‘one of the dingiest rooms ever to be visited by such a company . . . around a bleak, oversize table’. There they laid the foundations for formal G20 summits – hitherto it had been a forum just for finance ministers. They agreed that the G8, which included the traditional heavyweights plus Russia, was too limited a group for considering joint action in a global economic crisis. In discussions with the then French president Nicolas Sarkozy, Brown had agreed that they should press for an emergency summit of G20 leaders – but they still had to persuade the American President.
The Prime Minister decided he must see George Bush. His foreign affairs aide Tom Fletcher was deputed to pull every White House string to get an appointment with the President. Schedules were rapidly changed and the prime ministerial plane was set on course for Washington from New York on Friday 26 September. The group of journalists at the back of the plane grumbled about the lack of notice and then complained when they were told there would be no time for a press conference in the White House Rose Garden. They had no idea of the Prime Minister’s real agenda.
Brown and three advisers took their seats in the Oval Office opposite George Bush and three administration officials. The ice was broken as attention focussed on Shriti Vadera’s finger, which had been broken and was in a large cast – an earlier injury which had not healed rapidly. The leaders made small talk and even joked about Vadera’s injury. Brown then got straight to the point and said he wanted to talk about capital and the idea of governments recapitalising the banks. Bush looked puzzled: ‘What’s capital?’ He did not appear to have a grasp of one of the building blocks of banking – although he might legitimately have argued that the vast majority of US voters would be in the same boat. Bush seemed taken aback and had clearly not thought about the concept of boosting banks’ capital. His response was that Hank (Paulson) did all the technical stuff and that right now the focus was on getting TARP through Congress. Brown tried again to explain the politics of bank rescues as well as the financial arguments, but the most he got from the President was a promise to talk to Hank.
The other key subject that Brown wished to raise at the White House was the urgent need to hold a G20 leaders’ summit. The German Chancellor Angela Merkel and French President Nicolas Sarkozy had promised to throw their weight behind the idea when they had audiences with the President. Brown explained to Bush the consensus reached at his hastily-convened gathering in the UN’s dingy meeting room the previous day. Bush replied that he could not be seen to leave the United States with an election approaching. Brown, despite knowing that Sarkozy was keen to host the event in Paris, suggested that the summit could take place in Washington. Bush agreed, subject to Brown sorting out the agenda and the outlines of a communiqué. Both leaders knew that an international leaders’ summit in the middle of a financial crisis which broke up with a thin or ambiguous set of words would damage rather than sustain market confidence.
Brown pointed out that Bush would have to chair the meeting if it was to be held in Washington and suggested that the President tell Sarkozy that it had to be held on the Western side of the Atlantic. Bush, while voicing scepticism that there would be time to get every leader behind an agreed position, gave his assent. And so, the G20 leaders’ summit was born and since the first gathering in Washington in November 2008, then London in April 2009, it has evolved into the primary forum for economic debate amongst world leaders.
Some of the UK governmental team in Washington at that time were later to reflect that the extant American political system was not necessarily well suited to handling a global financial crisis. While Geithner and Paulson might be trying to achieve one thing, Bush might want another. The President had understandably delegated authority to put out the financial firestorm to those he considered experts at the Fed and the Treasury. So there was always going to be a risk of ‘salami slicing’ rather than one centrally co-ordinated plan. There was no single source of political nous, financial expertise and grasp of the global economic challenge in the leadership of the US. The British political system has been criticised for an excessive centralisation of power. But at a time of financial crisis and with a breakneck pace of developments it had a leader with an understanding of the problem, the beginnings of a plan and a chance of delivering it. Brown’s fellow political leaders in Europe at that stage either failed to grasp the severity of the problem and blamed the US anyway, or realised that action was needed but did not know what was required.
