Select Committee on Treasury Minutes of Evidence


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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