Miliband had a bad week. He did not locate a resonant voice when he made his own speech. He was then embarrassed when he was overheard in a lift excusing his failure to rouse the delegates by saying he couldn’t have ‘done a Heseltine’.101 The truth was that his performance came nowhere near hitting the conference G-spot in the way mastered by that Tory performer. The enduring image of the Foreign Secretary’s conference week captured him in a ridiculous rather than heroic pose. He allowed himself to be photographed wielding not a shining sword, but a bathetic banana.
Gordon Brown emerged from the conference stronger than he went into it. His exploitation of the financial crisis to assert his credentials as the right leader for the hour stayed the hand of plotters in the Cabinet and snuffed out the backbench revolt. Yet many senior Labour figures regarded it as merely a stay of execution. They departed Manchester unconvinced that he had a plan to lift the Government from the deep pit into which it had sunk. One of the most sceptical was Peter Mandelson. He was publicly loyal during the conference week, and helped with the speech. Yet his support had an ambivalent flavour even so, telling one interviewer: ‘I do not think changing the face at the top is the panacea some imagine’, not the most resounding endorsement.102 He privately continued to express despair to colleagues and some journalists about Brown’s capacity to turn things around.103
On Thursday, 2 October, Mandelson slipped into Number 10 to see the Prime Minister. He had received ‘absolutely no intimation whatsoever’ of what was to transpire.104 He assumed that Brown wanted to continue to use him in the strange new role of secret adviser that had developed over the past few months. When they sat down, a light lunch of sandwiches, yoghurt and bananas was laid out before them. Suddenly, ‘without any warning’, Brown popped the question: he wanted his visitor to return to the Cabinet. Mandelson recalls: ‘I choked on my yoghurt.’ He had come to the meeting thinking that Brown wanted his advice on the reshuffle not that he was going to be the centrepiece of it. Having established that Brown really meant it and wanted to give him a serious job, he responded that he had to have time to think. ‘I need to call a friend,’ he said. That friend was Tony Blair. Mandelson slipped out of Number 10 and nipped across London that afternoon to see the former Prime Minister. ‘After he’d finished laughing out loud at the irony of the situation’, Blair told Mandelson: ‘It’s a no-brainer. You have to do it.’105
This was the wildest plot twist in the stunningly convoluted history of the personal relations between the founding fathers of New Labour. Yet it had a strange kind of logic, almost an inevitability. ‘Peter was Gordon’s person before he was Tony’s person,’ reflects one of Mandelson’s friends. ‘They have a lot in common. Both are loners. They are not family people. They are both very selfish when they want to be. They are both political to their fingertips. They both have a deep Labour heritage. They are both intellectual.’106
The small group who founded New Labour had ever been a family. In the good times, they were a band of blood brothers who fashioned one of the most successful political projects. In the bad times, the family resembled a cross between The Sopranos and The Simpsons. Now, in these bleakest of times, two of the founding fathers were drawn back together to try to rescue their creation from oblivion. Whatever else divided the two men, they had a mutual stake in trying to save from destruction what they had made with Tony Blair.
For Mandelson, his remarkable third coming as a Cabinet minister, one of the most startling revivifications since Lazarus, satisfied his yearning to be back on the frontline of British politics and gave him the opportunity to redeem his reputation. When he sashayed up Downing Street in a blue double-breasted suit and strawberry cashmere sweater, he told reporters it would be ‘third time lucky’.107 For Brown, it created a coup de théâtre which stunned both friend and foe when the reshuffle was unveiled on Friday, 3 October. None of the media, all of whom had been working to the dated script that they still hated each other, saw this coming.108 To Brown’s anger, the Daily Mail snickered: ‘Arise, Lord Sleaze’.109 Most of the press, though, was dazzled. The Guardian saw it as ‘one of the most brilliant coups of his career’, which ‘reminded sceptics that he still retains plenty of political cunning’.110 ‘For a sinking Prime Minister,’ opined the Financial Times, ‘it is a gamble of astonishing audacity.’111
Brown suggested that he had recalled Mandelson to draw on the other man’s ‘immense experience and expertise’ at a time of financial crisis, saying ‘serious times need serious people’.112 He privately said: ‘I’m trying to use every talent I can lay my hands on.’113 His primary motive was political. In a stroke, it blunted the knives of the assassins. For most of his career, Mandelson had been a high-maintenance politician, a divisive and turbulent figure. In these strange circumstances, his recall was unifying and calming while also adding heft and celebrity to a generally colourless Cabinet. Blairites could not be part of any move against Brown now that the high priest of Blairism was back. ‘He’s extended the hand of friendship and we’ve got to take it and see what can be done,’ said one Blairite Cabinet minister.114
This dramatic flourish also distracted the media while Brown made other moves to strengthen his grip over the party. Geoff Hoon was replaced as Chief Whip by Nick Brown. As part of the price for his return, Mandelson thought he had extracted a promise from Brown that he would dispose of Damian McBride. McBride was moved to a less prominent role, but he remained at Number 10. With time on his hands, his activities would actually become more dangerous to Brown.
