Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 80-99)

20 NOVEMBER 2003


  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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