Federal Home Loan Mortgage Corporation The Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac, is a publicly traded, government-sponsored enterprise (GSE), headquartered in Tysons Corner, Virginia. In 2008 Lehman Brothers was the fourth largest US investment bank, with worldwide operations. Its two principal business units were the broker dealers Lehman Brothers Inc (LBI), based in New York, and Lehman Brothers International (Europe) (LBIE), based in London. The cash resources of the Lehman Group were managed centrally in New York by the parent company, Lehman Brothers Holdings Inc. (LBHI). Following a deterioration in LBHI's financial position, on the afternoon of Sunday 14 September 2008, the directors of Lehman Brothers International (Europe) Ltd (LBIE) sought assurances from LBHI that payments due to be made on its behalf on the following business day would be made. At approximately 12.30 am on 15 September, LBHI informed LBIE that it was preparing to file for

Chapter 11 Bankruptcy protection Chapter 11 of the United States Bankruptcy Code ( Title 11 of the United States Code) permits reorganization under the bankruptcy laws of the United States. Such reorganization, known as Chapter 11 bankruptcy, is available to every business, whet ...

under US law and that it was therefore no longer in a position to make payments to or on behalf of LBIE. Accordingly, overnight preparations were made for a number of UK based Lehman companies to protect their interests by seeking an

Administration Order As a legal concept, administration is a procedure under the insolvency laws of a number of common law jurisdictions, similar to bankruptcy in the United States. It functions as a rescue mechanism for insolvent entities and allows them to carry on ...

under UK law. This order was granted by a UK judge at 7.56 am on Monday 15 September 2008.Lehman Brothers International (Europe) Ltd - Joint Administrators' Proposals for Achieving the Purpose of Administration 28 October 2008 at http://www.pwc.co.uk/eng/issues/lehmans_administrators_proposal.html The immediate impact of the failure of the LBIE business in particular included 142,000 unsettled securities trades to which LBIE was a counterparty, of which approximately 83,500 were trades to be settled in Europe, 45,000 in Asia and 12,500 in the US. There were gross assets (i.e. grossed up for

collateral Collateral may refer to: Business and finance * Collateral (finance), a borrower's pledge of specific property to a lender, to secure repayment of a loan * Marketing collateral, in marketing and sales Arts, entertainment, and media * ''Collate ...

and Client Assets)totalling $628 billion and gross liabilities of $611 billion, which after counterparty and cross product netting and eliminating amounts relating to trust property, reduced to assets of $49.5 billion and liabilities of $32.6 billion. These were frozen and would remain so for several years. The Lehman collapse initiated a period of significant market turmoil. This was caused by complex financial interrelationships between the major banks, since assets on the Lehman balance sheet were inaccessible by counterparties, creating a domino effect in financial markets.

Failure of HBOS and Lloyds takeover

Following the market disruption caused by the Lehman collapse, attention turned to

HBOS HBOS plc was a banking and insurance company in the United Kingdom, a wholly owned subsidiary of the Lloyds Banking Group, having been taken over in January 2009. It was the holding company for Bank of Scotland plc, which operated the Ba ...

, then the UK’s largest mortgage lender. The bank had first appeared on the HM Treasury watch list after the Northern Rock problems surfaced, when it became clear that the HBOS funding model closely resembled that of Northern Rock. The bank was offering highly competitive and unprofitable housing market loans, combined with aggressive and high risk commercial lending. By July 2008, profits had halved and bad debts were up by a third. On 16 September HBOS saw 33 per cent of its value wiped out in a single day. The Financial Services Authority (FSA), the UK financial services regulator, responded by imposing a temporary ban on

short selling In finance, being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional "long" position, where the investor will profit if the value of the ...

of shares. At the same time, the UK government brokered an agreement with Lloyds Bank to acquire HBOS in a private sector deal. This was announced three days after the Lehman Brothers collapse, on 18 September.