Emerging from the Oval Office, the British team was informed there was an urgent transatlantic call. They were ushered into an anteroom in the White House. It was Jeremy Heywood on the line from Downing Street. He told Brown that Bradford & Bingley was being taken into state ownership that weekend with retail branches to be sold to Santander while the deteriorating mortgage book would be held in state ownership. Brown then spoke to Alistair Darling who ran through the terms of the nationalisation and break-up. It did not take them long to agree on it. Those present noted that it must be the first time the affairs of a British building society had been discussed so vigorously in and around the President of the United States’ office. It seemed like another weird twist in the astonishing chain of events which was unfolding daily.
Heywood had other urgent business to get through before the Prime Minister and his entourage left the White House. He told them to stay in the Oval Office anteroom and wait by a fax machine because he had documents to send over. They represented the various views of the Treasury, the Financial Services Authority and the Bank of England on bank recapitalisation – the collective wisdom of the tripartite body. There were numbers and estimates which had been crunched and collated by officials. Heywood felt the paperwork was so sensitive that he only wanted to fax over one copy and he made it clear that it was not to be given to White House staff to photocopy. So Brown and his team had to hunch over a single set of documents.
Unexpectedly, there was an extra paper, distinct from the tripartite work, which had been included in the fax-traffic. It was written by Mervyn King, who had requested that it be conveyed direct to the Prime Minister. It contained the Governor’s own estimate of the capital requirement for the leading banks – a staggering £100 billion.
The figure was higher than proposed in the main paperwork, which struck the Prime Minister’s group as odd because King’s colleagues had been working with the Treasury and FSA on the numbers. It was also clear that the Bank of England Governor was on a different planet to the FSA when it came to estimates of what the banks needed to shore up their finances.
Brown and his team climbed back onto their plane ready for the journey home and some time to think and rest. The party of journalists, who had no idea of the agenda being pursued by the Prime Minister, again grumbled about lack of photo opportunities and proper briefings. Brown promised he would brief journalists and turned left to move to his first-class seat. He stayed up throughout the whole flight, mulling over and discussing options with Vadera and Downing Street staff. He resolved to press ahead with the recapitalisation of UK banks, regardless of what the US government did. He describes in his book what decision he reached on that flight: ‘We needed a comprehensive plan centred on capital, and, if necessary, Britain would have to go it alone.’ And going it alone meant pursuing a very different strategy to the Americans, who were still focussed on making TARP work. The danger, Brown reflected later, was that it might not be enough to gain the confidence of the markets and might put the UK’s credit rating at risk. But the risk of doing nothing while the banks wobbled was even greater. Even if Bush and Paulson changed their minds, there would be no immediate change of plan. But Brown left the United States relieved that TARP could be used if necessary to purchase chunks of shares in banks. Seeds had been sown with the US administration.
As the plane cruised high above the Atlantic, there was an opportunity at last for the prime ministerial team to reflect. The talks with the Americans had been constructive and had shed important light on the administration’s handling of the crisis. But the reality was that for the UK’s struggling banking sector another week had been lost while Brown had tried to shift US opinion about TARP. One aide remembers feeling nervous that time was running out for Britain’s banks and that another depositor run which would dwarf Northern Rock was on the cards: ‘It was clear that while we could wait a few days I was completely convinced you couldn’t wait much longer – some banks were struggling to fund themselves overnight; the spectre of no cash in the ATMs was becoming extremely real.’
Instead of reclining in their seats and switching off, Brown and his advisers sat with tables down, running through the Treasury’s document and Mervyn King’s fax. The Governor had pushed for the government to insist on taking share stakes in all the leading banks, including the well funded HSBC and Standard Chartered. His argument was that the banks should not be given any leeway and that market confidence would be best maintained if there were not two classes of bank, those needing state funding and those which could raise money in the markets. The Prime Minister and his aides tossed around this idea. The legal issues seemed paramount. Could the Treasury force the banks to take taxpayer-funded capital? The answer was not clear. And because of that uncertainty it did not appear an attractive option.
