I was very conscious that the story could be leaked at any time. So many people had to know what had happened. Desperately anxious to get home, eight hours after my arrival in Cape Town I was back on the overnight flight to London. It was a long way to go for lunch.
Scanning the Sunday papers, I discovered that there was still no news on the story. Given the leaky nature of government, that was in many ways amazing. It was a huge relief to me, because I thought the only way we could get through this was if I told the House of Commons first. Over the years, as a minister in various departments, I have attached huge importance to telling MPs what has happened when there’s a problem, and to being as straightforward as I can. I have never understood the reluctance of some ministers to go to the House of Commons, or, especially in our early days, to attempt to bypass it when we had something to say. The House is one of the most well-established, well-known public platforms in the world. We should use it, out of respect to our fellow MPs, who represent the people of this country. Even government ministers are MPs, which is not the case in many other countries. And twenty years in politics has taught me that when ministers lose the respect of Parliament, their days are numbered.
I was due to make the statement at the normal allotted time of 3.30 p.m. As I was about to leave my office in the Treasury for the short drive to the Commons, I passed a television screen tuned to Sky News. There they were, the crucial details, being systematically leaked. I was furious. How had this happened? Earlier that day I had briefed George Osborne for the Conservatives and Vince Cable for the Liberal Democrats, on a confidential basis. I expected them to maintain that confidence and remain silent until after my statement to the House. Equally, it could have come from within government. It was a political story and had to have come from a political source.
In the event, the mood in the House of Commons was pretty understanding, although the media was not. The Daily Mail discovered that the discs had been compiled in a building I had opened seven years earlier, as Secretary of State for Social Security. The plaque commemorating the happy event was still prominently displayed at the front door. But the real problem was that in people’s minds the episode called into question the government’s competence. Stories started to appear about the loss of sensitive data all over government: laptops left on trains; papers left in pubs; mobile phones found in toilets; data dispatched from one office never to arrive at another.
The discs never were found. The organization within HMRC meant that it was far from clear who was responsible. There remains to this day no evidence that the information fell into the wrong hands. My guess is that the discs were destroyed once it was clear that the hunt was on, possibly within days.
All of this, though, further darkened the public mood. Nor did it help that the banking crisis was getting worse and the wider economy was bound to start feeling the pain. Our immediate problem was what to do with Northern Rock. It was having to borrow more and more money from the Bank of England every day in order to survive. Its borrowing eventually peaked at more than £25 billion. I sleep easily at night, but this escalating figure was the stuff of nightmares.
Although the borrowing was steadily reduced over the following three years, it was far from clear then that we would ever get it back. There was an additional problem too. Northern Rock was still owned by its shareholders, many of them people of modest means living in the north-east of England who had acquired shares when it gave up mutual status to become a public company. There was also a more unpleasant group of shareholders who had bought in after the bail-out in the hope of making a killing out of the British government. This meant that we had to watch our legal position. These people did eventually sue, after we had nationalized the bank, despite the fact that they had bought in in full knowledge of the trouble the bank was in. They were speculators who deservedly got burned.
At the time, we felt that we would have to continue to seek a buyer for Northern Rock. People understandably ask why we did not nationalize the bank then and there; why did we wait until February of the following year? The answer is twofold. Firstly, we were concerned about legal action by shareholders. They still owned the bank. Secondly, we were worried about the whole issue of nationalization. Then it was a highly controversial proposition. The Labour Party had in the past held the belief that the state should own key sectors of the economy. In the 1970s, for example, there had been a political dogfight between the Conservatives and Labour over whether shipbuilding should continue to be run as a state industry.
New Labour was very much built on the proposition that in a modern economy there is a limit to what the state needs to own. We certainly believed that there were some things the state could and should do, which markets could not. Owning the banks, however, once the battle-cry of the left, was anathema to New Labour. Put simply, I did not want to nationalize a bank if it could be avoided. Nationalization had to be an option for us, but, as I told the House of Commons throughout that autumn, only one of last resort. In fact, plans and draft legislation to enable us to nationalize Northern Rock were being drawn up from October 2007. The main focus, though, was still on trying to sell the bank. The obvious solution would have been to persuade a group of banks to form a consortium to buy up Northern Rock. I spoke to Stephen Green, then chairman of HSBC, whose advice and judgement I valued. He said he would ask his colleagues, but he was not optimistic. It simply was not in their commercial interest, he said.
I reminded him that his colleagues had repeatedly told me that nationalization was an abomination to them, that some had said it was a return to communism. I said that in France there always seemed to be a willingness to act pour la France when the call came. The problem in the UK was that the big banks might have their brass plates here in London, but their souls, if banks have such things, and certainly their shareholders, were elsewhere. Stephen was one of Britain’s more enlightened bank bosses and immensely helpful over the next couple of years. What he was telling me was a simple truth. In the old days the big banks saw themselves as British banks, albeit with huge operations overseas. Essentially, they were British and could be persuaded to do things that might be said to be in the national interest. But now they were not going to help me with a small rotten bank. How ironic that twelve months later they would view the British government in a very different light, when they came to us cap in hand.
