The day that changed the world
The credit crunch changed the course of countless lives in 2007 and cost the fortunes of many.
At least the weather was good. After a July of rain and floods, the sun came out. Gordon Brown, five weeks into his job as prime minister, was photographed strolling awkwardly along a Dorset seafront trying to make out that he was enjoying being on holiday. It was the first week of August.
Not all the news was happy. Amy Winehouse went into rehab (again). Wayne Rooney injured a metatarsal (again), and there was an outbreak of foot-and-mouth disease (again).
On the whole, however, Britain seemed a relaxed and contented place to be. The tabloids were getting into a lather of excitement because Kate Middleton had pulled out of a cross-Channel boat race. This, apparently, was incontrovertible proof that her relationship with Prince William was back on. The nation rejoiced.
But in the financial world, all was not quite so happy and relaxed. There had been signs that life was becoming increasingly tricky for the financiers who had become the masters of the new millennium universe: only a few days earlier, Wall Street had suffered its biggest one-day fall for three years; the price of oil had spiked to $78 a barrel; Warren Spector, co-president of American investment bank Bear Stearns, resigned after the collapse of two mortgage hedge funds. The term “sub-prime” was becoming commonplace.
These were straws in the wind. Then, as Northern Rock’s former chief executive Adam Applegarth would later remark, “life changed on August 9. That’s when the market just froze”. After years of being awash with money, liquidity dried up.
On that day, French bank BNP Paribas, which only a few weeks earlier had said it had “negligible” exposure to sub-prime mortgages, suspended three of its investment funds because they were in such deep trouble. The European Central Bank injected €95 billion (£70 billion) into the financial system and pledged unconditionally that it would meet the funding requirements of all financial institutions in the euro zone. In America, the Federal Reserve released $24 billion into the financial system.
Markets were more terrified than reassured by these bank moves. The following day, the FTSE 100 index suffered its biggest fall for more than four years; within hours, £63 billion was wiped off share values. Northern Rock had a torrid time: its shares were the worst performer of the week, losing nearly 10%, to 713½p.
Awful? Certainly not comfortable. But this was little more than a taste of things to come: by the end of the year, Northern Rock shares would be below 90p. And Applegarth would have resigned.
For Applegarth, it was convenient to put around the idea that the world suddenly changed on August 9. But it was also too simplistic.
Over the previous few weeks, there had been plenty of signs that the torrent of easy money for banks in general and buyouts in particular was starting to dry up. Cadbury had announced the shelving of its plan to sell its American drinks business – a move spurred by the unwelcome arrival of the corporate raider Nelson Peltz on its share register in spring. Macquarie, the Australian investment group, had already announced that two of its debt funds faced huge losses. (The explanation was the magnificently unenlightening “supply-demand imbalance”.) And the scale of the crisis in the American sub-prime mortgage market was already manifest: one borrower in seven was at least two months behind with repayments.
Yet over July and August, bankers found the scale of change in the financial world hard to accept. It was as if they believed that the first half of 2008 – with loans of $220 billion granted to fund buyouts, suggesting that 2006’s total of $500 billion could easily be surpassed – represented normal-ity. In early August, Bob Diamond, president of Barclays, blithely declared “we would expect at some point over the next two to three months to see the market [for leveraged loans] at more normal volume levels”. Presumably, he is still waiting. Or perhaps, like many other bankers, he is starting to accept that it was the easy money of the months before July that represented an aberration rather than the drought seen since the summer. CERTAINLY, at the beginning of 2007, it seemed that the buyout industry was unstoppable. In America, KKR and Texas Pacific announced a $44 billion deal to buy the TXU power company. That set a record, but within a few months it had been eclipsed by the $49 billion takeover of BCE, parent of Bell Canada.
In Britain, private equity targeted Sainsbury unsuccessfully, then Sainsbury fought off a bid from the Qatari-backed Delta Two – one of the many sovereign wealth funds that made their presence abundantly felt in 2007. After years of on-off merger talks with all and sundry, music group EMI fell to a consortium led by Guy Hands. And Alliance Boots succumbed to a £10 billion bid led by its deputy chairman, Stefano Pessina, and backed by KKR. Even as the buyout bandwagon began to grind to a halt, private equity was flexing its muscles as never before.
