by Adam Tooze
The Europeans were putting out one fire after another, bank by bank. But on the night of September 29, with the failure of TARP roiling the markets, Dublin cracked.64 The three main Irish banks—Anglo Irish Bank, Bank of Ireland and Allied Irish Bank—were all on the brink of collapse.65 The balance sheets of the banks registered in Ireland came to 700 percent of the country’s GDP. The Irish state did not have the financial resources to handle a general bank run. After a panic-stricken night of discussion, early in the morning of September 30 the Dublin government announced that for fear of dying it would commit suicide. As Europe turned on the morning news it learned that the Irish government was fully guaranteeing not just the deposits but all the liabilities of six major Irish banks for a period of two years. No other government had been advised in advance, nor had the ECB, nor had the Irish taxpayers.66 It stopped the run, but it left Ireland, with a population half the size of New York City, guaranteeing 440 billion euros in bank liabilities. The losses the banks incurred would bankrupt the Irish state. They would become the telltale link connecting the banking crisis of 2008 to the eurozone sovereign debt crises of 2010. But that was music of the future. The issue on September 30 was the immediate impact on the rest of the world. If Ireland was offering a safe haven, would the run now extend to the rest of Europe?
Given how tightly the Irish banks were integrated with the British financial system, it was in London that the pressure was most acute. The UK was forced immediately to raise its deposit insurance limit. London and Paris were conferring urgently, as were the Dutch. The Germans were less cooperative. When the UK Treasury tried to reach Berlin to discuss a common European response, they could not get the German finance minister, Steinbrück, to pick up the phone. So anxious did Chancellor Darling become that he resorted to calling on the foreign office to find out whether the British embassy in Berlin could make contact with the German government.67 And Berlin was not merely evasive. In the last days of September the Dutch government, reeling from the experience of bailing out Fortis, made a bold proposal.68 The European states should all establish bank rescue funds on a common basis, each amounting to 3 percent of GDP. In total the fund would come to 300 billion euros. The French government was enthusiastic. To address the crisis Sarkozy invited the G4—France, Germany, Italy and the UK—to Paris. Ahead of the meeting French finance minister Christine Lagarde spoke to the German business daily Handelsblatt about the need for joint measures.69 After the fraught transnational negotiations to rescue Dexia and Fortis, she was seriously concerned about the ability of small countries to cope with the crisis. “What would happen if a little European Union state confronted a bank collapse?” she asked rhetorically. “Maybe the government would not have the means to save the institution in question. So the question arises of a solution at the European level.”70 The Italians liked the idea.71 So too did the influential head of Deutsche Bank, Josef Ackermann.72 Europe needed something on the scale that Paulson was asking for in the United States. Suddenly, Berlin sprang to life. There must be no talk of joint bailouts, Steinbrück announced. Merkel let it be known that she would not attend the summit in Paris if it was labeled a crisis meeting. As if to bind herself, the chancellor gave an interview to the popular tabloid Bild-Zeitung, soon to become notorious for its nationalist coverage of the crisis, denouncing any blank check for bankers.73 And Berlin could count on support from Frankfurt. Jean-Claude Trichet of the ECB told journalists that a common European solution was inappropriate because the eurozone wasn’t a fiscal union. Likewise, Jean-Claude Juncker, prime minister of Luxembourg and long-serving chair of the Eurogroup, told German radio: “I see no reason why we should mount a US-style programme in Europe.” The crisis came from the United States. It was deeper there. Europe could get by with national solutions.
