Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 20 - 39)

THURSDAY 20 SEPTEMBER 2007

MR MERVYN KING, SIR JOHN GIEVE, MR PAUL TUCKER, MS KATE BARKER AND DR ANDREW SENTANCE

  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 crisis.

  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 week—the 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 in charge?

  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 responsible?

  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 you—the Chairman of the FSA, you as Governor, or the Chancellor—because 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 facility—this is the problem with an overt operation—once 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 what—you 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 that.

  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 its dividend?

  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 institutions.

  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 markets—Northern Rock—that 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 of what?


 
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