Eric Daniels's facade slipped only for a moment and then when it was least expected. At a low-key speech to a breakfast organised by a Jewish charity last Monday, the American chief executive of Lloyds Banking Group was clearly fighting back tears as he spoke in his distinctive gravelly drawl. Daniels, 57, renowned for his Buddha-like calm, was under extreme pressure. He was in the middle of a desperate fight to stop the government taking control of his bank. If he failed, he and his chairman, the City grandee Sir Victor Blank, would for ever be remembered as the men who steered Lloyds, the pride of British banking, onto the rocks.
Excusing himself for not being able to talk about the battle with the Treasury, Daniels spoke instead about his career. He had once worked for the US bank Citigroup in Latin America and employed a local man called Cristobal, who had blossomed under his tutelage. Daniels' eyes misted when he recalled his Panamanian protege and he wiped away a tear. Any tears Daniels might shed this weekend would not be the result of the wistful recollection of success, but more likely of abject failure. On Friday he and Blank lost their fight. After days of fractious negotiations, the government took majority ownership of Lloyds in return for insuring it against future losses on £260 billion of toxic loans.
In October Blank and Daniels had spotted their chance to seize control of HBOS, which was on the verge of collapse. Gordon Brown acted as midwife to the deal, promising that competition rules would be waived to allow the merger to go ahead. A new titan of the high street would emerge. In the HBOS accounts, however, lurked a timebomb: a slew of bad loans and toxic assets which ushered Lloyds into the arms of the government this weekend, having announced losses from HBOS of more than £10 billion just over a week ago. More than 80% of the assets being insured by taxpayers came from the HBOS side of the banking group. In return for the insurance, the governrnent took a £15.6 billion fee and, more significantly, increased its stake in the bank to 65% of voting shares, which could rise to 77%.
Lloyds share-holders are furious, with many demanding the resignation of Daniels and Blank. "People bought Lloyds shares because it was seen as a safe, plodding company and no one thought they would do anything risky," said Roger Lawson at the UK Shareholders' Association, which represents the interests of small investors. "the HBOS merger was a total strategic nightmare." How did we get to this point and how big a gamble is the government taking with our money?
Blank is one of New Labour's favopurite businessmen. Raised by his tailor father - the son of a Ukrainian immigrant - after his mother died of cancer, he was a high-flyer from an early age. At 26 he was made the youngest-ever partner at the City law firm now called Clifford Chance. He soon came to public prominence and became a fixture at Labour gatherings when chairman of Trinity Mirror, owner of the Daily Mirror. The close links continued when he took over the chairmanship of Lloyds TSB in 2006. The bank became a headline sponsor of the London 2012 Olympics, pledging £80m.
Under Blank and Daniels, Lloyds had a good credit crisis. During the boom years it had avoided the worst excesses of investment banking and other speculative activities - to the detriment of its share price, as investors chased the higher returns offered by its peers. The sub-prime crisis saw the tables turned. As its rivals lurched towards collapse, Lloyds sailed on serenely. A trap was waiting, however.
Blank had long nursed the idea of Lloyds taking over HBOS to create a British banking giant. By September last year HBOS was heading for disaster after its aggressive expansion into corporate and property lending. The Lloyds chairman saw his chance. Knowing the government would need to waive competition rules for a merger to proceed, Blank made use of his Labour connections and collared Gordon Brown at a reception at Spencer House in St James's, central London. Having found a quiet corner where the two men could talk without being overheard in a room of City grandees, Brown assured him that the competition rules would indeed be set aside.
HBOS, which the government feared would collapse, was saved - but, unbeknown to Blank, Daniels and Brown, Lloyds was blighted. Its shares are now worth less than a tenth of their value a year ago, having fallen from 483p to close at 42p on Friday. While Blank and Daniels must take the lion's share of the blame, Brown's role should not be underestimated. Without his undertaking that the competition rules would be ignored, the deal would never have gone through. "Gordon Brown was the rain-maker on the deal," said one Lloyds shareholder who asked not to be named. "It's a real shame that the most conservative and steady bank in the UK has been brought down by its [the government's] attempt to save the banking system."
Michael Fallon, the Tory chairman of the House of Commons Treasury sub-committee, described the meeting between Brown and Blank as "the most expensive cocktail party in history", adding: "Brown should never have egged Victor Blank on by offering to waive the competition rules. The law is there for a good reason." The criticism did not just come from Tory ranks. Ian Gibson, Labour MP for Norwich North, said: "Gordon should have taken more care. We may not yet have reached the bottom of this crisis."