Sarkozy retreated, saving face by dismissing the idea as an unauthorized personal initiative on Lagarde’s part. But the French and the Dutch were right. Within twelve months, precisely the scenario that Lagarde had sketched for Handelsblatt would come to haunt the eurozone. Crippled banks and ailing government borrowers would pull one another down. But prescient though the French might have been, nothing could be done without Berlin. On October 4 Sarkozy, Merkel, Brown and Berlusconi convened in Paris. The result was disappointing. Gordon Brown came away impressed by the sense that the Europeans thought the crisis to be an American problem.74 As one disillusioned British official remarked, the Europeans “didn’t see it coming. They didn’t understand the economics. They didn’t understand how collective action could work.”75 Sarkozy commented resignedly, “If we cannot cobble together a European solution then it will be a debacle. . . . But it will not be my debacle; it will be Angela’s. You know what she said to me? ‘Chacun sa merde!’ (To each his own shit!).” According to the German side, the chancellor’s language had been less vulgar. “Merkel had quoted a proverb taken from . . . Johann Wolfgang Goethe: ‘Ein jeder kehre vor seiner Tür, und rein ist jedes Stadtquartier’ (Everyone should sweep in front of his door and every city quarter will be clean).”76
Why were the Germans so resistant? After all, Germany had its fair share of ailing banks that might have benefited from a common fund. But the hard truth was that German taxpayers did not want to pay for other people’s bailouts, inside Germany or out. In a broader sense, the question of national versus federal solutions was for Merkel not just a matter of euros and cents. Since 2005 she had been toiling amid the wreckage of Europe’s failed effort to give itself a constitution. The Lisbon Treaty, enshrining the grand retreat to a nation-state–based vision of the EU, had been signed only in December 2007. In June 2008 it had suffered a serious setback when it was rejected by a referendum in Ireland. As the financial crisis hit, the Lisbon framework was undergoing emergency surgery. A case in the German constitutional court was pending. With the basic political frame of the EU in flux, Berlin was not going to support a huge increase in the powers of the European Commission to enable a bank bailout.77 Whatever solution was found would be based on intergovernmental agreement, not enhanced federal powers.
The most that the summit on October 4 could agree on was a statement calling for coordinated action, rebuking Ireland for its unilateral action the previous week. All the more shocking was what happened next. As the European heads of government made their way home from Paris, the news broke that the rescue of Hypo Real Estate had broken down. Depfa’s condition was worse than had been realized. An expert team dispatched by Deutsche Bank to Dublin had found that Hypo would need to come up not with 35 billion but with 50 billion euros to fill the gap at Depfa. The banks that Merkel and Steinbrück had enlisted in the bailout to support Hypo immediately reneged. As one German banker later put it to the investigative inquiry of the Bundestag, if Lehman’s failure had been a tsunami, then the bankruptcy of Hypo Real Estate would have been Armageddon for the German economy. Axel Weber, the head of the Bundesbank, spoke of a nuclear meltdown (Kernschmelze). Somewhat melodramatically, Germany’s bank regulator, Jochen Sanio, invoked Apocalypse Now.78 What really worried Berlin were rumors that German savers were panicking. As cash withdrawals spiked, the Bundesbank registered unprecedented demand for large-denomination euro notes. Abruptly, less than twenty-four hours after returning from Paris, Merkel decided that she must make a statement. It was all Steinbrück could do to persuade her that she should not do it entirely alone.79 On the afternoon of Sunday, October 5, Merkel and Steinbrück went before the TV cameras. They didn’t have a legislative mandate from the Bundestag. They were deliberately vague about the details. But the leaders of the two political parties that had ruled Germany since 1949 jointly declared that all savings deposits were safe.
