Examination of Witnesses (Questions 40
THURSDAY 20 SEPTEMBER 2007
Q40 Mr Fallon: Of the fact that Northern
Rock would be exposed if the wholesale markets froze.
Sir John Gieve: I think Northern
Rock has the most developed wholesale funding model among the
mortgage banks in Britain. There was a detailed knowledge in the
FSA of the positions of the individual banks. Did we foresee that
the way that events would unfold exactly in terms of the freezing
of the mortgage securitisation market and the impact on term money
markets? No, we did not see exactly how it would come through.
At the point of Aprilthis is before the eventswe
identified that there were vulnerabilities in the system but we
did not see exactly the path that they would lead back to Northern
Rock. And I do not think anyone did.
Q41 Mr Fallon: You did not see that
Northern Rock would run out of money?
Sir John Gieve: No, I do not think
Q42 Chairman: There was no risk analysis
of Northern Rock?
Sir John Gieve: I am sure that
as part of the supervision of Northern RockI am sure this
is the casethe FSA team require them to do different stress
tests, so I am sure the FSA and Northern Rock looked at the impact
on their balance sheet and operations of different stress tests.
I do not have the details of what those were but that is something
that I know the FSA has been doing a lot of work on.
Mr Tucker: I hold the same position
on the individual institutions, Chairman, but what I would add
is that from July onwards we were focused on what was happening
in the markets as a whole and analysing the channels of strain.
And we did identify that there could be spillover to the asset-backed
securities market and to the ABCP funding market and we briefed
colleagues on that. Our job in this structure is to identify what
is going on in markets as whole.
Q43 Mr Fallon: You briefed which
Mr Tucker: Colleagues in the Bank
and colleagues in the tripartite structure, but this was not about
Q44 Mr Fallon: All right, could I
turn, Governor, to the three-month facility that you announced
yesterday. Can you explain to us the role of ministers in this
three-month facility? Have they been urging it on you as long
as the big banks?
Mr King: No, the banks have clearly
been urging us to do an operation like this for a long time and
to some extent they would, would they not, because they are in
a position now of having to acquire liquidity at a much higher
price than they would have wished, given that in their risky business
models, the risk materialised. The real aim of trying to minimise
moral hazard, which is one of the objectives set down in the 1997
MoU, is not to provide liquidity at a zero cost, and we are not
doing that. The concerns that led me to want to propose this yesterday
were concerns about the banking system as a whole. This operation
was designed entirely in the Bank. We have the competence to do
that; I do not think people in either the Treasury or the FSA
have the competence to do that, just as we do not have the competence
to do their jobs. But of course I discussed it with the Chairman
of the FSA and the Chancellor. In these difficult times it would
be wholly irresponsible not to do so.
Q45 Mr Fallon: But when did Ministers
first canvass the option?
Mr King: This was discussed among
all parties over last weekend in the aftermath of the run on Northern
Rock and the concerns that were being expressed about what this
meant for the stability of the British banking system as a whole,
and at that point I judged that it was worth doing something,
but also limiting the moral hazard very clearly by capping the
size of the operation in order to give assurance that whatever
strains we might see would be alleviated.
Q46 Mr Fallon: Governor, you have
spoken on moral hazard and you have written us an eloquent essay
on moral hazard, but is not the criticism that you have passed
the theory but when it came to dealing with Northern Rock and
when it came to dealing with three-month funding actually you
failed the practical?
Mr King: No, I do not think that
is true at all. I am happy to explain a bit later if you like
why I think moral hazard is such an important issue. Can I just
answer this point. I have tried to set out a sequence of events
in which Northern Rock required ultimately a lender of last resort,
the way in which we would have preferred to do it was not open
to us, and at that point we did it in an overt way. I do not think
it was at all obvious what impact that would have. It might or
might not have led to people wanting to take their money out.
In the event it did and once that run had started people were
not behaving illogically by joining it and at that point the only
solution was the Government guarantee. I think this is a very
clear chain of events.
Q47 Mr Todd: I am going to come to
moral hazard because you are keen to talk about that but I just
want to explore the issue of information and how people understand
it in this story. I think you were quite correct in saying that
the initial step with Northern Rock could have been interpreted
in two ways. On balance, people felt that it gave a signal of
insecurity in that particular institution and they headed for
the queues. Is there not an argument for saying that subsequent
extension of the guarantees given to Northern Rock to the banking
system at large, with depositors effectively being secured by
the Government, and also the wider steps taken yesterday, also
convey a more generic message of wider concern about the banking
system in this country, which may convey similar messages of alarm
to people on a wider scale? So what I am exploring is how actions
that you can see and others in the tripartite agreement can see
are logical in themselves can be perceived on the outside in a
rather different way?