Preparation of the recapitalisation plan

By the end of September 2008, Mervyn King, Governor of the Bank of England,

Adair Turner Jonathan Adair Turner, Baron Turner of Ecchinswell (born 5 October 1955) is a British businessman and academic and was Chairman of the Financial Services Authority until its abolition in March 2013. He is a former Chairman of the Pensions Commiss ...

, Chairman of the FSA, and Alistair Darling agreed that plans needed to be prepared for the recapitalisation of the banking system. Until that point, the crisis had primarily been one of liquidity, but the problem had now shifted to one of lack of capital. The only realistic source of new capital was the UK government. Darling instructed the Treasury to prepare a recapitalisation plan that envisaged the injection of billions of pounds into UK banks in return for equity. This would be financed by UK government bond sales.

Royal Bank of Scotland imminent collapse

On 7 October 2008, following a 35% plunge in the bank's share price, dealing in the bank's shares was suspended. The bank Chairman,

Tom McKillop Sir Thomas Fulton Wilson McKillop, FRS, FRSE (born 19 March 1943) is a Scottish chemist, who was CEO of AstraZeneca PLC from 1999 until 2006 and chairman of the RBS Group from 2006 until 2008. Early life McKillop was born in Dreghorn, a smal ...

, contacted the Chancellor of the Exchequer, Alastair Darling, to advise that the bank was within hours of running out of money. Darling later observed that

When dealings in bank shares are suspended it is all over. I knew the bank was finished, in the most spectacular way possible. The game was up. If the markets could give up on RBS, one of the largest banks in the world, all bets on Britain's and the world's financial system were off.

This was the decisive event that triggered the implementation of the recapitalisation plan.

Detailed support measures

The intervention plan provided for several sources of funding to be made available to an aggregate total of £137 billion in cash injections and loans at peak, and a further £1,029 billion in guarantees at peak. As at October 2021, the OBR reported the current cost of these interventions as £33 billion, comprising a loss of £35.5 billion on the NatWest (formerly Royal Bank of Scotland) rescue, offset by some net gains elsewhere.

Cash support

Through the Bank Recapitalisation Fund, the government bought a combination of

ordinary shares Common stock is a form of corporate equity ownership, a type of security. The terms voting share and ordinary share are also used frequently outside of the United States. They are known as equity shares or ordinary shares in the UK and other Comm ...

and

preference shares Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt inst ...

in the affected

bank A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets. Because ...

s. The amount and proportion of the stake taken in any one bank was negotiated with the individual bank. Banks that accepted rescue packages had restrictions on

executive pay Executive compensation is composed of both the financial compensation (executive pay) and other non-financial benefits received by an executive from their employing firm in return for their service. It is typically a mixture of fixed salary, variab ...

and

dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-i ...

s to existing shareholders, as well as a mandate to offer reasonable credit to homeowners and small businesses. The long-term government plan was to offset the cost of this program by receiving dividends from these shares, and in the long run, to sell the shares after a market recovery. This plan covered the possibility of underwriting new issues of shares by any participating bank. The plan was characterised as, in effect, full or partial nationalisation. As at October 2021, the overall breakdown of cash support to banks and other entities was reported by the OBR to comprise the following: source: OBR Economic and fiscal outlook October 2021 Notes * UKAR:

UK Asset Resolution UK Asset Resolution (UKAR) is a British financial services holding company with headquarters in the West Yorkshire village of Crossflatts (near Bradford & Bingley's former headquarters in Bingley). It was established in October 2010 as a ba ...

– managed UK government holdings in Bradford & Bingley and Northern Rock Asset Management plc prior to their sale. * FSCS:

Financial Services Compensation Scheme The Financial Services Compensation Scheme (FSCS) is the UK's statutory deposit insurance and investors compensation scheme for customers of authorised financial services firms. This means that FSCS can pay compensation if a firm is unable, or li ...

