The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (28 page)

Banks were told that they had to be in a position to hold a board meeting at a moment’s notice. Chairmen, CEOs and chief financial officers were told to stay in London so that they could attend meetings at an hour’s notice. For HBoS and RBS, the senior independent directors were also required to await the summons. The fate of the existing bosses at the two Scottish banks was already sealed.

The detail of recapitalisation deals for each bank were thrashed out individually over the weekend. RBS was first through the door at the Treasury on the Saturday afternoon. Then HBoS, and then Lloyds. Shriti Vadera picked up the phone to John Varley at Barclays: ‘We need you to know that everybody else is here,’ she told him. ‘If you wish to come in we will talk to you.’ Varley was holed up at his Canary Wharf office, refusing repeated requests from Vadera and Myners to come to the Treasury. Instead, Varley and his team waited for notification of the amount of capital required, and handled all meetings by conference call. Varley’s team sensed ‘menace’ from the Bank of England and its desire to avoid ‘moral hazard’. In his office a board member challenged Varley to convince him that refusing government capital was not simply about keeping his job. He conceded that a failure to raise private capital would see him in a difficult position. By March he had agreed to raise £7 billion, a figure he told friends was ‘seared onto his heart’.

By the end of October, Barclays had indeed paid £300 million in fees in order to acquire £7 billion of expensive capital – principally from two private investors, connected to royal families in Abu Dhabi and Qatar. So Barclays paid a huge price to avoid UK nationalisation but instead became partly owned by Gulf governments. (In 2013 the UK financial authorities were scrutinising the deal with Qatar, and it emerged that Barclays had made large loans to Qatari entities at the same time.)

The government feared that Barclays was exhibiting an ‘emotional reaction’ against government capital that might prove to be a risk to financial stability. Around the same time the Bank of England deputy governor, Paul Tucker, emailed Varley and Bob Diamond to express concern about Barclays’ high costs of funding. At some point this message was misinterpreted, down the Barclays chain of command, and the bank began to ‘lowball’ – to report artificially low funding costs for the Libor benchmark. The entire process had an air of superficiality at the time. At the Bank of England they had already nicknamed Libor ‘the rate of interest at which banks don’t lend to each other’. Other banks such as RBS were arguably more active in Libor manipulation and received a larger fine. Barclays insiders say that the main manipulation was in fact the then secret massive loans from the Bank of England providing £36.6 billion of funding to RBS and £25.4 billion to HBoS. ‘Only the government knew about that,’ said a top Barclays insider at the time. When authorities raised concern about Barclays’ Libor manipulation, the banker commented that it was mainly done ‘by you, dude’. But despite the fighting talk there was considerable concern about Barclays’ accounting for the complex derivatives and trades. A combination of this concern and public pronouncements about possible nationalisation drove Barclays’ share price down to just 47 pence. On two days between January and March 2009, Barclays’ total market capitalisation was less than £5 billion.

Myners and Vadera spent two hours questioning Bob Diamond and a colleague at the Department of Business about the accounting practices in his part of the business, the so-called trading book, which was full of derivatives and opaque securities. Many felt that Barclays had not marked various toxic assets appropriately. By 2008, Barclays balance sheet was over £2 trillion, and £1.6 trillion of that was Mr Diamond’s Barclays Capital. Barcap alone had assets worth more than the UK’s national economic output. The crucial leverage ratio was forty- three times, more than RBS (thirty times). The models used by Barclays would later be described by the FSA as ‘clearly at the aggressive end of the acceptable spectrum’. Diamond parried the inquisition.

The attention heightened anxiety at Canary Wharf. ‘I think Gordon fancied the idea of nationalising the entire banking system,’ said one Barclays board member. In turn, the government suspected that paranoid members of the board were ‘obsessed with the idea of a Labour plot to nationalise Barclays’. Even as Barclays had evaded government capital the previous October, a new danger lurked in a scheme to remove rotting assets from the banks’ balance sheets. This was the Asset Protection Scheme (APS). For a fee, paid in shares of the bank, the government would insure losses in a giant ‘bad bank’. It was designed to get banks lending into the real economy. The original deal, with RBS and HBoS, was announced in January. It was the largest financial contract signed by the British government since the Lend Lease agreement with the US government during the Second World War. Few noticed its significance at the time because, to divert attention, Number 10 leaked details of Fred Goodwin’s pension on the same day.