As the plane touched down Gordon Brown had made up his mind. He wanted to press ahead with recapitalisation and he was minded to do that the following week. But there was a reshuffle to carry out and he wanted to consult Cabinet colleagues. He wondered if giving the Americans a bit more time might bring them behind capital rather than purchasing troubled assets. And he felt he should talk to European leaders and try to get them on board. One adviser remembers thinking ‘Oh my God, don’t hold your breath on that one – they are still in an Anglo-Saxon problem-mode, blaming others for the crisis’. But the Prime Minister seemed convinced he could persuade President Sarkozy. The problem for Brown was that time was fast ebbing away.
Back at Heathrow on the Saturday morning there was no let-up for Brown and his team. At the Treasury the rescue of Bradford & Bingley was in full swing. The Prime Minister went straight to Downing Street to be briefed by the Chancellor on the plan. The stricken building society had come out of the summer in terminal condition. Any hope amongst policymakers that it could stagger on unaided had evaporated. The disastrous fundraising exercises of the previous months had tarnished the bank irrevocably. The attempted ‘beauty pageant’ had left just one contender to pick up the pieces at Bradford & Bingley after HBOS had been dismissed as an unattractive option. The Spanish bank Santander, already owner of Abbey National and Alliance & Leicester, was ready to take on another historic name from the building society world which had transformed itself into a bank and then over-extended itself.
Regulators were able to use the new powers available to them thanks to the Banking Act of earlier that year. Much of the grief over Northern Rock was avoided – there was no leak about the need for a rescue before plans were in place and there was no prevarication because of uncertainty over the legalities. Queues were avoided even though the plight of Bradford & Bingley had become increasingly clear during September. The FSA and Bank of England had told Bradford & Bingley to ensure branches had plenty of space for customers to line up inside. The bank was instructed to have plentiful supplies of cash in the branches. Staff had received extra training in case there was a large build-up of customers at any time. With prompting from regulators, the bank had done what it could to improve IT systems to ensure online services worked smoothly, as one of the contributory factors in the Northern Rock panic was the website crashing. There was a determination to avoid the queues which had provided such damning TV images during the run on Northern Rock. Bradford & Bingley was not the only institution under scrutiny in this regard. Other banks and building societies had been told to draw up contingency plans to ensure extra staff could be brought in if queues at their branches started to build up.
It was the first ‘bank resolution’ of its kind in the post-Northern Rock era. The FSA simply told Bradford & Bingley that it was no longer licensed to take deposits, in effect ordering the bank to close its doors. The Bank of England’s Deputy Governor, Sir John Gieve, later reflected that ‘the resolution worked very well – it was the first time we used the powers – it was a very complex exercise which was well handled’. There were complications over the role of the depositor compensation scheme and whether EU state aid rules might come into play. But regulators found Santander easy to do business with. It helped that the Santander chairman was the former Treasury Permanent Secretary Sir Terry Burns. His Whitehall contacts and familiarity with the workings of the government machine were useful in ensuring the deal could be transacted swiftly.
On Saturday 27 September Alistair Darling had made one last effort to find a private sector solution for Bradford & Bingley. He summoned all the leading bank chief executives to the Treasury and urged them to come in through the back door to avoid the being caught on camera. In his book Back from the Brink, Darling describes his offer to them to take part in a rescue plan. They did not take long to reject the opportunity. ‘They recognised that nationalisation was the only way out, and perhaps it was a sign of the times that they were entirely happy with that.’
On Sunday the structure of the deal was made public. The bank was to be nationalised, wiping out shareholders and Santander would immediately take on the nearly 200 Bradford & Bingley branches with the deposits of 2.7 million customers. Santander was to pay £600 million for the transaction. Around £50 billion of mortgages would be left in the hands of the government and become a liability for the taxpayer. They were to be added to the existing book of former Northern Rock loans. It was a clean solution on paper. But Santander had to make it work. Transferring bank accounts from one institution to another is never easy, and it is even more difficult when confidence amongst depositors is fragile. Santander had to ensure the technology would function, bringing the Bradford & Bingley customers on board and running the new accounts with their own systems. Some regulators feared the possibility of an IT fiasco and even a spate of customer withdrawals. But their concerns proved unfounded and the nightmares of Northern Rock were not repeated.
