Carnage: Seven days that shook the world

Old certainties lie in pieces as markets hover on the brink of uncharted territory – and all trust has evaporated. Margareta Pagano and David Randall report

It took centuries to build sophisticated free-market economies, but this weekend, it looks like it may have only taken one week for it all to unwind. Not only have stock markets fallen to their lowest levels for decades, but, more than that, the assumptions that have underpinned commercial life for years are now threatened, some possibly doomed. Banker is not trusting banker, savers can trust no one, share traders do not trust governments, leaders (including conservative ones) suddenly discovered the virtues of public ownership; and there is the very real prospect of a country in the developed world actually going bankrupt.

Today the world's leading politicians and central bankers are working around the clock to flesh out a rescue package to prevent the crumbling financial system from cracking further. But they are now praying that the emergency package announced late on Friday night in Washington by the US Treasury Secretary, Hank Paulson, together with leaders from all the leading seven industrialised nations, will stabilise the world's financial markets when they open again tomorrow. In an unprecedented move, the world's heads of state have agreed to work together to buy shares in their banks and mortgages to prevent further systemic collapse.

Back in March, forecasters who said we were heading for the worst crash since the Wall Street crash of the 1930s were dismissed as doomsters. Today JK Galbraith's book, The Great Crash 1929 is flying off the shelves, as everyone, from governments to financiers, seeks a template for the new commercial world, whatever that will be. But, for now, we can only try to understand what has been, not what is to come. This is how the week's events unfolded:

Sunday

On a day that nearly everyone hoped would be confined to rest, recreation and a certain amount of sober reflection by traders around the world, German Chancellor Angela Merkel throws a pebble into hitherto calm Sabbath waters. Just 24 hours after a meeting between the four main EU economies in Paris concluded with President Nicolas Sarkozy declaring "European leaders acknowledge the need for close co-ordination and co-operation", she follows Ireland's example and guarantees all private deposits. It is a unilateral move that could see EU nations competing like fairground barkers to offer the best safety net for savers.

Words of a more elliptical nature come from the Chancellor Alistair Darling on The Andrew Marr Show. Asked if he was prepared to put public money into recapitalising banks, he says: "We are ready to do whatever it takes, and that is we've put money into the system to help banks generally. There are other measures that we will be taking too, and I'll announce them when we're ready to do that." Mr Darling knows that his officials are preparing plans to recapitalise banks for some time, but couldn't say so because the details are not yet ready, and the banks are not yet on board. But trading the next day will show that in the present febrile atmosphere, even cautious words can do damage.

And, in what was regarded by most media as a mere footnote, news comes from Iceland that the government and central bank are engaged in increasingly frantic efforts to prop up the country's swooning banking system with an injection of £7.78bn. As the world goes to bed, the problems of a small northern island with a population about the size of Coventry's seem the least of all our worries. Like so many of the experts' assumptions, how wrong that would prove to be.

Monday

After Mr Darling's comments the day before, the markets smell blood in the water. The FTSE opens at 4980.25 and within three hours it is down 300 points. Not a single firm in the FTSE 100 is rising, and, by 11am, there are only two stocks on the entire exchange that have gained. Mid-morning the price of oil falls to its lowest mark for eight months, the sort of tidings that, normally, would produce a bounce. Not today. Despite, or even because of, Mr Darling's assurances that he is assembling a cavalry to ride to the rescue of the banks, the plunge continues. By the merciful close, the index is down 391 points, a fall of 7.8 per cent (its biggest one-day collapse), and the lowest total for four years: 4589.2.

The issues of yesterday – which, at the pace things are moving, instantly seems like yesteryear – are picked at by Mr Darling, who chips at Ms Merkel for her unilateral personal savings guarantee (by now mimicked by Sweden, Austria, Denmark and Portugal). And, as the FTSE continues its descent, the Dow takes up the theme. It ends the day 3.9 per cent down, all part of a global fall that sees $2.5 trillion wiped off world shares.

In Washington, Congress begins investigating the murky roots of the banking crisis. Before them is Richard S Fuld Jr, chief executive officer of Lehman Brothers, the largest bankruptcy in US history. Asked if it was true that he took home some £275m in compensation since 2000, Mr Fuld took off his glasses, held them, and looked uncomfortable. It's not quite that much, he said. "We had a compensation committee that spent a tremendous amount of time making sure that the interests of the executives and the employees were aligned with shareholders," he waffled, before admitting that he took home £172m in those years. Democrat Henry Waxman could not resist the obvious conclusion: "Even as Mr Fuld was pleading with Secretary Paulson for a federal rescue, Lehman continued to squander millions on executive compensation." It is an issue that may yet keep American lawyers employed for years.