This was directed at a German audience. But it had far wider implications. Germany was not Ireland. Even on the most restrictive definition, Merkel and Steinbrück had given a guarantee in the order of at least a trillion euros. Was Germany positioning itself to take advantage of a global bank run? Berlin gave neither London nor
Washington prior warning. Within hours of the Merkel-Steinbrück performance, Prime Minister Brown convened an emergency meeting in Downing Street to consider London’s response. British officials “tried frantically to reach the Germans,” but once again Berlin wasn’t answering the phone.80 In the absence of a clear European policy, smaller countries with big banks, such as Denmark, were forced to make unilateral decisions and to extend guarantees of their own. In Washington, Paulson’s team was also scrambling to establish what Merkel had in mind. Was it a “moral guarantee,” or the kind of binding two-year obligation that Ireland had entered into? It felt as though the US authorities were losing their grip on the situation. “[T]his is going to move quick and force us to do some things we may or may not want to do,” Paulson told his staff.81 If Germany felt it necessary to issue a guarantee, where was America’s guarantee? On Monday, October 6, equity markets shed $2 trillion in value. With the finance ministers of the world converging on Washington for the autumn meetings of the IMF and the World Bank, the Americans decided to call an impromptu gathering of the G7 and G20 finance ministers at the US Treasury for October 10 and 11.
It was reassuring that the Treasury had realized the need for coordination. But a week was a very long time in a financial crisis and London could not wait. Gordon Brown’s government was facing the collapse of two giant banks—HBOS and RBS. Lloyds had agreed to buy out HBOS already on September 18. But the ailing mortgage lender was losing access to wholesale funding markets.82 Its credit rating was dropping, and as panic spread, retail and corporate customers withdrew £30 billion. If it failed before the takeover was complete, it would be a catastrophe to dwarf Northern Rock.83 Given its sheer size, RBS was even more dangerous. Since September 26, separate teams at the UK Treasury and Downing Street had been working on a bailout plan. To coordinate the crisis fighting, on October 3 Brown declared the establishment of a National Economic Council (NEC). The Daily Telegraph immediately dubbed it an “economic war cabinet,” an idea encouraged by the fact that it met in the underground, high-security conference room usually reserved for the government’s COBRA emergency-response committee.84 Despite the uncomfortable and ominous surroundings, the meetings were productive. Whereas Paulson’s TARP model was based on the idea of buying bad assets, London brought together two ideas: guarantees and recapitalization. Like Ireland and Germany, London would offer guarantees. The Bank of England and the Treasury would underwrite debt issuance by the banks. But these guarantees would be conditional on recapitalization either through market investment or from public funds. The details were worked out in frantic meetings in Whitehall and road tested with focus groups of investment bankers who were sworn to secrecy. On the morning of October 7, while Chancellor Darling was in conference with Europe’s finance ministers trying to hammer out an agreed policy on deposit insurance, the share price of RBS collapsed and trading had to be suspended. The bank that had been touted as the largest in the world as recently as the spring of 2008 was hours away from failure.85
The UK bank bailout package launched on October 8, 2008, after a night of cliff-edge negotiation with the leading banks, was an accomplished piece of political theater. Compared with Paulson’s struggles with Congress, Brown and Darling had the huge advantage of a solid majority in the House of Commons. Though Brown’s position at the head of the Labour Party was far from secure, he did not have to fear the parliamentary mutiny faced by President Bush. Altogether the commitments by the UK Treasury and the Bank of England matched or even exceeded those of TARP. Relative to the much smaller UK economy they were far larger.
The British scheme consisted of three parts:
The UK’s eight major banks were required to draw up plans for recapitalization. It was left up to them to decide whether they drew on a government fund of £50 billion (i.e., c. $75–85 billion), or raised resources privately.
£250 billion ($374–420 billion) would be used to guarantee new debt issued by participating banks.
A £200 billion ($300–350 billion) extension of the Bank of England’s Special Liquidity Scheme would allow banks to trade unsalable asset-backed securities for Treasurys.
