At the special meeting in Edinburgh to approve the rights issue, chairman Lord Stevenson told shareholders: ‘Armageddon may happen, and we should be prepared for it, and we are.’ Armageddon came three months later and no one was prepared for it.
The events leading up to the final collapse took place in New York. On 7 September the US Government announced it was taking the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, usually known as Fannie Mae and Freddy Mac, into public ownership. This was a huge step for a right-wing Republican administration led by President George W. Bush, which could not bring itself to call it nationalisation, preferring the term ‘conservatorship.’ The two companies were essentially mortgage wholesalers and had been wrecked by the sub-prime disaster, losing £14 billion in a year. Their bailout would eventually cost the US taxpayer more than $150 billion.
A few days later Lehman Brothers, one of the elite group of Wall Street investment banks, disclosed that it had lost $3.9 billion on mortgage debt in the previous three months alone. There were now severe doubts over the future of even the largest banks and these were reinforced when Bank of America, under strong pressure from the US Government, rescued Merrill Lynch, one of Lehman’s competitors, which had lost $20 billion in a year. Through late September the future of Lehman hung in the balance as politicians and regulators on both sides of the Atlantic tried to find a way to save it. Barclays showed interest in acquiring it, but the US Government would not guarantee Lehman’s losses and Alistair Darling refused to suspend UK company law to let a deal go through without it first being put to Barclays shareholders. The decision to allow Lehman to go bust destroyed any remaining confidence left in mortgage banks on both sides of the ocean. Five thousand Lehman employees in London lost their jobs.
On 15 September, a day the newspapers called ‘Black Monday,’ ‘Meltdown Monday’ or ‘Panic Monday,’ the FTSE 100 share index tumbled 200 points and HBOS shares went into freefall. The Financial Times described a macabre prediction game in progress: who will be next? The market had already decided: it would be HBOS.
The plight of the Bank had been watched closely by the UK Government throughout the summer. The company’s half-year results, revealed at the end of July, showed profits halved after a loss of £1 billion on its investments, a further £2 billion write-off to its reserves and bad debts up again. To save liquidity the dividend was being cut and would be paid by issuing new shares, rather than in cash. Andy Hornby also announced that the Bank was putting some of its best subsidiaries up for sale: BankWest in Australia, the insurance company Clerical Medical and the fund manager Insight Investment. Alistair Darling was sceptical about its future: ‘There was a whiff of death surrounding the whole operation. Two once solid institutions, the Halifax Building Society and the Bank of Scotland, were heading for the rocks.’1 HBOS posed a massive problem for the Government. They had not yet found a permanent solution to Northern Rock’s difficulties, but HBOS was much bigger – any collapse would destroy the savings of 20 million people and create havoc in the banking system. The FSA was already searching for options and the Treasury began to work on a contingency plan.
Worries focused on HBOS’ capital and liquidity. A further big fall in the value of its reserves following a massive write-off in 2007 suggested that its capital was progressively crumbling away and with it the bank’s capacity to absorb losses. It was also running short of cash. Hornby had tried to play down suggestions that HBOS was having problems raising money on the inter-bank market, but to add to its woes the credit rating agency Standard & Poors downgraded HBOS one notch from AA- to A+, increasing the costs it had to pay to borrow.
HBOS was haemorrhaging cash
It was about this time that I attended the dinner where my neighbour gave me the shocking news that he had withdrawn £20 million to put it in a safer place.*
In fact a massive run on the Bank was in full swing, but it was practically unseen by the general public. Unlike Northern Rock a year earlier, there were no queues outside branches and no television pictures to alarm bankers and politicians, but by electronic transfer, telephoned instructions and face-to-face withdrawals HBOS was haemorrhaging cash as its depositors lost faith. An estimated £30 billion was withdrawn by individuals and companies within a few weeks – a death blow.
On the other side of the balance sheet money was not coming back as quickly as it had done. As the economy turned down, householders could not sell their homes, so they were not moving and paying off their mortgages. Credit card debt was not being paid off as quickly. Companies were taking longer to reduce their borrowings and were unable to refinance deals with other banks. Many of those firms which had over-borrowed in the days of low interest rates and high economic growth were now in trouble. HBOS corporate teams were fighting fires all over the country. McCarthy & Stone, bought by HBOS and Tom Hunter in 2006 for £1.2 billion, was struggling to refinance its £800 million debt. Crest Nicholson was trying to get banks to exchange half of the £1 billion they were owed for shares in the company. Retail chain JJB Sports and property groups Kandahar and Kenmore had breached their lending covenants. The secondary market was also drying up. Recent deals were remaining on the books of HBOS as other British and foreign banks which once would have snapped up portions of HBOS Corporate’s loans withdrew from the market, meaning that the whole debt remained with HBOS.
In Bank of Scotland’s LIBOR [London Inter-bank Offered Rate: the interest rate at which banks trade among themselves] department staff were trying to complete a routine transaction: ‘We were trying to transfer £100 million to another syndicate bank. It was the sort of thing we liked to get done at the start of the morning, but at the end of the day we got a call asking ‘‘Where’s the money?’’ We checked everything over and couldn’t find anything wrong – the money had left us. The following day it still hadn’t arrived – I thought to myself: ‘‘Someone in treasury hasn’t pressed the right button; they’re going to get in trouble for this.’’ But that wasn’t the problem; the money never arrived, we just didn’t have the funds.’
Secret loans to keep afloat
To keep the bank afloat, Alistair Darling had to authorise the Bank of England to make exceptional loans to HBOS and other troubled banks, including the Royal Bank and Bradford & Bingley. In view of the severe fall in the HBOS share price caused by the false rumour six months before, the arrangement had to be kept secret from the market, but in confidence Darling told John McFall MP, chairman of the House of Commons Treasury Select Committee. The full extent of the loans did not become known for a year, when Mervyn King told MPs that, acting in its capacity as lender of last resort, the Bank of England had lent £62 billion to the troubled banks2. Over a third went to HBOS, which, with Darling’s approval, was also borrowing $18 billion from the US Federal Reserve through Bank of Scotland’s American branch.
Darling estimated that HBOS was having to borrow £16 billion overnight, every night, just to keep going. The figure may have been an over-estimate, but the timescale was not. The market had become very short-term. After the collapse of Lehman every bank wanted to conserve as much cash as possible, so lending for 24 hours was as long as they were prepared to let it out of their sight. HBOS had borrowed £278 billion on the wholesale money markets, 60 per cent of this for periods of less than a year. In the next 12 months it would have to refinance £164 billion as its loans fell due and had to be repaid, yet it was living from day to day. The strain on the treasury department was immense, but it remained calm and professional and took each day as it came.
The atmosphere was much more tense in the group’s City executive suite. Andy Hornby was feeling the stress of the constant pressure and uncertainty. Until then, in the words of one of his close colleagues, he had led a charmed life. Whatever he had done at school, at Oxford, at Harvard, in his first jobs in Blue Circle, Asda and Halifax, he had excelled. He had been the youngest, the cleverest, the highest achiever. Any setbacks he had encountered had been minor and, with his willingness to listen, learn and work hard, he had won people over and put any difficulties behind him. But this time his problems were of a different order of magnitude. He was having to react hourly to events that he not only could not control, but that he could not understand. His easy likeability was being replaced by irritability, and the lack of sleep and continual worry were showing on his face.
To be continued…
Beginning our series (How Scotland’s premier banks crashed the economy) for the tenth anniversary of the financial crash, this is the first extract from Apocalypse Now, Chapter 18 of Hubris: How HBOS wrecked the best bank in Britain by Ray Perman.