The new Business Secretary was ennobled as Baron Mandelson of Hartlepool and Foy, though he was always more Foy than Hartlepool. There were many predictions that it couldn’t last five minutes, that Mandelson was as certain to sting Brown as the scorpion was the frog in Aesop’s fable. This proved to be wrong. Cabinet members reported that Mandelson was having a positive effect on both the direction of the Government and the morale of the Prime Minister. James Purnell put it like this: ‘It’s a bit like people who created a rock band together, had a great success, and then had their ups and downs in their relationship. When they come back together as a band, they suddenly remember what it was that made them so close in the first place.’115
Mandelson managed to coexist, albeit with wariness on both sides, alongside Ed Balls. They agreed a mutual non-aggression pact in which they would not spin against each other as they had in the past nor argue in front of others at meetings.116 He provided Brown with some strategic nous, presentational flair and emotional support. ‘I know it sounds strange, but Peter has made Gordon much more relaxed and confident,’ said one member of the Cabinet. ‘At the same time, Peter can be blunt with Gordon about his faults in a way no-one else can.’117 Another minister who saw the two men together marvelled at how ‘they spoke to each other like brothers.’118 A third noted that ‘they have their own little code’ often impenetrable to anyone else, a semaphore which could convey a thousand words of meaning in a look or a phrase.119 At New Labour’s time of gravest crisis, Brown and Mandelson had found something which surpassed even the oceans of poison that had flowed between them. They were drawn back together by their mutual desperation to save the project itself.
34. The Great Escape
Gordon Brown rang Shriti Vadera when he heard the news. ‘How serious is this?’ ‘Oh crap,’ responded the former investment banker. ‘It is very, very serious.’1
Lehman Brothers collapsed into bankruptcy on Monday, 15 September. The 158-year-old investment bank had behaved like a wild teenager in its reckless pursuit of profits, leveraging its books by an astonishing factor of 44, meaning it had forty-four dollars of debt for every dollar of tangible capital. Leverage magnifies profits in booms and multiplies losses in busts. Huge bets on the American property market left the bank on its knees. Up to this point, no major financial institution had been allowed to go bankrupt. Hank Paulson put up $30 billion from the American Government to help rescue Bear Stearns earlier in the year. The US Treasury Se
cretary also set aside Republican free-market ideology to effectively nationalise Fannie Mae and Freddie Mac, the two mammoth institutions which stood behind more than half of all American mortgages. Merrill Lynch, whose ‘raging bull’ logo was totemic of the bubble, was about to be folded into the arms of Bank of America. The assumption in London was that Paulson would act to save Lehmans rather than risk triggering a cascade of banking collapses. Gordon Brown ‘didn’t expect Paulson to let Lehmans go’.2 Neither did Alistair Darling: ‘The feeling was the Americans would step in to save Lehmans. That was my assumption. The weekend before, that’s what I understood was going to happen.’3 At the Bank of England, they shared that mistaken belief, says the Deputy Governor, Sir John Gieve: ‘The markets thought and we thought that Paulson would prop them up.’4
The first indication that this assumption might be wrong came on Sunday, when Paulson rang Darling. The Chancellor was at his home in Edinburgh and the US Treasury Secretary was calling from the headquarters of the New York Federal Reserve, where he had spent the weekend trying to cajole Wall Street bankers to rescue Lehmans because he didn’t want to put up any taxpayers’ cash. Dick Fuld, Lehman’s intensely aggressive boss, had declined earlier opportunities to sell parts of his crippled bank. Paulson reckoned that Wall Street needed to be taught a lesson. Another bail-out was also politically unattractive. The previous rescues