The biggest bet in the world

By the time G7 finance ministers met on Friday afternoon, they were staring into the abyss. In a desperate effort to restore calm to the markets, they took decisive action and came up with a five-point plan, which includes spending billions of taxpayers' money to rebuild the global banking system and reopen the flow of credit. This is how the drama unfolded ..
It was 19 minutes to noon on Wednesday when Gordon Brown took the call from Mervyn King. With the seconds ticking away to the Prime Minister's first Question Time in the Commons since the summer break, the governor of the Bank of England had dramatic news: secret consultations between the world's most powerful central bankers had resulted in the decision to make the biggest co-ordinated cut in interest rates there had ever been.

With the world's financial system perilously close to complete meltdown, bankers were determined to show they meant business. The move was to be announced at midday in London and 7am New York time, and King was nervous that Brown might be embarrassed by a backbencher picking up the news via BlackBerry as he stood up to speak.

Brown had already been dealing with the financial crisis for more than six hours that morning, having held a 5am summit with Chancellor Alistair Darling at Number 11 to discuss details of a £50bn part-nationalisation of Britain's bombed-out banks, due to be unveiled to the stock exchange that morning.

With just 10 minutes to go before world markets heard the news, King's next call was to Darling. Both Prime Minister and Chancellor had been hoping for a rate cut for many weeks as the credit crisis began to take its toll on Britain's cash-strapped borrowers, threatening to tip the economy into a severe recession.

Just before Brown stood up to explain his drastic bail-out plan to Parliament, US Treasury Secretary Hank Paulson was appearing before reporters in Washington in an attempt to reassure American voters that their savings were safe. Asked if he planned to emulate Brown's bail-out package, Paulson was sniffy, defending his own $700bn 'troubled asset recovery plan'. Yet within little more than 48 hours, he was signing up to a promise by the G7 finance ministers to pour public cash into struggling banks, buying shares to ease the severe shortage of capital in the world's financial sector.

The reason for the volte-face was simple: Wall Street was locked into a vertiginous sell-off as terrified investors dumped stocks, commodities and the dollar, fearing that the mounting financial crisis would turn into a full-blown economic slump.

By the time the G7 finance ministers gathered in Washington on Friday afternoon, there was no doubt whatever that they were looking at disaster. The half-point rate cut, unthinkable just a few days before, was greeted with a shrug by investors who had lost their faith in governments' powers to fix the world economy. Wall Street had suffered the worst week in its history, with the Dow Jones index losing an extraordinary 18 per cent of its value, and every major stock market had plunged, day after day. On Friday alone, the Dow hurtled an eye-watering 700 points downwards, then swung up into positive territory, before settling 'only' 128 points down.

General Motors, once the proud symbol of America's car industry, was worth less by the end of the week than it was in 1929, and felt obliged to issue a statement saying it was not at risk of bankruptcy. By Saturday, it had announced talks about a merger with its rival Chrysler. Morgan Stanley was in desperate talks to save a proposed cash injection from the Japanese bank Mitsubishi, and on Wall Street the buzz was that Paulson's damascene conversion to state intervention had been triggered by the impending demise of another household name of US banking.

Thousands of miles away in Iceland, once a sleepy but prosperous example of the cautious Nordic economic model, a decade of financial excess was ending in tears. Reykjavik has been brought to the edge of national bankruptcy by its overstretched financial firms, and deposits from thousands of British savers, along with money belonging to local authorities and charities, was tied up in Icelandic banks. An IMF team was dispatched to assess its need for an emergency loan. Reports in Washington suggested that other countries were also teetering on the brink of insolvency.

G7 ministers were keen to avoid the policy paralysis that had been so evident when Nicolas Sarkozy gathered the leaders of Europe's big four economies in Paris a week earlier. Then, declarations of solidarity were swiftly belied by Germany's unilateral decision to guarantee all bank deposits, an example of the beggar-my-neighbour behaviour that had helped to deepen the Great Depression. The world's financial markets had delivered a clear message about the costs of indecision and disarray.

The strain of wrestling with the crisis was clearly visible on the faces of the finance ministers. France's Christine Lagarde, Washington's Hank Paulson and Alistair Darling all looked as if they had been burning the midnight oil - which they had. It didn't help that on Saturday, they all had to be at the White House by 6.45am to get security clearance for their breakfast meeting with George Bush.

The President has repeated his mantra that if they work together, the West's biggest economies would get through the crisis. For the first time since the turmoil entered a new and dangerous phase, Bush's remarks did not send share prices tumbling - but only because the market was closed for the weekend.

Darling's morning continued with a bilateral with Paulson, and talks with the new chairman of the Financial Services Authority, Lord Turner, over the plans for recapitalising some of Britain's biggest banks, details of which will be announced tomorrow.

Around the table at the US Treasury, Darling argued forcefully that recapitalising banks with public cash was the only viable solution to the worldwide crisis. Japanese delegates, rarely the most vehement contributors to G7 debates, argued passionately that the lesson from their country's own catastrophic banking crisis in the 1990s was that taxpayer-backed bail-outs of financial institutions should be carried out without delay. So keen was King to push home the importance of unblocking the credit markets, he summoned up the ghost of Elvis Presley, saying, 'as the King would say - a little less conversation, a little more action'.

It was not Elvis but the desperate need to restore calm to the markets that really prodded the G7 into action, however. When civil servants presented a first draft of the communiqué, several pages long and packed with waffle, finance ministers said they wouldn't sign it - because it wouldn't work.

Italian finance minister Giulio Tremonti even went public, saying 'the current draft is too weak', and wouldn't, at first, put his name to anything more than a page long. When the meeting ended, what emerged was a five-point plan, including a promise to buy up stakes in banks, on the British model.

Governments also pledged to prevent the failure of 'systemically important' banks, in a bid to avoid unleashing another financial domino effect like the one that followed the collapse of Lehman Brothers; take 'all necessary steps to unfreeze credit and money markets'; ensure that consumers around the world can have confidence in the safety of their savings; and take action to kick-start stalled markets in the mortgage-backed assets and other securities that banks use to help fund their lending.