As Sir Fred Goodwin sipped champagne in the House of Lords five weeks ago, he looked like a man in control of his destiny.

The Royal Bank of Scotland chief executive was one of a number of senior City figures who had been invited to a reception. Although the credit crisis was swarming all around him, with Bear Stearns having collapsed just days earlier, Goodwin seemed unperturbed.

He had been telling his shareholders that RBS’s balance sheet was in a good state of repair, succesfully killing off speculation that he would have to raise new capital through a fire sale of assets or a heavily discounted rights issue.

Two weeks is a long time in business, though. UBS only had to announce $19 billion (£9.5 billion) of additional write-downs on its American mortgage holdings and Goodwin’s view of life changed for the worse.

The Swiss bank had been significantly more conservative in its valuations of the positions than anyone had expected. Goodwin realised that, if RBS were to value its own book on the same principles, he could be in trouble.

Meanwhile, all of the world’s biggest banks were coming under pressure to stop the economy from sliding into recession. While central bankers were indicating that they were willing to help bail out the banking system, the implicit understanding was that the banks had to do their bit by rebuilding their capital bases and disclosing their losses at the earliest opportunity.

This was the message of last weekend’s meeting of G7 finance ministers and central bankers in Washington. And, while insiders deny any direct linkage between RBS and the Bank of England’s rescue package to be unveiled this week – “There was no quid pro quo,” said one source – the mood had shifted.

Both Mervyn King, governor of the Bank of England and Ben Bernanke, chairman of the US Federal Reserve, have made clear that bank shareholders, not taxpayers, should bear the burden of adjustment.

Goodwin knew that he would have to launch a multi-billion pound rights issue, whether he wanted to or not. He had tested his relations with the City through his acquisition of ABN Amro’s investment-banking business. Now he would have to put his reputation on the line once again. Plans for a £10-12 billion rights issue will be unveiled early this week.

“Once the UBS numbers came out, it was clear to the board that their situation was a little more difficult than they had thought,” said one insider.

“It may seem perverse to say so, but this is actually good news,” said one City grandee. “If we are going to move on from all this, banks need to recapitalise and get money flowing into the real economy.”

That is now the priority. AT 7.15 on Tuesday morning, the limousines began to pull up outside 10 Downing Street, dropping off Britain’s top bankers. They had been summoned for a meeting, originally intended to provide Gordon Brown with an update on the situation in Britain’s banking and financial markets ahead of his trip to Wall Street.

Everybody present knew, however, that what started life as a routine get-together, said by Downing Street to have been put in the diary some months ago, had turned into a crisis summit, to discuss the continuing impact of the credit crunch, particularly on the mortgage market.

Brown, who for the first time had faced questions about his leadership, was keenly aware that recession and tumbling house prices had killed the Conservatives’ reputation for economic competence in the early 1990s. Unless the downward spiral generated by the credit crunch was halted, Brown could go the same way.

John Varley from Barclays, RBS’s Goodwin, Andy Hornby from HBOS, Lloyds TSB’s Eric Daniels and Michael Geoghegan of HSBC were joined by about 30 other senior City figures.

After being met at the door of No 10 by Sir Gus O’Donnell, the cabinet secretary, they were shepherded to a room on the first floor and placed around a large table.

The prime minister sat down with O’Donnell on his left and Shriti Vadera, a former City banker and long-standing Brown adviser, now a minister in the Department for Business Enterprise & Regulatory Reform, on the right. Vadera has a reputation for rubbing people up the wrong way. Not on this occasion.

Brown picked a rhubarb yoghurt from a selection passed round the table, and asked Varley to kick off the debate.

Ever the diplomat, the Barclays chief executive thanked the prime minister on behalf of all those present for the opportunity to talk.

Life was tough, he said. Very tough. But Barclays was still lending money to homebuyers – and gaining market share. Varley passed to Goodwin, who painted a similar picture. He was followed by Hornby, who was equally downbeat.

As the bacon and eggs appeared, it fell to HSBC’s Geoghegan to say his piece. Compared with credit crises he had witnessed elsewhere in the world, Geoghegan said, Britain’s problems are nothing to get too excited about. If banks were suffering, it was up to their shareholders to bail them out – not governments.

The mood began to change. Goodwin countered some of his points, butting in.

“Mike seemed to be suggesting that some institutions should be allowed to fail,” said one industry source. “But many of those institutions who could face problems were sitting round the table.”

Brown’s questions gave a clear indication that the government was willing to help find a solution – and to encourage the Bank of England to think likewise.

“Gordon clearly understood what he was talking about in intimate detail,” said one of the bankers present.

“But you can’t help but feel that if Blair was still in power he would have done something by now, and would have had less of a chip on his shoulder about helping out banks.”

