Dusk was falling on Edinburgh that mid-September Sunday when British Chancellor of the Exchequer Alistair Darling picked up the phone to speak to then US Treasury secretary Hank Paulson. The chancellor was in his constituency home; Paulson was hunkered down in the offices of the New York Federal Reserve, where he had spent the weekend trying to save Lehman Brothers, one of the US’ blue ribbon investment banks.
With time running out before the financial markets opened on Monday, Paulson wanted to know whether Darling would approve the takeover of at least part of Lehman by the British bank Barclays. The answer was not the one former US president George W. Bush’s Treasury secretary wanted to hear. The UK authorities had reservations — big reservations — about Barclays acting as the white knight for the Wall Street bank and would only agree to a deal on stringent terms.
In particular, the chancellor wanted to know what Barclays was letting itself in for with Lehman — an institution nursing huge losses from the US sub-prime mortgage market — and whether Paulson would sweeten a takeover with US taxpayers’ cash. Barclays also knew it would need US taxpayer funds to proceed with the takeover of an institution which had billions of dollars of outstanding trades that needed to be guaranteed before any deal could be completed.
Paulson could not give Darling the assurances he sought and said he wished the chancellor had raised his questions earlier. Darling says the Americans had always known about London’s misgivings, which had been expressed countless times during a weekend that turned a slow-burn financial crisis into a full-blown global economic crash.
Even at that late stage, Darling and colleagues at the Bank of England and the Financial Services Authority, the City’s watchdog, believed the Americans would rescue Lehman. Had Paulson known what would happen next, it is likely he would have plumped for state ownership rather than letting the bank founder.
Up until Sept. 15 last year, the message of the year-long financial crisis was that governments would always offer a bailout to banks in trouble. Darling had nationalized Northern Rock seven months earlier; Paulson had orchestrated a takeover of Bear Stearns.
After Sept. 15, every bank — from HBOS in the UK to Goldman Sachs in the US — was perceived to be at risk. The financial markets were convulsed by a month of panic that saw bank shares drop precipitously, credit dry up and governments forced to abandon their free-market principles to save the system from collapse.
In Europe it quickly became apparent that the Americans lacked a plan to save Lehman. In the spring of 2007, when financial markets were still booming, the UK had proposed a four-country “war game” involving the financial authorities from the US, the UK, Switzerland and the Netherlands, so that the international community could respond to the possible failure of a big multinational bank. The idea foundered through lack of US cooperation.
The US Treasury and the New York Fed were overwhelmed by the scale of the crisis, which by the end of the weekend would also have claimed the independence of Merrill Lynch and ushered in the deepest slump in the world economy since the Great Depression. Lehman employees leaving their London office with their possessions crammed into cardboard boxes became, along with the lines of customers outside Northern Rock, an abiding image of the banking meltdown.
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