Compassion? That's not a word I use, said Thatcher

The next Archbishop of Canterbury, Rowan Williams, will not be afraid to challenge government, as his remarkson Iraq have shown. The last clash of church and state was in 1985 with the report 'Faith in the City', which called for urgent help for the urban poor. Here, in an exclusive extract from his new autobiography, David Sheppard, former Bishop of Liverpool, recalls taking on Margaret Thatcher at the height of her power

Soon after the Toxteth riots in 1981, my wife, Grace, and I were on a sabbatical in London when the phone in our flat went at breakfast time. It was my friend Derek Worlock, the Roman Catholic archbishop of Liverpool, who said: "She's here!"

We had known the prime minister might visit Liverpool, but understandably security ruled and no announcement was made until she arrived. A crowd had learnt that she had come and "was baying for her blood" outside the town hall. She asked: "Why is there such hatred?"

Derek and Michael Henshall, the Bishop of Warrington, talked about our role in working for reconciliation with parts of the community that had been deprived of good opportunities. Michael then spoke of the need for compassion. Denis Thatcher, who had come to stand by his wife, said to her: "That's not one of your words, is it?" She replied: "I find it so condescending."

They tried to explain that true compassion meant "suffering with". Derek asked that she consider appointing a minister for Merseyside with a seat in the Cabinet. Michael Heseltine soon appeared in that capacity, to Liverpool's considerable advantage.

The prime minister was generous in giving unhurried time to Derek Worlock and myself on three occasions, each time over-running the hour allotted. The first of these was in February 1984. We tried to paint the picture of the effect of the more confident citizens moving away from a city. I managed to ask a question when there was plenty of time for her to answer: "Prime Minister, knowing what we know about new technology, what three things would you hope for over the next 10 years? I'm thinking of communities where men have been able to sell their strength or their willingness to work in a gang."

She started to answer immediately. Then she stopped. A long silence followed. Eventually, she said: "Well, I despair." I recalled that moment on several occasions when her public statements were so full of confidence.

The following year, two days before the publication of Faith in the City, the banner headline across the front page of the Sunday Times read: "Church report is Marxist". As I spread the paper on the kitchen table, a service was being broadcast on Radio 4. A reading from the Old Testament prophets said: "There shall be integrity and truth in the land." I exclaimed out loud, "Oh Lord, how long?"

The Sunday Times report quoted a "senior government figure" saying that sections of the report were "pure Marxist theology". The Financial Times leader dismissed this as wholly untrue. Robert Runcie said that it would need "mental acrobatics" to find any section of the report of which that could be a true description. The "senior government figure" never broke cover to claim responsibility for the quotation.

On Monday morning there was a long succession of press calls. They said: "You are allowing them to slay you, and you're saying nothing!" Eventually we agreed that we must respond. Grace's account is that I said with a glint in my eye: "I'm going into battle."

Government attacks made Faith in the City famous. The story continued to have front-page treatment for four days. The most extended interview I had, and the sharpest, took place on Channel 4 News with Norman Tebbit. He did not engage with the report's content, but spoke of his own youth on a London council estate, claiming that he understood better than someone with my background what was needed in urban priority areas. I said that London had changed since then, not least with the growth in the numbers of black people. He angrily accused me of suggesting that he was putting forward racist views.

After the programme we went back to the hospitality room. He claimed that the archbishop's commission had been unbalanced in its membership, with no one properly representing right-wing views. Norman Tebbit then revealed that he had asked to be supplied with a dossier on members, and read out what it said about members of the commission, including reference to the "personal problems" of one named member. There was sucking of teeth among the Channel 4 staff.

When I listed members who were in management or with conservative views he dismissed every name. By then I was angry, and foolishly said that it was difficult to find thoughtful Christians on the right who knew about urban matters. At that point, Norman walked out.

The following morning I wrote in a letter to him that I regretted saying those words. My letter said: "If they had stood by themselves, I would wholly disown them. I think you will agree that they did not stand by themselves."

Early in January 1986 Robert Runcie told me that Michael Heseltine had come up to him at a Christmas party and said: "Your bishops have got it all wrong. Things are much worse than they say!" That month he famously walked out as minister of defence over the Westland affair.

In 1987 the archbishop and the prime minister agreed that there should be a meeting at Chequers between Mrs Thatcher and a dozen bishops, at which we would try to understand each other better. I arrived late for the lunch and was received with special courtesy by Margaret Thatcher, sympathetic at train delays. When the conversation got going in the afternoon she made a sharp comment about Faith in the City. As the only member of the commission present, I said that Lord Scarman had said it was the best analysis yet made. She said: "I prefer what the chief rabbi said." Immanuel Jacobovits had spoken of how the Jewish community had lifted itself up by enterprise.

I pressed on with some of our challenges. Now Mrs Thatcher repeatedly interrupted. It was like being heckled. Indeed my mouth went dry as I remembered it doing once when facing the Australian fast bowlers Ray Lindwall and Keith Miller! But I kept going. I told Derek Worlock how different this experience had been from the open way in which she had spoken with the two of us. He said: "She has to be seen to win when there are a number of people present."

So was the archbishop's commission that produced Faith in the City worth having? The very public debate started by the report – enlivened by the attempts to rubbish it – played a considerable part in bringing the needs of the cities to the attention of the nation. The situation required the national Church to question from its own standpoint the morality of Mrs Thatcher's economic philosophies. The report also led to the formation of the Church Urban Fund, which by 2001 had raised £37m.

Lord Scarman, whom the government appointed to inquire into the 1981 riots, said Faith in the City was "the finest face-to-face analysis that we have yet seen. In the long run it will take its place, I believe, as a classic description of one of the most serious troubles in British society".

'Steps Along Hope Street' is published on 17 October by Hodder & Stoughton, £17.99