- the UK's statutory deposit insurance and investors' compensation scheme for customers of authorised financial services firms. * CGS: Credit Guarantee Scheme - a scheme introduced in 2008 allowing banks to issue debt guaranteed by the government. The scheme closed in October 2012. * SLS: Special Liquidity Scheme - designed to allow easier access to market liquidity by using UK Treasury securities as collateral. The scheme closed in January 2012.

Other support schemes

Credit Guarantee Scheme

The Credit Guarantee Scheme formed part of the UK government’s banking intervention measures announced on 8 October 2008, becoming operational on 13 October 2008. The scheme was designed to allow banks to issue debt guaranteed by the government, with the intention of enabling them to borrow more, and more cheaply, and hence lend more. The banks that participated in the scheme included RBS, Lloyds, Barclays, Bank of Scotland, Nationwide Building Society, Clydesdale Bank, Tesco Personal Finance, Yorkshire Building Society, and Skipton Building Society. The Scheme was closed to new issuance on 28 February 2010 and was finally closed when the final guarantee expired on 26 October 2012.

Special Liquidity Scheme

The Special Liquidity Scheme (SLS) was launched by the Bank of England on 21 April 2008. The SLS allowed banks to swap mortgage-backed and other securities for UK Treasury Bills. This was designed to allow easier access to market liquidity by using UK Treasury securities as collateral. The background to the scheme was the market closure for many securities, leaving assets on bank balance sheets which were unable to be sold or to be pledged as security to raise funds. This contributed to a market seizure where banks became reluctant to make new loans, even to each other. Under the SLS banks were provided with the means to swap illiquid assets, such as mortgage-backed securities, of designated quality for Treasury Bills. The SLS had three key features: * The asset swaps were long term, with each swap for a period of 1 year and a renewal option for up to 3 years. * Banks retained responsibility for losses on their loans * The SLS was only available for existing assets as at the end of 2007; the scheme could not be used to finance new lending. The SLS was closed in January 2012 when the last of the SLS transactions expired.

Asset Purchase Facility (Quantitative Easing)

The Bank of England Asset Purchase Facility, more commonly known as

Quantitative Easing Quantitative easing (QE) is a monetary policy action whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to stimulate economic activity. Quantitative easing is a novel form of monetary pol ...

(QE), was introduced in 2009. This was primarily designed as an instrument of monetary policy. The mechanism required the Bank of England to purchase government bonds on the secondary market, financed by the creation of new

central bank money In economics, the monetary base (also base money, money base, high-powered money, reserve money, outside money, central bank money or, in the United Kingdom, UK, narrow money) in a country is the total amount of money created by the central ban ...

. This would have the effect of increasing the asset prices of the bonds purchased, thereby lowering yields and dampening longer term interest rates. The aim of the policy was initially to ease liquidity constraints in the sterling reserves system, but evolved into a wider policy to provide economic stimulus. QE was enacted in six tranches between 2009 and 2020. At its peak in 2020, the portfolio totalled £895 billion, comprising £875 billion of UK government bonds and £20 billion of high grade commercial bonds. In February 2022 the Bank of England announced its intention to commence winding down the QE portfolio. Initially this would be achieved by not replacing tranches of maturing bonds, and would later be accelerated through active bond sales. In August 2022 the Bank of England reiterated its intention to accelerate the QE wind down through active bond sales. This policy was affirmed in an exchange of letters between the Bank of England and the UK Chancellor of the Exchequer in September 2022. Between February 2022 and September 2022, a total of £37.1bn of government bonds matured, reducing the outstanding stock from £875.0bn at the end of 2021 to £837.9bn. In addition, a total of £1.1bn of corporate bonds matured, reducing the stock from £20.0bn to £18.9bn, with sales of the remaining stock planned to begin on 27 September. On 28 September 2022 the Bank of England issued a Market Notice announcing its intention to "carry out purchases of long dated gilts in a temporary and targeted way". This was in response to market conditions in which the sterling exchange rate and bond asset pricing were significantly disrupted following a UK government fiscal statement. The Bank stated its announcement would apply to conventional gilts of residual maturity greater than 20 years in the secondary market. The existing constraints applicable to QE bond purchases would continue to apply. The funding of the purchases would be met from central bank reserves, but would be segregated in a different portfolio from existing asset purchases. The Bank also announced that its annual £80bn target to reduce the existing QE portfolio remained unchanged but, in the light of current market conditions, the beginning of gilt sale operations would be postponed to 31 October 2022.

