Examination of Witnesses (Questions 20
THURSDAY 20 SEPTEMBER 2007
Q20 Mr Fallon: Governor, how long
have you been at the Bank?
Mr King: Sixteen and a half years.
Q21 Mr Fallon: You run exercises
to test financial stability all the time. Why have you just discovered
that all these legal instruments are somehow suddenly inadequate?
Mr King: Some of them we had realised
and discussed before as a result of exercises. On some of them
work is already going on, as I understand it, to think of the
legislation; and others are much more recent. I think the problem
in the Market Abuses Directive which prevented my first preference
course of action here, which was to be a covert lender of last
resort, is that it only came into effect in 2005 and the wording
in it is ambiguous. I had still hoped and indeed I pressed strongly
for the ability to conduct a covert operation but in the end the
strong legal advice among the tripartite authorities was that
it could not be done.
Q22 Mr Fallon: It is like the designer
of the Titanic saying it was unsinkable and then we discovered
that once four of the first six compartments are flooded the whole
thing sinks. You are telling us you cannot handle a financial
Mr King: No, none of what happened
was inevitable. But given what happened at each stage, if any
one of those four pieces of legislation were not there, we would
have been able to get through it. This was the unintended consequence
of these things. The legislation on disclosure was ambiguous and
I thought the right way was to conduct a covert lender of last
resort operation. I believe that would not have caused what we
saw last weekthe run of depositors on Northern Rock.
Q23 Mr Fallon: Okay, let me come
back to the Chairman's question as to who is really in charge
of this affair. You provided the additional funding that Northern
Rock wanted but you are isolated in the Bank from its operations;
the FSA said it was solvent but they cannot intervene in the markets;
and the Chancellor then guarantees the deposits. Who is actually
Mr King: I think those different
actions are all important and they all go to the responsibilities.
This would have been no different without the Memorandum of Understanding.
Q24 Mr Fallon: Who was in charge?
Mr King: What do you mean by "in
charge"? Would you like to define that?
Q25 Mr Fallon: What our constituents
want to know given this mess is who is in charge of it, who is
Mr King: We are each responsible
for the various responsibilities that we have been given under
the MoU. The final decision on whether to put taxpayers' money
at risk obviously belongs with the Chancellor, you would expect
that. I do not have the authority to put taxpayers' money at risk.
The responsibility for the design of the operations in markets
that we carry out is our responsibility at the Bank and the judgment
about individual institutions is that of the FSA.
Q26 Mr Fallon: Do you not see that
three of you having different responsibilities all trying to reassure
investors in your different ways that Friday morning ended up
with the result that savers did not trust any of youthe
Chairman of the FSA, you as Governor, or the Chancellorbecause
there were three people saying the same thing.
Mr King: No, it is not true there
were three people all out there saying the same thing. The question
of trust is one that you may want to reflect on. The behaviour
of depositors in Northern Rock was, in my judgment, a consequence
of a perfectly rational interpretation of what the end game might
be. It was not so much a question of trust. Once the depositors
of Northern Rock had heard the bad news and they suddenly realised
that Northern Rock needed a lender of last resort facilitythis
is the problem with an overt operationonce they had seen
that there was bad news about Northern Rock, and they could not
possibly be reasonably expected to have been sitting at home thinking
about the wholesale funding structure of Northern Rock, once they
learned that there was concern about Northern Rock it is not that
surprising that they thought perhaps it might be safer to take
some money out.
Q27 Mr Fallon: Would it not have
been easier to have handled this affair if you were still in charge
of banking supervision?
Mr King: I honestly believe not.
I think that now there is a much more formalised and legalistic
framework of supervision, which is not a consequence of the division
between authorities but of the evolution of the financial system.
I know that Callum McCarthy and Hector Sants have been working
day and night to monitor all the institutions for which they are
responsible. We have been extremely busy in the Bank doing the
same for our responsibilities. The idea that one institution should
cope with all of these I honestly do not believe would make sense.
As I said, the root cause of this, in my view, is not the question
of who does whatyou can argue the merits of that quite
separately and I do not believe it is a question of who is responsible
for what or the fact that there is a tripartite agreement. My
own view, for what it is worth, is that the MoU worked well and
it is very sensible to have the responsibilities laid down so
that you know what we are accountable for. The problems in this
case were quite different. They came from the inherent logic of
the economic position that Northern Rock found itself in and the
various constraints that were placed on the ability of the authorities
to take action.