Five years on, the so-called bad assets from Bradford & Bingley lumped together with Northern Rock’s toxic loans did not look so rancid. There is every possibility of government loans being repaid in full, a possibility which would have seemed insanely optimistic in the days after the Bradford & Bingley carve-up.
As Alistair Darling did a round of media interviews on the following Monday morning and later made a statement in the Commons, the banking crisis was lapping around the world’s financial centres. Confidence was ebbing by the hour. For the UK, it was Bradford & Bingley; in the US Wachovia was tottering and had to be rescued by the government and Citigroup in a government-brokered deal (though Citigroup subsequently pulled out after Wells Fargo tabled a rival bid). A few days earlier, JP Morgan had taken over the struggling mortgage lender Washington Mutual. The Benelux equivalent was Fortis, which had to be nationalised by three governments. The Belgian bank Dexia was not far behind in requiring a bailout with Belgian, French and Luxembourg taxpayers’ money. The whiff of fear in financial markets was becoming more pungent.
Events on that Monday evening (European time) ensured that this was to be a dramatic and desperately challenging week for policymakers in the capital of capitalism. Hank Paulson’s TARP legislation was unexpectedly and sensationally rejected by the House of Representatives. This was despite an agreement between congressional leaders to support the $700 billion package. In New York, traders watched the televised events on Capitol Hill in disbelief – Wall Street saw its worst day for leading shares since 1987. Nerves jangled in every other leading financial market. What had been billed as Uncle Sam’s Big Bazooka solution to the crisis had been ignominiously spiked. To some it seemed as if the world’s largest economy was powerless to stem the tide and that there was nothing left in reserve.
Darling’s problems took a turn for the worse on the Tuesday. He woke up to hear news on the radio that the Irish government had unilaterally announced a guarantee of all bank deposits and loans to banks, both by individuals and institutions. Immediately the prospect of a flight of savings from UK banks to government-backed accounts in Ireland was looming. Ulster Bank, part of RBS, looked especially vulnerable to a flow of deposits from the North to South of the border. The Irish move heightened the impression in the markets that governments were not working together and were being dragged along by the rapid pace of events rather than setting the agenda. The President of the European Central Bank, Jean-Claude Trichet, announced he had not been consulted which added to the sense of chaos. Darling took a call from Christine Lagarde, then French minister for finance, in which she voiced her concern about the Irish decision. She wanted to know if the British would follow. Such was the febrile atmosphere at the time that Lagarde reported she had heard a rumour that her own President was planning to introduce a deposit guarantee but she knew nothing about it. She called again later to reassure Darling that the rumour was not true.
Both Brown and Darling spoke to their Irish counterparts. Darling voiced his irritation in a terse conversation with the Irish finance minister Brian Lenihan and received an apology of sorts. He pointed out that the Irish banks’ balance sheets, like the UK’s, were considerably bigger than the total Irish government spending. Lenihan’s tongue-in-cheek response was that he hoped people wouldn’t notice. But it wasn’t long before international investors did notice the scale of the potential liabilities for the Irish government as a result of their sweeping guarantee. Little more than three years later the Dublin authorities had to negotiate a European and IMF bailout.
October 2008 will remain etched in British economic history as the month when the banking system nearly imploded. And the month dawned with a dramatic, but highly confidential move by the authorities. HBOS had limped along over the previous fortnight with some protection from the perceived safety net provided by Lloyds. Once investors knew that HBOS was set to fall into the arms of Lloyds, the pressure on the share price eased a little, though there was no ink on the deal. But even so the funding pressures were still intense with the bank struggling to borrow money even for a day at a time. So, on Wednesday 1 October, the Bank of England started lending money to HBOS covertly under a programme called Emergency Liquidity Assistance (ELA). Highly liquid Treasury bills, which HBOS could easily sell in the markets, were exchanged for mortgages. The existence of these loans, which were also extended to RBS the following week, was kept quiet for more than a year. Neither Parliament nor the media were informed. In retrospect, it was extraordinary and surprising too that the news never leaked. Bank of England sources later explained that they were in effect on a ‘war footing’ and the disclosure of such lifelines to banks would have jeopardised the ‘war effort’. They feared a leak at some stage that, as one source put it, would have put them ‘in a very difficult place’. If news had got out about the emergency loans in late 2008 and the recapitalisations had begun to lose credibility, the entire rescue package could have crumbled. But, to the great surprise of senior Bank officials, their secret was never exposed.
