The anger among Britain’s bankers had been building for weeks, much of it directed at Mervyn King, the Bank of England governor. As the tensions rose last week, they threatened to burst into the open.

“King doesn’t seem to get it,” said one senior banker. “Everybody else is putting all hands to the pumps, but the Bank of England has seemed content to sit on its hands.”

Another contrasted the approach of Hank Paulson, the US Treasury secretary, and Ben Bernanke, chairman of the Federal Reserve, with that of Alistair Darling, the chancellor, and King.

“We know exactly where Hank Paulson and Ben Bernanke stand,” said the banker. “They have said they will do everything possible to ensure that their financial system is protected. But what does King stand for? Who knows?”

That, say analysts, has been in sharp contrast to the clarity of the American approach. “Everything we have seen from the American authorities has the classic hallmark of Hank,” said one former colleague of Paulson from his time as head of the investment bank Goldman Sachs. “He has a very consensual leadership style. He gets as many opinions as he can.”

The conversations British bank bosses have been having with King were different, they say. Since the summer, when King first avowed that he would not step in to bail out the banks for their irresponsible lending on “moral hazard” grounds, Britain’s top bankers have felt they are fighting the credit crisis with one hand tied behind their backs.

Some claimed to have detected differences of opinion within the Bank. Paul Tucker, the Bank’s executive director with responsibility for markets, and Alastair Clark, a former senior figure brought out of retirement in the autumn, are said to have given them a more sympathetic hearing than the governor.

King’s stance was said to have been the subject of significant disagreement within the Bank, with some senior figures arguing that the credit crisis was too serious for him to stand on ceremony. News earlier this year of King’s reappointment as governor for a second five-year term brought groans from some in the sector.

The result of the bankers’ disquiet was an unprecedented behind-the-scenes lobbying campaign. The chairman and chief executives of Britain’s biggest high-street banks have been in regular telephone contact – something they normally shy away from – to establish a way to lobby for King to pump more money into the system to match the dramatic action taken by America’s Federal Reserve and the European Central Bank.

They agreed that they had to ensure the Bank gave them a fair hearing and that King was made aware of the seriousness of the situation. The money-market distress that erupted in August was returning, with the interest rates at which banks lend to each other rising sharply. The near collapse of Bear Stearns, one of Wall Street’s oldest names, suggested the credit crisis was entering a new and more dangerous phase.

Fortunately, the bankers had a platform where they could make their concerns known. A prearranged meeting at Threadneedle Street, organised to discuss reform of the way the financial market is regulated, as well as a new compensation scheme for bank depositors, gave them their opportunity.

So when the top names in British banking filed into the Bank at 2.30 on Thursday they had plenty to get off their chests. They included John Varley of Barclays, Sir Fred Goodwin of Royal Bank of Scotland, Andy Hornby of Halifax Bank of Scotland (HBOS) and Stuart Gulliver of HSBC.

They were not happy. A £5 billion pot of money that King had made available for three days at the start of the week had been sorely needed. In the auction process to secure it, the banks asked for nearly five times more cash than was available. They wanted more – and fast. King had agreed to offer another £5 billion just before the meeting, but even that did not head off the heated debate.

The bankers asked King to allow them to deposit mortgages with the Bank of England as collateral in exchange for cash, as their European counterparts can do at the European Central Bank. They also wanted to be able to put up loans to small businesses as collateral. Further demands included an overhaul of the emergency overnight lending facility, which the banks have been scared to use since Barclays dipped into it last summer and was forced to deny rumours that it was in trouble.

And, while all parties have agreed to keep to themselves exactly what was discussed, the Bank contenting itself with a brief statement promising continued “close dialogue”, their pressure seems to have worked.

Both the Bank and the bankers are now talking about a new spirit of cooperation to see the economy and the financial system through the crisis. King can be delphic but he appears to have recognised that the time for the blame game is over. The last thing the country needs is a central bank at war with its banks.

No precise numbers were agreed but, by the time the bankers left the meeting, the mood had lifted. In practical terms, the Bank will make liquidity available to the banks if they need it, and against a wider range of collateral.

If the Bank delivers, the bankers will have got what they have been calling for over the past seven months. Their side of the bargain is that they have to keep lending flowing into the economy and prevent the credit crisis turning into a full-blown credit crunch. IF it was a display of brinkmanship by the banks, it was because emotions were still raw about the fact that one of their number, HBOS, had been driven towards the brink by malicious market rumours. Coming after the collapse of Bear Stearns the previous weekend, it took a plunge of nearly a fifth in the share price of HBOS, Britain’s biggest mortgage lender, to bring the matter to a head.

Paul Baker, head of corporate broking at Morgan Stanley, received a phone call at about 8.30 on Wednesday morning from his colleagues on the bank’s trading desk.

Vague rumours about a British bank in trouble had turned into a concerted attack on HBOS – one of Baker’s clients. Fund managers at some of Britain’s most respected institutions had been calling to check out some bizarre suggestions that had come their way – partly from anonymous e-mails.

