At 4.18pm on Monday the monitors in Alistair Darling’s outer office at the
Treasury showed the Alliance & Leicester share price at 685p.
Six minutes later it was 586p and falling. TV images showed investors queueing
around the block outside Northern Rock branches.
The first run on a British bank in a generation was threatening to turn into a
full-scale stampede that could wipe out up to three high-street banks.
Slightly over an hour later Mr Darling was standing in the State Room in No
11 saying that he wanted to “put beyond doubt” the safety of deposits at
Northern Rock. Journalists couldn’t help notice his hands were shaking.
Just seven weeks into his new job as Chancellor Mr Darling has endured one of
the the worst crises on Britain’s financial markets since Black Wednesday.
Not surprisingly, questions are being asked in No 11 about how this
near-disaster came to pass.
At 9.45am today in a Commons meeting room Mervyn King, the Governor of the
Bank of England, will be required to provide answers. Mr Darling has
pointedly failed to say he has confidence in Mr King and senior figures do
little to discourage speculation that his job, up for renewal next year, is
on the line. The fallout from the “Run on the Rock” is heading firmly in the
Bank’s direction.
Untangling the chain of events that led to “Black Monday” begins on August 8
and a warning from Mr King to banks glancing nervously at the credit crisis
in the US. “We are certainly not going to protect people from unwise lending
decisions that they have made before,” the Governor said.
When the next day central banks in Europe and the US began injecting billions
of dollars and euros into the banking system, the Bank of England declined
to follow suit.
Mr King, together with his director for markets, Paul Tucker, believed that
the problems were of the banks’ own making. Relaxing the rules in a crisis
would only make matters worse next time around.
Complaints from the big banks at this hair-shirt policy were received with
growing sympathy by the Financial Services Authority, set up by Gordon Brown
ten years ago to supervise the banking industry. But, as the consequences of
the collapse of the sub-prime mortgage market rippled out from the US,
Threadneedle Street maintained an aloof silence.
Bank insiders now concede that more should have been done at this point. They
blame holidays and bureaucratic inertia for a failure to see how specks of
trouble on the horizon were beginning to mass.
In particular they admit that Mr King should have put aside his normal
reluctance to provide a running commentary on the markets for the media, and
make his position clear much sooner. He needed to spell out the principles
of bail-outs that seek to underpin financial stability without protecting
the greedy from their own recklessness. The distinction became alarmingly
live when on September 5 Northern Rock alerted the FSA that it was running
out of money.
Sir Callum McCarthy, the FSA chairman, faced questions over why his
organisation had not seen that the business model pursued by Northern Rock
was so exposed to the risk of a sudden reduction in cheap credit. There was
little time for recrimination, however, as behind the scenes the FSA, the
Bank and the Treasury began to plan to avert a collapse.
The obvious solution was for Northern Rock to be sold to another bank and
talks were opened with Lloyds TSB. Here, Mr King is said by his critics to
have made his second serious mistake, turning down a request by Lloyds to
provide assurances that it would help back it up if the market got worse
still. The Governor refused and Lloyds walked away on September 10.
The request threw into sharp relief what the Bank could or should do. It had
two options; it could agree to act as a lender of last resort – throwing
Northern Rock a credit life-line, although at a penalising rate – or it
could go further and announce that it was guaranteeing to honour 100 per
cent of the value of its deposits.
Mr King’s allies say that he rejected Lloyds TSB’s request because it wouldn’t
have worked without a full-scale guarantee. Because it is a public company
Northen Rock’s troubles would have to be disclosed as part of its sale –
triggering just the run everybody wanted to avoid. A full guarantee amounted
to a commitment to take Northern Rock into public ownership with little
legal backing.
Belatedly Mr King sought a way he could spell out the principles that would
guide whatever action was taken. It was arranged that he would write a
letter to the Treasury Select Committee setting out in general terms what
could be done to ensure stability. This was the document that would return
to haunt him.
What was picked up was aggressive rhetoric from Mr King on “moral hazard”.
Pumping more cash into the system now would only “sow the seeds” for future
trouble, he wrote.
It remains perplexing why the Governor should strike such a pose when he knew
that Northern Rock was in negotiations for the lender of last resort option.
At the very least, the letter was presentationally unwise. “Mervyn is an
academic first, a banker second and a politician third,” a Whitehall figure
said.
More media-handling errors were to follow when on Thursday Robert Peston, the
BBC’s business editor, revealed the Northern Rock bail-out. In fact
negotiations were still going on – they weren’t finalised until 3am on
Friday – but the cat was now out of the bag. The view from Threadneedle
Street is that ministers should have seized the initiative at this point.
Instead Mr Darling, in Portugal for a meeting of EU finance ministers, spent
Friday morning hoping that news of the intervention wouldn’t trigger panic.
At 11am Downing Street caused consernation by briefing lobby journalists that
“facilities are in place to ensure support” for Northern Rock savers. The
Treasury knew that this went further than the line agreed with Mr King and
told No 10 to be more careful. As reports circulated that queues of worried
savers were forming at cash machines, Mr Darling cut short his trip and
headed home.
