Alistair Darling was on holiday in Majorca with his wife and children. The Chancellor was not really alert to the severity of the crisis until he picked up a copy of the Financial Times in the supermarket and read its reports of extraordinary measures by the European Central Bank.75 He rang his officials that morning.76 They confirmed that Jean-Claude Trichet, the Frenchman who headed the ECB, was pumping unprecedented billions of euros into the money markets to try to alleviate the credit crunch. Ben Bernanke, the successor to Greenspan at the US Federal Reserve, followed suit by injecting billions of dollars of liquidity to forestall a chain reaction of banking collapses. The Bank of England, however, was staying aloof. Mervyn King, who had led the Bank for the past four years, was a former professor at the London School of Economics and the first Governor with a largely academic CV. John Eatwell, a contemporary at Cambridge, describes King as ‘a thinker and rather cerebral for a central banker. He’s just not a down and dirty markets man.’77 An alpha mind in his specialist subject of controlling inflation, King was a novice when faced with a crisis in the money markets. Colleagues noted that he had long been ‘intensely suspicious of the City side of banks’.78 The chairman of a large retail bank contrasts him with his predecessor: ‘Mervyn is not a deal-maker like Eddie George was. Eddie loved a bargaining session in a smoke-filled room. That’s not Mervyn’s forte.’79
He was also intellectually stubborn. One Treasury mandarin observed that ‘it was not very easy to change his mind.’80 A very senior official of the Bank itself goes further and describes the Governor as ‘rigid and doctrinaire’.81 There had been some forewarning of the attitude he was likely to take towards banks that got into trouble. According to a colleague at the Bank: ‘In war game meetings, Mervyn used to say there was no point as he would never bail anyone out.’82
The academic Governor was a rigid adherent to the theory of ‘moral hazard’. King took the view that banks in difficulties should not be rescued from their mistakes, but punished as a warning to others. ‘He was a hawk on moral hazard,’ says his deputy, Sir John Gieve.83 From his desk overlooking the fine courtyard of the Bank building in Threadneedle Street, King took an important decision about the August crisis. Alone among the major central bankers, he refused to pump cash into the inter-bank market. Even when he later relented a little, he released much smaller amounts of liquidity than the American and European central banks and demanded a punitive rate of interest. The City protested. The Treasury pressed. Number 10 was agitated. King dug in. Brown and Darling were frustrated by his inflexibility, but feared the consequences of overruling the Governor. ‘It took all of us some time to see how serious this financial crisis was,’ says Gieve. ‘We were slow off the mark.’84 King was encouraged to maintain his stubborn position because the Governor wrongly believed that no British bank was at imminent risk.
Eyes blinking behind spectacles, King looked owlish. That didn’t mean he was entirely wise. ‘He hadn’t grasped the full extent of the crisis that was unfolding,’ says Sir Steve Robson. ‘He put a good deal more emphasis on what he saw as the concerns of moral hazard – if you rescued people it would encourage other people to behave badly – than he did on the need to deal with a threat to financial stability. The contrast between the speed with which the European Central Bank responded to the crisis and the speed with which the Bank of England responded doesn’t cover the Bank in great glory.’85
World stock markets hurtled downwards with shares in banks leading the plunge. On Friday, 10 August, the FTSE 100 suffered its biggest drop in more than four years. The first response from Gordon Brown was to argue that his superb stewardship of the economy had insulated Britain from the worst of previous crises and could be relied on to do so again. He genuinely, if wrongly, believed this: the British economy was more resilient than most during the emerging-markets crisis of 1997–8 and after the bursting of the dotcom bubble. ‘Gordon was taken by surprise by the speed with which the credit crunch unravelled,’ observes Irwin Stelzer, an American economist who was close to Brown. ‘He also had a big stake in persuading himself that he had immunised the British economy from this disease that he figured was coming from across the ocean.’86 Brown either didn’t see or didn’t want to see why a crash in the financial sector would be peculiarly challenging for Britain because he had allowed banks to become such a large part of the economy. On Saturday, 11 August, he optimistically declared that Britain was in ‘as good a shape as it could be to weather the storm’.87
Whether or not this was at all correct, it certainly was not true of some of its banks. The storm would expose their unsound foundations. The first revelation was that Northern Rock was built on sand. The unstable Rock was by now far removed from its origins in the regional friendly societies of the north-east of England. The parable of the Rock was, in some ways, similar to the story of Labour. Both party and former building society had grown out of the self-help and co-operative ethic of what was called ‘the respectable’ working class in the nineteenth century. Both bank and party had been transformed by global capitalism into unrecognisably different creatures.