Comparisons with Blair rankle with Brown. Lord Desai, the economist and Labour peer described Brown as “a worrier with an academic approach to solving problems” who was “put on earth to remind people how good Tony Blair was”.

But Brown insisted that he was fully engaged in seeking a solution to the crisis.

“I’m not complacent and I will always be vigilant,” he said. “I wake up in the morning thinking what can we do to help homeowners, to help those people who have small businesses, people looking for jobs, and people wanting opportunities so they can have better jobs for the future.”

Brown’s concern was how to ensure that money pumped into bank balance sheets would make its way through to the areas of the economy that the government wanted to stimulate – the housing market, and particularly access to cash for first-time buyers.

Some of the investment bankers round the table pointed out that this was impossible – there was no way to govern it. Bruce Wasserstein from Lazard and David Soanes of UBS were particularly vocal on this point.

Antonio Horta-Osorio, the chief executive of Abbey, then left Brown with some stark choices. If you want the big banks to end up with 100% of the UK mortgage market, the straight-talking Spaniard said, then do nothing. If you want choice in the market – and for building societies to survive – then the government would have to do something.

Not only that, but if Brown wanted interbank lending rates to fall back toward the Bank rate, he would have to ensure that the Bank of England pumped liquidity into the system. If he didn’t care about this, he added, then do nothing.

His concerns about building societies were echoed by Graham Beale, chief executive of Nationwide. Beale stressed the importance of ensuring that any attempts to pump liquidity into the markets would have to use a mechanism that worked for even the smallest societies.

Technicalities prevent smaller societies from posting their mortgage books at the Bank of England as collateral against emergency cash.

Building societies were one of the main causes of concern in last week’s meeting at No 10. Now that the world’s top banks are making an aggressive push for savers’ cash, it is becoming ever more difficult for societies to fund themselves.

The Financial Services Authority has begun to demand that building societies hold a higher proportion of cash on their balance sheets, it has emerged. Billions of pounds that could be lent to the housing market are being held back on building society balance sheets.

The regulator is now insisting that all societies hold cash equivalent to at least 20% of their deposits, according to industry sources. Some societies have been told to hold sums equivalent to as much as 35% of their savings book in cash, advisers say. This ratio had previously been in the mid-teens.

Recent accounts filed by several building societies show a huge leap in the value of cash deposits they have lodged with the Bank of England. Yorkshire Building Society had almost £400m lodged with the bank at the end of 2007, compared with £2.3m at the end of 2006. Britannia, Britain’s second-biggest building society, had £513m on deposit with the bank at year end, up from £7.3m a year earlier. The much smaller Coventry Building Society had deposited £128m with the Bank, as opposed to only £1.4m at the end of 2006.

Analysts say the huge surge in cash balances provides evidence of the regulator’s tough new stance. It is estimated that the new requirements may have removed as much as £20 billion from the financial system – money that could have been lent to homeowners.

The Downing Street discussions ended at about 9am, with little by way of a solution. “The eggs were a bit overpoached, the bacon was overdone too,” said one of the bankers attending. “I guess it goes to show that not everything in Downing Street is half-baked.”

Brown said the situation required an international approach and he would consult with Wall Street’s banks during his trip to America.

Curiously, there were no Bank of England representatives round the Downing Street table. The Bank, however, has for weeks been working on a plan that could get the banks, and the government, through the crisis.

Although speculation has been frenzied about this week’s announcement from the Bank, Threadneedle Street has maintained a stony silence, even amid suggestions that it is merely carrying out Treasury orders.

The truth is that King, the governor, has been leading a team of officials devising the Bank’s response to the crisis for several weeks. King set out the outlines of the plan last month when he gave evidence to the Commons Treasury committee.

“Two principles would underlie any central bank role,” he said.

“First, the risk of losses on their lending should remain with banks’ shareholders. The banks neither need nor want the taxpayer to insure them against these losses.

“Second, a longer-term solution must focus on the overhang of assets and not subsidise issues of new assets.”

The scheme, it is clear, will involve the banks swapping their mortgage-backed securities for gilts – government bonds – for a period of one to three years, a “term liquidity facility”.

Ownership of the securities would remain with the banks, and thus off the government’s balance sheet. New gilts would be issued by the Treasury’s Debt Management Office to provide the Bank’s side of the swap.

The scale of the rescue plan will be considerable, with estimates suggesting as much as £100 billion, but Simon Ward, an economist with New Star Asset Management said this seemed “excessive”.

“The UK swap facility should be £44 billion to equate total UK and US support,” he said.

Suggestions that the Bank should wash its hands of the problem were wide of the mark, he added. “I think they should be working on the whole range of options,” he said.

Peter Spencer, economic adviser to the Ernst & Young Item club, agreed on the need for action.

“We are very concerned about the risk of overshooting markets,” he said. Borrowing in the gilts market was still relatively cheap, he said, and was the right way to proceed.