Mr King: I think that the announcement
of a guarantee, had it come before the run on Northern Rock, would
indeed have been interpreted in the way that you suggested might
have happened and I think would have been an irresponsible thing
to have done. It would undoubtedly be said, "Why on earth
is this being done?" It was clear why it was being done when
you could see the run on Northern Rock because and,, at that point,
only a Government guarantee was capable of stopping that run,
there was no other way out.
Q48 Mr Todd: That guarantee has now
been extended beyond Northern Rock, that is the point I am making.
Mr King: For the reason that,
once depositors see that if a run starts our current ability to
deal with it, given that the insolvency legislation and the deposit
insurance, is inadequate, people must know that there is a Government
guarantee and it is the Government guarantee that prevents the
run. This is not a permanent solution. We have to find a way through
to a better permanent system but a Government guarantee is there
now to give complete reassurance that no depositor will lose.
The important point to hang on to here is that no depositor has
lost anything at all.
Q49 Mr Todd: Absolutely but extending
that point a little further, the extension of liquidity that you
have offered yesterday, on terms I entirely accept, does that
not also convey a wider implication of concern, because I think
that I have interpreted your actions as being to try and act cautiously
and in a rather focused way and give a clear message that the
broad system is working reasonably well, we have a strong economy
and our banking system should be able to cope with these circumstances?
There is an argument for saying that some of the actions which
have been taken most recently suggest to an outsider that that
statement of confidence is misplaced.
Mr King: I do not think confidence
in the banking system as a whole is misplaced. As you say, there
is always a delicate judgment to make about whether putting in
place an auction of the kind that we did would create more concern
because of the fact that we were doing it than it would benefit
the system in terms of alleviating the strains, but my judgment
was that after the Northern Rock run and the impact of the sight
of depositors queuing in the streets to take their money out,
there were potential strains, at least, in the system that were
worth guarding against. It is a difficult balancing judgment.
I cannot claim that it is obvious that the judgment was right
or not but we have to make these judgments in real time and I
think given where we are today I would still have done it yesterday.
Q50 Mr Todd: In your covering note
to the letter that has been publishedand I do not know
whether the letter to John was published at the timeI quote
the words you said there: "I am conscious that in sending
you this statement I am taking a snapshot of a fast-moving situation
with a long exposure camera."
Mr King: Absolutely right.
Q51 Mr Todd: I think that was a reasonable
summary of the position you found yourself in. Can we talk about
moral hazard. Your focus on that has perhaps been interpreted
as being academic, even puritanical, in comparison to the approach
taken by other central banks, and it is certainly noticeable that
in the public statements of other central bankers there has not
tended to be the same emphasis on moral hazard as you have placed
on it yourself. Can you explain that difference of approach?
Mr King: I do not believe that
moral hazard is just some dry academic concept.
Q52 Mr Todd: Nor do I.
Mr King: It is moral hazard that
has actually led us to where we are. I do not want to blame anybody
at all for what has happened. I think one of the interesting aspects
of this crisis is that all the players have acted completely rationally
given the position they were put in, and the point about taking
moral hazard seriously is that if what we do is to say to the
banking system if you take these risks again in the future then
do not worry we will provide you with ex post insurance, that
means there is no incentive for them to take out any insurance
or to behave in a less risky way beforehand. Why do I think this
is important? About four weeks ago I remember listening to an
interview on the radio in which a young woman was explaining that
she had taken out a mortgage for her and her husband. They had
not anticipated the events that occurred with the rise in interest
rates and she had found herself in a problem where they were short
of liquidity. They had turned to other sources which were more
expensive and they had now built up debts of £100,000 which
she could not repay. She put those points to someone from the
banking industry who I thought responded very reasonably, namely
"We are deeply sympathetic, we understand the nature of your
problems, but can you imagine what would happen if the banks were
to forgive you those debts? What could the banks say to those
customers who actually behaved more prudently, that did not borrow
more than they could afford? What would happen to people's willingness
to behave prudently in future if we bailed you out?" It is
a little bit strange that that seems to apply to the borrowers
from banks but not to the banks themselves.
Q53 Mr Todd: By my question was slightly
different to that because I have to say I agree with your missives
on this (I have got a rather stern puritanical streak too!) but
the puzzle is why that has not been emphasised by your colleagues.
Mr King: It may not have been
emphasised in speeches to the same extent.
