by Gordon Brown
In just over a year, from mid-2007 to late 2008, Fred Goodwin had doubled the bank’s debt and inter-bank borrowings to £500 billion, suffered a £2 billion write-off in Germany, and amassed further losses in American and eastern Europe. And, with too little capital in the first place, funding was about to dry up. Yet at no point did I ever hear Fred Goodwin express real contrition to me – or to anyone else – for his role in the bank’s collapse.
HBOS had fallen too, but for a different reason. It had staked everything on rising prices in the property market. When the new finance officer of the merged Lloyds–HBOS gave a slide presentation in New York entitled ‘Understanding the HBOS Loan Book’, he revealed an astonishing figure: 40 per cent of HBOS’s £432 billion loan book was what he called ‘outside Lloyds’ appetite’. It was a curious phrase, but it meant that these loans should never have been taken on. His conclusions about the biggest loans on their books – £116 billion of corporate lending – were as brutal. Two-thirds – that is, over £70 billion – should never have been agreed, he said. The bank’s business model enjoyed the innocuous label ‘integrated finance’ but it was little more than a cover for speculative property deals funded for a group of privileged customers by an undercapitalised bank: deals which, worryingly, were ramped up in number and cost even as the bank approached the precipice of financial ruin. When added to its exposure to billions of dollars’ worth of toxic sub-prime debts, which were only finally revealed at the time of the Lloyds merger, HBOS was, to all intents and purposes, bust.
Well into the crisis, in late 2008, I had a conversation with one of the country’s leading bankers who told me all I needed to know about the gulf between his profession and the rest of society. He admitted that he himself was only beginning to understand the risks that his bank had been taking. I questioned the justification for continuing to pay bankers huge bonuses even as the consequences of their poor judgements were coming to light. ‘But they’ll leave the country,’ he responded. I refrained from offering him the response that ordinary members of the public would have given him. The very fact that the government was forced to step in at all exposed the bankers’ rationalisation of their big bonuses – that they bore the risks they took on their own shoulders and that they paid the price when things went wrong – as utterly illusory and self-serving.
Why did we not spot these problems much earlier? I had spoken often before this point of the hazards of an interconnected global financial system, but despite the fact that I and others had pressed for years for some sort of early warning system, no one anywhere had the detailed information we needed to comprehend the extent of these global entanglements and liabilities. And although in retrospect I hear many players claiming that they had warned us of the risks we faced, no one had presented to me or to international organisations any concrete picture of the extent of those risks within the system, nor of the scale of the shadow banking operations that operated at its fringes.
Although the crisis exploded out of America, British regulation was deficient too. We had created what I still believe is the right framework – a tripartite group of Bank, regulator and government as our early warning system – but from the start the FSA had been in a territorial tug of war with the Bank of England and, as I look back on their minutes, none of the three partners gave the tripartite system the time, input and commitment that was needed. What’s more, the FSA did not probe the shadow banking system, which effectively existed beyond the regulator’s reach. Even in the formal sector, the assessments of the FSA depended less on in-depth examinations by investigators than on bland assurances from the investigated – all this a product of the neoliberal culture of the time that talked about better regulation but in fact favoured even more deregulation.
On 18 September 2008, we banned one of the practices that seemed to have got out of hand: short selling, which is the business of betting on, and profiting by, a fall in a share’s value. This brought only temporary respite, as did Warren Buffett’s $5 billion investment in Goldman Sachs. He warned that without a $700 billion federal bailout of US banks, America faced an ‘economic Pearl Harbor’. The US administration then announced their plan to end the crisis: the Troubled Asset Relief Program, whereby they would pick up the banks’ diseased assets and place them in a separate fund. But when the bailout bill – commonly known as TARP – initially failed to pass through Congress, markets around the world collapsed further.