The plight of HBOS was well known to regulators, not least because 50 per cent of total funding requirements came from wholesale markets. And after Northern Rock, any institution with that sort of funding ratio was seen as vulnerable. From April, the FSA and the Bank had begun contingency planning for a rescue of HBOS. This included the likely need for emergency funding. HBOS was closely monitored throughout the summer. But after the collapse of Lehman in mid-September and the consequent freezing of the wholesale markets, it was surprising that HBOS had managed to stagger through until the end of the month. Only on 1 October did it request assistance from the Bank of England, the need for funding by now urgent. Four years later, an independent review of the Bank’s handling of the situation suggested it could have intervened sooner and pre-emptively to provide a helping hand to HBOS. The bank continued to draw funding from the Bank of England through until 13 November, with a total debt owing of £25.4 billion. It was repaid in early 2009.
As the Treasury fought fires at Bradford & Bingley and battled to hold the line after the shock of the Irish deposit guarantee, it was hard to focus on the urgent need to prepare the wider action plan for the banking sector. Darling had instructed officials the previous Friday to work with the Bank of England and the FSA on a recapitalisation initiative. This was on the same day the paperwork from the tripartite had been faxed over to Washington along with Mervyn King’s big number estimate of the hole which had to be filled. But since then it had been hard for Treasury civil servants, who had more immediate challenges to deal with, to move this agenda forward.
Vadera had arrived back at Heathrow mindful of Brown’s demand that work on a rescue plan must begin immediately. If there was one lesson to be learned from the United States, they reasoned, it was to be ready for the financial storm which could make landfall at any moment. Vadera knew that injecting equity capital into the banks – in other words, shareholders’ funding – had to be the centrepiece of the plan. And if it couldn’t come from shareholders it would have to come from the government. But she thought this would take time to implement because of the legal hurdles to be cleared. She also believed that a device to underpin bank lending was essential. She and Scholar had worked on proposals from Sir James Crosby to stimulate the mortgage market. This would have involved the government providing guarantees for mortgage-backed securities. There had always been doubts surrounding this approach, but Vadera believed it would be feasible to extend the idea to the entire inter-bank lending market. If one of the threats to lending in the wider economy was the banks’ reluctance to lend to one another, then any scheme to remove the risk from that market would have wider benefits.
The biggest challenge was to work out how to make the banks raise more capital and if necessary make them take it from the government. But that, so the thinking went, could be easier if the carrot of the funding scheme was dangled in front of them – if you want the funding guarantees, you will have to raise capital first. Then there was the question of how much capital each bank should have to find. What would happen if the FSA came up with estimates and the bank disagreed? Would the FSA have to come up with new regulations? Vadera’s view was that you could leave it to the markets to impose the solution. All the regulators had to do was say what they thought was the requisite amount of capital and investors would force the banks to raise it. The final piece of the jigsaw would be provided by the Bank of England extending their special liquidity scheme. Introduced in April, the plan was to allow banks easy access to funding in exchange for mortgages and other loans. It had proved highly successful and King, somewhat reluctantly, had pushed back the closing date from September to January. Now he would be asked to double the funds offered from £100 billion to £200 billion.