Participating banks

The plan was open to all UK incorporated banks and all building societies, including the following:

Abbey An abbey is a type of monastery used by members of a religious order under the governance of an abbot or abbess. Abbeys provide a complex of buildings and land for religious activities, work, and housing of Christian monks and nuns. The con ...

, Barclays,

Clydesdale Bank Clydesdale Bank ( gd, Banca Dhail Chluaidh) is a trading name used by Clydesdale Bank plc for its retail banking operations in Scotland. In June 2018, it was announced that Clydesdale Bank's holding company CYBG would acquire Virgin Money for ...

, HSBC,

Lloyds TSB Lloyds Bank plc is a British retail and commercial bank with branches across England and Wales. It has traditionally been considered one of the " Big Four" clearing banks. Lloyds Bank is the largest retail bank in Britain, and has an exte ...

Nationwide Building Society Nationwide Building Society is a British mutual organisation, mutual financial institution, the seventh largest co-operative banking, cooperative financial institution and the largest building society in the world with over 16 million members. ...

, Royal Bank of Scotland, and Standard Chartered Bank. The extent to which different banks participated varied according to their needs. HSBC Group issued a statement announcing it was injecting £750 m of capital into the UK bank and therefore has "no plans to utilise the UK government's recapitalisation initiative ... sthe Group remains one of the most strongly capitalised and liquid banks in the world". Standard Chartered also declared its support for the scheme but its intention not to participate in the capital injection element. Barclays raised its own new capital from private investors.

Royal Bank of Scotland (now NatWest)

The total UK government investment in RBS was £45.8 billion, with public ownership peaking at 84%. After announcing the recapitalisation measures in October 2008, the UK Government purchased an initial tranche of RBS shares in December 2008 totalling £20 billion; it then converted preference shares into ordinary shares in April 2009 and purchased a final tranche of shares in December 2009, taking the final total to £45.5 billion. The average price per share paid by the Treasury was 499 pence, after receiving income from redeeming the preference shares. In August 2015 the UK government began the process of selling its RBS shares. It sold a 5.4% stake at an average of 330p per share. This brought its shareholding down to 72.9%. This transaction represented a loss of £1.9 billion (£1.1 billion excluding financing) to UK taxpayers. A second sale took place in June 2018, when the UK government disposed of second tranche of shares, representing a 7.7% stake, at an average price of 271p per share. This brought its shareholding down to 62.4%. In both cases, the government sold well below the average price of 499p per share it had paid, with the June 2018 transaction representing a loss of £2.1 billion to UK taxpayers. In March 2021 the UK government sold a further tranche of 590 million shares in NatWest at a price of 190.5p per share. This was followed by an announcement in July 2021 that the UK government would carry out open market sales in NatWest for a year from August 2021. By January 2022, it had sold 170.4 million shares in the NatWest Group totalling about £420 million, reducing its stake in the bank to 51%. After further sales in 2022, the UK government’s RBS shareholding reduced below 50% for the first time since 2008, from 51% to 48.1%. This involved 550 million shares in NatWest at an average price of 220.5p per share, realising £1.2 billion.

Lloyds Banking Group

and

together raised £17 billion, £8.5 billion in preference shares and a further £8.5 billion issue of ordinary shares. The Fund purchased the preference shares outright, for a total £13.5 billion investment, and underwrote the issues of ordinary shares.