To its credit, TARP attempted to provide a comprehensive resolution to the crisis. But for me TARP promised too little too late. No longer was it going to be enough to carve out the banks’ bad assets. Even with the rotten assets stripped out, the banks would remain too weak and too overleveraged to recover. What was needed was a bolder plan – to recapitalise the banks. Shriti, I and others were turning the question Hank Paulson was trying to answer on its head. Instead of buying up diseased assets that in any case could not be quantified or even properly priced for sale – leaving people in doubt as to whether the bad assets had been removed – why not strengthen the banks, deleverage them and enable them to clean up their act? Of course, I was not prepared to subsidise banks that did not reform. Instead our proposal would inject new capital into the banks subject to their cleaning up their books and, if necessary, through public ownership.
What was happening was unthinkable, but we had to think it through. When I spoke to the Labour Party conference on 23 September, I said the crisis was a defining moment for us – a test not just of our judgement but of our values. My speech at the conference was high-pressure and high-stakes, not just because of the economic challenges but because from August onwards David Miliband was reported to be contemplating a leadership challenge. When I said of the young Tory leaders, David Cameron and George Osborne, ‘this is no time for a novice’, it was generally taken as referring to David too. He backed away.
As the conference came to a close I boarded a plane for New York to attend the UN General Assembly on 25 September. The minute I arrived I brought together at short notice some of the best economists in the world, including two Nobel Prize-winners. There was complete consensus on the need for massive fiscal stimulus and growing support for bank recapitalisation. When later that day Shriti and I met with American investors, I couldn’t let them know we were looking at recapitalisation – that would have set off a round of market speculation – but Shriti teased out of them what we needed to know: that even they, the beneficiaries of TARP, did not see TARP as the solution. And when I met with Tim Geithner, who was then president of the New York Fed, he conceded that within the TARP legislation, there would be a provision that would enable the government to purchase bank shares. I was encouraged. A recapitalisation in the US might not yet be probable, but it was possible. Buoyed by that additional information, I called Alistair and asked him to speak to Hank Paulson about recapitalisation. Alistair came back reporting that Hank was not giving much away. We still had a long way to go.
After my conversation with Alistair, I told Tom Fletcher, my private secretary for foreign and security matters, to arrange an appointment with President Bush for the next day, 26 September, and announced to my long-suffering events team, led by the ever-diligent Barbara Burke, that there had been a change of plan: we would have to shorten our stay in New York and fly to Washington. Before departing, however, I convened an impromptu gathering of the main heads of government who were still in New York for the UN General Assembly. The purpose of this meeting – described fully in the next chapter – was to put forward my proposal for an international forum with which to tackle the causes and consequences of the crisis over the longer term, plans that I would put to President Bush the following day.
I landed in Washington around 3.45 p.m. on Friday 26 September and reached the White House at about 4.15 p.m. President Bush, who always had a ready joke, was in remarkably good spirits. He told me he knew how the Republicans could defeat Barack Obama and was frustrated by their failure to label him an ‘elitist’ who had deride
d ordinary people for clinging to their religion and their guns. ‘He’s a Harvard elitist,’ said President Bush, who had himself gone to Yale.
When I turned to the matter of the banks I expressed my view that Hank Paulson’s toxic-assets plan, which was on that very day embroiled in congressional controversy, was a start but provided only half the answer. I suggested there was a more direct approach: taking equity in the banks. The crisis had moved, I said, from appearing to be a liquidity problem to what it now clearly was, a solvency problem, and that nobody believed the protestations of the banks any more. He said that this was a matter for Hank and that he would speak to him, but at this stage the priority was to get TARP through Congress.
As the meeting in the Oval Office finished, a fax came through from No. 10, and a request for an urgent call with Alistair. I went into an anteroom to talk to him. He reported that Bradford & Bingley was going under, and we agreed that there was no alternative but nationalisation. I then I picked up the document that had been sent by fax, which contained the figures I had requested from the Treasury: our estimates of bank losses and what it would cost if we decided on recapitalisation. The figures I now had showed we were only days away from a complete banking collapse – of companies unable to pay creditors, workers left unpaid and ATMs without cash to dispense.