There were three separate tales that stood out among a morass of tittle-tattle, the traders said. Mervyn King had supposedly cancelled a trip to the Far East. He was also said to have barred anybody at the Bank of England from leaving their post over Easter. The Bank was in firefighting mode, it was said, because HBOS had been forced to go to it for emergency funding.

HBOS shares had opened the day 3% up. Almost instantly they were 7% down – a 10% swing in a matter of seconds, but none of it made any sense.

Baker picked up the phone to Andy Hornby, the HBOS chief executive, to tell him that his shares had gone into freefall. David Hutchison, head of corporate broking at Dresdner Kleinwort, HBOS’s other key adviser, was on another line – his traders were being peddled the same rumours.

It was all nonsense. The rumours were better coordinated than the usual market gossip, so it appeared that somebody was doing this deliberately, to make money from the falling share price.

By 8.50am the stock had plunged 18%. HBOS started to issue strong public denials, while Baker and Hutchison rang the bank’s biggest shareholders to calm nerves.

There is speculation that one trader made £100m, but the figure has not been corroborated and most brokers say that it would be very hard to crystallise that profit in such a short period of time.

Hornby, meanwhile, ordered a forensic team to start investigating the share register to see who would have an interest in forcing down the HBOS share price. At 9.30am he had learnt enough to decide to involve the Bank and the Financial Services Authority (FSA).

When Alliance & Leicester and Barclays had been hit with similar rumour-driven attacks last summer, both the Bank and FSA had kept quiet, insisting they could not be drawn into commenting on every rumour about every institution. This time they knew better.

Bank officials began calling news agencies, urging everyone to ignore any tales about banks in trouble. Stories about King having cancelled a trip to the Far East were “fantasy”, officials said. No such trip had been planned. The governor had cancelled a visit to the West Midlands, something he has done in the past, but Rachel Lomax, his deputy, went ahead with a visit to Swindon. Easter leave for Bank staff had not been cancelled, a fact confirmed by callers to the Bank on Good Friday.

The FSA then kicked into action. A statement issued by Sally Dewar, the watchdog’s managing director of wholesale and institutional markets, soon made it clear that a manhunt was under way.

“We will not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumours and dealing on the back of them,” said Dewar.

Rumours had been dogging financial stocks in Britain and America since Bear Stearns ran into trouble a few days earlier. Calls were made to the deputy news editor of The Sun a week last Friday claiming that a leading bank was in trouble and had sent a memo telling all frontline staff to stop lending.

On Wall Street on Monday, Lehman Brothers was forced to issue a statement assuring the market that its financial position was “very strong”. It was prompted to act after rumours of liquidity problems dragged its share price down by half.

MF Global, the US-listed brokerage spun out of the London hedge-fund firm Man Group last year, was another victim. Its shares plunged 71% amid rumours of funding difficulties, prompting another denial.

Morgan Stanley’s Baker said: “This is an extraordinary time when irrational fear can result in such extreme volatility in share-price movements.”

In London, Icap, the interdealer broker run by Michael Spencer, the billionaire treasurer of the Tory party, was hammered by similar rumours, knocking its shares 15% lower.

By Tuesday night, rumours that a British bank had been brought to its knees by funding problems were beginning to emerge in New York, Singapore and Australia. Initially Lloyds TSB was the victim, before HBOS was targeted.

“I got into the office a bit late on Wednesday morning,” said one fund manager, who controls a top ten shareholding in HBOS. “I shouted across to the dealing desk as I came in, to ask what was going on. They shouted back that HBOS was bust. That was shortly followed by some tale suggesting that Lloyds TSB had been asked by the Bank of England to bail out HBOS. My immediate reaction was to buy HBOS, as it was clearly all utter nonsense – and we’re up more than 10% thanks to that.” AT HBOS, Mike Ellis, the finance director, held a dinner for some of his biggest shareholders on Wednesday night. His reassurances on the company’s finances were largely unnecessary as none of the long-term investors in HBOS had believed the market rumours.

The traders driving the price lower are thought to have been short-term investors from hedge funds or, ironically, the trading desks of other big banks.

The provisional list of suspects is being drawn up with the help of Sabre, an FSA computer system designed to hunt down suspicious stock market trades.

By the time the 40 members of the FSA’s market monitoring team return from their Easter break on Tuesday, Sabre will have spewed out a long list of names that profited from the collapse in the HBOS share price.

Roughly 6% of HBOS shares in issue have been sold short – a process where traders borrow shares from another institution, sell them in the market, then buy them back later. The only way to make money from short-selling is for a share price to fall.

Sabre can identify every single trader in London through a unique code number. Proving who spread a rumour, however, is rather more difficult. Having a short position on British banks was a legitimate stance. Spreading rumours to ensure that position comes good is illegal.

“I wouldn’t support a rogue trader at all, and whoever has been behind this needs to be punished,” said Sandy Chen, banking analyst at Panmure Gordon. “Having said that, there was a legitimate trade to make here, in the current environment. Will HBOS go bust? No, of course not. Will the shares fall because the market could begin to think that way? Well, that’s a different question.”

