Examination of Witnesses (Questions 80-99)
20 NOVEMBER 2003
MR MERVYN
KING, SIR
ANDREW LARGE,
MR RICHARD
LAMBERT, PROFESSOR
STEPHEN NICKELL
AND MR
PAUL TUCKER
Q80 Mr Ruffley: Do you think you
should be doing more as a Committee to talk down the house price
bubble?
Mr King: I think the only thing
the Committee should be doing is just telling it as it sees it.
If we try to get too clever, by trying to pretend that occasional
obscure words can change people's behaviour, that will be foolish,
because that will be to give ourselves power that we do not have.
What we should do, I think, is simply state the facts as we see
them and our analysis and let people draw their own conclusions.
Q81 Mr Ruffley: In the July minutes,
the Committee argued that a Ô% cut was unlikely to cause
house prices to re-accelerate. Does it follow that a Ô%
rise is going to have much effect on house prices the other way?
Mr King: It is not going to have
a dramatic effect, but we are not trying to have a dramatic effect.
Even before the interest rate rise, our central projection was
that house price inflation was likely to slow gradually over the
next two years, with a lot of risks on either side, and that has
been reinforced by the latest change in policy that we have made.
None of us on the Committee would pretend that a quarter point
change is going to have any dramatic effect, and, as Steve said
earlier, we do not want to make a policy change that has a dramatic
effect, we want people to see policy evolving in a fairly steady
way.
Q82 Mr Ruffley: The money markets
are pricing in around 5% base rates by next autumn. If that comes
to pass, what is the Bank's assumption about what that does to
the house price level? It will be different from your current
assumption in quite a big way, will it not?
Mr King: I am not sure if it would
make a difference in a big way, because that is already in people's
expectations. Presumably, it would have some impact, but by how
much I think it is impossible to say.
Q83 Mr Ruffley: There is no estimate
you might want to give?
Mr King: No, I do not, because
I do not think that giving these precise numerical estimates,
of things that we cannot possibly know precisely, actually is
terribly informative.
Q84 Mr Ruffley: Can I conclude by
saying, given that the house price bubble seems to be at the heart
of the debate about the outlook for the economy and a very major
variable, is it not rather disturbing that you admit quite openly
that you have no ability to forecast house prices or have any
helpful estimates?
Mr King: Personally, I do not
think it is ever disturbing to be honest about what we know and
do not know. I think if anybody were to come into this room and
tell you that they knew what was going to happen to house prices
you would regard them as a fool, and I do not think the MPC are
fools. We try to make judgments. The one point I would make to
you, which I think is a useful insight into this, is that house
prices are not given by some exogenous path out there that descends
on the UK, and that determines what happens to our economy. What
happens to house prices is reflecting developments in people's
incomes and expectations about those incomes, as well as interest
rates and a whole lot of other things. To that extent, what we
are trying to understand is whether the evolution of the path
for consumer spending is consistent with a prospective outlook
for house prices. We are looking at things that have to fit together.
We simply do not know what will happen to house prices and I think,
if anyone believes that the MPC should be making interest rate
decisions on the basis that they pretend that they know what is
happening to house prices, that would be most unfortunate. We
simply do not know. There are some things we can make better judgments
about than others, and, on an asset price—whether it be
an exchange rate or house prices—it is something which is
extremely difficult to judge. What I hope people will take comfort
from is that we will respond to developments in the economy promptly
and quickly as they occur, in order to keep the economy on track
to meet the target. That I think is the only way to achieve stability.
Mr Ruffley: That is very helpful, Governor.
Thank you very much.
Q85 Mr Plaskitt: Governor, in your
opening statement, which was quite short, nevertheless you mentioned
twice the subject of household debt. You referred to the growth
of secured and unsecured credit continuing at high rates, and
shortly after that you talked about the current high level to
which household debt has risen. Then you qualify slightly the
two expressions of concern and you go on to say but it is not
as fragile as some people have suggested. Then when I turn to
the Inflation Report you get the same mix. There are three bits
of evidence you give which, on the face of it, sound quite alarming
in respect of debt. You talk about unsecured borrowing growing
at 15% per annum, a very, very high figure. You remind us that
total household debt is now equivalent to 130% of post-tax income,
and we have seen a paper by Rob Hamilton, from inside the Bank,
which concludes that increases in the debt to income ratio might
go on growing for up to ten years. Take those three and you can
begin to understand why you might be ringing alarm bells about
debt, but are there not factors on the other side of the equation
as well? Your Inflation Report reminds us that the debt servicing
costs have been stable for years and that household net worth
is historically high. Is there any way we can steer through this
central banking balancing act and hear from you whether you do
think there is a reason to be worried about debt or not?
