Back from the Brink

by Alistair Darling

  Worse than that, I was aware that some of his advisers had opened up a separate channel to the banks with which we were negotiating. I could never prove who was behind this, but it was clear that some of the senior bankers had a direct line to No. 10. They seemed remarkably well informed of Treasury plans and thinking. The banks tried to get better terms for themselves. At times some in N0. 10 appeared to be arguing the banks’ case with the Treasury. As we worked up proposals to stabilize the banks, we had to consider how the risks could be shared between the government and individual banks. There were billions of pounds at stake, and I needed to drive as hard a bargain as I could. That would be difficult if the banks knew our thinking in advance. Any attempt to talk to Gordon about this parallel operation was met with brusque dismissal: it wasn’t happening.

  In early January, Bank of America needed support and had to be rescued. Citigroup, one of the world’s largest banks, was effectively broken up. The Irish government nationalized Anglo Irish Bank. Commerzbank had to be rescued in Germany. It was decided that I would make a statement to the Commons, setting out what we were doing. I had to show that we were dealing with the problem now confronting us. I couldn’t have chosen a worse day to do it on, 19 January 2008, when RBS had to announce write-offs that, far from amounting to £2 billion as the markets were expecting, came to £7 billion. I went to the House with a series of measures to boost lending and secure the two banks in which we had major shareholdings, RBS and the newly formed Lloyds HBOS. To try to maintain some capacity in the mortgage market, I decided that Northern Rock would no longer pursue a policy of rapidly reducing its mortgage book. For RBS, I announced an increase in lending of £6 billion over the following twelve months. I also announced that we would insure bank assets, for a commercial fee, against losses on the banks’ existing loans. The idea behind this was to provide sufficient protection to allow the expansion of lending. I also extended the credit guarantee scheme I had set up in October. By that time over £100 billion of these guarantees had been taken up, with the result that the interest rate at which banks lent to each other had fallen from 6 per cent to 2.5 per cent. This falling rate indicated that banks were beginning to trust one another’s ability to repay loans once more, in turn making it more likely that lending to the wider economy would resume. These were worthwhile measures, but they were drowned out by the RBS losses.

  I went back to my office in the Treasury in a black mood. The position at RBS was far worse than anyone had imagined. The insurance scheme set up for the banks in general was likely to end up being used only by RBS. The other banks were not so badly affected, and in time they were able to raise money commercially and did not need further capital from the government. That evening I asked my officials to draw up contingency plans in case RBS were to fail. For the first time, we had to consider full nationalization. The implications were considerable. The remaining shareholders would be wiped out, and it would have a huge impact on confidence in the UK. There was a further problem. Our gross domestic product (GDP) at that time amounted to about £1.5 trillion. RBS liabilities were thought to be £1.9 trillion. What would happen if not only did we have to take on RBS but things got worse and we were required to nationalize Lloyds HBOS, or even Barclays? Fortunately, that didn’t happen.

  In February I announced details of the ‘asset protection scheme’, as the insurance scheme was called. It was the largest insurance policy ever written, insuring £325 billion of assets. Most of these were mortgages and business loans, which were hard to value. Although I was far from certain what would happen at the time, this guarantee has worked. RBS is managing the wind-down of those bad loans and the bank is recovering. In return for this insurance, RBS had to pay a fee amounting to £6.5 billion, which came back to the Treasury. It was the culmination of the work that had started over Christmas and was now in place. Although in theory the scheme was open to other banks, none of them needed to take it up. We also increased our shareholding in RBS so that we now effectively owned nearly 84 per cent of the bank. I saw no reason to acquire the rest of the shares. Indeed, the fact that RBS remains a quoted company means it will be easier to sell the shares and allow the government to recover what, on any view, was a massive investment in the bank. This was the final step we had to take to complete the rescue of RBS from its folly. Other countries had looked at splitting banks into ‘good’ and ‘bad’ entities, with the bad one taking the worthless assets in the hope of selling them on when their value improved in years to come. That’s what we had done with Northern Rock. In the case of RBS, I thought it better to provide a guarantee but to leave the bad assets within the bank. As it turned out, this was the right approach.

  Another measure, which I had announced on 19 January, was barely noticed at the time, but was part of a series of measures designed to reassure the markets and to stabilize the economy. It was intended in part to help larger companies that were struggling to raise funds. The Bank of England was to spend £50 billion to buy assets from banks, financial institutions and financial markets, as well as companies. These were good quality assets, which will eventually be sold on, but the cash received by the firms would, at least in theory, be available for investment. Mervyn had agreed that the Bank would run the scheme, provided the government was prepared to underwrite it.

  However, this was not just a scheme to help large companies. It was designed to go much further than that. I said in the House of Commons: ‘In future the monetary policy committee will keep under review whether this facility could be used as an additional way for meeting the inflation target, in line with similar operations at the US Federal Reserve.’ This was barely reported, which goes to show that if you want to keep something quiet, announce it on the floor of the House of Commons. It was, in fact, the beginning of a major new policy which came to be known as ‘quantitative easing’.