were sparking angry attacks from both the Republican right wing, who saw it as interference with the free market, and the Democratic left, scandalised by giving tax dollars to the rich and reckless of Wall Street. The fierce anti-banker backlash in America was heightened by the presidential election campaign. Paulson rang Darling to seek his assistance with a potential takeover of Lehmans by Barclays. Down the line from New York, the US Treasury Secretary complained that the British authorities were being obstructive by raising a huge number of questions about the viability and safety of the deal. Darling responded that they needed cast iron assurances that bringing the enormous liabilities of Lehmans on to the books of a British bank was not going to endanger the UK’s financial system.5 Paulson remarked to aides: ‘He doesn’t want to import the American disease.’6 The two men could not give each other what they wanted. The call ended with Darling still assuming that, when push came to shove, Paulson would retreat and rescue Lehmans. He said later: ‘The American purse would have been big enough to do it.’7 The Chancellor discovered he had misjudged his American counterpart in a later call from New York that Sunday. Barclays was walking away from the deal and Paulson was still not prepared to act. ‘Hank told me that basically they were gonna let them go.’ The Chancellor was stunned, but felt powerless to protest. ‘Both of us were aware of the seriousness of it. But I could no more tell the US Treasury Secretary that he’d got to save a bank than he could tell me that I’d got to save a bank. It is American taxpayers’ money he was on about.’8 Darling immediately rang his officials to tell them to accelerate contingency planning to cope with more British bank failures.9
The fall of Lehmans, the largest corporate bankruptcy the world has ever seen, was an incredible shock to the brittle confidence of the financial markets. At the Bank of England, it was seen as a ‘disastrous error’ after which ‘things really fell apart.’10 Lehmans was the counterparty to some $440 billion of trades with other financial institutions. As John Eatwell puts it: ‘A whole series of trades just failed all around the world.’11 There was blind panic and modern communications transmitted the virus around the globe in an instant. Credit markets went into cardiac arrest. Banks lost all confidence in banks. The amount they charged each other for short-term loans doubled overnight as borrowing rates between them went ‘through the roof’.12 Within forty-eight hours, European banks simply stopped lending dollars to each other. There was massive dumping of shares in any institution that appeared the least bit fragile; there was a crash in the shares of those which looked most exposed. By the end of Monday, the Dow had dived 504 points, its biggest drop since 9/11. Paulson, flipping from one stance to another from day to day, did intervene on Tuesday to spend $85 billion rescuing the giant AIG, which had insured many of the toxic loans held by the banks. The authorities also responded with a temporary ban on short-selling of financial shares and central banks flushed hundreds of billions of dollars of liquidity into markets. This parachute was not strong enough to brake the freefall. The measures were totalling billions, but they were a response to an evaporation of confidence in instruments valued in trillions. The heart of the problem was the $55 trillion of credit derivatives, a market that had been allowed to grow to a monetary value more than twice the size of the combined GDP of America, Japan and the European Union. In the bubble years, bankers convinced themselves that by spreading these instruments everywhere they had derisked the financial system. What they had actually done was ensure that the contagion would infect every financial centre in the world when the greed of the boom turned into the panic of the bust. No-one could be certain which contracts still had value and which were now worthless. More than any other single event, it was the fall of Lehmans that turned a crunch into a meltdown.