Vadera bounced her ideas off Tom Scholar. They tallied with his thinking and some of the work beginning to emerge at the Treasury. But the question was how to move them forward quickly. External expertise was needed but bringing in outside advisers risked a leak. She decided to call on City bankers she knew and could trust. UBS was a good starting point as Vadera had spent much of her career there. Robin Budenberg was the first on her contact list at UBS and she called him on the Wednesday evening. A laid-back character, diplomatic and with a sharp eye for the workings of corporate Britain, Budenberg was described by colleagues as very sane and level-headed. He was used to working with government, having been an adviser on the evolution of Network Rail in 2001 when he crossed paths with Vadera, then at the Treasury. He was also involved in the sale of the government’s stake in British Energy, which covered much of the UK’s nuclear industry, a few weeks before the collapse of Lehman. Budenberg later went on to head UK Financial Investments, the body which managed the government’s share stakes in the banks.
Vadera had to tread carefully. She had to avoid giving too much away. So tense was the atmosphere that any hint of an official government plan in the making would move markets. Talking to bankers in those terms was impossible. She was acting in her capacity as a business department minister, under the radar and quietly ‘enquiring’ about the state of the bank funding markets. Gordon Brown knew that she was talking to people in the City but she was under no illusion that her involvement had to be deniable. If it leaked, her job would be on the line.
Budenberg, who had had other conversations with Vadera from time to time, sensed there was an urgency about her questioning on this occasion. He had received calls over the previous few weeks from people in government asking what was happening, the usual off-the-record gossip between people in the political and business world. But Budenberg could tell this was different – he was being asked to express a view on something that felt like it could become a project. He said he was ready to talk and would consult his UBS colleague David Soanes, the investment banker who was an expert on banking industry debt markets. Vadera insisted that nobody else be brought into the loop. She also wanted to test opinion on Wall Street and how banks were faring there – so she made a call to Michael Klein, a Wall Street hotshot who had quit Citigroup that summer.
What Vadera really needed to do was speak directly to a major bank to find out more about the funding market. It was much more opaque than other financial markets as there was little quoted data by which to judge fully the severity of the stresses and strains. But she could hardly approach the big UK banks which were caught up in the maelstrom – they would not want to divulge their true positions. HSBC was the obvious choice, but because it was a global bank with ample sources of funding it was one of the few institutions still lending to other banks. Its perceptions might not be typical of the market as a whole. That left Standard Chartered, a British bank but with almost all its activities outside the UK. Vadera reckoned it would at least know what was going on in the market so she contacted the chief executive, Peter Sands.
The call to Sands was wide-ranging, Vadera asking for his opinion on the state of the markets. There was no hint that a plan was being hatched. As a member of the Department for Business ministerial team she had an understandable interest in how banks were funding each other. Sands told her that his finance director, Richard Meddings, would know all about who was doing what in the relevant markets. Meddings, as it happened, was an old friend of Robin Budenberg. Sands suggested that a meeting would be beneficial but Vadera pointed out that it would be impossible for her to host it officially. Sands then agreed to organise it himself at Standard Chartered.
On the afternoon of Thursday 2 October a disparate group of Whitehall people and bankers arrived discreetly at the reception area of Standard Chartered’s head office in the City of London, tucked away behind London Wall. There were no press photographers or TV crews present even though in importance it ranked with most other meetings involving policymakers trying to tackle the financial crisis. Shriti Vadera was there and so too was Tom Scholar from the Treasury, also craving anonymity at such a sensitive gathering. Robin Budenberg and David Soanes of UBS slipped into the building. Michael Klein, formerly of Citigroup, also attended. They were whisked up to the boardroom on the top floor of the building. There were plentiful supplies of beer and wine and the atmosphere was rather more relaxed than a normal City business meeting. Soanes recalled that the bottles seemed incongruous: ‘I remember thinking that whoever had laid it out was being quite optimistic about what that meeting was for – I was nervous at the speed with which we were having to make decisions.’ And as the meeting progressed and the participants grasped the reality of what they were facing, an unsurprisingly sober mood prevailed. There was little appetite for the beer and wine.