  Interest rates were now down to 0.5 per cent, making bank credit as cheap as it could be. Of course, what customers pay their banks will always be more than the official bank rate, because they are covering other costs, as well as contributing to the bank’s profits. But the bank rate is the Bank of England’s way of controlling how much it costs to borrow, and so influencing the rate of inflation in the economy. When inflation starts to rise, the interest rate goes up, and when it falls, the rate comes down. When an economy goes into a downturn, the central bank will almost always cut interest rates. But we had reached the stage where the bank rate could not be cut any further. In discussions both with the Bank and with No. 10, we agreed that we were anxious to avoid the problems Japan had experienced ten years earlier. Then, their interest rate had fallen to near zero, but the economy had continued to stagnate. They had left it too late before doing more. What we needed now was the ability of the Bank of England to increase the quantity of money circulating in the economy, hence ‘quantitative easing’, which was to be implemented by purchasing financial assets in return for cash. It would be necessary for the Treasury to indemnify the Bank for any losses that might arise from the way it did this. This was the first time that quantitative easing had been implemented in the UK, although the US Federal Reserve had used the same tactic in 2008, so it wasn’t entirely unchartered territory. The Bank and the Treasury had been working on the scheme for weeks. They called it ‘unconventional monetary policy’, which to me sounded somewhat sinister. ‘Quantitive easing’ isn’t much better: it sounds like an unpleasant medical prescription rather than an economic one. The key thing, though, is that it worked. Eventually, £200 billion was put into the economy and it was one of the measures that helped restore confidence.

  When we announced the measure, Gordon and I were keen that the Bank of England should take the lead since, although we under-wrote the operation, we were anxious that it should be seen as part of the Bank’s armoury and not as a political ploy. The announcement was made on 5 March, immediately following a meeting of the Bank’s Monetary Policy Committee. I believed I had an agreement with Mervyn King that he would hit
the airwaves immediately after the meeting. The policy needed careful explaining in an authoritative way. On the day, there was absolute silence from the Bank until halfway through the afternoon, clear evidence that the Bank moves in a completely different way to the rest of us. In a world of 24-hour news, a three-hour gap before an explanation could have been disastrous. It allowed our opponents to characterize the measure as just a way of printing money. Vince Cable claimed we were leading Britain ‘down the road to Harare’. However, and not for the first or last time, he was to change his mind subsequently and see the merits of what we were doing. George Osborne’s judgement was no better. He said: ‘Printing money is the last resort of desperate governments.’ How strange, then, that when he became Chancellor he said he would look favourably on any requests by the Bank for more quantitative easing. Two years later there is still discussion about whether more quantitative easing is needed, so maybe it wasn’t such a bad idea after all. For my part, if it were to be done again, banks should be compelled to lend out a good deal of the money rather than keep it in their vaults. It may have shored up the banking system, but lending remained constrained.

  There was one other banking failure to deal with at the end of March. One of Scotland’s oldest building societies, the Dunfermline, had got itself into difficulties. It was a small society with just thirty-four branches and 300,000 members. Its problems stemmed from a range of factors. They had got into commercial property lending in excess of £650 million, much of it in 2005 and 2006 when prices were at their highest. They were now losing money on many of these loans. They had also bought more than £150 million of high-risk, self-certified mortgages from two American firms, including a subsidiary of Lehman Brothers. In addition, they had to write off a substantial sum for the purchase of an IT system. They couldn’t raise the capital they needed. It was decided that the society would be transferred to the Nationwide building society, which had already absorbed a number of other societies on a voluntary basis.

  It was a sad end for an old-established society. I wasn’t surprised, though. A few weeks earlier I had gone into a branch with the children to withdraw a small sum from their accounts, on which I was still a joint signatory. The unfortunate teller took almost an hour to put the transaction through the computer system. He kept apologizing, and I was almost at the point of telling him to close both accounts. I realized, however, that as I knew the society was already in trouble, and the staff knew full well who I was, that closing my children’s accounts might be misconstrued. We left the money where it was.

  In the meantime, the recession was biting and the differences between Gordon and myself were becoming more visible. In early March I had to go to Reading for a meeting of yet another newly created council. This one brought together regional development agencies with local government and some others. Peter Mandelson and I chaired it. To be blunt, I doubt it ever achieved anything beyond receiving endless reports calling for various degrees of action. While I was there, I took the chance to visit the high street. This is always a risky business, especially when you are accompanied by television cameras and reporters. Sure enough, I wasn’t disappointed. As we walked along, a shopkeeper emerged from his jeweller’s shop to tell me that the VAT cut had made no difference for him. I decided that it would be better to engage him in conversation than to cut and run, and walked into his shop. I assumed that a shop like his, selling luxury goods, would be feeling the pinch. Not a bit of it, he said, he had had a good weekend. Why, I asked? Because the economy had been out of the newspapers for the last few days. He was making an interesting point. Reading the newspapers day after day, or watching the news bulletins, the picture was bleak indeed. No wonder people stayed at home hoarding their money. But offered a few days respite, they would come out to buy.