“The concern is that this will be all about just helping the big boys,” he added. “Why not complement it by pumping some money directly to the building societies?”

Spencer thinks that if the rescue plan works it could make his gloomy prediction for the economy next year, with growth slowing to just 1.5% unduly pessimistic. “If it does the job, things could look a lot better next year,” he said.

David Miles at Morgan Stanley said: “Any government intervention in the markets would provide valuable time for the banks to find new ‘cash’ buyers of their debt. However, in the near term it is unlikely that government intervention would change banks’ behaviour and encourage them to lend, given that the macro outlook has changed the underwriting appetite.”

The stakes are high. On his prediction of a 15% fall in house prices over the next two years, the early 1990s’ curse of negative equity would return with a vengeance, with some 1.2m households with mortgages seeing their house values drop below the level of their home loans.

The woes are not confined to the housing market. City firms that specialise in rescuing struggling companies are beefing up their teams of advisers in anticipation of a record number of business failures this year.

The environment for UK business owners could become more difficult than it has been for the last 15 years, and restructuring experts are in high demand.

“We expect it to get as bad as the last recessionary period of 1989 to 1993. We’ve hired more than 100 people in the past year and the pace has stepped up enormously over the last few months,” said Dermot Power, partner in the business restructuring practice at BDO Stoy Hayward.

Experts are warning that the number of businesses going under is likely to surpass that seen after the 2001 dotcom crash and, if the economy worsens, business failures could equal those during the recession of the early 1990s.

Accountancy firm Ernst & Young has been preparing for a busy year helping business owners. Its restructuring team has been expanded by more than 25% over the past 12 months to a team of 300.

“This is a tougher downturn than 2001 and it could potentially be carnage. This time it’s across a swathe of sectors and industries from retail and consumer, to property, construction and homeware,” said Alan Hudson, restructuring partner at Ernst & Young.

New figures show that British companies are already finding 2008 much tougher than last year. The first quarter has seen 4,798 businesses fail, according to data from Experian Business Strategies – an increase of 8.5% from the previous quarter and the first recorded increase since 2006.

This weekend details are being finalised for the rescue plan to allow banks to swap their mortgage-backed securities for gilts. The swap is likely to be for about £50 billion of mortgage-backed securities, to run for just over a year. By then, the Bank and the Treasury hope, credit markets will be returning to some kind of normality. That is the big question, in London and on Wall Street.

Some of the biggest names in New York are claiming that the credit crunch is winding down but are giving mixed signals about how long it will be before the financial crisis can be declared over.

Jamie Dimon, chief executive of JP Morgan Chase, said: “I do think we are more than half way through – maybe 75% to 80% through.”

But asked when he thought the markets would turn, Dimon said: “We simply don’t know. There are some good signs and some bad signs.”

Richard Fuld, chief executive of Lehman Brothers, told shareholders at the bank’s annual meeting that “the worst of the impact of the financial markets is behind us”, before adding “the current environment will remain challenging”.

Earlier this month Lloyd Blankfein, chief executive of Goldman Sachs, reached for the metaphors to clarify his cautiously optimistic view. “We’re closer to the end than the beginning. We are getting to that point where people are seeing the light at the end of the tunnel,” he told shareholders at Goldman’s annual meeting.

After announcing huge lay-offs and knocking $6.6 billion (£3.3 billion) off the value of Merrill Lynch’s assets last week, John Thain, the firm’s chief executive, called the last three months “as difficult a quarter as I’ve seen in 30 years on Wall Street”.

“We are planning for a slower and more difficult next couple of months . . . and probably next couple of quarters,” he added.

The light may be at the end of the tunnel but it is flickering.

JOBS CARNAGE ON WALL ST

Even the job market experts are having difficulty keeping up with the number of layoffs on Wall Street.

In just two days last week, 12,000 jobs were cut at Merrill Lynch and Citigroup, and thousands more are under threat.

“Every time we think it’s going to level off, we get another big cut,” said James Pedderson of the employment consultant Challenger, Gray & Christmas, publisher of widely followed job statistics.

The company’s figures are having to be constantly revised.

“You probably have to go back to 2001 to see anything like this,” said Pedderson.

Last year the sub-prime mortgage crisis and the collapse of the credit markets led to a record 153,105 layoffs in the American financial-services industry, according to Challenger. In the first three months of this year 26,719 jobs have been axed.

With a quarter of the year gone, the figure could be taken to suggest that the pace of losses has slowed. But it’s too early to call the bottom yet, said Pedderson.

“If bank earnings keep suffering, they will keep cutting. It’s not over yet,” he said.

In London, the estimates of eventual City job losses range from 20,000 to 40,000. On a single day last week, 1,300 job cuts were announced at UBS and Merrill.

