Examination of Witnesses (Questions 100
- 119)
THURSDAY 20 SEPTEMBER 2007
MR MERVYN
KING, SIR
JOHN GIEVE,
MR PAUL
TUCKER, MS
KATE BARKER
AND DR
ANDREW SENTANCE
Q100 Ms Keeble: Can I just come back
on that because is it not the case that people do not know where
the risk is, which is one of the factors which has led to the
seizing up of the market, and is it not also the case what we
want is not wisdom after the event, it is a warning of where the
risks are, and unless there is a more robust assessment of that
then you do not know where the next Northern Rock is going to
be?
Mr King: There are two points
I would make on that. First of all, it does not matter fundamentally
whether we know exactly where the risk is, provided that the regulators
know exactly what the position is of the banks with retail depositors
because the ultimate aim here is that we are concerned about protecting
depositors and the payments system, not protecting banks or shareholders
or other investors like hedge funds. The key point here is that
the investors themselves know what risks they have taken on. This
is the issue. I think the problem has been that many investors,
ranging from German public banks to other banks, have discovered
that they did not know exactly what risks they had taken on.
Q101 Ms Keeble: Yes, which is a bit
of an indictment.
Mr King: It is an indictment of
them.
Q102 Ms Keeble: Yes, but it is also
the fact that they do not have any system of robustly assessing
what their risks are because of the ratings that are provided
to the taking on of these investments.
Mr King: I do think that investors
must take responsibility for what they buy. As Warren Buffett
said, do not invest in what you do not understand.
Q103 Ms Keeble: Can I just ask one
question because you have referred repeatedly to the pressure
for greater liquidity, the regulation in relation to savers' deposits
is 5% and five days worth of business falling due, which Northern
Rock actually had, did it not, so is there an argument for saying
that those rules need to be looked at?
Mr King: I think this is a very
important point that you make of should the regulatory system
not put more weight on liquidity, and the Bank of England and
the FSA have been urging in international fora that more attention
be paid to this issue. It takes a very long time to get agreement
at international level about what the appropriate regulatory arrangements
should be and we have been pressing that case internationally
for quite some time.
Q104 Ms Keeble: Can I ask one further
question which is just about the Inflation Report. We all have
hindsight but looking at your own Inflation Report the one warning
I see about all of this is where it was talking about domestic
demand and it says: "Recent developments in financial markets,
if they become more widespread, could pose a downside to the central
case." A downside risk is a bit of an understatement given
what then ensued. I think we would expect to have perhaps a greater
projection of an impending crisis. Would you want to re-visit
that phrase and give greater weight to the risks that you had
foreseen?
Mr King: If we were back at that
time when we were writing this—
Q105 Ms Keeble: This is August.
Mr King: This was before 9 August.
If you are asking whether before 9 August we would have said the
same things, I think the answer is yes. After 9 August we would
have said something rather different.
Q106 Ms Keeble: But anyone could
have said there is a downside risk, even if I could have said
there is a downside risk.
Mr King: I have been very clear
with this Committee throughout. I do not pretend to be able to
forecast the future with any great foresight at all; no one can.
Nobody that I know said on 9 August these events would occur.
We have been saying for several years that they could occur, that
there were risks. It is not that we were not aware of it. We said
these risks are there and the banks themselves decided to take
those risks. It was their judgment, they decided to take the risks
and on 9 August those risks came home to roost. I could not possibly
and I would not pretend now that I could have anticipated that
9 August would be the event but once it had occurred we then responded.
Q107 Mr Love: You indicated in an
earlier answer that the takeover panel rather curbs the ability
to bring the parties together when there is a possible takeover
in view. Going back to questions that Mr Mudie asked, do you not
think since there were press report for some considerable time
about a possible takeover of Northern Rock and that Northern Rock
was in some difficulties—and we have discussed that—that
more active intervention ought to have taken place by the authorities
to assist that process?
Mr King: Perhaps Sir John could
comment but as far as I know a great deal was done. It was clearly
the responsibility of the FSA in discussion with Northern Rock's
board, and it cannot be forced onto Northern Rock's board, they
have to make the judgments, but I think everyone in this process
was hopeful that discussions about a bid would emerge to provide
a suitable end game to all of this. However the point you referred
to at the beginning meant that even if a bank and Northern Rock
had reached agreement on a bid, that could not possibly be final
until we had gone through all the processes laid down, and no
depositor would have known that it would have been final until
then and they would have known that there was always a probability,
small though it might be, that something might have gone wrong
with Northern Rock in the intervening period before the bid could
be consummated and that posed a risk to them and therefore it
is not surprising that they thought they might wish to take their
money out.