Vadera came clean about the severity of the crisis for British banking and the fact that the government was considering a radical response. But she was still careful not to reveal her full hand. She asked the bankers what they would do in the circumstances to try to shore up confidence. Vadera and Scholar were pleasantly surprised that the City representatives came up with areas for intervention which corresponded with what 10 Downing Street and the Treasury were already working on. The business minister was especially interested in the bank funding issue and how to make that work better. One key area of discussion was how the financial markets might react to government underwriting of inter-bank loans and what sort of fees should be levied on the banks. Meddings at one point left the boardroom to consult his group treasurer on issues surrounding bank-to-bank lending. There was not so much debate on recapitalisation, perhaps because Scholar and Vadera did not want to let on too much.
Late into the evening Vadera and Scholar made their excuses and got up to leave. Their final shot was to ask if the bankers would work together on a note summarising the options. As the two returned to Whitehall, those who remained in the Standard Chartered boardroom accepted the challenge and carried on working. When they broke up, Meddings and Budenberg had a quiet word in the corridor. The friends had had many experiences working together in the City over previous decades. But absolutely nothing in their careers to date compared to this. Lehman had gone bust but the idea that RBS might topple seemed quite extraordinary. Until Vadera’s bleak assessment at the beginning of that evening’s meeting they had not realised the extent of the rescue for the UK’s banks which was being proposed. Budenberg remembers the conversation: ‘[Meddings] said: “Can you believe we talked about what we just talked about?” It seemed unbelievable at that time. I was gobsmacked at that stage.’ They chuckled quietly because the very idea that they had just been discussing a plan to save the banking system seemed ridiculous.
The banking team knew the urgency and did not waste any time. Despite a late night on the Thursday they were back at Standard Chartered at 6 a.m. the next day. An intensive six-hour meeting followed. Senior lawyers were consulted and by lunchtime they had finished drafting their document. It contained a three-point action plan: boosting bank capital, underpinning the bank funding market, and extending the Bank of England’s Special Liquidity Scheme. With regard to capital there was an acknowledgement that the government might have to provide it though it was assumed that it would be offered rather than forced on the banks. According to one participant, ‘there was still a feeling at that stage this was a liquidity crisis not a capital crisis – that was what evolved the following week and that was why equity (capital) later became more of an issue’. At the time the document was written, there was much more emphasis on those parts of the plan which involved the government and Bank of England tackling funding issues. The full horrors of the banks’ balance sheets and the threat to their solvency had not become clear.
The bankers then sent copies to Scholar at the Treasury and Vadera at her office. Both took the document and merged it with other paperwork to be dispatched to ministers. Scholar had to take care with how it was presented in the Treasury to avoid ruffling the feathers of officials who had been deputed to work on this policy area. He had to let Darling know how the thinking and options were developing. Copies were sent over to Gordon Brown and Jeremy Heywood at 10 Downing Street. The Prime Minister noted that the outlines were similar to the thinking developed in Washington and on the flight back. The ad hoc banking team waited for news back from Whitehall. But as the hours ticked by they heard nothing.
There remained one outstanding problem – getting Mervyn King onside. The Governor would have to give his blessing to the proposed big extension of the Bank’s Special Liquidity Scheme. Relationships at that time between the Governor and the Chancellor were far from perfect. Some in the Treasury suspected that King had no time for Darling and patronised the Chancellor and his officials during debates on policy options. Wide-ranging discussions on global economic policy were to the liking of both Mervyn King and Gordon Brown, though, and it was felt that the personal relationship between them was good. So the Treasury sent word to 10 Downing Street that Brown needed to work on King to finalise the key elements of the rescue plan. Even during the reshuffle, Brown had meetings with the Governor and they took place almost daily as the crisis rumbled on. Officials would need to check that they remained focussed on the job on hand: ‘We would leave them alone for long periods – then we would go in and chivvy them along, and make sure they were getting to the right place.’ And the right place involved doubling the Bank of England’s liquidity scheme to £200 billion – that is, funding in exchange for old mortgage loans. King was also brought up to date with the government’s plans for new bank capital.