Furthermore, the private-equity industry found itself in the spotlight over the way its executives organised their personal finances. Nicholas Ferguson, one of the founders of Schroders Ventures, which later became Permira, pointed out the uncomfortable fact that most private-equity bosses paid a lower rate of tax than their office cleaners. The chancellor took note. New rules on capital gains tax were outlined – yet to be finalised.
It was not only private equity that was doing the acquisitions. ICI, an iconic name in British industrial history, disappeared from the stock market when it was bought by Akzo Nobel of the Netherlands. Two other famous names, Jaguar and Land Rover, are also about to change hands: they were put up for sale by Ford and are likely to be bought by Tata of India.
Scottish & Newcastle was on the receiving end of a £7.3 billion bid from Carlsberg and Heineken. And after months of nudging, wooing and cajoling – all to no avail – BHP Billiton finally bid for Rio Tinto.
Perhaps the most significant, not to say convoluted, takeover saga of the year had ABN Amro of the Netherlands at its centre. In March, The Sunday Times disclosed that Barclays was considering a bid for the Dutch bank with the idea of creating an £80 billion pan-European group. The following month, Royal Bank of Scotland, led by Sir Fred Goodwin, appeared as a rival bidder. And eventually, in partnership with Santander of Spain and Fortis of Belgium, Goodwin proved that a consortium bid for a bank is possible. ABN went for £49 billion. IT was a significant deal, but not so entertaining as the saga of Sports Direct, brought to the market in February by the distinctly unCity figure of Mike Ashley. The shares were sold at 300p, Ashley pocketed £900m by selling 43% – and the share price went into freefall. David Richardson had agreed to be chairman, but then resigned, unable to persuade Ashley to play ball with institutional shareholders. Ashley’s reaction was robust: “Some of these City people act like a bunch of cry-babies.” The whole of Sports Direct is now worth little more than £700m.
The credit crunch claimed the heads of three of the world’s largest investment banks – Merrill Lynch, UBS and Citi.
There were also spectacular departures in British industry, not least Lord Browne, the chief executive of BP, after lying in affidavits in a court case involving his private life. He was succeeded by Tony Hayward – youthful, but not so youthful as Andrew Witty, 43, named as the man to take the helm at Glaxo Smith Kline.
Property and building were also hit hard. Taylor Woodrow and Wimpey teamed up, only to see their combined share price go south. Hapless private investors in a number of commercial property funds were told that they would have to wait if they wanted to get their money out.
The coming year is likely to be less than happy for Lord Black, former proprietor of the Telegraph. He was sentenced to six-and-a-half years in jail, after being convicted in Chicago of fraud and obstruction of justice. He is due to start his term in March.
As the year draws to a close, Amy Winehouse is out of rehab but threatened with charges of obstructing justice. For her, the outlook is none too bright. For business, it’s not much better.
WORDS THAT SPELL TROUBLE
BUSINESS CYCLES spin off their own language and this year’s credit crunch has been no different as investors, home owners and bankers alike have been scolded by an alphabet soup of acronyms.
At the start of the year few people outside the dullest parts of the banking industry had heard of collateralised debt obligations, let alone Ninja loans. Now the two have combined with a series of other acronyms to create turmoil.
Here’s a short guide to some of 2008’s hottest words.
ABCP: Asset-backed commercial paper
A short-term investment vehicle, typically maturing between 90 and 180 days. The security itself is typically issued by a bank and backed by physical assets. They are generally used for short-term financing needs.
CDO: Collateralised debt obligation
Collections of bonds and loans of different maturities and credit quality that are supposed to allow investors to choose their risk, ranging from low-risk, investment-grade to highly speculative. CDOs became hugely popular in the past few years but, as the market grew, investors and credit-rating agencies lost track of the risks. Sub-prime mortgages were popular components of CDOs. Global CDO issuance totalled $157 billion in 2004, $249 billion in 2005, and $489 billion in 2006.
SIVs: structured investment vehicles
Funds typically sponsored by big banks that make a profit by exploiting the differences between the interest rates on long-term and short-term securities. Unlike CDOs, which have a short life span, SIVs are set up as long-term investment vehicles. They, too, have been hit hard by the credit crisis triggered by the collapse of the sub-prime mortgage market.
Ninja loan: no income, no job or assets
As property prices soared, unscrupulous lenders started easing up their lending requirements and unscrupulous borrowers took out loans they knew they couldn’t afford. Both sides expected rising house prices to bail them out if the loan went bad. The credit crisis and falling house prices put the squeeze on buyers and lenders.
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