Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 880 - 899)

TUESDAY 13 NOVEMBER 2007

PROFESSOR WILLEM BUITER AND PROFESSOR GEOFFREY WOOD

  Q880  Mr Dunne: There were many other issues which you identified at the beginning which caused the problem?

  Professor Buiter: Yes, but banks generally were not lending to each other, and that is never a good idea because that also means they are not lending to households and to non-financial corporations.

  Q881  Mr Dunne: We were told by the management of Northern Rock that they had an Irish subsidiary and had they been able to have a facility in place with the ECB through their Irish subsidiary in time, they might have been able to secure some liquidity through that.

  Professor Buiter: Correct.

  Q882  Mr Dunne: Do you think that would have been an appropriate thing to have done?

  Professor Buiter: Sure.

  Professor Wood: For Northern Rock, yes.

  Q883  Mr Dunne: I think you said earlier that the currency for lender of last resort is critical but in this case had the liquidity operations been managed by the Bank of England in the same way as the ECB the pure currency risk was something presumably that could have been priced into the facilities?

  Professor Wood: You mean if they borrowed from their Irish subsidiary? Sure, they would have had to switch into sterling and if they were a well-run bank they would have hedged that risk.

  Q884  Mr Dunne: Indeed. So would it be prudent then for British banks today to ensure that they have facilities with other central banks in order to maximise their prospects for liquidity if they need it?

  Professor Wood: I suppose if you are saying that other central banks give out liquidity too generously (which I think they did) it would be prudent from the point of view of individual British banks, yes. I do not think it would be prudent from the point of view of the British banking system. But in any event, if all banks borrow abroad and switch into sterling, they can only get that sterling from the Bank of England. So any one bank could protect itself by borrowing abroad, but the system could not.

  Professor Buiter: I think they should all do so, if they can, and of course not just in the Euro zone but in the United States as well because at the US discount window you can discount anything, including cats and dogs, in principle.

  Q885  Mr Dunne: Indeed, and two of the major British banks have taken out very substantial facilities with the Fed, have they not.

  Professor Buiter: Yes.

  Q886  Mr Dunne: Does this not raise questions of credibility about the regulation of the British financial services and banking industry?

  Professor Buiter: We have a financially integrated global system and that means that liquidity can be purchased abroad as long as sterling is convertible. I hope it will remain that way.

  Q887  Mr Dunne: Do you see damage being done to the British banking industry in particular or do you think this is not a peculiarly British problem?

  Professor Buiter: To me it was the way in which inappropriately restrictive British liquidity policy could be mitigated by some banks, the ones who were lucky enough to have subsidiaries abroad in the euro zone or the United States that they could use.

  Q888  Mr Dunne: In addition to the points that you made at the very beginning, what other lessons do you think the regulatory authorities here need to learn to ensure that these liquidity problems do not recur in the UK?

  Professor Wood: The regulatory authorities in a sense did ensure that it did not occur in the UK once they dealt with the Northern Rock issue. What they should certainly do is to make clear again—it has been made clear in the past—that in times of difficulty they will accept a wider range of collateral than usual, but they should also give the warning that they charge much higher rates of discount for it.

  Q889  Mr Dunne: The issue of providing a lender of last resort facility on a covert basis, which appears to have happened in the US and on the Continent, does not appear to be capable of happening in this country; can you explain why?

  Professor Buiter: I think that particular statement of the Governor is not correct. There is nothing in the appropriately titled "MAD"—Market Abuse Directive—to prevent covert support to banks in trouble. On the day he said it, the statement was contradicted by a spokesman for the Commission, and every lawyer I have talked to since then says that they have no idea where that interpretation came from. If it is true then the Directive really is appropriately named. We think we know, for instance, that the ECB, which is a EU central bank, has engaged in covert discounted borrowing which really falls into that category and has gone beyond that, quite likely. Because it is covert we have the issue of absence of evidence and evidence of absence. But a) I think it is not true and b) if it were there should be an enormous outcry against it, but it was not an issue, they could have done that.

  Q890  Mr Dunne: So you think the powers exist at the moment and they have just misinterpreted it and got it wrong?

  Professor Buiter: Yes.

  Q891  Chairman: The Governor made that point in this Committee, Professor Buiter, and he said it was four pieces of legislation acting together.

  Professor Buiter: The other pieces were by and large correct. The deposit insurance scheme is a shambles. You cannot do under-the-table mergers or takeovers—and that is absolutely correct, but that is why you should be able to take banks into public ownership. That would be a solution for that particular thing on a short-term basis. And whatever the third one was—

  Q892  Chairman: Insolvency.

  Professor Buiter: Deposits get frozen, yes, that is also correct. Of the four things he said I only disagree factually with one which is the MAD.

  Q893  Mr Simon: All the people that we have had so far—the Bank, the FSA, the Chancellor and Northern Rock—have all explained to us that the Tripartite arrangements work, whereas to most of us that seems a bit counter-intuitive because they do not seem to have worked very well. You are the adjudicator in this: do the Tripartite arrangements work?

  Professor Buiter: I think we have already said that in provision of liquidity they worked but did not work well.

  Q894  Mr Simon: How do you think they could work better?

  Professor Wood: Again Willem has made two suggestions. One is that the Bank of England take over the supervision for liquidity purposes of individual banks. That would be a perfectly sensible idea. The other is to turn the FSA into a bank. I think that would be maybe sensible but certainly difficult.

  Q895  Mr Simon: Do you think there should be a different set of arrangements when a certain point of crisis is reached or passed?

  Professor Wood: No, I think that would be misguided. It would be like having two pilots on the plane and saying this other one is going to take over when things get difficult. When do they get difficult enough? We should have sensible arrangements from the start.

  Professor Buiter: The Tripartite agreement needs to be changed along the lines that Geoffrey just restated here. It did not work well and the reason it did not work well was not an accident, it was simply a design fault.

  Q896  Mr Simon: And you reckon with your two modifications or some version—

  Professor Buiter: Either of them—not both please, just one.

  Q897  Mr Simon: Obviously not both. One of which is greatly more unlikely it seems to me than the other. You reckon that would have solved this problem and this would not happen?

  Professor Wood: All I can say is in previous episodes in the past in this country and elsewhere it did.

  Q898  Mr Simon: What do you think are the chances of them doing something like that?

  Professor Wood: You should ask the Government that, not me.

  Q899  Mr Simon: Obviously we did ask the Chancellor last week and he did not give us a very full and accurate reply.

  Professor Wood: Well, you can tell him from me that I think it is a good idea.

  Professor Buiter: We hope that after mature reflection he will decide that change is the better part of valour.


 
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