There were three prospective buyers in the mix at that stage. Two were private equity funds. The third was Virgin Money. I had met Richard Branson many times when I was Transport Secretary, since he operates Britain’s west-coast railways and an airline. Charismatic, ceaselessly energetic, and understandably very jealous of his brand, he was keen to get into banking and thought he could make a go of it. For our part, transferring Northern Rock to a brand that was publicly known might have helped restore confidence. But the taxpayer would only have seen a share of the private sector’s return if the value of the business had reached at least £2.7 billion. The big problem was that all three bids meant we would have to put in a lot of public money upfront. If there were losses, we would have to take them. If there were profits, we wouldn’t see them. I could not justify it. The process took weeks to work through, but just before Christmas I reached the conclusion that we would probably have to nationalize the bank in order to protect public money.
The situation was deteriorating. Before the House of Commons rose in December, we had to draw up contingency plans for a recall between Christmas and New Year if there were to be another run on a bank. I thought it unlikely, but we had to be prepared. My preference was to get agreement from Gordon over the Christmas break and, on the assumption the bids would come to nothing, to nationalize Northern Rock in January.
In the meantime, it was becoming clearer by the day that this was no ordinary credit crunch. The fundamental problem was that the banks had woken up to the fact that they were sitting on billions of pounds of what they had thought were valuable assets but were, in fact, worth considerably less than
what they had paid for them – if, indeed, they were worth anything at all. There was a growing realization that most banks owned this toxic stuff, but they did not know how much was owned by each individual bank. Only a handful of people understood what was happening, and that did not seem to include the senior executives of the banks. This was not just a British problem: it was a huge problem in the US, as we were to discover over the next twelve months, and in Europe, where many believe the problem still remains three years later.
In autumn 2007 it was believed that once the banks presented their annual results, in the first few months of the new year, everything would become clear. Even if there were some inevitable losses and write-downs, confidence would be restored. However, in a rapidly deteriorating economy, an asset that was worth something one day might be worth nothing just a few months later. Trying to put a value even on something you could see, like a commercial office block, was becoming increasingly difficult. Trying to value a complex financial instrument that few people understood was virtually impossible, especially when no one wanted to buy it. The result of all this uncertainty was that the banks were finding it harder to lend to each other. Worse, this meant they were less able to lend to ordinary people.
I was convinced that we needed to get more money into the economy to free up lending, because without it the system would freeze. The obvious way to do this was through the Bank of England. I had many discussions with the Governor about this, but he seemed to be reluctant to do what I thought was needed. He had some perfectly reasonable arguments: how do you make sure the money ends up where it’s needed? He was also worried about inflation. Frankly, at that time, with a recession looming, domestically generated inflation was simply not a problem.
Mervyn’s analysis was that the underlying problem was that banks did not hold enough capital. In that he was right. But he did not accept that there was a second problem, a much more immediate one, which was lack of liquidity – that is, the banks’ reluctance to lend to one another. That was what had happened with Northern Rock and I did not want it to happen to another bank, let alone to the banking system as a whole.
Mervyn argued that, because the problem was lack of capital, if we were to intervene we would be letting them off the hook. This was the doctrine of moral hazard. He had very strong and fixed views about the role of a central bank. So, while the European Central Bank (ECB) and the US Federal Reserve saw their role as being to boost liquidity in markets when needed, Mervyn favoured a far narrower approach, focused on setting interest rates and funding routine market operations – where the Bank of England makes available relatively small amounts of money, secured against a bank’s assets. These operations rarely attract public attention. In August 2007, just before the collapse of Northern Rock, it was reported that Barclays had borrowed overnight from the Bank. They had done this to cover one day’s trading and to square off the books – a routine operation. This was seized on as part of a growing frenzy, when in fact it was an entirely normal and prudent step to take.
I agreed with the Governor that capital was a problem. But I could see that unless we got money into the system we ran the risk of further bank failures. The Bank was slow to recognize the nature of the crisis. The underlying problem may have been lack of capital, but the immediate cause was lack of liquidity. Moreover if a liquidity problem remains untreated, it has a tendency to make a problem with solvency worse. It was not a choice of which one to deal with: we had to deal with both. I was so desperate that I asked the Treasury to advise me as to whether or not we could order the Bank to take action. The answer was that it might be legally possible, but that there would be wider implications of such an action. We had set great store by making the Bank independent and a public row between myself and Mervyn would have been disastrous, particularly at this time.
Shortly before Christmas, Mervyn and I met at No. 11 to review the past few months. He told me that he now recognized that a number of banks had a real problem with lack of liquidity, that it wasn’t just the lack of capital that was the problem and that one way or another more money needed to be put into the system. He regretted not having confronted these issues before. In the end, as a result of a US initiative, the ECB, the Swiss and the Japanese, together with the Bank of England, did put more money into their economies – in the UK to the tune of about £10 billion.
There was a further development at the end of the year which confirmed in my mind that if 2007 had been bad, the new year would be worse. On a Saturday morning, just before Christmas, I answered the door at home in Edinburgh. There on the doorstep was Sir Fred Goodwin, chief executive of RBS, holding a gift-wrapped panettone.