Tuesday

An upbeat start on the London markets, but, ultimately, a day of portents and rumours, and the growing tremors of a deeper, seismic events to come. The FTSE opens 2 per cent up, just about the time that Moscow is suspending trading on its market for an hour. By 9am the FTSE is already retreating from that early optimism.

Half an hour later comes the first of a series of shudders from Iceland. Icesave, the internet subsidiary of Landsbanki, is stopping customers – 300,000 in the UK – withdrawing their funds. And there's soon more: Iceland, a country whose banks had swept across Europe over the past few years in a tide of acquisitions, is so short of funds that the government is having to borrow from Russia to help in the nationalisation of Landsbanki, its second-largest bank, and its currency, the krona, is being pegged. Then figures are released showing UK manufacturing output fell for the sixth month in a row, something that has not happened since Margaret Thatcher's first year of office.

And the rumours fly. Royal Bank of Scotland has asked the Treasury for a capital injection (strenuously denied, but the firm's shares still fall by a quarter), the Government is soon to unveil a rescue package for the banks, and, according to the BBC, they had done so in response to pressure from leading bankers. But some in Europe are not happy at the prospect of such state aid. At a meeting in Luxembourg, Czech finance minister Miroslav Kalousek says: "Politicians in Europe are going crazy. We didn't live through 40 years of real socialism only to return to it." He talks, but no one's listening. The FTSE closes a hesitant 16.03 points up, and, in New York, the Dow takes a further dive by 508 points, not helped by the announcement from the International Monetary Fund (IMF) that US bank losses could reach £1.4 trillion.

At 5pm, Gordon Brown and Alistair Darling meet the governor of the Bank of England, Mervyn King, and the chairman of the Financial Services Authority, Lord Turner. A No 10 spokesman denies it is an emergency meeting, but, in the present climate, what else could it be? At 7.30 comes the news from Mr Darling that he will announce a comprehensive rescue package for the banks before trading opens tomorrow. Treasury officials and bankers will spend much of the night in talks. At 8.30pm, they ring Gandhi's, a fashionable eaterie, and order take-aways - £245 worth. It's going to be a long night.

Wednesday

A day that could be scripted by Lewis Carroll. Before the day is even fully light, Alistair Darling announces his £500bn rescue plan: £50bn for recapitalisation of the eight participating banks, a guarantee of £250bn of new short and medium-term bank debt, and an extra £200bn to allow banks to swap mortgage-backed securities for cash. Preferential shares, probably, for the Government (ie taxpayers) in return, and, says Mr Brown, we might even make a profit. We've been working on this for weeks, says Mr Darling. The market's response? Opening 2 per cent lower, it embarks on a bipolar course through the day that has moments of manic highs, but more lasting depressions. It ends more than 5 per cent down at 4367, concluding the worst three-day run in more than 20 years.

The half-point interest-rate cut (soon seen as part of a co-ordinated trim around the world) makes a difference for a while, but an afternoon IMF warning that Britain is on the brink of a recession pushes stocks towards a gloomy day's end. Helping them on their way was the news from Iceland: more large sums heading the way of its banks (this time from Sweden), and emergency powers to take over companies, limit directors' authority, and call shareholders meetings. The Icelandic boom, which saw the average family's wealth rise 45 per cent in five years, is over. It, and especially the roaring expansion of its banks (which hold liabilities eight times the nation's GDP), was all built on foreign debt. But why, apart from those adventurous private savers in Icesave, should we care?

That becomes obvious during the Chancellor's statement to the Commons. In response to a question from George Osborne, Mr Darling confirms that British local authorities had large sums invested in what was now the world's shakiest banking system. Within hours, the Local Government Association is calling for government help, and, in the course of an evening in which council after council coughed to savings in Icelandic banks, it seems as much as £1bn is at risk. And thus a day in which the rate cut is going to save a £150,000 mortgage payer £570 a year ends with many more people not knowing whether to call their bank manager or the Samaritans.

Thursday

Not every country is in turmoil. In China, the nation's ruling Communists open a four-day conference relatively unscathed by the panics and financial implosions. Their economy will grow by 9 per cent this year.

Back in the parallel universe, the Dow Jones has its worst one-day fall since 1987, down 7.3 per cent to 8579, its lowest for five years. The FTSE perks up in the morning, and is still up in mid-afternoon, but it can't resist the siren call from across the Atlantic and ends the day 52.9 down at 4313.8. Iceland takes control of another one of its banks, and closes its stock exchange. And, according to the Halifax, UK house prices are falling at a record rate, down by 13.2 per cent in the year to September. The record of the day, however, is set by Britain's trade gap in goods – the largest deficit since 1697. Small wonder that the Church of England says that more than 8,000 have logged on to an online prayer asking for divine intervention.