The question was: would Barclays sign up to the APS, and on what terms? At a likely fee of £4–5 billion, and a market capitalisation not much higher, Barclays again faced the spectre of de facto nationalisation. The key was a series of secret ‘stress tests’ of its solvency conducted by the FSA. The tests subjected the bank’s books to the impact of a severe downturn, involving 12 per cent unemployment, a 50 per cent fall in house prices, and a 60 per cent fall in commercial property prices, but this was not revealed in advance. ‘None of us was expecting them to pass,’ says one former government minister. At Barclays the view was that this was their ‘High Noon’. They had heard directly from the lips of one government minister that they were not going to pass the test. The bank was only hours from part-nationalisation, from losing its previous self-determination.

In the early hours of 27 March the first edition of the
Financial Times
appeared with the headline: ‘Fears rise Barclays will need injection’. And then, a few hours later, that had been updated to ‘Barclays’ stress test signals no new funds’ – pretty much the exact opposite. The test had not been published, indeed it never was to be published, unlike similar stress tests in the USA. But there was some truth in both headlines. In May the FSA released a statement saying that the threshold was a Core Tier 1 ratio of 4 per cent. Lloyds and RBS were to say later, however, that they were being judged at a ratio of 5 per cent. Officials suggest that banks that had already claimed government capital would require a larger buffer. The end result was that Lloyds could have achieved a greater solvency score than Barclays, despite the fact that Lloyds was for the rest of 2009 effectively owned to an even greater extent by the UK government, and yet Barclays escaped completely. Government insiders believe Barclays scraped through the stress test on close to 4 per cent. Barclays’ insiders emphasise that this was a matter of pass or fail and they were told that they had passed. In any event, news had got out early. In government, it was suspected that Barclays had bounced the FSA into announcing a better result by leaking an early arithmetic result to the press. By this point, the Tripartite Authorities had not issued an official verdict. There were large elements of discretion in an exercise that the FSA had not formally carried out before. Stress tests would differ from bank to bank. By the time the papers were carrying stories about Barclays passing, financial stability demanded sticking to the public story, said one sceptical member of the government at the time.

At the top of the Barclays tower they believed that Brown had taken fright and retreated from Mervyn King’s plan for blanket state ownership. The key trigger was the concurrent G20 meeting and the revelation of the impact of the RBS and Lloyds part-nationalisations on Britain’s parlous public finances. It suited everybody to leave Barclays free. Other leading Barclays figures are adamant that the bank was never in any actual financial difficulty, and was always going to sail through any fair and independent stress test. The real fear, for Barclays, was that it had been decided in government that, by hook or by crook, Barclays would fail the test. Why? Because the government had earlier promised the other banks, particularly Lloyds, that this would be an across-the-board UK bank recapitalisation, and that had cemented Lloyds’ purchase of the HBoS disaster at a point of near collapse. In a subsequent interview with the
Telegraph
, the then Lloyds chief executive Eric Daniels confirmed that Lloyds had expected other banks, presumably Barclays, to be taking government cash. ‘We entered it [the recapitalisation scheme] on the understanding that there would be multibanks involved. The same assertion was made at the time of GAPS [Government Asset Protection Scheme]. Things didn’t turn out as they were presented.’

The fear about the first-edition headline of the
FT
, was that it was murky government figures forcing Barclays’ hand. A furious effort involving warning journalists off the first-edition splash was galvanised. Framed copies of both editions of the newspaper were displayed in one director’s office.

