From The Sunday Times
Five days that shook the world
As the markets dived, ministers, mandarins and bankers thrashed out a survival plan
BEFORE US Treasury secretary Hank Paulson could address a worried world last Friday night the lights needed fixing in the auditorium of the Office of Thrift Supervision.
The recent glare of publicity has literally been too much for the 62-year-old former Goldman Sachs chief and he has been forced to shield his eyes from the television spotlights, giving him the look of a troubled captain at his lookout. A tall official crouched to what proved an uncanny guesstimate at Paulson’s height so the assembled cameramen could take light-readings off his face. “It’s too bright,” he said. The lights came down. “Now it’s moody,” shouted a cameraman. The lights went up a notch and the stage was set. “All rise for King Henry,” quipped a journalist as Paulson lurched towards the podium.
Paulson was again at the epicentre of the world’s financial earthquake after one of the most tumultuous weeks in the history of modern capitalism.
“Never has it been more essential to find collective solutions to ensure stable and efficient financial markets,” Paulson said. It was no exaggeration.
In the past year $8.4 trillion (£5 trillion) has been wiped off the value of American stocks. The Dow Jones Industrial Average, a key measure of US financial health, dropped 18% last week, the worst fall in its 112-year history, and ended with the most volatile day on record.
The Dow fell 697 points early on Friday then soared by more than 300 points before closing 132 points down. Much of those “gains” were based on expectations that Paulson would shed light on his plans to stop the economic turmoil. Tomorrow will tell whether he said enough. But the signs were not good.
Last week’s falls came days after the US Congress passed Paulson’s $700 billion Troubled Asset Relief Programme (TARP), whose huge price tag and lack of detail has failed to appease schizophrenic markets.
This weekend Washington is host to the world’s finance chiefs. Finance ministers and central bankers from the Group of Seven countries, including the chancellor Alistair Darling and Bank of England governor Mervyn King, have been trying to find a way to stop panic-selling in the stock markets and unfreeze the credit markets.
Paulson said the G7 had finalised an “aggressive” action plan. But details remained scant. And there were no signs of an explicit pledge to guarantee bank lending that many in the markets had hoped for. Paulson put a lot of emphasis on “things”.
“What I emphasised to my colleagues is that we have a broad set of authorities that we didn’t have before. And these allow us to do a wide range of things,” said Paulson. “The important thing is we want to do it as soon as possible but we want to do it right and we want it to be effective.
“Trust me, we are not wasting time, people are working around the clock to do this,” he said. But trust is in short supply. And unless a firmer plan can be drawn up this weekend, and announced publicly before the Hang Seng index opens in Hong Kong tomorrow, world stock markets seem likely to continue their rollercoaster ride.
Going into the weekend meetings, Darling stressed decisive action was needed. “It is absolutely essential that the world’s largest economies act together and they act together now,” he said. “We need to show that we are able not just to talk about these issues but step up to the mark and do something about them.”
Darling too had endured the most extraordinary week after he was forced into nationalising in effect parts of the banking system. The Great British Bank Bailout is being held up in Washington as a way out of the crisis and has been received with applause from former free-marketeers who would once have condemned it as undisguised socialism. But, as Paulson can no doubt tell Darling: in the current climate today’s good idea may be tomorrow’s TARP.
DARLING’S daring rescue plan originated 10 days ago when two senior executives of the Swiss bank UBS were handed a dossier by the Treasury’s most senior civil servants, Tom Scholar and John Kingman.
The Treasury’s proposals were scant on detail and lacking meaningful numbers, but the document outlined the possibility that the government could take stakes in Britain’s banks alongside further moves to bolster liquidity in the money markets.
Robin Budenberg and David Soanes of UBS were told to take the document away and turn it into something workable. Budenberg has been advising the government on British Energy, while Soanes has had the ear of the Treasury since a meeting of bank bosses in Downing Street in April.