Wall Street has been busy retrenching in recent months. Merrill announced 3,000 new job cuts last week on top of 1,000 it has already announced.

As many as two-thirds of Bear Stearns’ 14,000 employees may lose their jobs when JP Morgan Chase completes its takeover of the firm. Lehman Brothers is reducing its workforce by 5%. Morgan Stanley is cutting several thousand jobs. Washington Mutual is sacking 3,000 employees and UBS 2,000.

After announcing 9,000 job cuts last week, Citigroup’s chief executive Vikram Pandit said: “It is clearly feasible for us to take 10%, 15%, 20% off our cost base, especially in information technology and operations.”

That would mean tens of thousands of jobs lost worldwide for a bank that employs 370,000 people, including about 11,000 in Britain.

“It comes in spurts,” said Pedderson. “In January we had 16,000 layoffs, then it went quiet, and now we have 12,000 in two days.

“There are a lot of people out there who were making six-figure salaries that they are not making anymore.

“That’s got to be hurting the rest of the economy.”

THE ‘MARMITE’ EXECUTIVE

“THE people who win pay more than the people who don’t win,” said Sir Fred Goodwin, chief executive of Royal Bank of Scotland (RBS), after stealing ABN Amro from under Barclays’ nose.

The £49 billion cash offer for the Dutch bank from a consortium of RBS, Fortis and Santander, had always been considered pricey. The deal got bogged down in legal complications and by the time it was completed in October, the offer stood some £10 billion ahead of a rival share-based offer from Barclays.

Accusations that Goodwin and Co were overpaying were spread far and wide. The credit crisis had already reared its head – when the deal was completed, the Northern Rock debacle was a month old.

Yet nobody appreciated that the world’s largest banks were about to see their balance sheets devastated by an infection of toxic debt. In fact, the FTSE 100 gained more than 10% between the RBS consortium’s final offer being made in July 2007 and the deal’s acceptance two months later.

Some shareholders were unhappy with the deal. When RBS shareholders were asked to vote on the deal, however, 95% of them gave Goodwin their approval. Somehow, RBS managed to raise money in the credit markets to pay for its £10 billion share of the deal.

Goodwin had done it once more, securing a deal in the face of widespread criticism. But it was only a matter of time before he fell foul of his investors again.

Having insisted for months that the bank had no need to raise more capital, Goodwin will go cap in hand to his investors tomorrow morning for another £10 billion, this time just to shore up his balance sheet.

Now, more than ever, Goodwin’s head is on the block.

“It does feel like he’s walking a tightrope,” said Colin Morton at Rensburg Fund Management, one of the bank’s shareholders.

To his friends, Goodwin, 49, is an affable, Formula One motor-racing fan, who likes to tinker with old cars and play golf.

However, he does not suffer fools gladly. Goodwin is confident in his convictions and does not like to be contradicted. As a result, shareholders and analysts often alight upon the same word to sum him up: arrogant.

Several RBS shareholders have had difficulty trusting Goodwin for years, fearing that he will spend their money on acquisitions wherever possible.

He has been accused of overpaying on deals since the £5.8 billion takeover of Charter One in America in May 2004.

Lobbying from investors led to RBS handing back surplus cash from its balance sheet in dividends and share buybacks.

“Goodwin is one of these ‘Marmite’ chief executives,” said one analyst. “You either love him or hate him – there’s no middle ground.”

HOW WE GOT HERE: CHRONOLOGY OF THE CREDIT CRUNCH

Sept 13, 2007: Northern Rock seeks emergency financial support from the Bank of England. The news sparks a run on the bank.

Oct 24: Merrill Lynch announces $8.4 billion of losses and writedowns. Chief executive Stan O’Neal quits on October 30.

Nov 4: Citigroup announces a further $8-11 billion of sub-prime-related writedowns and losses. Charles Prince resigns as chairman and chief executive.

Dec 19: Morgan Stanley posts a $3.59 billion fourth-quarter loss and $9.4 billion of mortgage-related writedowns.

Jan 15, 2008: Citigroup posts its first quarterly loss because of $18.1 billion of sub-prime-related writedowns.

Jan 17: Merrill Lynch reports its worst-ever quarter, revealing about $16 billion in mortgage-related writedowns.

Feb 14: UBS says it is writing down $18 billion in bad loans.

Feb 17: The government decides to take Northern Rock into temporary public ownership.

Feb 19: Credit Suisse marks down the value of asset-backed investments by $2.8 billion. Barclays raises its 2007 write-down to £1.6 billion.

March 3: HSBC’s investment-banking arm takes a $2.1 billion write-down on sub-prime assets.

March 17: The American bank Bear Stearns, facing collapse, is bought by JP Morgan.

April 1: UBS doubles its writedowns to $37.4 billion. Chairman Marcel Ospel steps down.

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