The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (24 page)

Diamond even precision-timed with fellow Barclays executive Gary Hoffman, the other dignitary handing out the prizes, to avoid having to hand Ronaldo his winner’s medal. So, having gained Hoffman’s agreement, Diamond counted down the line of multimillionaire footballers and timed it so that he would give Wayne Rooney his medal, not Ronaldo. It almost worked – until Ronaldo, wearing a shirt with the letters ‘AIG’ across his chest, swapped places in the line and gave Diamond a humble thank you for his first Premier League champions’ medal. Diamond gave him an awkward couple of pats on the shoulder. A brief encounter between the King of British Football and the King of British Banking.

May 2007 was pretty much the end of the long peacetime for British banking. Events had been set in train that would lead to the collapse of hedge funds, the collapse of investment banks, the collapse of lending to banks, the collapse of Northern Rock, and eventually the collapse of half the UK banking system. The conventional high-street banking crises, epitomised by the bank run on Northern Rock, was the most visible manifestation of failure in UK banking. But there were twin crises in Britain, centred on the City of London. The one most commonly read about in the news, and another, just as important, in the invisible banking system. So May 2007 was also the high watermark of what would become known as the ‘shadow banking’ system – a parallel international system of loans, lending, creditors and debtors that operated on low levels of capital, and had few of the safety systems of the conventional banking system. This shadow system was global, and spewed out credit, profits and bonuses and became intertwined with the raciest elements of the conventional system in Britain – until its collapse.

Bob Diamond found himself at Old Trafford because Barclays Bank sponsored the English Premier League. Diamond was then chief executive of Barclays Corporate and Investment Banking and Wealth Management. But the Premier League sponsorship was not about Barclays’ high-rolling casino arm. The bank had inherited the sponsorship from Barclaycard, the bank’s pioneering but separately run credit-card unit. In 2001 football was part of a conscious effort to get the Barclays credit card away from its up-market image and into the hands of every Briton, even those classified as ‘near-prime’. It was an effort to increase the use of credit cards in the UK from one in twenty-five transactions closer to the one in four seen in the USA. Less than half of Britons had credit cards, versus 70 per cent in the USA. The answer was ‘risk-based pricing’: Barclays dropped its credit standards and offered cards to some of the 700,000 applicants turned down every year, in return, eventually, for higher interest rates. It did not end well.

Arrears surged. Bad debts mounted. Punters lured by a combination of football and fleetingly free credit could not afford to repay Barclaycard’s famously high rates of interest. Yet Barclay’s then chief executive was also admitting that he would not advise his own children to pay the high rate of interest on his bank’s own cards.

Barclaycard’s ‘near-prime’ strategy went into rapid retreat. Insiders say this was part of the reason that Barclays decided to take on football sponsorship at corporate level. And that’s why, a few years later, Bob Diamond found himself scheming to avoid the world’s best football player. But Diamond’s presence also marked something much more important. He was at Old Trafford because Barclays got burnt by consumer credit very early in the consumer-credit binge. In those early days, it also got burnt by its mortgage lending. In 1990–91 Barclays needed to tap shareholders twice for new capital, after the crash in property values. Prior to the crash, it had been all too eager to offer mortgages to all and sundry, in an effort to win market share from NatWest (itself later bought by Royal Bank of Scotland).

‘The 1990s were regarded as seminal in a bad way,’ one senior insider told me. ‘Barclays got it so long on property and so wrong in property that it was seared into the consciousness of the corporation never to let that happen again.’ In the subsequent boom of the 2000s, the property exposure of its global bank-loan portfolio was below 8 per cent. On this score at least, Barclays had become extremely cautious, although, as we shall see, this is not the full story – particularly in relation to Mr Diamond. But in the great British credit bubble, in most areas of mortgage finance, consumer credit and property-development funding, Barclays let other British banks make the running. For almost all of the competitors who chose to take up the slack, it proved fatal. For Barclays, it was the first of many dodged bullets. And this dodged bullet would in the end have a very important role to play as large swathes of the British banking system collapsed into the hands of the state.