Q108 Mr Love: Can I just turn to
Sir John because there is unhappiness at Northern Rock, there
is unhappiness with the suitors; where did it go wrong and what
responsibility does the FSA or other authorities have for it going
wrong?
Sir John Gieve: Firstly, as a
member of the FSA board I will give you an answer, but of course
it is for Callum McCarthy and Hector Sants to come here to speak
for the FSA, not for me as a non-exec. Two things: firstly we
were alerted first to the position of Northern Rock on 14 August
but it was not obvious to them or to us at that point that they
were going to require government assistance. There were two things
that they were actively exploring: one was a possible merger or
takeover, and the other was raising money both through short-term
money markets and by securitising their debt. They were still
hoping to securitise some debt and thus relieve their liquidity
pressures right into September, and it was only when that proved
impossible that it became clear that they needed another source
of liquidity. In terms of the crisis, the key question is was
it worth on Friday announcing that the Bank was making a facility
available or should we have said at the same time that the Government
guaranteed all the deposits? We did realise there was a risk that,
if you like, the shock effect of an announcement would overwhelm
the positive effect of saying the Bank was standing by with some
money. We knew that was a risk but we thought that it was not
an overwhelming risk and it was worth taking that step. As a result
the guarantee which proved essential in the end came out on Monday.
If we had known it was going to be essential on Monday we might
well have offered it on Friday but that was not certain at that
stage.
Q109 Mr Love: Can I move on, you
mentioned earlier, Governor, that the Market Abuses Directive
of 2005 requires you—and you got legal advice to this effect—to
make public the lender of last resort.
Mr King: It does not require us
to make it public; it requires the recipient company or bank to
make it public.
Q110 Mr Love: It has to become public.
Recognising that was the case and also you mentioned earlier that
you accepted that depositors of Northern Rock were rational in
rushing down to Northern Rock following that announcement, was
there any consideration given that because of the impact of the
public statement there might be another way to do this that would
not have required such a public profile for Northern Rock at that
time?
Mr King: It was not obvious that
the shareholders at that stage would decide to take their money
out. If they had been reassured by the provision of the facility
and kept their deposits in then there would have been no clash
of that kind, but once some people had started to do it—and
this is the key point—once some people had started to take
their money out did it then make sense for others to join in.
As I have said before, the only solution at that point was a Government
guarantee. But it is a big step and to have done that at an earlier
stage when it was not strictly necessary might well have caused
wider problems and I think would have incurred the difficulties
and we now need urgently to get out of this temporary position
into a more stable long-run structure for the legislation around
banks.
Q111 Mr Love: Let me press you on
that because the statement yesterday about the three-month facility
you mentioned that because of the impact on the banking sector
but there are some concerns that it specifically related to smaller
banks—I will not name them but they are being named regularly
in the press at the present time—to what extent was that
a consideration in yesterday's statement?
Mr King: I am not going to go
down the road of individual institutions and you would not expect
any Governor to do that. We put that facility in place for the
reasons I gave. It was designed and structured in a way that minimised
the moral hazard but it provides some liquidity to the markets
at a point when the strains seemed somewhat greater. I have explained
it was a balance of judgment and that was the balance that we
struck.
Q112 Mr Love: It would seem from
all that we have discussed here that the run on the Northern Rock
came as an enormous surprise to everyone. Should we have expected
it? Should it not have come as a surprise? I know we have not
had one for 140 years but should the authorities, whichever of
the three tripartite authorities, have had a better judgment about
how the public would respond to these events?
Mr King: I think everyone knew
that a run was a possibility. The question was what could you
have done to avert it at that stage? It was not obvious that the
announcement of the lender of last resort facility would prompt
the run. It might have done the opposite and actually reassured
depositors. It did not and at that point the guarantee was necessary.
Q113 Mr Love: Can I just stop you
there because it has been widely reported that the Bank expected
that the announcement would reassure rather than panic; was that
the case?
Mr King: Nobody could have known
what the net effect would be. It did reassure wholesale funders
to Northern Rock. The situation on that front eased after the
announcement, but of course those people were aware of the liquidity
problems of Northern Rock. I do not think anyone could have known
with any certainty at all what would have been the consequences
on retail depositors of the announcement.
Q114 Mr Love: The interpretation
put on yesterday's events is that everyone is chastened by the
experience of Northern Rock. Have you yet had an opportunity to
try and assess the reputational damage that has been done to the
British banking system as a result of the first run for 140 years?
Mr King: I think that is what
really matters and I do not believe that in a year's time people
will look back and say there was any lasting damage to the British
banking system. It is very well capitalised, it is very strong,
and, as I explained before, although the banks at present are
having to pay a bit more for their liquidity than they would wish,
they will be able over the coming months to take these vehicles
and conduits they have set up back onto their balance sheets and
they will be strong. Headlines come and headlines go and even
television pictures come and go, and I cannot believe and I do
not believe that there is any lasting damage to the reputation
of the British banking system, although I fully understand that
the impact of the pictures on television last weekend came as
a shock to many.