Bradford & Bingley

Bradford & Bingley was nationalised by the UK government on 29 September 2008. The bank was divided into two businesses after the takeover. The depositor base of 2.7m customers and its network of 197 leasehold branches were sold to Santander Bank for £612 million. The Bradford & Bingley mortgage book, along with its equivalent at Northern Rock (Asset Management) were brought together under a single holding company, UK Asset Resolution (UKAR).

Northern Rock

The Bank of England extended emergency loans totalling £25 billion to Northern Rock after it was unable to continue funding its loan book with wholesale financing in 2007. This triggered a public run on the bank. Attempts were made to find a private sector buyer. When these failed, Northern Rock was nationalised in February 2008. After further losses emerged,

HM Treasury His Majesty's Treasury (HM Treasury), occasionally referred to as the Exchequer, or more informally the Treasury, is a department of His Majesty's Government responsible for developing and executing the government's public finance policy and ...

devised a strategy to divide Northern Rock into a “good bank” and “bad bank.” The “good bank” was Northern Rock plc, which was responsible for holding and servicing all pre-existing customer savings accounts and some pre-existing mortgage accounts. Northern Rock plc received additional capital of £1.4 billion of equity from the UK government. The strategy was to prepare the bank for sale into the private sector. The “bad bank” was Northern Rock (Asset Management) plc, which held and serviced the closed mortgage book. On 1 October 2010, the UK government established of UK Asset Resolution as a holding company to manage and run down the assets of Northern Rock (Asset Management) plc alongside those of Bradford & Bingley. On 1 January 2012, Virgin Money purchased Northern Rock plc, and in July 2012 additionally purchased a substantial tranche of Northern Rock (Asset Management) mortgages from UKAR.

Timeline

2007

UK political perspective

Alistair Darling Alistair Maclean Darling, Baron Darling of Roulanish, (born 28 November 1953) is a British politician who served as Chancellor of the Exchequer under Prime Minister Gordon Brown from 2007 to 2010. A member of the Labour Party, he was a Member ...

, the Chancellor of the Exchequer, told the

House of Commons The House of Commons is the name for the elected lower house of the bicameral parliaments of the United Kingdom and Canada. In both of these countries, the Commons holds much more legislative power than the nominally upper house of parliament. T ...

in a statement on 8 October 2008 that the proposals were "designed to restore confidence in the banking system", and that the funding would "put the banks on a stronger footing". Prime Minister

Gordon Brown James Gordon Brown (born 20 February 1951) is a British former politician who served as Prime Minister of the United Kingdom and Leader of the Labour Party from 2007 to 2010. He previously served as Chancellor of the Exchequer in Tony B ...

suggested that the government's actions had 'led the way' for other nations to follow whilst

Shadow Chancellor The Shadow Chancellor of the Exchequer in the British Parliamentary system is the member of the Shadow Cabinet who is responsible for shadowing the Chancellor of the Exchequer. The title is given at the gift of the Leader of the Opposition a ...

George Osborne George Gideon Oliver Osborne (born Gideon Oliver Osborne; 23 May 1971) is a former British politician and newspaper editor who served as Chancellor of the Exchequer from 2010 to 2016 and as First Secretary of State from 2015 to 2016 in the ...

stated that "This is the final chapter of the age of irresponsibility and it's absolutely extraordinary that a government has been driven by events to today's announcement"; in addition to offering opposition support for the plan. Darling said in 2018 that the country was hours away from a breakdown of law and order if the Royal Bank of Scotland had not been bailed out and people could not access money.

International perspective

Central banks

On 8 October 2008 there was a strategic and co-ordinated global effort by seven central banks to calm the financial crisis, by cutting interest rates by 0.5%. The banks were all members of the

OECD The Organisation for Economic Co-operation and Development (OECD; french: Organisation de coopération et de développement économiques, ''OCDE'') is an intergovernmental organisation with 38 member countries, founded in 1961 to stimulate e ...

and included

The Bank of England The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the English Government's banker, and still one of the bankers for the Government of ...

