Today is the second birthday of the credit crunch – and the second year has been even more troubled than the first. On 9 August last year, HBOS was still independent and Bradford & Bingley's mortgages remained unnationalised.
Lehman Brothers had yet to collapse and the US government had not taken control of mortgage groups Fannie Mae and Freddie Mac. The IMF had not bailed out Iceland. Sir Fred Goodwin still headed Royal Bank of Scotland. Bank of England interest rates were 5 per cent rather than today's 0.5 per cent. Quantitative easing was an unknown phrase.
"This last year has been particularly difficult for our industry," admits Eric Daniels, chief executive of Lloyds Banking Group, for whom the prospect of the HBOS merger was only a dream on the crunch's first anniversary. Last week the deal became a nightmare when he revealed £13bn of bad debts.
The credit crunch started on 9 August 2007 when French bank BNP Paribas suspended three funds facing losses on US sub-prime mortgage lending. That caused banks to stop lending to each other, interest rates to soar, and provoked the funding crisis at Northern Rock which resulted in the run on its funds. The Rock's former chief executive, Adam Applegarth, famously conceded: "Life changed on 9 August. That was when the markets froze." But on the first anniversary of the crunch, Northern Rock remained its only substantial victim – nationalised with a policy to run down its operations. Central banks had provided liquidity to lenders in Britain, Europe and the US while Bear Stearns was rescued by JP Morgan; HBOS, Bradford & Bingley and RBS had raised capital through rights issues – but banks and regulators still believed sticking plaster rather than surgery was the solution.
There was hope at last year's anniversary that the worst was over. Not so. The UK high street banks raised £20bn of new equity in the first year of the crunch; in the second they have had to find almost £70bn, including the £1bn placing last week by Standard Chartered. When existing investors couldn't stump up more capital, the Government acted as underwriter and became the sector's biggest investor.
This time last year, economists debated whether the financial crisis would turn into a wider recession – unaware that economic growth had already turned negative. Only since then has the Government sought to stimulate the economy by cutting Vat, removing stamp duty on many home purchases and subsidising a new-for-old car-scrappage scheme. It was in the second year of the crisis that the Bank of England slashed interest rates. And it was in the past year the IMF provided aid to countries from Pakistan to Belarus. Since last August there has been some consolidation in the banking industry besides the Lloyds-HBOS merger – including Bank of America buying Merrill Lynch and Santander acquiring Bradford & Bingley's savings business – while sovereign wealth funds have invested in many banks, including Barclays' £6.5bn capital injection from Abu Dhabi and Qatar.
But governments have been the main catalyst for change. The US Fed took control of insurance group AIG and launched a $700bn bailout of Wall Street's investment banks. Iceland's main lenders have been nationalised, Belgium seized the Fortis banking business and the Swiss National Bank now has a stake in UBS.
And the same question is being asked now as a year ago. "Will it get worse?" Michael Geoghegan, chief executive of HSBC – which did not take direct government investment and last week reported a $5bn pre-tax profit – is cautious. "There are two trains of thought," he says. "We're at the bottom, or we may have another leg to drop. Nobody can tell at the current time. If there is going to be a deterioration, it's most likely to be in the fourth quarter."
Yet the influential National Institute of Economic and Social Research last week called the bottom, and figures, including UK bank results, give reason for optimism. The decline in manufacturing output in Europe and the US has slowed sharply, according to surveys of purchasing managers, and rose in Britain, where production statistics were the strongest since the start of the crunch. The same surveys showed continued growth in key Chinese and Indian markets.
The UK services sector also grew for the second month running, with the purchasing managers' index reaching a 17-month high and car sales rose for the first time since April 2008.
And house prices – the first indicator to turn negative after August 2007 – have increased every month since February according to last week's figures from Halifax and Nationwide, returning them to last November's level. The Royal Institution of Chartered Surveyors last week joined Nationwide in suggesting house price inflation for 2009 could be positive again. Eric Daniels, whose Lloyds bank now includes Halifax, is more cautious, but says: "We now expect residential prices to fall by 7 per cent or less this year and rise modestly next year. We were previously forecasting a 15 per cent drop."
He adds that contrary to the national trend, his bank's mortgage repossessions peaked last autumn. Despite last week's bad debts, which caused the bank to report a £4bn half-year loss, Mr Daniels says: "It seems the UK economy is stabilising but the growth will be below trend as the excesses of the boom years are unwound. We expect company failures to continue to rise, peaking in 2010, but not to reach the heights of the last recession."
Mr Daniels – who is laying off thousands of employees because of the HBOS takeover – expects unemployment to peak next year, too, at similar levels to those seen in the early 1990s. That is not a government view, but Lloyds is 43 per cent owned by the state, and when it finalises details of the scheme for the Treasury to insure its bad debts, it could join RBS as a government subsidiary.
The third year of the credit crunch – and many years thereafter – is thus likely to be dominated by government efforts to sell its bank stakes to recover the vast public sums. Since the crunch's last anniversary, the Treasury has established UK Financial Investments to hold its stakes and it must devise an unprecedented privatisation programme to sell £50bn of shares.
The Bank of England believes the third year of the crunch will remain difficult for Britain. It admitted the recession has been deeper than previously thought when it added £50bn to its quantitative easing programme last Thursday. While listing improvements to the economy, it warned that banks' attempts to strengthen their balance sheets will continue to restrict lending to business.
Governor Mervyn King will this week highlight his qualification to the optimism when he reveals the Bank's latest forecast of inflation – becoming increasingly negative – and its view on the economy.
But the banks believe they are now providing homebuyers and small businesses with loans on reasonable terms and Mr Daniels thinks Lloyds' bad-debt losses have now peaked. His job in the third year of the crisis is to make the HBOS merger profitable while rivals opportunistically exploit those banks hobbled by state ownership or balance sheet constraints. Standard Chartered is planning to buy RBS's Asian operations and Barclays' acquisition of parts of Lehman from its administrator allowed it to report a rise in profits to £3bn last week.
"Barclays has continued to generate profits in every reporting period since this crisis began," emphasises chief executive John Varley. But he worries that a regulatory clampdown will mean a different style of banking by the time credit crunch's next birthday is celebrated. "Given the experience of the world over the past two years, the managing of systemic risk looms large in the minds of governments and regulators today," he says.
"I acknowledge that there were excesses in risk, leverage and reward in the banking sector. This industry got many things wrong and there is much to be sorry about. So there must be change. The change should, however, not provoke the throttling of important aspects of the market economy."