Through the early autumn of 2008, Britain’s most exclusive dining club would convene in an upstairs room at Number 11 Downing Street. Here they were confronted with the mortality of the banks they represented. However, many seemed more concerned with the preservation of the status quo and their own pay packets than the imminent collapse of the UK’s cash-machine network. With the benefit of hindsight, one could pinpoint these dinners as missed opportunities, when the relationship between Britain and its banks could have been fundamentally reshaped.

At one such dinner Chancellor of the Exchequer Alistair Darling told his guests that the entire British banking system was going the way of Northern Rock a year before, and Bradford & Bingley a few weeks previously. If necessary, he said, he would nationalise the major banks.

Fred Goodwin of the Royal Bank of Scotland sat underneath a painting entitled
Death’s Head
. Next to him sat Barclays’ John Varley, the tall patrician chief executive who, according to the City folklore, reined in Bob Diamond’s aggressive investment-banking style. António Horta Osório represented Santander, the Spanish bank that had swallowed struggling areas of British high-street banking, including Abbey, Alliance & Leicester and, days before, the remains of Bradford & Bingley. All were overstretched demutualised building societies. Alistair Darling wrote that Horta Osório ‘took care to sit well away from the centre of the table’. Graham Beale represented Nationwide, a rare success, the big beast of the surviving building societies. Peter Sands or Richard Meddings came on behalf of Standard Chartered, which had helped shape the UK recapitalisation at its offices in the City. Dyfrig John or Douglas Flint attended for HSBC; like Sands, they ran an Asia-focused bank headquartered in the UK and did not require any government capital. Lastly, representing Lloyds TSB, there was Eric Daniels, who, according to the chancellor’s book on the crisis, ‘had presumably by now had the opportunity to open the books to the horrors of what he had bought’ after a government-aided merger with HBoS. HBoS chief executive Andy Hornby was at some of the meetings, and the ghost of ex-chief executive James Crosby lurked somewhere close to Mr Daniels, in hellish chains of property debt. The banks had been given secret Treasury codenames since the beginning of the crisis, either an animal or a planet or on one occassion a dead rockstar. The Badger had already been trapped. Elvis lived, but only in state ownership. The Phoenix was not going to rise again. And the Tiger had been tamed with some help from Spain.

The RBS chief executive led the delegation from the first dinner. Uniquely, Sir Fred, as he then was, actually signed off the bulk of Scotland’s banknotes. RBS, alongside Bank of Scotland and Clydesdale Bank, continued to issue bespoke Scottish notes backed by deposits at the Bank of England. If they were really lucky, Sir Fred’s sporting heroes, sponsored by RBS, got to feature on a commemorative note. Lord Myners, a Treasury minister at the table, would later tell Parliament that at RBS’s futuristic Gogarburn HQ a man was employed to ensure that only notes with Sir Fred’s signature should be stocked in the cash machines (RBS denies this). Here was a man who not only ran the world’s sixth largest bank, but who could also delude himself that he ran his own currency. Indeed, his bank had assets of £2.2 trillion, one and half times the size of the UK’s annual GDP. The UK’s assets were still far bigger, but if any bank was too big to fail, it was RBS. Perhaps that is why Sir Fred remained defiant to the end, despite admitting that his bank was entirely reliant on the day-to-day life support of overnight borrowing from the Bank of England. Delusion and denial were combined with a knowledge that an uncontrolled collapse of RBS would wreak havoc across the nation.

The chancellor had been concerned about RBS, codenamed Phoenix, ever since Sir Fred, like a particularly depressed carol singer, had appeared uninvited at the door of Darling’s Edinburgh house the previous Christmas, carrying a wrapped panettone as a present. At this point Sir Fred had probably begun to digest the sheer insanity of RBS’s cash purchase of ABN Amro, which had gone through after the credit crisis began – and without RBS seeing the Dutch bank’s books. Sir Fred had arranged a consortium of international banks to mount a hostile takeover that snatched the bank from an approved deal with Barclays. The Scottish bank was hailed by the press and by the Scottish first minister, Alex Salmond, for its daring deal-making. But rival chief executives were troubled. ‘If you look at the RBS accounts in ’08 and ’09,’ one chief executive told me, ‘there’s this big lump in it, which is basically an unexplained set of things which is ABN. How anybody had any idea of what was going on… We couldn’t work it out.’ The original motive for the purchase of ABN was to get hold of the bank’s successful US unit, La Salle. Strangely, even after La Salle was sold to Bank of America, RBS was still just as keen to buy. RBS also left the booming and very profitable South American parts of ABN Amro to Santander. The remaining core of the company was chock-full of toxic derivative waste. As the takeover was hostile, Sir Fred would not even have had the chance to find out if the deal was good or bad. As it turned out, it was fatal. Barclays’ guardian angel, meanwhile, had saved it from buying ABN.