The issue that had kept bankers and Treasury officials up all night was whether the £50 billion recapitalization should be forced through at a stroke, or whether this might spook the markets. Would it be better to proceed in stages? Perversely, the ailing banks resisted to the bitter end. None of them wanted to become a ward of the state. On the brink of failure they were still angling for whatever margin of advantage they could extract. In the end, £15 billion in government funds were put into RBS (a 57.9 percent stake) and £13 billion into Lloyds TSB-HBOS (a 43.4 percent stake).86 Barclays and HSBC, Britain’s strongest banks, ostentatiously opted out of the schemes. They took neither the capital nor the guarantees. The UK government never mustered the authority or even made the attempt to impose recapitalization on either of them. HSBC, with its large base in Asia, was strong enough to raise funds through the markets. Barclays resorted to a highly irregular deal with a gulf sovereign wealth fund to which it lent the funds to recapitalize itself, a transaction for which it was later to pay a substantial fine and for which its senior management would face criminal charges.87
Against the backdrop of the TARP debacle and the shambles in Europe, Gordon Brown’s scheme looked like a breakthrough. From New York, Paul Krugman lavished praise on Britain’s Labour government. Britain’s Social Democrats had figured out how to rescue financial capitalism.88 It certainly helped that the Labour government was less averse to nationalization than Hank Paulson was. Less charitably it might be said that since the 1990s, New Labour, like the Democrats in the United States, had entered into an enthusiastic partnership with the City of London. It was, therefore, no coincidence that it was now Labour in Britain and the Democrats in the United States who were showing such energy in the struggle to fix the banking crisis. It was a monster they had helped to create. In any case, given the enormous burden that UK taxpayers were going to have to bear in supporting HBOS and RBS, it was hard to see that there was ever any alternative to nationalization.
The reaction of investors was not so enthusiastic as that of the pundits. When the G7 finance ministers assembled on Friday, October 10, global markets were in a state of panic. That afternoon in the famous wood-paneled cash room of the US Treasury, the mood was less than amicable. Italy’s finance minister, Giulio Tremonti, and Shōichi Nakagawa for Japan hammered home the damage that had been done by the US decision to let Lehman fail. Steinbrück repeated his line about the end of Anglo-American capitalism.89 Jean-Claude Trichet indulged in a little theatrics by handing around a single graph showing the surge in the Libor-OIS spread since the Lehman failure. It was a benchmark of the funding pressure the European banks were under. The Americans, seconded by Mervyn King of the Bank of England, held their cool and insisted that though Lehman might be the proximate cause, it was hardly the fundamental source of all the world’s problems. To turn the discussion in a more positive direction they proposed a short five-point plan:
There would be no more failures of systematically important institutions.
There would be measures to assist recapitalization.
They would work to unfreeze liquidity in interbank markets.
They would provide adequate deposit insurance.
They would rebuild markets for securitized assets.
As a surprise treat for the finance ministers, President Bush made an impromptu appearance to add some easy charm to the discussions. Unfortunately, Bush’s remarks were not well calculated to reassure his guests. “You folks don’t need to worry,” he told them. “Hank’s got a handle on this. He’s going to freeze that liquidity.”90 Given that TARP was still in limbo and that freezing liquidity was the last thing anyone needed, it can hardly have been comforting.
Back in Europe three days later, the agreements in Washing
ton set the tone for a meeting of the eurozone heads of government in Paris. Sarkozy was the host, but the lead part belonged to Gordon Brown. Though the UK was not a eurozone member, the City of London was the financial capital of Europe and the British bank bailout plan was now being touted as the model. Politically, Sarkozy hoped to use Brown’s weight to push the Germans into a more cooperative attitude.91 Though what emerged from the meeting on October 12 was a huge headline figure for bank guarantees, it was less than a European plan. There was no agreement on a common European response. The European Commission issued a permissive license to member states to issue debt guarantees as long as they were extended to all banks in the country, both domestic and foreign. There must be no discrimination. For the duration of the crisis European states were free to pump capital into the banks. The EU would act as an agency of oversight and try to minimize the extent to which the European common market would be torn apart. But it was not a crisis fighter in its own right. In total, the commission would review and approve twenty schemes for bank-debt guarantee and fifteen for recapitalizations.92 On top of that came applications for support for individual banks—forty-four from Germany alone. But it was case by case, country by country. Merkel’s veto was decisive. It would be three long years before a common European bailout was back on the agenda.