Northern Rock was no longer a mortgage bank at all by any normal definition. It had been turned into a vehicle for highly leveraged financial engineering designed to implement a ferocious expansionary strategy. The author was the Chief Executive, Adam Applegarth, who was the second-youngest boss of a FTSE 100 company. Aged just thirty-eight, and without any banking qualifications, Applegarth was charismatic, a driven marketing man, brazenly confident and animated by a thirst for glory. He dominated Matt Ridley, the gentleman amateur who chaired the company, and the rest of a board which was unwilling to restrain Applegarth or was incapable of doing so as he made a dash for growth by seizing a big portion of the British mortgage market.
His pioneer product was the ‘Together’ loan, which allowed young customers to borrow six times their annual income rather than the much safer multiple of three. The bank also lent up to 125 per cent of the value of a property. These loans came to represent nearly a third of its book. The traditional mortgage bank drew its money from a stable base of customer deposits. To finance these extraordinary deals, the Rock borrowed in the wholesale market, where banks make short-term loans to each other. This phenomenally risky business model left the bank acutely vulnerable in the event that credit suddenly became more expensive. ‘We were all fascinated by Northern Rock and how it was expanding so fast,’ says the chairman of a rival mortgage bank. ‘It was destroying our market.’88 When Applegarth’s big gamble appeared to be paying off, City analysts lauded the Rock’s Chief Executive as he gobbled up market share from the old mortgage giants such as the Halifax and Nationwide. Funds piled in to fill their boots with the bank’s shares. By early 2007, it had grown from a small regional operator to the fifth-largest mortgage lender in Britain. Other banks succumbed to the temptation to imitate. The prudent old disciplines of lending were thrown aside. It became easy for borrowers to get a mortgage on high multiples of salary, adding further fuel to the property boom. Personal debt in Britain swelled to a size larger than anywhere else in western Europe.
The Abbey was owned by Santander, a Spanish bank which wasn’t allowed to behave the same way because it was subject to stricter Spanish banking law. ‘We were being murdered on the mortgage side by Northern Rock,’ recalls one of Santander’s board members. The irritability of the Santander board was tempered by their conviction that ‘Northern Rock was going to end in tears.’89
By the summer of 2007, Applegarth depended on the inter-bank market for some 70 per cent of his funding just at the moment when that market was freezing up. The credit crunch bit most immediately and deeply on Northern Rock. Unable to raise fresh financing as loans fell due, the bank was a matter of weeks away from insolvency. The Financial Services Authority finally became alive to the crisis at the Rock on 10 August. A further four days passed – a sign of a serious lack of communication between the T3 – before the Bank and the Treasury were alerted. Warn
ing lights at last began to flash in Threadneedle Street, where the Rock’s problems were regarded as ‘alarming because it showed how fragile even the safest bit of banking actually is’.90 Darling was back from holiday. He was briefed by John Kingman, his Second Permanent Secretary, and Clive Maxwell, the Director of Financial Services. Darling’s officials told him that it looked bad, but should not be a cause for immediate panic because the Rock ought to have enough cash to survive into September. The traditional solution in this situation was to forestall a public panic by getting a larger and healthier institution to take over a troubled bank and keep the rescue secret until it was a done deal. The Treasury was initially optimistic that there was enough time to mount such a rescue. But Kingman became disturbed when he opened talks with the chief executives of other banks and found them apprehensive about ‘contagion risk’. One official realised: ‘These were conversations they were only willing to have out of politeness. They didn’t think they could sell it to their boards.’91 The two likeliest white knights – ironic candidates as