The collapse of Bear Stearns has produced an environment in which short sellers can make serious money. Rumours that in normal times are dismissed as ridiculous have additional weight. In unusual times, unusual things do, after all, happen.

Fears about the capital strength of Royal Bank of Scotland and Barclays have been circulating for months, after both banks were hit by write-downs related to the credit crunch. WITH Britain’s debt-laden consumers coming under increasing pressure to meet their mortgage payments, fears are growing that mortgage banks will be hit by a sudden leap in bad debts.

Figures produced in an obscure filing from Bradford & Bingley last week revealed that its mortgage arrears have soared by 50% in the first three months of the year.

The bigger risk for Bradford & Bingley and every other lender is securing funding to support their operations. Britain’s banks are hugely dependent on funding from the wholesale financial markets, which is increasingly difficult to find and becoming ever more expensive.

Alliance & Leicester has a loan-to-deposit ratio of 200% in its UK business, according to figures from UBS. In other words, it has loaned twice as much money as it has taken in from savers. The shortfall has to be made up from funding in the financial markets. All British banks rely on wholesale funding to some extent.

The cost of funding that shortfall has been soaring, thanks to the global credit crisis. The interest rate that banks charge one another to lend in the money markets climbed to almost 6% last week. In normal circumstances this rate should only be a little above 5.25%, the official Bank rate. Alliance & Leicester warned at its recent full-year results that this funding mismatch would cost it £25m this year. All other lenders are in the same boat.

This is the main reason lenders are refusing to offer new home loans to tens of thousands of customers. The easiest way to ease the funding crisis is to gradually lend less money.

“We’re all being prudent,” said HBOS’s Hornby. Two weeks ago the bank raised £750m in a 10-year bond to maintain the strength of its balance sheet. The move was described as prudent by analysts, yet HBOS had to pay the market an interest rate of 9.4% to get its hands on the cash.

One senior investment banker said: “If the short-term money markets freeze, there is literally nowhere else for the banks to go for money, other than the Bank of England.”

The situation in the bond market, where big companies raise money, is virtually without precedent. In the past 21 working days, it has been closed for eight of them.

While companies are keen to raise money, the investors who buy the bonds have been spooked by a volley of bad news. And when the market does open, it is only for short windows like last Wednesday when four companies, including BT, raised $5.4 billion (£2.7 billion) in bonds in three hours.

But the terms and the spreads are far different from the heady days of last summer when the global economy was firing on all cylinders. Companies now have to act quickly to take advantage of these windows and accept that the pricing of these instruments is far different from before.

The spreads are now about three pecentage points above Libor (the London interbank offered rate) for five- to ten-year bonds. At these levels, they are an attractive investment opportunity for investors who still have money to invest, but unfortunately many of them, such as the hedge funds, are no longer in the market.

The bond market remains one of the few places to raise capital. For many, the traditional route of borrowing from banks has been closed mainly because the banks themselves are unable to raise capital at attractive prices. WHERE will it all end? Hopes that the credit crisis would be quick and dirty have been dashed. Dave Ramsden, the Treasury’s top economist, told MPs last week that the government does not expect money-market conditions to return to normal until the middle of next year.

Most market participants are reconciled to a prolonged period of difficulty, as the banks seek an “orderly workout” of their losses. The big fear, which last week’s 0.75 percentage point cut in interest rates by the Fed was intended to head off, was that these losses will be compounded by the effects of a deep recession in America.

When Wall Street traders left for their Easter break, still digesting the loss of Bear Stearns, the worry was that there was something artificial about last week’s bounce in the stock market.

“The whole sub-prime mortgage thing is hanging over the market, but overall it has been a good week, with good volume,” said one trader, who was rushing home to watch a basketball game. “I’m glad that this week is over.”

Another said: “You will see winners and losers. The losers are the Bear employees.”

Suki Duggan, owner of DonSuki’s hair salon on Manhattan’s Upper East Side, said she had seen an influx of men ducking into the salon this week. Some of her regulars were getting treatments they hadn’t previously, including one called ‘blending’ which tones down grey hairs, to “take ten years off the face”.

“Men are frightened. People are getting laid off, and few places are hiring senior workers because of the high pay they demand. These older men have to appear fresh and valuable because there is no room for tired and stale employees in this economy.”

A doctor at a New York skin laser and surgery specialist agreed. “One guy I hadn’t seen for four years said he lost his stock, his job, everything. The best investment he could make is Botox, laser and skin fillers.”

In London, the rush for cosmetic surgery among laid-off City workers has yet to happen but the mood is distinctly nervous. A year that started badly in the markets has got progressively worse. A difficult first quarter is nearly over. The optimists are hoping for something better in the second, perhaps with the help of the new mood of cooperation between King and the banks. Some, however, think it can only get worse.

Additional reporting: Julie Earle-Levine

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