Q28 Mr Fallon: Okay. Given the that
additional funding offered to Northern Rock had to be overt in
the end why have you not made public the advice in the letter
that you sent to the Chancellor last Thursday?
Mr King: I should be very happy
to publish it at any moment but that is a question for the Chancellor
and not for me.
Q29 Mr Fallon: He is preventing it
being made public?
Mr King: No, I do not think. I
would welcome it if you would like to ask him now for the letters.
I have nothing against publication but I do not think it is for
me to proffer that.
Q30 Mr Fallon: I see. If all the
deposits in any bank are now guaranteed by the Government how
does that not encourage exactly the kind of excessive risk-taking
that you warned us about?
Mr King: It does not encourage
the moral hazard of the banks themselves. It encourages potential
moral hazard on the terms that might be offered to retail depositors,
not the structure of the funding which the banks put in place
for the conduits and vehicles and the risk of a big maturity transformation.
You are quite right, however, that this is not a sustainable position
and it is very important that we move as quickly as possible to
an exit route towards a sensible framework, but that sensible
framework will not be where we started. The system of administration
for banks which means that retail depositors find their deposits
frozen for months on end and they cannot access them is a system
which is a direct inducement for retail depositors to take their
money out at any sign of trouble.
Q31 Mr Fallon: On what date did you
first become aware that Northern Rock was seriously exposed with
the freezing up of the wholesale market?
Mr King: Would you excuse me if
I refer to the sheet which sets out dates here. I would like to
refer to this calendar in doing that?
Q32 Mr Fallon: I just want the date
you first became aware of it.
Mr King: 14 August was when the
first Tripartite phone call between deputies took placed and I
was alerted to it. 9 August was when the financial market disturbance
began and it was on 14 August that I was first alerted to that.
Q33 Mr Fallon: On what date were
ministers first alerted?
Mr King: On the same day, I imagine,
because it is a tripartite process. I cannot vouch for who in
the Treasury was told. You would have to ask them; I do not know
Q34 Mr Fallon: Were you aware that
in its interim statement on 21 July Northern Rock reported that
the FSA had allowed it to weaken its balance sheet by widening
its Basel II waiver and thus enable it to pay a 30% increase in
Mr King: I was not aware of that
on 25 July. After that it became irrelevant, it was water under
the bridge. What I had to deal with on 14 August was the position
as it was on 14 August.
Q35 Mr Fallon: Were you not involved,
Sir John? Did you not read the interim statement of Northern Rock?
Sir John Gieve: No, I did not
read the interim statement of Northern Rock.
Q36 Mr Fallon: It was the bank that
was most exposed to the freezing of the wholesale markets because
of its particular business model and it produced interim results
on 25 July and you did not read them?
Sir John Gieve: No, I did not.
Remember this was 25 July. At that point the markets were disturbed
but the events of 9 August had not happened, and I do not as a
member of the FSA board try and second-guess the teams who actually
carry out the supervision, who of course would have been in close
contact with Northern Rock and indeed with any other bank.
Q37 Mr Fallon: So neither you nor
the Governor realised how exposed Northern Rock was until the
middle of August? Is that the position?
Mr King: The 14 August was when
we were first informed through the tripartite process. That is
the process that informs the Bank. We do not monitor individual
Sir John Gieve: Can I just say
that in our Financial Stability Report in April, for example,
we identified the increasing wholesale funding of banks as a potential
risk if markets became less liquid. That was one of the warnings
we gave, so I was concerned in a general way about the growth
of wholesale lending. Did I know the details of Northern Rock's
position before this blew up? No, I did not.
Q38 Mr Fallon: You were concerned
about wholesale lending back in April but it did not occur to
you until you were alerted on 14 August that one institution's
business model depended so strongly on access to the wholesale
marketsNorthern Rockthat it was going to be in trouble?
Sir John Gieve: As I have said,
there is a range of institutions
Q39 Mr Fallon: For four months nobody
at the Bank realised the implications?
Sir John Gieve: The implications