It was while I was flying back across the Atlantic that I resolved what we as a government had to do regardless of the Americans’ decisions. As has been my habit for decades, I was writing notes – action points and reflections – on the back of the faxes I had been sent. I was particularly drawn to the question Shriti had been asking for some weeks now in her email exchanges: ‘is it capital?’ Only one possible course of action remained. I wrote it on a piece of paper, in the thick black felt-tip pens I’ve used since that childhood sporting accident affected my eyesight. For good measure, I underlined it twice. It said simply: RECAPITALISE NOW.
The banks were sure to resist; after all, we would be asking some of Britain’s proudest businesses to submit to semi-nationalisation, and we would be asking others who had said they did not need capital to go out and get it, a move that could dilute shareholder equity and so perhaps threaten the position of the executives. But they still needed the government to provide liquidity or they could no longer function as banks. So we had a bargaining position. I wrote it out with my felt-tip pen: NO LIQUIDITY WITHOUT RECAPITALISATION.
It didn’t have the elegance of ‘No taxation without representation’, but it would do. As our plane crossed the night sky, I did not have any doubt – and I certainly could not afford to show any – about the decision I was making, even as I churned over the difficulties ahead.
No one in our media travelling pack was aware of what we were planning. I asked Mike Ellam, the Downing Street director of communications, what story the press were filing from the back of the plane. We joked that they were probably weighing up whether the meeting with the president was short enough for them to get away with calling it a snub. My team, who had gathered around my seat, laughed, and I went back to work.
Once we had touched down in London, we talked the proposal through with Alistair, Shriti and Treasury officials, who started work on a comprehensive plan – to be published within days – that would turn the orthodoxy of the past thirty years on its head.
Events moved quickly. On 4 October, there was a mini-summit in Paris with President Sarkozy, Chancellor Merkel, Prime Minister Berlusconi, President Barroso, and the prime minister of Luxembourg, Jean-Claude Juncker, who was then also president of the Eurogroup (the finance ministers of Eurozone nations). Most of Europe still considered the problem an essentially American one, but the Belgian banks Fortis and Dexia had just had to be rescued, Dresdner Bank had just been merged with Commerzbank in Germany, and generally European banks were more highly leveraged than US banks.
In the next few days, confusion reigned over European policy to guarantee bank deposits. Chancellor Merkel first offered to guarantee them, then redefined the offer not as a cash guarantee but rather a political guarantee to reassure markets; the Danish prime minister Anders Rasmussen announced a day later that he would bail out the banks; and there followed an EU Finance Ministers’ Declaration of minimum Europe-wide guarantees for bank deposits.
But on Tuesday 7 October share prices fell across the world, by nearly 10 per cent in some places, and governors of central banks were forced into a coordinated move on interest rates, to be announced the next day. Not only were financial markets frozen but the world economy looked as if it was going into cardiac arrest. Ben Bernanke later reported that he feared for the survival of twelve of the USA’s thirteen biggest financial institutions. I could envisage in a few days’ time the cash machines simply not dispensing money in the morning.
At least we were now in the final stages of preparations for implementing our recapitalisation plan. Privately Mervyn King, Alistair, Shriti and I discussed what conditions we would lay down. I had two red lines: I had determined that there would be no recapitalisation without changes in remuneration and bonus payments, and without the resignation of executives at the centre of the crisis.
As matter of courtesy I phoned President Bush to inform him of the announcement we would be making the next day. There was as yet no sign of the Americans adopting our approach. Alistair, who had gone to meet the chief executives of the banks to go over the final details of our plan, rang me to report that the banks were incredibly unhappy and resistant. The truth is that despite the chaos around them they had not yet recognised the scale of the problems they had created and now faced. Even the most vulnerable banks were saying they did not need the capital, nor did they want it. They thought that to accept it would publicly signal their weakness. We thought that to refuse it would bring them down, and were in no mood to compromise.
But irrespective of whether some banks needed public capital or not, we needed a united front from the banks on the need for rescue measures. Alistair asked if I would speak to Stephen Green, head of HSBC. Green gave me all the assurances I wanted: that he would raise a token amount of private capital and would support the plan.