With Paulson’s American bailout plan coming under fire, and Ireland sparking chaos across Europe by guaranteeing all bank deposits, pressure was mounting on Scholar and his colleagues to come up with a UK solution to the problem.
Over the rest of Thursday and throughout Friday, Budenberg and Soanes began to flesh out a plan which was handed to Darling and Gordon Brown on Saturday. By Sunday night, they had recruited the help of advisers from JP Morgan Cazenove. David Mayhew, chairman of Cazenove, and Naguib Kheraj, the former finance director of Barclays who had started as the advisory firm’s chief executive just three days earlier, beefed up the detail.
Eventually, after a tense set of negotiations with the bosses of Britain’s banks, set against further chaos in the stock markets, the £500 billion bailout was unveiled on Wednesday morning.
Only then were the government’s advisers from UBS and JP Morgan Cazenove, who had arrived at the Treasury at 7am sharp on Monday morning, able to leave.
Hailed as the most elegant solution yet to the global credit crisis, the scheme hammered out in the early hours of Wednesday has been praised in equal measure by bankers, shareholders and politicians.
“The only complaint was that it should have happened sooner,” said Jim O’Neil, head of economic research at Goldman Sachs. “The dilemma is that this does nothing for the situation in the US and Europe, but if this were applied globally the chances of getting the money markets back to some normality would be very high.”
The UK plan may yet form a blueprint to be copied all over the world in a concerted bid to resolve the credit crisis. However, with equity markets still in freefall on Friday, and the money markets reaching new levels of chaos, it has clearly not been the instant solution everyone had hoped for.
As bankers trooped into the Treasury on Thursday and Friday to examine the small print of the package, it was still unclear what payback the government will expect in exchange for the taxpayers’ assistance.
“Initially, my reaction was: yes, I welcome this,” said John Hitchins, head of banking and capital markets at Price Waterhouse Coopers. “Only time will tell whether it’s enough and we need to see the small print. The conditions for the banks that take the facility are not specified.”
THE week did not begin well. Although officials had been working on a bailout plan for some weeks, there was alarm in the Treasury when weekend reports implied an announcement was imminent.
Amid confusion over Germany’s rescue of Hypo, a troubled real estate bank, and over whether chancellor Angela Merkel had guaranteed her country’s bank deposits, the focus had unexpectedly shifted to Britain to the exasperation of officials.
“There was a lot of work to be done, not least in getting all the banks on board, and yet the impression was given that we were going to unveil a £50 billion bailout first thing on Monday morning,” said one Whitehall official.
When there was no announcement, and Darling went to the House of Commons to say only that “it would be irresponsible to speculate on the specifics of future responses” and that “providing a running commentary could add uncertainty in already febrile market conditions”, he merely added to the uncertainty.
So at 6pm the big guns of the retail banks were in 11 Downing Street and Barclays’ John Varley, for one, was not happy. He made it clear the time for dithering had long passed — the banks needed action.
HSBC’s Michael Geoghegan backed him up. So did Eric Daniels of Lloyds TSB and Andy Hornby of HBOS. Royal Bank of Scotland’s Sir Fred Goodwin, who had watched his bank’s shares dive 20% in Monday’s trading following a credit downgrade from Standard & Poor’s, was uncommonly quiet.
Their concerns were still many and varied. They wanted the government to do something to support the capital position of the banking sector. If there was to be such an intervention, they said, it would have to involve preference shares — for the government to buy equity in the banks would simply pose too many problems.
This was not the only concern, however. The banks’ bosses were still calling for guarantees on deposits to match those introduced by Ireland. Intervention in the money markets was also on the agenda.
Darling sat and took the criticism. All he could offer were assurances that plans of some kind were afoot and that he would get back to them in due course.
Just 100 yards away, in the corridors of the Treasury, plans were already much more advanced than Darling was willing to admit. Having seen the measures proposed by his American counterpart Hank Paulson picked apart just one week earlier, Darling was reluctant to show his hand too soon.
Meanwhile, the market was preparing for the worst, anticipating a government intervention that would be hugely dilutive to existing shareholders.