saviours in the light of later events – were the Royal Bank of Scotland and Lloyds TSB.92 RBS pulled out because Sir Fred Goodwin, its Chief Executive, wanted to conserve cash for what would prove to be a ruinous acquisition of the Dutch bank ABN Amro. Lloyds TSB was ready to buy the Rock, but after looking at the books said it would only do so if the rescue was underwritten with a £30 billion two-year loan from the Bank of England so that Lloyds could rebuild the Rock without putting itself at risk. Hector Sants, the Chief Executive of the FSA, thought this was a reasonable proposition. Mervyn King, with his stern view about moral hazard, did not believe the Bank of England should be financing take-over deals. The Governor continued to set his face against helping a feckless bank because he believed ‘it was better in the long term for them to fail.’93
That should have left the deciding vote with the Treasury. On the evening of Sunday, 9 September, Darling had a conference call with King and Sir Callum McCarthy, the Chairman of the FSA. The Governor was still refusing to co-operate. The Chancellor did not feel confident enough in either the deal or himself to take the advice of those officials telling him to overrule King.94
This was the first major test of Brown’s tripartite arrangement and it cracked under the stress. The authorities failed to spot the risks being run at the Rock. They were then slow to see the potential for disaster. Even once they did they couldn’t agree on a rescue. It exposed the ambiguities about who was supposed to be in charge during a banking crisis. ‘I got the sense that the Treasury didn’t know what their role was,’ says the chairman of a large retail bank. ‘In the old arrangement, everyone knew what their job was and it was the Chancellor who had the final say. Under the tripartite arrangement, everyone was confused about what everyone’s powers were.’95
It was a failure of both institutions and people. The structural weaknesses were exacerbated by repeated ‘personality clashes’ between the most important players.96 Mervyn King had a mutually suspicious relationship with Gordon Brown. ‘Mervyn got up Gordon’s nose,’ says one senior Treasury official. Brown was hugely infuriated by King’s previous criticism of Government policy, especially the level of debt. ‘Gordon is a very sensitive man and that really wound him up.’97 Brown retaliated by withholding confirmation that King would be reappointed as Governor for a second term. King ‘scarcely saw him’ for the first year that Brown was Prime Minister.98 Alistair Darling was an inexperienced Chancellor, less than two months into the job and still finding his depth, working for a Prime Minister who thought he knew everything there was to know about how to run the Treasury. Darling was also at a psychological disadvantage in dealing with King, a veteran of Threadneedle Street whose financial expertise was regarded as far superior to that of the new Chancellor. ‘Alistair did not stand up to Mervyn over Northern Rock. Gordon and Ed Balls would have told Mervyn what to do,’ says a Treasury official.99 A member of the Monetary Policy Committee, who also knew how Whitehall worked, thought the new Chancellor ‘was initially in awe of Mervyn’. When the Governor was obstructive over the rescue, ‘Alistair started to get pissed off with Mervyn. After the Northern Rock fiasco, he started to stand up to Mervyn a bit.’100 On the account of Sir Steve Robson, the Governor even went so far as to suggest he would resign if Darling tried to compel him to put the Bank’s money behind a rescue of Northern Rock.101 The assessment of one expert witness with very senior experience in both the banking and Treasury world is scathing: ‘The tripartite arrangement couldn’t cope with the pressure. As soon as a crisis broke, the whole thing blew apart.’102
To justify his resistance to the rescue, King additionally argued that European law prevented the sort of covert action that had saved troubled banks in the past. This was debatable. The Germans swiftly and smoothly moved to save their three endangered banks without worrying about that. Yet King had his way. On Tuesday, 11 September, Sir John Gieve, the Bank’s Deputy Governor, rang Applegarth to say there was no deal to rescue the Rock.