Mr King: I think really I would
say, "Hear, hear," to your very careful and balanced
statement of the issues. I think it is important to weigh up those
factors. It is most unfortunate that the discussion on debt tends
to fall in a rather exaggerated way on one side or the other.
After the Inflation Report press conference, one headline was
"Bank complacent. Debt crisis; what debt crisis?" Another
headline, on the same day, "Debt disaster looms." Neither
is a sensible way to present the issue. Just to go through one
or two of the factors. If we look at what are the risks, what
are the vulnerabilities to the economy at present from levels
of debt, could we see a repetition of the increase in the number
of households facing negative equity? On the face of it, that
looks somewhat unlikely. It would require a very, very large fall
in house prices to get us back to the levels of negative equity
that we saw in the early 1990s. In terms of the aggregate position,
that factor is somewhat more comforting. In terms of income servicing,
the ratio of interest payments to incomes, that is running now
at about half the level that it was in the early 1990s, and again
it will require a very, very dramatic rise in interest rates to
get us back to where we were in the early 1990s in aggregate.
From that picture, I think people have exaggerated the vulnerability
of the economy to likely changes in policy. On the other hand,
if you asked the question are there groups of households who may
find themselves in difficult situations, then, because the debt
ratio has risen, there are minority groups of households, if you
look at households facing ratios of debt servicing to income of
more than 40, 50%, where it would not require a very large increase
in interest rates for those families to find themselves with the
sorts of difficulties that they had faced ten years ago. I think
it is a problem now not facing households in aggregate but that
there are groups of households, as a result of the fact that interest
rates have fallen, who may themselves have been tempted to take
on more debt than otherwise they would thus be leaving themselves
in a position where total debt servicing payments were still relatively
high, not because interest payments were high but because they
had taken on extra debt and they are vulnerable now to an increase
in interest rates. Whether that would be a significant issue for
us would depend upon whether they had reduced their spending dramatically
and whether that would account for a large fraction of spending.
The message that we put out was that people should think carefully
about how much they borrow. It is very easy to borrow in haste
and repay at leisure. There is a reason therefore to be cautious.
I am not saying people should not borrow, there are many people
who think carefully about it. It makes sense to borrow to buy
a house, but nevertheless the scale of borrowing is an issue,
it is a very important financial decision that should not be rushed.
People should not borrow in haste and repay at leisure, they should
think carefully about it. At this stage, I think this is something
that we will track very carefully and try to monitor. We are trying
to balance this. We are trying to make sure we understand that,
as far as we see it now, there is not a reason to react in a sort
of knee-jerk way to the aggregate numbers that you quoted so accurately
and say "This is a disaster," that would be a completely
false way of reacting. Equally, I do not want to be complacent
and suggest that there are not groups of households who could
face quite severe problems if conditions were to change. It is
possible, further down the road, that might be a matter of consequence
to a Monetary Policy Committee, if that led to significant changes
in consumer spending.
Q86 Mr Plaskitt: In other words,
I think you are saying that the headline that appeared that screamed
"Christmas debt crisis," it is wider than that?
Mr King: It is just exaggerated,
yes. There may be some families who are in a difficult debt situation
but it is not because Christmas is coming up.
Q87 Mr Plaskitt: In the minutes of
the November meeting there is an interesting sentence in paragraph
26, where you said: "The Committee also noted that because
of higher household debt burdens where there is increased uncertainty
as to the strength of the response of consumption to any given
interest rate change." Are you suggesting there that, in
fact, because of that higher amount of household debt, there might
have been a change in the transmission mechanism between alterations
in interest rates you make and the impact on household behaviour?
If there is, the implication is that you have to do less on tightening
of policy before it has an effect, now that there is this higher
level of household debt. Is that a correct interpretation?
Mr King: There are two parts to
that. It is almost right. The first part is, yes, that there may
have been a change in the transmission mechanism, we are not sure.
