Companies don’t go bust because they fail to make a profit, runs the old City saw, but because they run out of cash. This was never more apt than in the fall of HBOS.
True, the bank had a shortage of capital that left it dangerously exposed to losses. Yes, its share price was collapsing long before it hit the wall because the market had lost confidence. But the death knell rang only when the money ran out in 2008.
One striking omission from this week’s report into the fall of HBOS and the regulatory cover-up that followed was the role of the Bank of England. For almost a year, the Bank was HBOS’s life support system. Threadneedle Street experienced at first hand the devastation caused by reckless management as it put its own balance sheet at risk. By the end, it had as much as £50 billion on the line with HBOS. When the reckoning for the guilty came, it turned its back.
It could do so because the Financial Services Authority, as regulator, was formally in charge of the disciplinary clean-up. But where was the moral suasion from an institution that had introduced the term “moral hazard” into the industry a year earlier with Northern Rock?
It’s not that the Bank didn’t recognise its role. Months before the demise, according to minutes from the court of directors, the Bank was angling for “responsibility for the prudential regulation of the liquidity of banks”. By the time that Peter Cummings, HBOS’s head of corporate banking, had been made a scapegoat by the FSA four years later, the Bank was in charge — as it is today.
The Bank was acutely aware of just how badly HBOS was run because it did everything in its power to stop the collapse.
From the beginning, HBOS’s problem was funding. Mortgages, which formed the bulk of its lending, are typically for 25 years. To raise the money it lent out, HBOS used a combination of customer deposits and borrowing from the markets. In late 2007, more than half of the market contribution — about £150 billion — was so short-term that it had to be repaid within six months. In the jargon, it was a perilous maturity mismatch. Once the credit crunch struck, HBOS struggled to replace those short-term funds. As the situation became desperate, it tapped — of all places — Germany’s Bundesbank. “For a short period, we at the Bundesbank were the main financer of collateralised lending into British banks,” Axel Weber, its president at the time, recalled recently.
At the last minute, the Bank of England stepped in, with four special funding auctions between December 2007 and April 2008, scheduled for about £10 billion each. According to insiders, the first two auctions were fully subscribed. The third, in March, caused huge problems for HBOS. The following day a rumour shot round the markets that the Bank of England had bailed it out and the shares slumped by 17 per cent. There was substance to what HBOS claimed were “unfounded, vicious rumours”. The March auction apparently was widely shunned, but HBOS had tapped it for a little less than £5 billion.
Traders heard about it and smelled weakness. As a result, HBOS did not touch the April auction, and nor did anyone else. Instead, five days later the Bank launched a much bigger “special liquidity scheme”, which became known in banking circles as the “HBOS liquidity scheme”.
If there was any doubt that the Bank was entirely aware of HBOS’s dire position, this week’s report dispelled it. By the end of September 2008, banks and building societies had used the liquidity scheme for £75 billion of funding. HBOS alone accounted for more than a third — £28.4 billion. Once Lehman Brothers went bust in mid-September, HBOS was finished. In the week that followed, big businesses withdrew £12.5 billion of deposits. On October 1, HBOS had even run out of collateral to pledge at the special liquidity sheme. So it applied for an emergency Bank of England loan — like Northern Rock a year earlier — which eventually reached £25.4 billion. HBOS was bust six days before the Royal Bank of Scotland.
The story of HBOS’s slow demise is not only an illustration of why the regulatory system needed reform, as the Bank scrambled to save it while the FSA handled supervision, but also a reminder that Bank officials were as complicit as former regulators in not pursuing a full investigation, or demanding management reprimands beyond Mr Cummings.
While RBS’s end was caused by over-reaching ambition, HBOS’s tale was more prosaic. The people in charge were simply incompetent. No one was more aware of that than officials at the Bank.
This week’s report pointed the finger at FSA regulators, just as those regulators previously had pointed the finger at FSA juniors such as Clive Briault, who was partially exonerated by the report, and Mr Cummings, who was no more guilty than Andy Hornby, his chief executive.
Where is the mention of Lord King of Lothbury, the Bank of England governor, or Sir Paul Tucker, his former deputy for financial stability? Why didn’t Andrew Bailey, the deputy governor for regulation, who was seconded to the FSA in 2011 and oversaw the report, extend the investigation into Mr Cummings to the nine others now facing censure? Why did he not launch the HBOS inquiry until a year and a half after arriving at the FSA?
This week’s report is not the end. The Bank is being investigated by the Serious Fraud Office for colluding in the rigging of the auctions it ran in 2007 and early 2008. The suggestion is that officials let the lending banks take state money on the cheap to prevent a financial meltdown. If true, more heads will roll. But arguably that’s more defensible than the buck-passing these reports tend to serve.