  I had also arranged to do an interview with Mary Riddell of the Daily Telegraph around this time. Inevitably, like so many of my interviews, it did not take her long to probe the differences between me and Gordon. She began with the question of Sir Fred Goodwin’s pension. We discussed this for a while, and then it was put to me that the story about his pension had been leaked by No. 10. I had heard the rumour too, although I couldn’t see why on earth they would do it since it was bound to backfire. Then I was asked if I minded the fact that Ed Balls gave frequent counsel to Mr Brown. I said I wasn’t bothered – because I wasn’t. But the very fact that these questions were being asked demonstrated how undermining such tensions can be.

  This theme continued. I was asked whether or not the government was to blame for the failures in the banking system. I said the key thing was that a culture had been allowed to develop over the past fifteen years, in which the relationship between what people did and what they got paid for it had gone way out of alignment. If there was a fault, and clearly there was, then that was our collective responsibility. The model of us telling the regulators ‘You tell us it’s OK and we’ll go along with it’ had failed. Now we had to regulate according to risk. However, my public acceptance that mistakes had been made was seen as evidence of weakness by No. 10. I thought it far better to admit what had gone wrong and then to try to put it right. No one will listen to a word you say unless you are prepared to show some humility and honesty. Nor did I believe that the political damage would be that great. After all, no other country in the world had foreseen the scale of the calamity; no other regulatory system had picked it up. The real problem was that the political mood of the time had allowed a culture of complacency to grow, with disastrous consequences.

  Two years later, both Gordon and Ed Balls acknowledged that bank regulation had failed. I believe that had we all said so at the time I did, people would not have thought any less of us. Rather, they might have been prepared to accept that mistakes had been made and to listen to what we proposed to do to rescue the situation.

  While we increasingly disagreed over what to do in the Budget, and relations became more fraught over the banks, Gordon and I were at least as one about what we wanted to get from the G20 summit, now fixed for 2 April. The UK had plunged into a sharp recession in the first three months of 2009. Germany had suffered an even greater plunge, although that was barely reported here. Because of their relatively stronger manufacturing position, they bounced back more quickly than we did. Most European countries were in recession. So was the US. In Japan, growth continued to stagnate. Even the emerging Asian economies had seen a sharp reduction in their growth figures. In short, there was a growing appetite among countries all over the world to act together to try to get themselves out of what looked like a steep decline in their fortunes.

  At that stage, travelling around Britain, it did not feel like we were experiencing a recession. In many parts of the country, in Edinburgh and London in particular, restaurants and shops were still full, people were still going out. It was not like the early 1980s or early 1990s, when the terrible effects of recession stared you in the face wherever you looked. It wasn’t until two years later that the full effect of the downturn would begin to be felt, its effects exacerbated by the deliberate actions of the new Tory-led coalition government. This was always going to be a long, slow recovery.

  The first tangible evidence I had that countries might sign up at the G20 for something more than the ritual communiqué came when Gordon played host to the Chinese premier Wen Jiabao, who came to Downing Street in early February. From my experience of meeting with Chinese ministers, it is apparent that they tend to think on a different timescale. There is also something of a paradox. China was aware that it was the third largest economy in the world (and is now the second largest). They wanted to be at the top table and to influence events. But when it comes to international agreements, and particularly those that might prove onerous – on measures to prevent climate change, for example – they are inclined to say that they are merely a developing country battling with a legacy not of their own making. They are acutely aware of issues like climate change and security of energy supply, and they are intensely polit
ical in the way they make decisions. But they move at a different speed: they take time to analyse what is happening and are hesitant in reaching conclusions, particularly those that might commit them to something long-term. I suppose that is what comes of not having to face an electorate.

  At this meeting, though, the mood was very different. The premier and his fellow ministers were very focused on the need to do something about what seemed to be an impending disaster. After all, if the Americans were in no position to buy Chinese goods, they themselves would have a real problem. Part of the Chinese government’s deal with its people is that they provide employment and rising standards of living. For as long as they do that, the people will put up with living under an authoritarian regime. As Gordon pressed his opposite number on the crucial point, the need to rebalance a world where China exported and America imported, Premier Wen showed that he was open to talking about it, rather than giving the customary response, which was politely to ignore the question. There was a recognition that China needed to do more to boost domestic demand and encourage their people to spend more. Perhaps it was China’s worry about the political consequences of a downturn that led them to use their banks to flood the country with money. We may have struggled to make lending agreements with the banks work; the Chinese had no such difficulties.

  A further indication of how far some countries had travelled came later in February, at a meeting of heads of government and finance ministers of Germany, France, Italy, Spain and ourselves, held in Berlin on a bitingly cold and snowy Sunday. Germany maintained a rhetoric of opposing spending to stop recession. The previous autumn I had been described by Peer Steinbrück, my German opposite number, as practising ‘crass Keynesianism’. Although a member of the SPD, Labour’s sister party in Germany, he attacked us in a way that was extremely hostile, and ignored the fact that Germany had spent about the same as us on boosting its economy through various measures, including giving subsidies to its car industry. Just before Peer left office, following his party’s defeat that autumn, I asked him why he had made those remarks. He explained that to German politicians, of right and left, debt is anathema because of the connotations it has with what happened to Germany in the 1920s and the political consequences that followed. Germany did spend to boost its economy.