To put it another way, when you have got very high levels of debt
the transmission mechanism is different from the average that
we have seen in the past. If the levels of debt were to come down
again we might revert to where we were. It could be different
now than it was in the past. There is more uncertainty about the
transmission mechanism, the impact of a change in interest rates
on spending, and hence inflation. How do we react to that? I think
the phrase you used was we would need to do less. I do not think
that is true necessarily. I think what it suggests is that if
you are more uncertain about the transmission mechanism then you
need to think a little more carefully, maybe go a little more
steadily. In the end, you may have to do as much, if not perhaps
a little bit more, but it is a bit risky to make very large changes
in interest rates. If circumstances change, certainly we are prepared
to do that, but it suggests that doing it cautiously, steadily,
is an approach that would make sense at this juncture.
Q88 Mr Plaskitt: Finally, on the
issue of household debt, there is a sentence in your Inflation
Report where you say outstanding credit card debt has grown particularly
quickly from 2% of income in 1993 to 7% in 2003. Do you think
that is a function of fundamental changes or developments in the
economy, or is it a function of the strategy being pursued by
credit card companies?
Mr King: I imagine credit card
companies are quite keen to encourage people to use credit cards.
That is what they are there for. It is a balance between the two,
demand and supply.
Q89 Mr Plaskitt: Why suddenly have
they had so much more success at doing that in the last few years?
Mr King: A good question. I do
not know the answer to that question. What I do know is, and I
think this is something which is related to your other concerns
on this Committee, that if you look, as we have in our survey,
at unsecured debt, much of the unsecured debt—the sort of
two-thirds to three-quarters that is not credit card debt—seems
to have been taken out by households who are better off, taking
up personal loans, hire purchase debt, for whom there is no obvious
reason on the surface to think that they have not made a careful
calculation of their circumstances. For the bottom income decile,
they are disproportionately using credit card debt. To the extent
that has risen very rapidly and it is among those groups, there
may be some cause for concern there, but I just do not know and
I am not going to rush to any judgment here. I do not know why
that has happened, but certainly I can understand it is worth
knowing more about that.
Q90 Mr Plaskitt: Over the period
that you mention in the Report, 1993 to 2003, we have seen a dramatic
change in the marketing practices of the credit card companies.
That happens to be the period in which they have, the number of
different offers out there has escalated dramatically over that
period of time. You have seen, in the latter part of that period
of time, the advent of the 0% offers, the balance transfer offers
and the direct issue of a credit card to people unsolicited. All
that has happened in that time frame. Do you not think that is
part of the explanation as to why, in particular, in relation
to the lower decile you talked about, there has been this sharp
growth in unsecured credit card debt?
Mr King: I do not know. The figure
I gave was related to the bottom decile. It does not follow from
that they have been taking up most of the increase in credit card
loans, that is likely to have been a factor among the bulk of
better-off households, and for those households it may well be
the case that they have been offered better terms and conditions
and have decided to take advantage of them in a purely rational
way. This is the outcome of a competitive process, and it would
be quite wrong of me to suggest that there is anything sort of
inefficient or wrong about that. If you are looking at the distribution
of debt burdens and those households who are vulnerable to a change
in interest rates then that bottom decile group is one that one
would like to focus on, certainly.
Professor Nickell: Surely it is
worth pointing out that the interest rate on credit cards is vastly
lower today than it was 10 years ago.
Q91 Chairman: Some of them are, but
the Bank rate is vastly more as well?
Professor Nickell: Not vastly,
relative to this change.
Q92 Chairman: We do not want to open
this up because it is a separate inquiry. You have got your Bank
rate of 3.75%. We have been given figures of credit card rates
at 30%, store cards, but also some credit cards are 20%. The issue
for us is, why is it six, seven, eight times what the Bank rate
is, and that is the big issue? We will give it to you as a frightener.
Professor Nickell: I absolutely
agree with that.
Q93 Chairman: We do not want to lose
our inquiry. Governor, you mentioned some figures you had. It
would be good if you could share them with us, on credit cards?
Mr King: On the survey, yes. When
the survey is completed and the results are available, certainly
we will be happy to send them to you.
Chairman: Thank you very much.
Q94 Mr Beard: Turning to financial
stability. Sir Andrew, we touched earlier on your speech at the
National Liberal Club this week, and you said that the implication
of the Financial Services Action Plan was not so much that it
was putting a straightjacket around the economy but it was the
question of financial stability that was worrying you. Would you
like to elaborate on that point?