Q115 Mr Love: You said earlier on
that your concern, if I can call it that, about moral hazard related
to the seeds of future financial crises. Do you perceive any negative
effects from yesterday's announcement of injecting liquidity into
the market? Will that create problems as you indicated both in
your statement to this Committee and publicly that may have consequences
further down the road?
Mr King: I think not. I think
the banks in this country realise that they have not been provided
liquidity for free. I think they understand the reasons for the
decision that was taken yesterday that they would have to pay
a penalty rate to obtain liquidity from the Bank. I think that
is appropriate and it is appropriate because of the circumstances
in which we are providing it, with the realisation of risks that
the banks themselves took in full knowledge of what the consequences
would be. The one thing I would like to say at the end is if these
same problems were seen in the banking system today and they had
been the result of some completely different cause, say a major
terrorist attack, we would be injecting liquidity at absolutely
zero cost because that would not be the result of the risks that
the banks themselves took. The reason for the penalty rate now
is not a punishment it is not to blame anybody; it is simply to
make sure that when people think about the risks they are taking
in the future they do so in the knowledge that it is costly to
take risks.
Chairman: Graham seeks clarification
to one of Andy's questions and George has a short question before
I ask one final question.
Q116 Mr Brady: Just a very quick
point of clarification really to Sir John. You said that if you
had realised what the consequences would be when you announced
the facility on Friday you might also have announced the Government
guarantee then. The Governor has told us that the question of
the guarantee was not discussed until Sunday. Can you make it
clear whether there was any consideration at all on Friday or
before that as to whether a guarantee ought to come at the same
time as the facility was announced?
Sir John Gieve: We had of course
discussed what would happen if the negative news of the announcement
outweighed the positive news, and obviously a Government guarantee
was one of the possibilities. But I think this the Governor was
saying that it was formally discussed as an action, and whether
we should take the action now or tomorrow, on the Sunday. We did
realise that simply announcing that there was a new source of
funds for Northern Rock might not be sufficient to restore confidence,
but we thought there was a reasonable chance that it would, and
in any event it was the right thing to do. They were having to
make a profit warning and I think for them to make a profit warning
without having clarity on their sources of funding would have
been disastrous.
Q117 Mr Mudie: All this discussion
today has been about the financial markets, but of course you
are here in a wider capacity and we are talking about the real
economy. I see that Kate has not said a word in two hours and
as she is the housing expert I would say the number of repossessions
on the latest figures has gone up from 33,000 to 77,000 which
means that we are starting to get back into the very worrying
situation where we had the last negative equity collapse. The
Fed not only gave the financial markets some help, which you might
disapprove of, but they also put some aid in on the mortgage side
to give some relief to people who were in danger of losing their
houses. A lot of these mortgages are sub-prime in this country
and there were lenders who would foreclose in the way the big
banks would not. I had a ten minute rule bill about it and I have
researched it. I know you are preoccupied with all the financial
markets but have the Treasury, Financial Services or yourselves
got it anywhere on the agenda because it is a genuine problem
where people are losing their homes in greater numbers? Have we
got an agenda to see whether and what help can be given to stave
repossessions off until the market turns?
Ms Barker: I think the first thing
I would say in response to that is although it is certainly true
that repossessions have risen, they nevertheless remain at relatively
low levels.
Q118 Mr Mudie: They have more than
doubled, Kate.
Ms Barker: Yes, I realise that
but relative to the levels we saw in the last crisis, they are
nothing like so high, and the housing market itself, on the latest
figures we have, remains relatively robust, so I do not feel that
we are yet in a situation where we would want to necessarily take
those steps nor indeed would I really be the appropriate person
to carry that forward.
Q119 Mr Mudie: But in terms of the
wider organisation then if you are not the appropriate person
to that, I disagree with you on the figures; the figures are starting
to be alarming. What you have said is the conventional wisdom
of three months ago and they are more alarming set against the
background of what we have been discussing for the last two hours,
and there are a lot of people out there in danger of losing their
homes. If it is not on an agenda and if you do not prove to be
correct and the numbers stay at this level, would you not think
it is an appropriate thing to start looking at to see which is
the appropriate agency, whether it is Treasury, whether it is
Financial Services, whether it is you, to do something about it
along the lines of the Fed?
Ms Barker: To go back on that,
it is very difficult to take any pleasure in these numbers. These
are very serious events for the individuals concerned. I do not
feel however they are at the kind of levels I personally would
describe as alarming.
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