In return for the insurance policy agreed this weekend, the government will receive a premium paid in new Lloyds shares. This could eventually take its holding in the company from 65% up to 77%. it is undoubtedly a hefty premium, equivalent to 21% of the value of the assets being insured. "It's like the home insurance on a £200,000 home costing £40,000," said one analyst.
More significantly, like Royal Bank of Scotland (RBS) which sealed a similar deal 10 days ago, Lloyds has made commitments to help stimulate the economy by lending more. It has pledged £14 billion - £3 billion for mortgages, £11 billion for businesses - this year and next. Analysts are sceptical about the promises, however, saying that without detailed comparison with previous lending it was difficult to judge whether any more would really be made available. "Now this dominant stake has been taken, it is very important that there is transparency in the lending agreement," said John McFall, chairman of the Commons Treasury select committee. "If this boosts confidence in lending, that would be a welcome step."
Critics suggest this is a big "if" and were this weekend drawing attention to the phenomenal risks being taken on by the taxpayer. The innocuous-sounding asset protection scheme has given the state an unprecedented degree of control over banking. The taxpayer now owns Northern Rock, Bradford & Bingley's mortgage book and almost all of RBS and Lloyds and, through them, more than half of all mortgages, retail accounts and loans to small and medium-sized firms. There is also a mind-boggling potential exposure to losses should the fortunes of the banks and the wider economy deteriorate. The scheme insures RBS and Lloyds against the fall in value of £585 billion worth of assets, roughly equivalent to the government's entire annual spending.
Ministers admit the full cost of the scheme is uncertain. "We just don't know," Stephen Timms, financial secretary to the Treasury, said yesterday. John Redwood, the Tory MP for Wokingham, said: "If buying one very large bank was careless, buying two is lunatic. When the government bought RBS it bet the farm. Buying control of Lloyds, it is betting the farm, the shop, the factory and everything else of value in our overborrowed country."
For taxpayers there could be a further sting in the tail. As British companies struggle to cope with recession, more and more are turning to their banks for emergency support, in some cases swapping their loans for stakes in the company. Through RBS and Lloyds, the government will face difficult decisions as to whether to let companies go under or to take control. If they choose the latter - as there will be political pressure to do - a creeping tide of nationalisation could spread through the economy.
The problem is likely to crop up first among housebuilders and property developers, which are key to the government's targets of building 140,000 new homes every year until 2016. Many are already under extreme pressure and RBS and Lloyds, thanks to its purchase of HBOS, are the sector's biggest bankers. As many as 1,600 UK property firms could go bust this year as the country's economic woes mount, according to recent research from the insolvency experts Begbies Traynor. Many more will have to hand over the keys to their state-controlled banks.
On A shareholder internet forum this weekend, the reaction to Lloyds's effective nationalisation was apoplectic "This is the biggest bank robbery in British history," said one poster. "Welcome to the socialist republic of UK plc," added another. One contributor suggested that Daniels and Blank be "strung up" in particularly painful fashion.
Perhaps unsurprisingly, the pair have the support of government, with a source close to No 10 saying they have "the full backing" of the prime minister. Daniels, further assailed by questions about his tax status, was unrepentant yesterday. "I am absolutely confident this will turn out to be a very good acquisition," he said. "We are going into this very uncertain period extremely well capitalised. This will be a bank with a very good future." The problem is that if he is wrong, it is the taxpayer who will bear the pain.
Additional reporting: Matthew Goodman, Robert Watts.
When the tall and imposing figure of Sir Victor Blank, chairman of Lloyds TSB, sidled up to Gordon Brown at a party last September, their chat was to result in the destruction of one of Britain's oldest and proudest banks. Michael Fallon, a Tory member of the Commons Treasury committee, yesterday called it the "most expensive cocktail party in history". It coincided with Lehman Brothers filing for bankruptcy and the entire banking system teetering on the brink of collapse. Any sensible chairman would have concluded that it was a good time to batten down the hatches.