At 8.45am on Tuesday Sir Fred Goodwin of RBS stood up before some of his biggest shareholders and competitors at the annual Merrill Lynch banking conference at the Landmark Hotel in Marylebone, central London.
Reports had begun to circulate two hours earlier that RBS, Barclays and Lloyds TSB had asked the government for capital, demanding £15 billion each. Bank shares were in freefall as the news — which proved slightly wide of the mark — prompted investors to panic.
After a brief presentation in which he claimed RBS was on track to meet targets, Goodwin opened the floor to questions. It was not long before he was asked what it felt like to have seen his stock plunge by about 35% during the time he was on stage.
Goodwin’s face fell. Most of the investor meetings that had been scheduled around the conference were swiftly cancelled.
Darling was forced into a similar change of plan by the plunging shares. After a hurried trip to Luxembourg for a finance ministers’ summit, Darling was back in Downing Street for an emergency meeting with Brown, King and Lord Turner, chairman of the Financial Services Authority.
By the time the market closed, there was still no clear idea what Darling was planning. RBS had lost 40% of its value, HBOS had lost 40%, Barclays was down 9%, while Lloyds TSB was down 12%.
The conclusion was simple. Further refinement of the rescue plan would have to wait. It was time to press the button.
At about 9pm, the bank bosses got the call they had been waiting for that summoned them to the Treasury. Shortly before 10pm, they began to file through a side door into the vast office complex on Whitehall.
Along with Daniels, Varley, Hornby and Goodwin came Douglas Flint, the HSBC finance director, Abbey chief executive Antonio Horta-Osorio, Richard Meddings, the finance director of Standard Chartered and Graham Beale, the chief executive of the Nationwide building society.
By the time the bank bosses went in to meet Darling at 10pm on Tuesday night, there was an element of tension. HSBC, Abbey and Standard Chartered bank were all pointing that they did not need capital injections from government, but they were willing to endorse the plan.
There was tension too between the advisers. While Darling and his coterie of Treasury mandarins had just scoffed a
£245 takeaway from Gandhi’s Indian restaurant in Kennington, south London, only a few poppadoms remained for the advisers who had left the room to prepare the bank bosses for the meeting.
The outline plan was there: a capital injection of up to £50 billion from the government into Britain’s banks through the use of preference shares, an extra £200 billion to be pumped into the money markets, and guarantees worth £250 billion on longer-term funding for the banks.
For the next hour, the bank bosses grilled Darling line by line on what he meant exactly on each individual element.
Andy Hornby of HBOS was the most aggressive questioner — although he is unlikely to attend any more such meetings if the merger between his bank and Lloyds TSB goes through.
When the meeting broke off at 11pm, there were still differences of opinion but a clear commitment to finding a solution.The bankers went off to put their heads together. Paul Myners, the new City minister, started to lead the discussions alongside Shriti Vadera, the business minister who is one of Gordon Brown’s closest confidantes.
The meeting reconvened at 11.30pm, before breaking up again half an hour later for another time-out for the bank bosses.
A third meeting came to a close at about 1.30am, at which point the bank bosses and Darling left for the night, with the Treasury promising to come back with a workable agreement by morning. The banks still had concerns about what their shareholders would think of the plan.
They were keen to make sure that their investors would have the opportunity to raise capital before the government was called upon. Before they left, the bank bosses had all agreed to raise their tier one capital ratios by a collective sum of about 1% before the end of the year.
The team had been whittled down to Myners, the UBS advisers, the JP Morgan Cazenove team, Scholar, Kingman and Nigel Boardman, a partner from City law firm Slaughter and May. Yvette Cooper, the chief secretary to the Treasury, dipped in and out, passing messages to Darling.
At about 6am, Britain’s bank bosses started to receive phone calls detailing the final version of the plan. The £50 billion injection had transformed into two tranches of £25 billion — one for restoring capital bases, the other for increasing lending to the economy.