Over at the FSA in Canary Wharf, London, Sir Callum McCarthy had identified a
problem with the attempts to reassure savers. The Financial Compensation
Scheme only underwrites £31,700 of savings and takes months to pay out. In
such circumstances it was hard to say that the Rock’s savers were behaving
irrationally in wanting their money out. If the Government briefed that it
was considering improving the scheme then that would only fuel the panic.
Instead Mr Darling – not Mr King – took to the airwaves to stress that
savers could take their money out if they wished. It was a reassurance, of
course, designed to have the opposite effect.
On Saturday the Chancellor returned to the Edinburgh home he shares with his
wife, Maggie, while Mr King retreated to an oast house in Kent. The pair
kept in almost constant touch. In between political firefighting the
Chancellor and the Governor discussed whether a guarantee would be necessary.
The decision to underwrite 100 per cent of savers’ funds was taken in
principle on Sunday. Government insiders say that the Bank was neither
“pushing nor pulling” but was content for Mr Darling to take the final
decision.
It seems that it was decided to hold back to test the mood of the market. As
Monday dawned Mr Darling gave interviews saying that savers would be
protected with “whatever it takes” but stopped short of giving the
guarantee. “It is, I’m afraid, yes,” Mr Darling said when he was asked
whether his job was on the line.
The news was grim: queues were lengthening as the limitations of the
compensation scheme became obvious and panic spread. The reassurances may
have had more force in the mouth of Mr King himself. Asked whether the
Governor should have engaged more publicly with the crisis, a senior
Whitehall source said: “Mervyn was very difficult.”
Whatever doubts there were about issuing a guarantee evaporated shortly after
Monday lunchtime when the share price of other banks, notably Alliance &
Leicester and Bradford & Bingley, began to slide. The whole banking
system was in peril unless confidence was restored.
“I want to put the matter beyond doubt,” Mr Darling, his nervousness obvious,
said. “In the current market circumstances, and because of the importance I
place on maintaining a stable banking system and public confidence in it, I
can announce today that following discussions with the Governor and the
chairman of the FSA, should it be necessary, we, with the Bank of England,
would put in place arrangements that would guarantee all the existing
deposits in Northern Rock during the current liability in the financial
markets.”
An option floated more than ten days earlier had finally been taken.
Critics say that had it been given before September 10 the sale to Lloyds TSB
might have proceeded without a hitch and with no crisis.
The FSA clearly believes that had Mr King not been hung on his own rhetoric
over “moral hazard” he could have eased the pressure on the system before
Northern Rock got into trouble. The Bank is also blamed for being
obstructive over the takeover and Mr King for refusing to provide
reassurances in his own mouth on Friday.
With the Bank pumping in £10 billion to kickstart the credit market and
Northern Rock’s board celebrating a great escape, the Governor’s high-minded
words in his letter to the Treasury Committee look ever more unwise. Michael
Fallon, senior Tory MP on the committee, suggests that Mr King is in for an
uncomfortable time in Portcullis House today.
“Normally we are quite respectful,” Mr Fallon said. “But when you have a
situation where no one appears to believe the Chancellor, the Governor of
the Bank of England nor the head of the FSA, and where people are queueing
around the block like Zimba-bwe, something has clearly gone very wrong.”
In the line of fire
Mervyn King, 59, Governor of the Bank of England
— A grammar school boy, he went up to King’s, Cambridge, and won
a Kennedy scholarship to Harvard. Academic spells at St John’s College,
Cambridge, the University of Birmingham and the LSE followed.
— He joined the Bank of England as a nonexecutive director in 1991,
before a seven-year stint as its chief economist. As a founder member of the
Bank’s Monetary Policy Committee he has earned a reputation as a hawk. He
became governor in 2003.
— He has a surprisingly sharp tongue. He once told an MP on a
cross-party committee who suggested he change his economic outlook to ensure
he reached the Bank’s top job: “The cynicism of politicians is not something
you should visit on everyone else. I look forward one day to an apology”
Sir Callum McCarthy, 63, chairman of the FSA
— An economist by training, he graduated from Oxford and, later,
Stanford University’s School of Business
— He worked in the chemical industry before moving to the Department for
Trade and Industry. He left for a career in finance, rising to CEO of
Barclay’s North American operations. In 1999 he became director-general of
Ofgem, and succeeded Howard Davies at the FSA in 2003
— If any single figure has incurred the wrath of the general public over
the Northern Rock affair, he has. Branding the thousands of customers
queueing to withdraw deposits “irrational” will have won him few friends
Alistair Darling, 54, Chancellor of the Exchequer
— Educated at Loretto, the boarding school, he studied law at Aberdeen
and practised as a solicitor between 1978 and 1984
— He was first elected to represent Edinburgh Central in 1987. Within a
year he was spokesman on home affairs, and then frontbench spokesman on the
City and economic affairs. On Labour’s 1997 victory he became Chief
Secretary to the Treasury and was soon promoted to the Cabinet as Secretary
of State for Social Security, later becoming Trade Secretary and Transport
Secretary