3 A Home Visit from the Bank Manager
Edinburgh is my home. I have lived most of my life in the city which has been home to banks, insurance companies and other financial institutions since the Scottish Enlightenment. Political economy was born here, in the visionary works of Adam Smith and when thinkers such as David Hume were exploring theories of morality. It has been a long debate.
As the newly elected Labour MP for Edinburgh Central in 1987, I was already well aware of how important the financial services industry was to the city’s well-being. Bank of Scotland (now HBOS) and RBS had their headquarters in the city. Scottish Widows and Standard Life, Europe’s biggest mutual insurer, are based here. My grandfather started his working life as a clerk in 1908 earning £10 a year, before moving on to Standard Life.
The skyline of the city centre is dominated by the castle on its rock and the grand central dome of the old Bank of Scotland. It looks down from the Mound, a man-made hill created with earth dug from the city’s Georgian New Town development and vast tips of rubbish dumped by residents of the medieval Old Town. Founded in 1695, Bank of Scotland predates RBS, which was set up in 1727. The rivalry between the two banks was always been less than friendly and they spent the next hundred years or so trying to bankrupt each other.
RBS’s original head office, a splendid Palladian mansion on St Andrew Square, was built at a time when Edinburgh was a centre of government, law, commerce and culture. The founders did not stint on rich ornamentation. A great banking hall, the Telling Room, features a domed roof studded with gold, star-shaped windows. Three centuries on, at the height of its dominance in the world banking sector, the autocratic Sir Fred Goodwin and his fellow executives decided they had outgrown the historic centre. The new RBS headquarters, ironically, is built on the site of a former asylum, at Gogarburn on the edge of the city. It is a splendid contemporary building, designed for a bank with global ambitions, built around a mock high street with all the modern conveniences – coffee shops, chemists, florists, a hair stylist. At the western end are large offices with dramatic views over the Pentland Hills surrounding the city. The management suite, featuring the most palatial offices of all, was out of bounds to more junior staff. When it opened this £350 million campus, RBS bestrode the international banking scene. The expansion of commercial and retail banks into investment banking was the fashion, and it was a leader. Yet by February 2009, it would post a loss of £24 billion, the biggest loss in UK corporate history. It is a shame that its headquarters – a virtual city – now seems like a monument to its hubris, a testament to all that was wrong at this once modest and careful Scottish bank. When the crisis threatened, I was acutely conscious of what it would mean to the city and its people. The banks employ thousands of people, and many others, in the professions, in the service sector of shops and restaurants and the taxi trade, depend on them.
By international standards, Edinburgh is a small city and large numbers of its citizens continue to live in its heart, part of its living history. It tends to be socially stratified. I would often meet the city’s bankers in the airport lounge on my weekly commute to Westminster more often than I ever would socially. Now I was about to entertain one of the key figures of the banking world, in my home, on a Saturday morning.
Sir Fred Goodwin then lived about a mile away from me, in the s
outh side of the city. He was an awkward person, clearly very driven, but always warily on edge. At the official ceremony, when the Queen opened the new RBS headquarters at Gogarburn, he was in his element. But, like most senior bankers, who recognize that schmoozing goes with the job, he generally remained aloof on social occasions. It was as if he was there because he had to be. He was not going to enjoy it; it was a matter of duty under duress.
I also remembered attending a meeting of the directors of RBS a few years earlier to hear an economic presentation when I was Scottish Secretary. What struck me was not so much Fred, who as ever wasn’t giving much away, but that this was a remarkably Edinburgh-centric board for an organization that was rapidly on the way to becoming one of the world’s largest banks. Where was the American? Or an expert on the Far East?
Fred Goodwin’s office had contacted me a few days earlier and said he’d like to meet up. Although it would mean not having my private secretary with me, I felt entirely relaxed about seeing him alone, at home. I was also intrigued. I had seen other CEOs of the banks alone in the past – none of this was abnormal – but I knew that his asking to see me in private could only mean that he was worried about something.
I could see that he was exceedingly tense. Fred doesn’t do small talk and so we sat down and got straight to the point. I could see him becoming increasingly anxious, although this wasn’t new – I’d noted that the more I spoke to bankers around this time, the more anxious they became. His message for me was clear: unless the Bank of England put more liquidity into the system, quickly, it would seize up, inevitably leading to another bank failure. By now, the Federal Reserve and the ECB had been flooding their systems with cash. I knew that there had been a meeting between the CEOs of the banks and Mervyn King earlier that month, at which they’d asked him to take the same action. They felt that they’d received in return a lecture on moral hazard – one with which I was by that time all too familiar. Fred emphasized that by this point they were beyond considerations of moral hazard. Mervyn was continuing to insist that it wasn’t the job of the central bank to assist banks in their continued profligacy, but that merely underlined the fact that he didn’t recognize the scale of the problem. The collective view of the banks was that whatever the Bank was doing, it simply wasn’t enough. I wondered whether the timing of Fred’s visit had something to do with the fact that the banks’ annual reporting in February and March would reveal the extent of their exposure to toxic assets.
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