The crucial stress test was not fully discussed by all regulatory authorities before the results were made public to the papers. Indeed, Barclays’ official announcement three days later was curiously worded: ‘On 27 March 2009, Barclays confirmed that its capital position and resources were expected to meet the capital requirements of the UK FSA.’ The independent review into Barclays, chaired by Anthony Salz, described the result as ‘a close call involving extensive debate with FSA officials and a significant milestone in avoiding government ownership’. The FSA itself refused to supply details of the tests, even under freedom-of-information requests. The whole exercise was slightly arbitrary, in any event. Barclays could pass or fail depending on how stringent the FSA decided to make the test. ‘We did not have a problem passing the stress test. We had a political problem,’ said a Barclays official. The parameters were not decided in advance or confirmed for weeks afterwards. At a subsequent 2011 stress test the FSA chairman Lord Turner did critique the presentation as ‘confusing and potentially misleading’, and left his staff with the impression that its capital was above the then intended threshold of 10 per cent, when it was 9.8 per cent. The ‘pass mark’, though, was changed to 9 per cent. Back in 2009, the most the FSA would do was to release a general statement about its methodology two months later. No details were given about the marks used on the Barclays’ trading book that had been the subject of that two-hour meeting with ministers. In 2013 the FSA’s most senior executive, Hector Sants, who signed off the stress-testing exercise, joined Barclays. History might have turned out differently if the current structure, with the Bank of England as lead regulator, had been in place in 2009, leaving the stress-test judgements in the hands of Sir Mervyn King.

The big picture, however, was that Barclays scraped through the stress test and escaped part-nationalisation because of the conservative nature of its exposure to property in its conventional bank loan book – despite its very large exposure to property derivatives in its trading book. Barclays represented the bipolar nature of Britain’s banks in a nutshell. There was a conventional high-street bank trusted by depositors; and, inextricably entwined with it, there was a high-bonus, high-adrenaline, high-risk international investment bank. The same heady combination that had seen Bob Diamond on the pitch at Old Trafford had saved Barclays at its ‘High Noon’. Through 2008 Barclays did quietly reduce its exposures to notorious opaque property derivatives. ‘Looking back on it, we weren’t anything like aggressive enough in just shipping out inventory. Quite a lot of the trading book that was sickly over that period from mid-2008 had a property flavour to it,’ says one insider. Barclays had learnt the lessons of its history on one side of its bank; less so – perhaps not at all – on the other side of the bank.

The answer for some would be a legal split of some sort. The coalition government that came to power in 2010 opted for a ring fence to remove the implicit multibillion subsidy to the borrowing costs of investment banks. The so-called ‘too-big-to-fail’ subsidy arose from the presumption that a troubled investment bank connected to a high street bank would always get bailed out by a government. Darling and others pointed out that the most high-profile failures in the banking crisis – Lehman, Northern Rock and HBoS – would fall and fail on either side of a ring fence. But it is also true that Northern Rock and HBoS were not pure retail banks: their massive securitisation requirements were an intrinsic part of the shadow banking system. It did seem at one point that the government’s bank-reform proposals would most greatly impinge upon HSBC and Standard Chartered, the two banks that did the least to cause the problem. It should also be pointed out that high-street banking arms were less pure than bosses at Barclays suggested. A number of scandals concerning the gouging of fees, loan-insurance payments and mis-sold interest swaps to small businesses showed the impact of the sales culture on the high-street arm of the bank. The fact was that the retail arms had to compete for capital, and at least try to match the return on equity in the casino arms of the banks.

It appears that a careful assessment of the failure of the Scottish banks and the demutualised building societies was not at the heart of bank-reform proposals. Bankers and politicians tacitly colluded in failing to learn the actual lessons of the crisis. Britain never had its catharsis, and the delusion that British banking could go on as before remained. There were two separate problems: loss-making property-centric ex-building societies (a failure of Mrs Thatcher’s 1986 Building Societies Act); and the loss in confidence in the regulation of investment banking, credit derivatives and the shadow banking system in London, which occasionally lived off high-street depositors. The former is often overlooked in a haze of anger at the pay packets of the latter. Internationally, London’s reputation was tarnished. Alistair Darling could smell the
Schadenfreude
at meetings with other finance ministers. Trade missions trying to push British banking abroad met with somewhat frosty receptions.