Back around the table at Number 11, on Monday, 7 October 2008, RBS was just hours from running out of money to put in its cash machines. An anonymous press briefing – blamed by ministers on bankers – suggested that all the banks around the table were in trouble and had asked for capital, not just RBS and HBoS. A similarly false rumour had emerged earlier in the year about recapitalisations. On the morning of 8 October there was blind panic in trading of shares of UK banks, and RBS in particular. There were also large corporate withdrawals from RBS bank accounts. An executive recalls that even sophisticated investors made errors. One man withdrew £50,000 from the Bishopsgate branch in the City of London, but then redeposited it in a NatWest around the corner – essentially the same bank. Alistair Darling broke off from a Luxembourg finance ministers’ meeting and flew home on an RAF plane to deal with the crisis. The government’s recapitalisation plan had to be brought forward. RBS took a somewhat aggressive stance, even with the Bank of England, which was trying to help it. The central bank’s Special Liquidity Scheme was meant to trade cheap funding strictly for then illiquid and untradeable bundles of British homeowner mortgages. RBS attempted to cash in a bundle of debts which on close inspection included a Spanish car park. The bank had built up a property portfolio that extended as far as the USA, where its assets embraced a cemetery in the Deep South and a golf course dozens of miles from the nearest road. It is a grand fallacy that RBS tripped over simply because of the calamitous takeover of ABN Amro. RBS was hugely outcompeting other banks on commercial deals, and on property. ‘We were losing a lot of business to RBS and HBoS,’ another UK bank chief executive told me. ‘I certainly remember saying to my guys “When are we going to see RBS and HBoS trip up, because trip up they must?”’ RBS’s global exposure to property at the peak of the crisis was 33 per cent of its total loan book. A reconstruction using the latest capital standards of RBS’s balance sheet at the time it bought ABN Amro, by regulators, revealed a capital ratio of just 2 per cent. Competitors were flabbergasted that the FSA waved through the ABN Amro purchase. But RBS might have failed in any event.

Perhaps the regulators should have paid more attention in 2003 when RBS offered a gold credit card with a £10,000 credit limit to Monty Slater from Stockport, Cheshire. It wasn’t just that Monty could not afford to repay, nor even that he had not asked for the card. Monty was a dog, targeted by a consumer database. The story was treated as an amusing boom-time banking distraction. Actually it was a vivid example of how the essential bond between bank and borrower was breaking. The banks did not know what they were lending, nor to whom. Indeed, by 2008 a Shih Tzu might have ranked as one of RBS’s more solvent debtors.

For an artificial hill, the Mound in Edinburgh, dominated by the Assembly Hall of the Church of Scotland, has seen its fair share of history. The ‘Sermon on the Mound’, in which Margaret Thatcher addressed the Kirk’s 1988 General Assembly, is widely believed to be the moment that the prime minister proclaimed, ‘There is no such thing as society.’ That quote actually came from an earlier interview with a women’s magazine. But in her speech to the General Assembly she presented a philosophical and theological justification for her ideas on free markets and capitalism. Perhaps she would have received a less frosty reception at the neighbouring Mound headquarters of another venerable Scottish institution – the Bank of Scotland. Certainly it was during the Thatcher era that BoS embarked on a lending boom that over the following two decades grew at 20 per cent per year. But it lacked a commensurate growth in its deposit base. The problem was temporarily solved by access to high finance, the so-called wholesale markets, but those did not even cover half of its lending. To fill the strategic gap, in 1999 BoS tried to buy NatWest, a bank double its own size, but lost out to RBS. A deal with Abbey seemed on the cards, but fell through. In 2001, on the rebound, BoS hosted talks that would lead to the creation of Halifax Bank of Scotland (HBoS), and the end of three centuries of independence. Halifax’s 11 million savers would fill some of the deposit gap, and BoS’s then conservative commercial lending teams would find the companies to fund. What could go wrong?