Two months later, in July 2008, HBOS, then Britain’s biggest mortgage lender, tried to raise £4 billion from its own shareholders. It was a disaster. Only 8 per cent of investors agreed to buy more stock. Within days, the Chancellor warned Britain that it faced its worst economic crisis for 60 years and that the recession would last far longer than most had feared. Within a week, the world economy was plunged into the worst financial storm since the Wall Street crash of 1929.
The pace of the crisis accelerated to such an extent that almost each day delivered a new horror. On September 7, the mortgage lenders Fannie Mae and Freddie Mac, which accounted for almost half of all America’s home loans, were bailed out by Washington in one of the biggest financial rescues in history. The US taxpayer was faced with guaranteeing $5 trillion of outstanding loans. Three days later, Lehman Brothers admitted that it had lost $3.9 billion in 12 weeks. Rumours spread across Wall Street and the City that Dick Fuld, the head of Lehman, had not been able to find a rescue buyer.
On September 12, 2008, office workers descending into Wall Street’s subway on their way home may have noticed the stream of limousines pulling up around the corner. Like hearses, they delivered 30 of the world’s most powerful financiers to the office of the Federal Reserve. Between them, the men controlled the world’s banking system and they had been summoned by Mr Paulson to be told that Lehman was bust. He said that the US taxpayer was not going to bail it out and warned them that, if they failed to rescue Lehman or carve it up, they would all be caught up in the havoc. Those who attended included Lloyd Blankfein, chief executive of Goldman Sachs, and John Thain, his opposite number at Merrill Lynch. Mr Fuld was not invited.
By 3pm on Sunday, the rescue talks were off. Barclays had wanted to do a deal but was blocked by Britain, which demanded that the US Government should sweeten any deal with American money. With the collapse of Lehman now inevitable, employees of the bank in Canary Wharf and Manhattan were summoned back to their desks to calculate the bank’s colossal exposure and prepare for bankruptcy.
Mr Thain realised that his bank would be the next casualty. As Lehman employees packed up their belongings, Mr Thain was secretly signing a deal to sell Merrill to Bank of America for $44 billion. He even made sure that $4 billion of bonus payments for himself and Merrill staff were accelerated before the agreement was signed.
Six weeks before US presidential elections, Mr Paulson was adamant that the American taxpayer would not be called upon to bail out Lehman. Just before midnight, Mr Fuld announced that the bank was bust. During the course of one day, half of Wall Street had either been taken over or been declared bankrupt.
A far bigger, immediate financial crisis loomed. AIG, the world’s biggest insurer, was on the brink of collapse. Washington could not let AIG fail because it would have triggered a terrifying financial unravelling across the world. AIG, founded in Shanghai, owned substantial businesses. Most importantly, a huge financial markets business, with big operations selling products called credit default swaps, effectively writing insurance policies against other companies’ bankruptcies. In September 2008, it controlled assets worth $1 trillion. By the end of Monday, Washington had bailed AIG out with $85 billion and taken control of a 79.9 per cent stake.
In London, Sir Victor Blank, venerable chairman of Lloyds TSB, was signing a deal to bail out HBOS. After a run on HBOS shares, the British Government agreed to waive all competition rules and allow Lloyds to buy the bank, grabbing a third of the UK mortgage and savings market in one go. The deal went through but the strain of assuming HBOS’s bad debts on the healthier Lloyds became unsustainable. The transaction bought HBOS only a month before it needed to be bailed out.
The US Treasury Secretary became convinced that the whole banking system was vulnerable and came up with a plan three days later to rescue everybody. He proposed setting up a bailout fund into which $700 billion of taxpayer money would be pumped to buy lenders’ bad debts so the banks would start trusting each other again and start lending. Despite all-night talks during which politicians were ordered to leave their BlackBerries outside and Mr Paulson went down on one knee to beg Nancy Pelosi, the leader of the House of Representatives, to be sympathetic, it failed. On September 29, Congress blocked the creation of the fund and the markets slumped.
Mr Paulson’s counterparts on the other side of the Atlantic were also having a bad day. Having sought to secure HBOS days before, the Chancellor was forced to announce that Bradford & Bingley was to be nationalised and made the British taxpayer take control of £50 billion of its mortgages. To make matters worse, Iceland, whose own financial system was intertwined with the fate of British investors, started to collapse.
Desperate to create a fund that would help to restore some confidence in the US financial system, Mr Paulson endured new talks to persuade Washington to agree to the $700 billion rescue plan. On October 3 on the White House lawn, Mr Paulson announced his deal.
On the morning of October 7 in London a bloodbath broke out in the markets. A Treasury official phoned Mr Darling, who was in Europe at a meeting of finance ministers, to say that RBS stock was down 40 per cent, pulling the rest of the banking sector with it. A team led by the Prime Minister’s trusted aide Baroness Vadera rapidly drew up a three-point plan to provide liquidity, guaranteed funding and capital injections. They agreed a new £50,000 threshold to guarantee retail deposits. They pulled together a rescue package of £50 billion for the banking system, supplemented by another £200 billion of support. By the end of the day, five central banks including the Bank of England had cut interest rates by half a percentage point.
Had observers been in any doubt about the purpose of releasing a wall of money on the British banking system, it would have become clear to them on the morning of October 13. The Government announced that it had pumped £37 billion into RBS, Lloyds and its new business, HBOS, to prevent the three lenders collapsing and part-nationalised them.
In the months that followed Wall Street and the City proved that they had emerged from the storm. The credit crisis began to spread to other industries, such as the automotive sector. But Westminster and Washington began the process of devising long-term assistance schemes and drawing up new regulatory regimes.
Within 18 months of the height of the banking crisis, Mr Paulson and Mr Darling had both been voted out of office. In neither case because they were seen to have personally failed to deal with the worst financial crisis for almost a century, but because politically both countries had moved on. Mr Paulson’s battered mobile Motorola phone, which was used to negotiate every bail-out, is now an artefact in the Smithsonian Institute. Observers may hope that the banking crisis is contained, if not consigned, to history.
Suzy Jagger covered the American sub-prime crisis as US Business Correspondent until February 2009.
Angus Macleod
Scottish Political Editor
Within the 2005 general election there lay a warning for Labour north of the Border that went largely unheeded. The party in Scotland, as everywhere else in Britain, had benefited for years from the Tony Blair “Big Tent” approach to building support across voter categories and divides. Yet, as opposition to the Iraq War lingered, that essential coalition of interests showed signs of breaking up in Scotland. Suddenly, middle-class Scottish voters who had supported the party since the mid-90s were increasingly exasperated and bitter. While its Scottish working-class heartlands stayed loyal, less committed Labour voters turned to the anti-war Liberal Democrats and SNP, to voice their dissent. Urban seats in Glasgow, Edinburgh, Aberdeen and throughout Scotland’s central belt, while still returning Labour MPs, had become highly marginal.
If there was disillusion with Labour at UK level, the same was true at the Scottish Parliament. Devolution