And maybe they're being answered. Not only is nationalisation (partial or otherwise) now acceptable on both sides of the Commons, there is a bidding war on which party could be most punitive on executive bonuses. The Tories, calling for a complete ban, won. Mr Brown's strongest words were reserved for Iceland. As more councils and charities discover they could lose major funds, he fumes: "We are holding the Icelandic authorities responsible. We are demanding that the money be paid back to the local authorities. We are prepared to consider all forms of action, including to freeze assets."

Friday

In Russia, the government offers its banks a £51bn bailout; in Japan, the sub-prime crisis claims the scalp of Yamato Life Insurance, which files for bankruptcy with $2.7bn liabilities; Germany is preparing a rescue scheme for banks; Iceland (the country) seems to be heading into liquidation; and in the US, the Standard & Poor's credit rating agency says General Motors, Ford and Chrysler could all be forced into liquidation. The FTSE closes 8.85 per cent down on the day at 3932, ending the second-worst week in its history, having lost 21 per cent since Monday. The Dow finishes a further 1.49 per cent down. Henk Potts, director of investment strategy at Barclays Stockbrokers, said the markets were "very close to panic".

And from Washington comes the spectacle of the most right-wing president in generations embracing the policy of near-nationalisation. His Treasury Secretary says that part of the already-announced $700bn bailout would be used to take stakes in wobbly banks. Mr Bush now finds himself in the role assumed 73 years ago, with rather more grace, by President Franklin D Roosevelt. Ahead of Saturday's G7 meeting, Mr Bush says: "The world is sending an unmistakable signal: we're in this together and we'll come through this together." Hardly poetry, but the right message to the flapping traders who continue to discount billions of government commitment.

Yesterday

London lawyers are on their way to Iceland to retrieve our money, traders are stuck to their screens adjusting their positions, bankers are huddled in their offices working out how the Government's bailout will work, while our political leaders use up a year's worth of carbon footprint as they criss-cross the globe flying between the emergency IMF-G7 rescue talks in Washington to those in Paris tomorrow.

The world financial system is "on the brink of systemic meltdown," IMF chief Dominique Strauss-Kahn warns, as G7 finance ministers meeting in Washington agree to follow the British lead in part-nationalising their banks. British treasury officials, meanwhile, pledge to take majority stakes in banks should this be necessary to prevent the system's collapse.

But what everyone wants to know now is when will this crisis be over? What the world needs is some kind of sign; some indication that the fat lady is ready to get up and sing. But, this weekend, there's no sign she's even in the theatre, let alone in the wings.

Research by Jesse Loncraine

The digested analysis. Digested...

* Starting with New Century in April 2007, a series of US institutions filed for Chapter 11 bankruptcy protection, as risks of sub-prime lending finally emerged.

* Bear Stearns revealed in June that it was spending $3.2bn to bail out two of its funds that invested heavily in sub-prime loans. Nine months later, the Fed loaned JP Morgan $29bn to rescue Bear Stearns.

* Banks revealed as making "covenant-lite" loans with very relaxed borrowing terms. Private equity groups used this easy money until the loans disappeared in July.

* 9 August 2007: the official start of the credit crunch. BNP Paribas froze three funds that had difficulties with its sub-prime lending.

* Northern Rock involved in bank run in September 2007, the first in the UK since 19th century. Customers were frightened by the Rock's need for emergency funding. Nationalised in February 2008.

* Banks turned to petro-dollar-fuelled, government-backed sovereign wealth funds. In November 2007, Abu Dhabi gave Citigroup $7.5bn for a 4.9% stake; Kuwait took a $2bn stake in Merrill Lynch.

* Most major UK banks issued new shares or tapped investors for capital in March and April 2008. Shareholders' stakes diluted as a result.

* Nationalisation of US mortgage backers Fannie Mae and Freddie Mac in September 2008. They had $5.4 trillion of mortgages guaranteed, but were worth $40bn combined.

* Attempts failed to sell US bank Lehman Brothers. It ended up in administration.

* The joke was that Iceland (pop: 320,000) was the world's biggest hedge fund, with all its investments overseas. But the fund's investment gambles didn't come off.

The Crash by numbers

£250bn wiped off the FTSE last week

21% drop in value of Britain's 100 top companies last week

111 profits warnings issued by British firms between July and September

8.9% fall in the FTSE on Friday, to end its worst week since Black Monday in 1987

£1bn losses by more than 100 local authorities with investments in Iceland banks

To have your say on this or any other issue visit www.independent.co.uk/IoSblogs

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