The Secondary Banking Crisis: The Bank of England's 1973 Lifeboat

On the evening of Friday 21 December 1973, a group of clearing bankers was summoned to the Bank of England in Threadneedle Street to decide what to do about a finance house called Cedar Holdings. Cedar lent money to homeowners at second-mortgage rates and had borrowed to do it from the inter-bank market. Its lenders had stopped rolling over their deposits. If Cedar failed over the Christmas weekend, the people in the room believed, the next name on the list would fail in January, and the name after that in February.

Talks ran through Saturday and into the small hours of Sunday morning. Barclays, National Westminster, Hill Samuel and the Crown Agents put up a facility of around £72 million between them, and Cedar opened for business on the Monday. Five days earlier the Bank had already begun assembling something larger and more permanent, a standing support fund that everybody involved immediately started calling the Lifeboat.

Over the following two years the Lifeboat would lend roughly £1.3 billion to twenty-six British deposit-taking institutions. The Bank of England's own share of the losses came to about £100 million, a sum close to its entire capital and reserves at the time.

What Competition and Credit Control Let Loose

Britain's banking system in 1970 was a cartel with a rulebook. The London clearing banks agreed their deposit and lending rates collectively, pegged to Bank Rate, and the Bank of England controlled the volume of credit by issuing ceilings and requests rather than by pricing it. Innovation was slow because nobody could compete on price.

In May 1971 the Bank published a consultative document titled Competition and Credit Control, and from 16 September that year the old arrangements were gone. The interest-rate cartel ended. Lending ceilings were abolished. In their place came a reserve asset ratio of 12.5 per cent for the clearers and a power to call for Special Deposits, with credit to be rationed by its cost rather than by instruction from Threadneedle Street.

Officials at the Bank had reasoned that competition would improve the allocation of credit and that the price mechanism would restrain the quantity. Duncan Needham's study of the period argues that the Bank badly misjudged the interest elasticity of demand for bank credit, and that when money began growing at rates nobody had planned for, the authorities were unwilling to raise rates far enough to stop it because of the effect on the mortgage market and on the government's own borrowing costs (Needham, 2014).

Anthony Barber, Chancellor since 1970, then added fiscal fuel. His Budget of 21 March 1972 cut taxes by well over £1 billion and set an explicit target: output was to grow at an annual rate of 5 per cent between the first half of 1971 and the first half of 1973. Sterling came under pressure within weeks and was floated on 23 June 1972, freeing monetary policy from any external anchor at exactly the moment it most needed one. Broad money grew by roughly a quarter in 1972 and again in 1973.

Who Took the Money

Where the new credit went matters more than how much of it there was. The clearing banks lent a great deal of it to a second tier of institutions that the Bank of England did not supervise and in most cases had never heard of in any detail.

These were the secondary or fringe banks. Many held their status under Section 123 of the Companies Act 1967, a provision under which the Board of Trade could certify a company as carrying on a bona fide banking business, largely for tax purposes. A Section 123 certificate conferred the word "bank" without conferring any prudential regime. The Bank of England's formal supervisory reach extended only to the institutions it had accepted onto its own lists, and the fringe sat outside them.

Their business model was uniform and simple. Borrow short in the wholesale inter-bank market, where money was now freely available and cheap in real terms, and lend long against commercial and residential property, which was rising fast enough that a borrower's equity grew faster than the interest accrued. London office rents roughly doubled between 1970 and 1973. Property companies with modest asset bases turned themselves into balance sheets of several hundred million pounds.

The political culture of 1973 had already turned against this world before its finances did. Edward Heath, defending his own government against the Lonrho affair in the Commons on 15 May 1973, produced a phrase that attached itself to the whole sector: it was, he said, "the unacceptable face of capitalism." At the Labour conference that autumn Denis Healey promised to squeeze property speculators "until the pips squeak."

November 1973

The trigger was London and County Securities, a fringe bank whose deputy chairman happened to be Jeremy Thorpe, the leader of the Liberal Party. Press enquiries into its accounting through the autumn of 1973 culminated in a profits announcement at the end of November that the market read as an admission. The share price collapsed, and depositors of every other fringe institution began asking who else was carrying what.

Conditions could hardly have been worse for a credit event. The Yom Kippur War had begun on 6 October, and the oil embargo and quadrupling of crude prices that followed were already working through the British economy and the wider financial system. The National Union of Mineworkers had started an overtime ban on 12 November. On 13 November the Bank raised Minimum Lending Rate to 13 per cent, the highest in its history to that date, and on 13 December the government announced that from the new year industry would work a three-day week to conserve coal-fired electricity.

Equity markets were pricing something close to national collapse. The FT 30 Ordinary Share Index had peaked at 543.6 on 19 May 1972 and it kept falling through all of 1974, reaching 146.0 on 6 January 1975 — a decline of 73 per cent, the deepest in the index's recorded history.