Brown’s diplomatic skills had been fully stretched in his dealings with the Governor – they were also to be tested in a round of European diplomacy. He had a good bond with the French President. They knew each other well from their time as finance ministers on the sometimes-dreary merry-go-round of European meetings. There was a positive chemistry between them, despite Brown being left of centre and Sarkozy further to the right. Sarkozy was to prove to be an important ally. With France holding the EU Presidency, he had convened an emergency mini-summit for Saturday 4 October in Paris. It was held in the grand surroundings of the Elysée Palace and the aim was to demonstrate that Europe could match the ambition and urgency displayed by Hank Paulson and the TARP legislation, which had passed into law on the previous day. The willingness of EU leaders to attend the hastily-convened summit on a Saturday afternoon demonstrated the heightened state of concern about the financial crisis raging through their banking systems.
British government sources at the Elysée meeting described it later as ‘bizarre’. The German Chancellor Angela Merkel made it clear she regarded the banking crisis as an Anglo-Saxon problem, born in the United States and compounded by the UK’s failings. Sarkozy chaired the meeting around a large table with Merkel on his right and Brown on his left. Jean-Claude Trichet, president of the European Central Bank sat next to Brown offering support to the British prime minister’s call for co-ordinated action. Italy’s Silvio Berlusconi and Luxembourg’s Jean-Claude Juncker, president of the Euro Group, were the others round the table. Brown explained why he thought the situation, far from being an issue only for the UK and the US, was serious and how it affected every economy across Europe. He pointed out that European banks had borrowed as heavily as others and invested in the same sort of mortgage-backed securities as US institutions caught up in the sub-prime crisis. He urged his counterparts to consider a joint guarantee on bank lending as one part of an agreed Europe-wide action plan. Merkel was especially hostile, arguing it was unaffordable and unnecessary. There was criticism around the table of the unilateral Irish deposit guarantee announced a few days earlier. Sarkozy was more sympathetic – Brown had buttered him up and told him that, with the EU Presidency, France could be seen to be providing leadership in these troubled times.
As well as Sarkozy, Trichet was very supportive of Gordon Brown. Unlike some of the others around the Elysée table, he knew that this was a lot more than an Anglo-Saxon obsession. He understood the potential perils threatening EU economies if banks cut back loans to one another. He pushed the idea of government guarantees on inter-bank lending. Individual economies, he believed, should carry out their own bank recapitalisations. For Trichet, a grand plan implemented pro-actively and ahead of market expectations was the urgent necessity. The summit put its weight behind the idea of a G20 leaders’ gathering, the plan pushed by Brown at his White House talks the previous weekend. And the leaders pledged to build a new financial system that would lay to rest the old speculative capitalism. But the summit ended without firm agreements or commitments to co-ordinated plans.
Once back in their respective capitals, the political leaders who had witnessed Merkel’s scepticism and occasional hostility at the summit were surprised to see her television appearance on Sunday in Berlin. One of Germany’s major banks, the property lender Hypo Real Estate, was foundering that weekend. A rescue package put together by commercial banks had crumbled. The German government was obliged to step in to co-ordinate an alternative bailout deal and underwrite a bigger slice of the liabilities. Merkel, appearing at a media conference in Berlin, was asked whether the government would come to the help of German savers if their money was at risk. She answered: ‘We want to tell savers that their deposits are safe.’ It was not clear whether the German Chancellor was making a conscious pledge to underwrite all bank deposits, but that was how the media chose to interpret her comments. The unity of the previous day’s summit now looked a sham. Germany appeared to be acting unilaterally and in defiance of any co-ordinated European action.
The British Prime Minister and his aides were perplexed. Merkel had made clear the previous day how vehemently opposed she was to open-ended guarantees of bank deposits. Yet here she was doing precisely that and with no warning to her European colleagues. Sarkozy called Brown to assure him that Merkel had been trying to supply a ‘political guarantee’ to reassure the markets and that there was no new policy for depositors’ savings. The German Chancellor later called Downing Street and conceded that the Prime Minister might have been on to something when he had talked of a Europe-wide banking support plan. She seemed, to those officials who were aware of the call, to be more open to guidance and willing to co-operate with any initiatives that might materialise.