Q54 Mr Todd: Or acted on.
Mr King: It has been acted on.
If you look at what the ECB and the Fed have done in their market
operations they have not provided complete ex post insurance,
they have not put sufficient liquidity into the banking system
to enable the banks immediately to take back onto their balance
sheet all the risky conduits and vehicles that they have created
without incurring a cost. All banks around the world will pay
a price for what has happened. What I want to do is to make sure
that when they get liquidity from central banks they pay a price
for it and do not get it free. The banking system as a whole can
afford to do this. If I thought there was a risk to the British
banking system as a whole and that the capital that the British
banking system has was inadequate to take this onto their balance
sheets, I would be out there putting liquidity in at a lower price
to stabilise the British banking system. That is not necessary.
If you always provide ex post insurance you can be quite sure
that in five or ten years' time another crisis will come. That
is exactly what we have seen in the last 20 years. The one thing
I do not want to do is to find myself five or ten years down the
road saying, "Why did I take the easy option? Why did I do
that? Why did I sow the seeds of a future crisis?" The whole
regime of monetary policy that we have put in place has been to
demonstrate that taking the easy option and giving in in the short
run without looking to the long-run consequences of those actions
is damaging. Every manufacturing company I go out and meet around
the country every month has come to realise that the short-term
option which they wanted ten to 15 years agoa cut in interest
rates at the first sign of a problemis not the way to go;
it is having a stable framework. We need to put that view back
into the financial system.
Q55 Mr Brady: Governor, can I ask
when you first discussed the possibility of the 100% guarantee
for retail deposits?
Mr King: The first discussion
I had about that subject was on Sunday after the run had started.
Q56 Mr Brady: Did the impetus for
that come from the Bank or from the Treasury?
Mr King: It came out of discussions
among all three of us. I think it was clear to everyone that the
only way to stop the run at that stage was indeed a guarantee.
Q57 Mr Brady: And what was it that
finally made that decision necessary? You referred earlier to
seeing the screens and the impact on the screens, was that part
of the rationale?
Mr King: No, I think it was clear
that if the run had continued then all the retail deposits would
have disappeared because once it had started it was not illogical
for others to come in behind it, and therefore something had to
be done to stop the run, and at that point without an adequate
insurance scheme, without the ability to put the company into
a position where it could immediately repay the depositors, only
a Government guarantee would stop the run. It was the only solution
at that point.
Q58 Mr Brady: You have already said
that it is a temporary solution, which I suppose is obvious, but
what is the set of circumstances which needs to be in place for
the guarantee to be removed? Does it require the piece of legislation
to which you referred and the whole regulatory environment to
be changed or can it happen sooner?
Mr King: I think you have to ask
the question why was this not regarded as something so urgent
in the past? Governments of all parties did not regard it as a
top priority and I think the reasons are because, first of all,
the recent circumstances are pretty unusual so it was not a pressing
problem and, secondly, at that point the Bank of England did have
the ability to act as a lender of last resort in ways that we
were not able to this time. However, I think that has all gone
now. My feeling is that legislation introduced not too speedily
but after careful thought is absolutely crucial now and that is
the exit route from where we are into a more stable future system.
This Committee clearly has an important role in leading it because
this is notand I would urge you not to regard it as sucha
political issue, this is a cross-party issue in which everyone
has an incentive for putting in place a more stable structure
for our banking system.
Q59 Mr Brady: Can I also ask for
some clarification about the extent of the guarantee. I do not
think this is clear yet. Does the guarantee extend to retail deposits
held with overseas banks operating in the UK or is the guarantee
only to British banks?
Mr King: Sir John has been involved
in the discussions. Can I just summarise the broad principle behind
it which is that this would be extended to other banks if they
found themselves in a similar position, that is to UK retail depositors
and other unsecured creditors, but perhaps Sir John could comment
on that. The Treasury put out a notice at 7 o'clock this morning
and I think questions on the detail of that should go to them.
Sir John Gieve: The note that
the Treasury put out was about the guarantee to Northern Rock,
and that is the only guarantee in place at the moment, and it
defines what "existing deposits" means and it defines
that in terms of "accounts up to midnight on Wednesday 19
November", with the addition that accounts closed in the
last few days can be re-opened. It defines the wholesale market
cover as being to existing and renewed wholesale deposits, so
wholesale deposits that are rolled over at the end of their term
will be covered and so will existing and renewed wholesale borrowing
which is not collateralised. The point about the broader banking
sector is covered in what the Chancellor said. If another bank
found itself in the same circumstances it would get the same treatment.