Words about supporting lending to “small business and home buyers” had been added at the last minute as part of the dress-up exercise designed to make it more palatable to taxpayers.
“GOVERNMENT owning banks is uncharted waters,” said Robert Barrie, the head of European economics at Credit Suisse.
“I think it’s going to be pretty awkward, not as awkward as it would have been without intervention, but still awkward. If the government has a significant stake, can it really not take an interest in what they’re doing? I’m not sure.”
Late last week, the big banks started picking the government’s brains to find out how the recapitalisation plan would work in practice.
The preference shares the government is offering would charge a hefty interest rate of between 9% and 12% depending on which institution is asking. At those prices, it makes sense for the banks to attempt to tap their own shareholders first.
The bailout scheme covers every concern raised by the big banks since the credit crunch erupted a little over a year ago. Debate over the finer points — such as exactly how much capital each bank will have to raise is only just beginning.
“To assess the solvency of a bank you need to be able to asses the assets entirely,” said Peter Spencer, the chief economic adviser to the E&Y Item Club. “There are a lot of a mortgage-backed securities on bank balance sheets now and it’s difficult to put a value on them.”
Banking sources say that the UK banks will need about £75 billion of additional capital, more than the £50 billion set out in the government’s plan, though some of the extra capital could come from the markets, depending on their state. Their combined loss of capital as a result of the credit crisis was £150 billion but some of that has already been made up by earlier capital-raising exercises. Some will not be needed because the banks will be more constrained in their future lending.
“The banks behaved as if their lending, particularly on mortgages, was riskless,” said one City source.
Officials at the Bank of England did not expect to see an instant reaction in the money markets but they do believe that the plan will see the wholesale markets gradually re-open once the details of the guarantee for the banks are absorbed.
In theory, it solves the problem that Britain’s mortgage lenders have been clamouring for government action on — new mortgage-backed securities can be put up as collateral against some of the money the Bank is now pumping into the system. The problem is that nobody wants to issue such securities until the dust settles.
The Bank rejects suggestions from the banks that it has dragged its feet in responding to the crisis. Part of the problem, say sources close to the Bank, was that the banks themselves refused to acknowledge their need for capital.
As long as this was the case, King was unwilling to prop up a system he believed to be seriously undercapitalised.
Now, the crucial need is for a fast response. That was the pressure G7 finance ministers and central bankers have been under in Washington this weekend, and it is the pressure closer to home.
“There’s no excuse for delay,” said one banking source. “We need to get on with it.” Details of the new capital for the banks should be finalised in days, not weeks.
The softer costs of getting involved in the scheme are less clear. The bailout plan warns that the government will “take into account” the pay packages and dividend policies of a bank while deciding how much capital it is required to hold. It has the right to do this through the existing powers of the Financial Services Authority.
It seems difficult to imagine that taxpayers will take a favourable view on banks treating staff and clients to freebies all around the world if the government ends up holding a stake of 20% or more.
“I would expect the government to have a degree of influence but I doubt they would want to be seen to be micro-managing, even at the level of director pay,” said Richard Everett, regulatory partner at the law firm Lawrence Graham, who previously worked at the FSA. “However, if the annual report came out saying they’re going to pay the finance director and the chief executive a very large bonus, then the PM might invite them into the office for a quiet chat and cup of tea.”
It’s clear that in spite of the bailout, the solution to the problems won’t be found overnight. “All these attempts by Mervyn King and Ben Bernanke at best help to make this an orderly process, but they certainly cannot turn it around,” said Ken Goldstein, economist at the New York-based think tank the Conference Board.
He believes that global economies are entering a long period of contraction. “It’s an unreal expectation to believe any government can wave a magic wand and make this all go away. This is real life not a fairytale,” he said.
Harvard Business School professor John Quelch, former dean of the London Business School, is equally gloomy. “It’s possible that you could get a perfect confluence of events that could turn it around in a week and see a 2,000-point leap in the markets and credit flowing again. But it’s just not very likely.”
Additional reporting: Kate Walsh
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