Sir Andrew Large: The point I
was making is that there are a large number of Directives which
are going to need to be implemented over a short period, and the
amount of work that is needed to implement them is going to be
very significant, for example, assuming the Directive to the change
capital adequacy rules goes through, assuming the same for accounting
standards, and a plethora of others. The point I was making is
that there are so many areas of activity that businesses in the
financial sector (but it is the financial sector I am looking
at particularly here) are going to have to undertake in a short
period of time, that there is a danger that people will find it
difficult as well to keep their eye on the ball in relation to
their risks and their businesses. They have to do this in parallel.
I was merely just making that point, and indeed echoing some remarks
that Callum McCarthy made on that subject a couple of months ago.
Q95 Mr Beard: We have got an inquiry
on the insurance industry and we have been hearing very different
evidence about the health of the insurance industry, which you
have warned about on other occasions. Those connected with the
industry now assure us that, with the FTSE back above 4,000, all
is well in the world and there is nothing much to bother about.
Independent experts are pointing out to us that the industry's
main exposure now is to bonds and these have had a weak market
in the last year, so their solvency remains an acute issue, or
an issue anyway. How does the Bank, with its financial stability
responsibilities, view the insurance industry now?
Sir Andrew Large: Are you referring
to the life insurance industry, and particularly in the UK?
Q96 Mr Beard: Yes.
Sir Andrew Large: I think that
the issue that has arisen, as far as the life industry is concerned,
really has been that people now reflect on the confidence they
have in that industry. One needs to ask the question why, and
what has happened that has caused this, and I think that you can
look at several different factors. One indeed has been the question
of a downturn and the fact that the assets that they had were
significantly in the equity market, and that has given rise to
questions or concerns which have been alleviated by the improvement
in the stock market. I will come to the debt position, if I may,
in just a moment. Another thing that has happened, of course—another
form of risk, if you like—that the life industry has been
coming to terms with, regulatory risk. We have seen that, in terms
of regulatory risk, there have been some shortcomings, starting
off with the pensions area and other matters which your Committee
has been taking a look at since. So both these things have come
together. In terms of the present situation of the management
of those risks, I think it is fair to say that one can only assume
that life companies are now more aware of the regulatory responsibilities
that they have and the risks to reputation (and to potential sales
on the other hand), so I do not wish to comment more on that.
On the question of how they manage the risks in their assets and
liabilities, clearly to the extent that they are more in debt
than they were means that if there is an upward move at some stage
in interest rates, that causes a downward move in the value of
assets, there is a negative impact. Equally, interest rates are
used not just in the valuation of the assets but also the liabilities,
and you have to look at the two together. My own feeling is that
the risk management processes within the insurance companies,
in terms of how they handle these risks, have been on a steep
upward curve. Whether it has been fast enough is something that
FSA do look at case by case, but broadly speaking I do not think
that the change of composition more towards debt is giving rise,
or should give rise, to concerns of confidence. What it may do
is cause people to question the impact on the level of their assets,
and hence their ability to provide good performance for policy-holders,
but that is a somewhat different matter, I think, than the question
you were asking.
Q97 Mr Beard: Is the industry boosting
its solvency artificially by underprovisioning for these misselling
claims that you were touching on?
Sir Andrew Large: That is something
which the FSA will have a far clearer idea on than I have, but
I think it is unlikely to be the case because I am sure that they
will be keeping a very close watch on the manner in which that
is being done.
Q98 Mr Beard: Do you still have the
anxieties you have expressed previously, or are they being assuaged?
Sir Andrew Large: To what anxieties
are you referring, if I may ask?
Q99 Mr Beard: You mentioned in a
speech two days ago that, for instance, there was no international
accord regulating the insurance industry equivalent to Basel II?
Sir Andrew Large: This was why
I asked the question initially as to which part of the industry
you were thinking about, and we have been talking about the life
industry. I think, on the global scene, there are questions about
the general insurance industry, partly because it has become firmly
integrated with the rest of the financial establishment, which
used not to be the case. Partly also because although that integration
has happened, it is very difficult to get to grips with and to
find the data on precisely where are the risks that different
parties have, and in particular I refer here to the reinsurance
arena. There is a series of things which have changed in the global
sense, as far as insurance is concerned. The data side, or lack
of it, is one. Another is that the way in which contracts are
valued and accounted for has been different in different parts
of the financial world, which is a reason that we are keen to
see accounting standards becoming similar across the whole financial
services world, so that is another risk. These vulnerabilities
have arisen just because of the fact that insurance is now integral
with the banking and the securities markets, and so there are
new vulnerabilities that we have to take account of.
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