At the Bank of England, ‘the big question on everyone’s lips was “Who’s next?” ’13 As the tide goes out, you discover who is swimming naked. British banks had short-term borrowings of an incredible £750 billion which had to be refinanced every fortnight to three months. When global credit markets froze ‘that money vanished’.14 Two of Britain’s largest banks – Halifax Bank of Scotland and the Royal Bank of Scotland – were starkly exposed. Darling was warned that the position of HBOS, Britain’s biggest mortgage lender, ‘was absolutely dire’.15 Within thirty minutes of the stock market opening on Wednesday, 17 September, its share price was cut in half. The Government really didn’t want to be forced to take it over. Fortunately – or so it seemed at the time – there was a white knight on a black horse willing to come to the rescue. Lloyds TSB had been Britain’s most conservatively managed bank and was thirsty to make acquisitions. At a drinks reception before a bankers’ dinner in St James’s on the Monday, Gordon Brown had a conversation with Sir Victor Blank, the Chairman of Lloyds TSB, a respected figure in the City and a long-time Labour sympathiser. Blank was not interested in HBOS to do a favour for the Government. Lloyds had been frustrated for a long time that competition rules prevented it from expanding by buying other banks. As waiters hovered with trays of champagne, the Prime Minister indicated to Blank that the rules would be waived in these exceptional circumstances, a promise which helped the Lloyds Chairman sell the take over to his board.16 Darling agreed that the risks of financial contagion ‘trumped the competition concerns’.17 Just forty-eight hours after Blank’s conversation with Brown, the deal was announced. The Prime Minister was keen for his personal intervention to be advertised as an example of his leadership in a crisis. ‘Brown knew Blank very well and was able to have a laugh and a chat with him,’ a Number 10 spinner bragged to the press. ‘Would any other leader be able to do that?’18 This boast would later boomerang horribly on Brown. When Lloyds ate HBOS, a bank loaded with toxic assets, it gulped down a poison pill.
The next British bank on the skids was the Bradford & Bingley which ‘was getting into deeper and deeper trouble’.19 After ‘the horror of Northern Rock’ both ministers and Treasury officials regarded it as vital to the Government’s reputation that ‘B&B was done quickly and cleanly’.20 On Saturday, 27 September, Darling called the leaders of the big banks into the Treasury to try to persuade them to buy B&B. To his alarm, the Chancellor found that none of the banks were biting. ‘We all basically said we weren’t interested,’ says one of the bankers at the table. ‘No-one wanted it.’21 Anxious to avoid outright nationalisation, by Sunday night the Treasury had scrambled together a hybrid solution. It was announced the next day that the Government had taken over the £50 billion mortgage book while the rest of the bank was sold off to Santander, the Spanish bank which already owned Abbey and Alliance & Leicester. Thirty-six hours of high-speed negot
iations were smoothed by the involvement of Terry Burns, a former Permanent Secretary at the Treasury, who was a member of the Santander board as the Abbey’s Chairman. Some lessons had been learnt from the Northern Rock debacle. The Government had since equipped itself with better legal powers to effect quick rescues.22 What took five months with the Rock was telescoped into a weekend when it came to the Bradford & Bingley. The Treasury quietly congratulated itself that this rescue was implemented without a panic and no queues of depositors clamouring for their money. Yet they were also becoming daily more troubled that much larger banks were near the edge. In the words of one senior Treasury official: ‘Most of our internal discussions asked: “How big is the problem?” and concluded that was anyone’s guess.’23
The Government had so far responded like firefighters, dashing from blazing bank to bank to hose them down before they set light to another institution. ‘We are dealing with the problems one by one,’ remained the public line from Gordon Brown.24 In private, Number 10, the Treasury and the Bank of England, all increasingly terrified by the escalating scale of the crisis, were converging on the view that a much more comprehensive answer was required to shore up confidence before the entire British banking system slid towards collapse. Darling was now ‘reaching the conclusion it was the systemic problem we had to deal with’ and they couldn’t go on ‘dealing with this piece by piece’.25
In a little-remarked-upon speech nine months earlier, Mervyn King had first suggested that the surest way to restore trust and stabilise the financial system was to recapitalise all the banks by injecting them with public money. Something similar had been done successfully by Sweden during a banking crisis in the early 1990s. The Governor was now minded to force help on them even if it meant effective nationalisation of every British bank. ‘Mervyn would have done the lot,’ says one senior civil servant. In a 180-degree turn from his earlier inflexibility about moral hazard, ‘Mervyn had gone completely to the other extreme.’26
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