, The European Central Bank and the U.S Federal reserve along with central banks in China, Switzerland, Canada and Sweden.

Comparison with U.S. TARP

The British rescue plan differed from the initial United States' $700 billion bailout under the

Emergency Economic Stabilization Act of 2008 The Emergency Economic Stabilization Act of 2008, often called the "bank bailout of 2008", was proposed by Treasury Secretary Henry Paulson, passed by the 110th United States Congress, and signed into law by President George W. Bush. It became ...

, which was announced on 3 October and entitled the

Troubled Asset Relief Program The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase toxic assets and equity from financial institutions to strengthen its financial sector that was passed by Congress and signed into law by President ...

(TARP). The £50bn being invested by the UK Government saw them purchasing shares in the banks, whereas the American program was primarily devoted to the U.S. government purchasing the mortgage backed securities of the American banks which were not able to be sold in the secondary mortgage securities market. The U.S. program required the U.S. government to take an equity interest in financial organisations selling their securities into the TARP but did not address the fundamental

solvency Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-t ...

problem faced by the banking sector; rather was aimed at tackling the immediate funding shortfall. The UK package tackled both solvency, through the £50bn recapitalisation plan, and funding, through the government guarantee for banks' debt issuances and the expansion of the Bank of England's Special Liquidity Scheme. Announced on 14 October, the U.S. subsequently undertook investments in banks through the

Capital Purchase Program The Capital Purchase Program or CPP is a preferred stock and equity warrant purchase program conducted by the US Treasury Office of Financial Stability as part of Troubled Asset Relief Program (aka, TARP). According to the first congressionally man ...

and the

FDIC The Federal Deposit Insurance Corporation (FDIC) is one of two agencies that supply deposit insurance to depositors in American depository institutions, the other being the National Credit Union Administration, which regulates and insures credi ...

guaranteed banks' debt through the Temporary Lending Guarantee Program.

International reactions

Paul Krugman Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was ...

, writing in his column for ''

The New York Times ''The New York Times'' (''the Times'', ''NYT'', or the Gray Lady) is a daily newspaper based in New York City with a worldwide readership reported in 2020 to comprise a declining 840,000 paid print subscribers, and a growing 6 million paid d ...

'', stated that "Mr Brown and Alistair Darling, the Chancellor of the Exchequer have defined the character of the worldwide rescue effort, with other wealthy nations playing catch-up." He also stated that "Luckily for the world economy,... Gordon Brown and his officials are making sense,... And they may have shown us the way through this crisis." Other commentators noted that although the capitalist model should have allowed inefficient businesses to go bust, the banks were "too big to fail". The British banking bail-out example was closely followed by the rest of Europe, as well as the U.S Government, who on 14 October 2008 announced a $250bn (£143bn)

to buy stakes in a wide variety of banks in an effort to restore confidence in the sector. The money came from the $700bn bail-out package approved by U.S. lawmakers earlier that month. A wave of international action to address the financial crisis affected stock markets around the world. Although shares in the affected banks fell, the Dow Jones went up by more than 900 points, or 11.1 per cent, while London shares also bounced back, with the

FTSE100 The Financial Times Stock Exchange 100 Index, also called the FTSE 100 Index, FTSE 100, FTSE, or, informally, the "Footsie" , is a share index of the 100 companies listed on the London Stock Exchange with (in principle) the highest market ...

Index closing more than 8 per cent higher on 13 October 2008.

References

External links

HM Treasury Press Notice 100/08
Financial support to the banking industry
BBC News (Oct 2010) - Banks face new funding crisis
{{Economy of the United Kingdom United Kingdom bank rescue package Bank rescue package October 2008 events in the United Kingdom Economic history of the United Kingdom Banking in the United Kingdom Great Recession in the United Kingdom Policy and political reactions to the Eurozone crisis Banking crises

Background

July 2007 to September 2008