The Lifeboat

Gordon Richardson had been Governor of the Bank of England for less than six months when the fringe began to go. On 19 December 1973 he convened the chairmen of the English and Scottish clearing banks and secured agreement to a joint support operation, with a Control Committee chaired by the Deputy Governor, Jasper Hollom, to run it.

The structure was deliberately mutual. Clearing banks provided 90 per cent of the recycled deposits and the Bank of England 10 per cent, which meant the commercial banks carried most of the exposure and therefore most of the incentive to police it. Support took the form of replacing deposits that the inter-bank market had withdrawn, at penal rates, against the supported institution's assets and with its management placed under supervision.

Forrest Capie's official history of the Bank draws out the reasoning. The fringe banks themselves were small and individually expendable; what the Bank feared was that their failure would run back up the chain into the clearing banks that had funded them, and from there into the international standing of London as a place to hold deposits (Capie, 2010). The Lifeboat was not a rescue of the fringe. It was a device for unwinding the fringe slowly enough that the clearers survived the process.

By March 1974 the clearers had begun to balk. Support was running at more than a billion pounds against a sector whose collateral was falling in value every month, and the committee capped further commitments at roughly £1.2 billion. Anything beyond that would have to be handled case by case, which in practice meant by the Bank alone.

That is what happened with Slater Walker Securities. Jim Slater had built the most admired investment operation in London, an asset-stripping machine turned banking group whose share price had once made him the emblem of the new City. Its overseas positions and share-dealing losses were beyond the Lifeboat's remit, and in October 1975 the Bank of England provided a guarantee facility of about £110 million. Slater resigned; Sir James Goldsmith replaced him as chairman. Slater's later description of his own position was the most economical summary anyone gave of the period: he had become, he wrote, "a minus millionaire."

The Crown Agents proved worse still. A statutory body that handled the financial affairs of overseas governments, it had used its own funds to lend into property and the secondary banks through an own-account operation nobody in Whitehall was watching. Losses reached about £212 million and the government had to stand behind them. The Fay Committee of inquiry reported in 1977 that the organisation had drifted into a business it did not understand with no adequate supervision from its sponsoring department.

What the Property Market Did

Every fringe bank's solvency depended on a single assumption, which was that commercial property could be sold at something near its book value. From the 1973 peak to the trough of 1975 and 1976, British commercial property values fell by roughly half, and property shares fell considerably more than that. Rent controls on commercial lettings introduced in December 1972, a development land tax proposed by the incoming Labour government, and mortgage rates above 11 per cent removed both the buyers and the exit.

Denis Healey, Chancellor from March 1974, faced a fiscal position that made a general property rescue impossible. Inflation reached 24.2 per cent in 1975. The budget deficit widened towards 9 per cent of output, and within two years the government would be negotiating the IMF loan that defined the decade. The Lifeboat survived the transition of government intact, which was itself notable: it was run by the central bank and the commercial banks, and no Act of Parliament authorised it.

The Banking Act of 1979

Britain had supervised its banks by conversation. The Governor's eyebrow — the raised brow that told a chairman he had gone too far — worked when the City was small enough that everyone could be summoned to one room. Section 123 of the Companies Act 1967 had accidentally created a class of institution that was called a bank, funded like a bank, and supervised by no one.

The Banking Act 1979 ended that. It made deposit-taking a licensed activity, created a two-tier structure of recognised banks and licensed deposit-takers, gave the Bank of England statutory authorisation and revocation powers, and established a Deposit Protection Fund covering 75 per cent of the first £10,000 of a sterling deposit. Michael Moran's account of the politics traces how reluctantly the Bank accepted formal statutory powers, having long preferred the flexibility of informal authority, and how much the European Community's First Banking Directive of 1977 forced the timing (Moran, 1986).

The regime proved incomplete soon enough. Johnson Matthey Bankers had to be bought by the Bank of England for £1 in October 1984, producing the Banking Act 1987 and a Board of Banking Supervision. Margaret Reid's contemporary history, written by a Financial Times journalist who had covered the whole episode, concluded that the fundamental failure of 1973 was one of information: the Bank did not know what the fringe owed, to whom, or against what, because no one had ever required it to be told (Reid, 1982).

The pattern recurred. When a British bank next queued on a pavement in September 2007, the institution had again funded long assets in wholesale markets, and the regulators had again been looking at capital rather than at liquidity. David Kynaston's history of the Bank notes that the Lifeboat's most durable legacy was the principle that the central bank's job extends to institutions it does not supervise, once their failure would reach the ones it does (Kynaston, 2017).

The Lifeboat was wound down through the late 1970s as assets were sold and loans repaid, quietly enough that no date marks its end. Of the twenty-six institutions taken aboard, most were dismembered, absorbed or liquidated over the following decade; a handful traded their way back. The Bank of England never published a full list of who was rescued.

Jasper Hollom's Control Committee met weekly for the better part of three years to decide which of the City's names would be allowed to survive the week, and for most of that time the public had no idea the meetings were happening. Britain had been three days from a chain of bank failures in December 1973, and it learned so only when the historians got to the files.