As markets continued to plummet, and rumours about the Rock rattled around the City, King’s reputation took a hammering. The next day, MPs on the Treasury select committee received a letter from the Governor formally expounding his unbending view about rescuing feckless financiers. ‘The provision of large liquidity penalises those financial institutions that sat out the dance, encourages herd behaviour and increases the intensity of future crises.’103
In theory, this was correct. In practice, even ‘Unswerving Mervyn’ was beginning to bend under the weight of this crisis and the pressure of so much criticism. By the time that letter was delivered, he was already beginning to ‘somersault’.104 On the evening of the 13th, King told a secret session of the Bank’s Court, its governing body, that he was going to give an emergency loan to the Rock using the Bank’s facility to be a lender of last resort.105 Darling, sceptical that this would remain secret for long, successfully argued that they should bring forward the announcement to the next morning.106 Even that wasn’t soon enough. The emergency loan leaked that very night. Robert Peston, the Business Editor of the BBC and biographer of Brown, had the scoop which generated huge media headlines that the Rock was shattering. This turned a hidden drama into a public crisis. Some in Whitehall suspected that the journalist’s source was within the bank or acting for it and hoped to calm the speculation which was destroying the share price. Some in the Treasury and the banking world believe that the leak came from Number 10 in a misguided effort to suggest that Gordon Brown was on top of the crisis.107 Whoever was responsible, the result of this leak was calamitous for both the Rock and the Government.
On the morning of Friday, 14 September, long queues began to form at branches of the Northern Rock. Depositors were rushing to extract their money. The lines grew longer when these anxious savers were joined by others who found they could not make withdrawals online because the bank’s website was overwhelmed by the volume of customers trying to access their accounts.
The media called it a panic, but the behaviour of these depositors was perfectly rational. Told that their bank was running out of cash, it made absolute sense to retrieve their savings before all the money was gone. The Government guarantee plan for depositors only promised a full refund of the first £2,000 of lost savings, 90 per cent of the next £33,000, and nothing at all above that.
Northern Rock was now in a double vice. It could not raise fresh funds on the wholesale market and money was gushing out in withdrawals by terrified depositors. Britain had its first bank run in more than a century and that appalling event was being broadcast to the world by television pictures of the customers clamouring to escape the Rock. ‘It was stunning to see these lines of people waiting to get their money out,’ says Irwin Stelzer. ‘There were two reactions in America. One was: “My God, they’ve got a bank run.” The other was: “Look how nice and orderly the Brits are when they queue up.” ’108 In the context of the greater banking collapses that followed later, this came to seem less globally sign
ificant. In September 2007, the run on the Rock seized both Number 10 and the Treasury with terror that it would be catastrophic for the Government’s reputation and Britain’s global standing as a safe home for investment. Cabinet ministers were flabbergasted by the ‘huge great queues’.109 Officials saw that ‘it was a searing experience’ for Brown and Darling.110 The Prime Minister made ‘anxious’ phone calls to colleagues.111 One recipient of a call was his former adviser at the Treasury, Shriti Vadera. ‘What are people saying about Northern Rock?’ he asked. The International Development Minister replied: ‘I’m in Addis Ababa. They’re not saying anything about Northern Rock here.’ ‘Right,’ said Brown. ‘We’ll have to do something about that.’112 Soon afterwards, he moved her to the Business Department.
Neither Brown nor any of the other key actors had yet got on top of events. Confronted with the first bank run since the nineteenth century, the authorities continued to flounder. Darling was trying to follow events from abroad. He was at a summit of European finance ministers in Portugal as the Rock went critical. Christine Lagarde, the Finance Minister of France, observed Darling dash in and out of the meeting to make calls to London. Eventually he did not return at all.113 The obvious move was to stem the flow of withdrawals by announcing a more solid government guarantee for depositors. According to the chairman of a retail bank, they spent Friday ‘fiddling around with the legal position’ rather than acting swiftly. ‘They should have guaranteed deposits quicker, on the Friday rather than the Monday evening.’114
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