Sir Victor thought differently. This was a chance to snaffle HBOS, his stricken rival, at a knockdown price. But he could not do it unless the prime minister agreed to waive competition rules. Mr Brown, faced with the possibility of having to nationalise HBOS, was only too pleased for Lloyds to take it off his hands. This weekend's taxpayer-funded bailout of Lloyds Banking Group shows how much these two men have to answer for. A bank that before September was described as too staid is now 65% owned by the taxpayer. This rises to 77% if the £15.6 billion fee it has incurred for putting £260 billion of its bad assets into the government's insurance scheme is included.
This was a rotten deal. In the midst of a financial hurricane it has become apparent that Lloyds had no idea what it was getting into. Eric Daniels, the chief executive, has admitted to carrying out three to five times less due diligence than would normally be the case. The news that HBOS had lost an astonishing £10.8 billion last year was apparently a shock to the Lloyds board.
As recently as January Sir Victor was offering public assurances that "everything is out there". Eveyything was not. As Roger Lawson, of the UK Shareholders' Association, put it: "Shareholders are angry and they would like to see the whole board, Blank included, go because it has been a total disaster." Investors saw Lloyds as a safe, plodding bank, a far cry from its frisky rivals. At a stroke, a good bank turned bad and shareholders have seen their investments plunge as Lloyds has been forced into the arms of the taxpayer.
Sir Victor and Mr Daniels should go. They may argue that in years to come the cocktail party deal will give Lloyds a dominant position in the UK market. But that is a hollow boast. Without the taxpayer bailout, Lloyds would not survive to take part in the next economic upturn, whenever that comes. It is a crippled organisation, dependent on state support. The only thing keeping the two men in their jobs is the fact that the government, as the biggest shareholder, wants them there. They are in it together.
There was, of course, one other person in that conversation last September. For a man who cannot bring himself to say sorry, Mr Brown has been anxious to play down his role in broking the Lloyds-HBOS deal - with good reason. He knows it could be as toxic to his reputation as some of the bank's bad assets. This time the mud looks like sticking. As one disgruntled investor put it: "This is Brown's doing, pure and simple. This time Macavity has been caught in flagrante."
He is right. Between them Sir Victor and Mr Brown have made a bad banking crisis worse by fatally contaminating one of Britain's few good banks. Mr Brown was the foster parent. People should remember this the next time either of them claims to have acted competently during this crisis. Sir Victor should go now; the electorate can decide on Mr Brown's fate when he deigns to call an election.
The newly-formed Lloyds Banking Group is being prepared to survive a 1980s-style U-shaped recession, one of the worst periods the British economy has suffered since the first world war. The latest rescue plan for Lloyds, announced yesterday, has only been agreed after Britain's biggest high-street bank underwent a series of extreme tests to see how it would survive them.
The government is not demanding the head of either Lloyds chairman Sir Victor Blank or his chief executive Eric Daniels - despite howls of protest from private investors who have seen a huge erosion of their wealth. Roger Lawson, chairman of the UK Shareholders' Association, which represents private investors said: "Lloyds shareholders are incandescent about what has happened. They are angry about the merger and they would like to see the whole board, Blank included, go because it has been a total disaster."
Yesterday Daniels remained defiant that the HBOS takeover was a good deal. He said: "I am absolutely confident that this will turn out to be a very good acquisition. We did it at the right time in the cycle. When you buy on the upside you pay a hefty premium and if you buy in a down period you can get something for a very good value."
These remarks incensed investors who blame Lloyds for walking blindfolded into the takeover of HBOS without doing due diligence. David Peters, 62, a semi-retired chartered accountant from Milton Keynes, said: "Our lifetime savings were invested in Lloyds and RBS. We had about £500,000 invested, including a £100,000 inheritance from my wife's mother, and we were taking out about £25,000 a year in dividends. Our savings are now worth £20,000 and we have written off any dividends for the next two years."
For the time being it looks as if the Lloyds board will survive intact. The government will support Sir Victor Blank, the chairman, and Eric Daniels, the chief executive. Given that the government was one of the co-architects of the deal, that support is hardly surprising. However, private investors will think differently and, if their frustration is given a voice, will pile on the agony for Blank and Daniels. The HBOS takeover may prove to be viable over time, but the dilution of ordinary investors means they are unlikely to enjoy it. Politically this deal will prove difficult. One of the best ways of extracting value from this deal is to lay off up to 30,000 staff and close branches. Lloyds has said it wants to avoid compulsory redundancies, but some unpalatable actions are going to have to be taken and the blame will be laid at Gordon Brown's door.