Late in the day Tom McKillop, the chairman of RBS, phoned me. He explained his problem was cash flow. All he needed, he said, was ‘overnight finance’. A few days later his bank collapsed with the biggest losses in banking history. RBS’s problems were not simply about liquidity, and additional cash flow could not have helped for more than a day or two. The problems were structural. The bank owned assets of unimaginable toxicity and had too little capital to cover their losses.
Finally, that evening, bank CEOs came to the Treasury to hear the details of the plan. They were shocked by the amount of capital we said they needed – £50 billion – and tried to halve it. Alistair and I rejected the compromise and told them the deal on offer was final.
I went to bed at midnight on Tuesday 7 October, with my mobile phone next to me in case of any further disasters. Alistair and I had decided to announce the plan at 7 a.m. the following day, and that we would phone other national leaders and finance ministers immediately beforehand and afterwards.
When I got up the next morning I told Sarah that she would have to be ready to pack our things for a sudden move out of Downing Street. If what I was about to do failed, with markets collapsing further and confidence ebbing from Britain, I would have no choice but to resign. As I walked into the office, I didn’t know if I’d still be there at the end of the day.
Before the markets opened Alistair announced the government-led recapitalisation plan to buy up to £50 billion of bank capital and equity, together with a £250 billion credit guarantee for banks issuing debt and £200 billion of extra liquidity. We had insisted that in return for making capital available the banks had to lend to get the economy moving.
At 9 a.m. Alistair and I held a joint press conference to answer questions from journalists who were still trying to get their heads around the scale of the measures. I phoned Sarkozy, Merkel and Berlu
sconi to ask them to consider recapitalisation too. Then I went over to the House of Commons, as I did each Wednesday, for Prime Minister’s Questions.
Adding a further twist to a day of high pressure, twenty minutes before I got to my feet in the Commons Mervyn King called me to confirm that at midday, precisely when PMQs would start, the Bank of England would announce what had already been leaked: an interest-rate cut to 4.5 per cent as part of globally coordinated action by the central banks.
We now had to agree how much capital each bank would receive. Fred Goodwin had changed his tune. Having previously denied the need for any capital, he was now telling Shriti that taking some capital would be prudent. He said he didn’t want to shock anyone but that his needs might be as high as £5 billion or even £10 billion. When she recounted the call to me she told me her reply: ‘I am shocked – not by how high your estimates are, but by how low.’
When HBOS realised that RBS would be taking up the offer, they too came on board and their new partner Lloyds also joined them. That weekend, bank by bank, we hammered out the numbers and the terms of the government’s stake in the failing institutions.
Barclays stood aloof. Earlier in the summer it had gone for help to the governments and sovereign wealth funds of Qatar and UAE. Indeed, only 19 per cent of its first rights issue in July had been taken up before Qatar and other sovereign wealth funds came in. Now, according to our calculations, Barclays had to find £13 billion from share issues or sales by June 2009. A deadline was imposed by the Bank of England and the FSA but institutional investors shied away and a further rights issue was deemed impossible. Now needing to devise a debt instrument that would convert to equity, Barclays turned again to Qatar and UAE. In the deal they then brokered, Qatar would raise their stake in the bank to 12.7 per cent and UAE would go even higher to 16 per cent. Qatar’s 12.7 per cent stake would turn out to be temporary: in the autumn of 2009 Qatar were to sell off a 3.5 per cent stake and in November 2012 they sold off more. But what Barclays executives and its board now did, to escape British government control, was in my view unconscionable. They paid the sovereign funds a service fee – in Qatar’s case, £300 million – that they never disclosed. Because of this they have been warned they may well be subject to a Financial Conduct Authority (FCA) fine for handing over money they did not properly declare. However, the FCA probe had to be temporarily suspended to give way to a Serious Fraud Office investigation into a £3 billion loan subsequently given by Barclays to Qatar.