Examination of Witnesses (Questions 1660
TUESDAY 18 DECEMBER 2007
Q1660 Mr Love: So you are going to
leave it to the Treasury Select Committee to make up their mind.
Mr King: I think the Treasury
Select Committee are an admirable group of people to recommend
where that power should reside.
Chairman: You are going too far, Governor!
Q1661 Mr Mudie: Does that include
Mr King: Absolutely.
Q1662 Mr Mudie: Governor, I would
like to follow up on a question Mr Fallon put to you in terms
of this leak that was very embarrassing for the Chancellor, Prime
Minister and yourself. I accept that you are nothing to do with
it, but The Sunday Times did say it was a senior Bank of
England official. I would be interested to know what you have
done since The Sunday Times came out. Have you had your
senior people in? Have you checked diaries? Have you asked which
ones put you in this embarrassing position a few days before this
Mr King: I do not believe that
anybody in the Bank would make comments of that kind. I know my
colleagues well and I would not dream of saying, "Who had
lunch with whom and when?" That is not the kind of comment
that anyone in the Bank makes.
Q1663 Mr Mudie: Do you think it is
a type of reporting that The Sunday Times gets up to, using
a source in the Bank, a senior source in the Bank of England?
Mr King: I do not believe for
a minute that those words in quotes corresponded to anything that
a Bank of England official actually said.
Q1664 Mr Mudie: So The Sunday
Times were just bolstering their story by the lazy use of
a Bank of England senior source?
Mr King: You might think that,
I could not possibly comment. I have learnt over the years not
to believe a lot of what is in the newspapers.
Q1665 Mr Mudie: The press are after
the Chancellor, and yesterday's Financial Times made three
assertions about Northern Rock, and I would like to go through
them with you. One of them I raised with you last time, but I
will be specific. Was there a rescue bid from Lloyd's TSB on the
table the weekend before the run? That is the first part of that
question. Was it specifically put to the Chancellor as either
advisable or acceptable, and did he reject that advice, if given?
Mr King: There was no firm bid
on the table at all. There was one pretty vague telephone call,
originating in FSA, which came to Bank officials and then passed
to me, saying that there might be a bidder but they wanted to
know first, before putting a bid on the table, whether it would
be possible for them to borrow about £30 billion without
a penalty rate for two years, and I said, well, the Bank of England
does not normally lend £30 billion to a going concern. In
any event, our balance sheet is not big enough for us to make
that kind of decision, and it was absolutely clear, whatever way
you looked at it, it was clearly state aid. It was for a takeover
bid to pay a positive share price to another company; so it was
clearly state aid. So I said to the Chancellor that this was not
something which the Bank of England would do. My advice, clearly,
was that this was not an operation which either central banks
or governments normally did. If it were to go ahead it would require
an indemnity for the Bank of England from the Treasury. Our legal
advice was that this was clearly state aid and (and this was perhaps
most important off all) it would be quite impossible to make an
offer of a loan of that kind to one bank to buy Northern Rock
without making it quite clear to other potential bidders that
they too would have access to it, and I think, as the Chancellor
said when he came to you before, the idea that if he stood up
and said, "I am willing to lend £30 billion to any bank
that will take over Northern Rock"that is not the
kind of statement that would have helped Northern Rock one jot
or tiddle. It would have been a disaster for Northern Rock to
have said that. So, I do not think it was ever a practical proposition,
but, in any event, no formal bid was tabled as far as we were
Q1666 Mr Mudie: Mr Brady pressed
you on this and I would like to come back to it. Did the Chancellor
get specific Bank of England advice to give the retail depositors
a guarantee at the same time as the announcement of lender of
Mr King: No. I have said that
before. No, he did not.
Q1667 Mr Mudie: Absolutely not?
Mr King: Absolutely not. There
was no discussion, in fact, among the principals until the Sunday.
On the Saturday I spoke with the Permanent Secretary of the Treasury
and I met the Chancellor in person on the Sunday morning, and
that is when I made my clear advice, as he pointed out to you
when he gave evidence to you earlier this year.
Q1668 Mr Mudie: Let us be clear:
which day did the lender of last resort leak out and become public?
Mr King: It leaked out late on
the Thursday. Rumours in the market started on the Thursday afternoon
which led to a meeting at four o'clock of the standing committee
of deputies, and at that meeting it was decided that, because
of the concern about leaks in the market, not the television leak
later on but rumours in the market, that the facility should be
announced at seven o'clock the next morning. That is when the
decision was taken, on the Thursday afternoon. There were television
reports later that evening.
Q1669 Mr Mudie: Against that timetable
you did not give advice to the Chancellor that when he made that
announcement he should also announce the guarantee for the retail
Mr King: No, we did not.
Q1670 Mr Mudie: The third thing was
that the Chancellor was advised to use the full leverage of the
Bank facility to push the shareholders and management to accept
an immediate private sale. Did the Bank give advice to the Chancellor
to use that leverage at that sensitive time or, to your knowledge,
did the FSA give the advice?
Mr King: Can you repeat the proposition.
I do not recall anything like this. This is a proposal for
Q1671 Mr Mudie: On the back of being
so helpful to Northern Rock. You have said yourself, Governor,
one of the things that is going to be a problem, if the negotiations
went well and you were prepared to think there was an offer acceptable,
the shareholders are going to have a say.
Mr King: Indeed.
Q1672 Mr Mudie: And I think the proposition
is that at the time you were putting the money in and there was
disarray and panic, et cetera, you had leverage to say to the
shareholders, "We want an immediate private sale." Those
are the exact words.
Mr King: Well, there was no proposition
like that on the table, and my understanding and our legal advice
was that it would not have been possible, because whatever accelerated
deal one tries to bring about, the shareholders must be given
proper time to consider a bid and others must be given a chance
to make their counter bids. So, there was no advice at all to
do that. It was not possible.
Q1673 Mr Mudie: Can I ask your deputy,
because he has been getting a rough press and this is an opportunity.
Do you think you have operated well the link between the FSA and
yourself in the area you are in? Has it worked well or have there
been deficiencies, and have you contributed to the deficiencies?
Sir John Gieve: I think the links
between the Bank and the FSA have worked well in terms of exchange
of information and communication. They do not just depend on me.
I am on the Board of the FSA, Callum McCarthy is on our Board,
but we have put in place daily calls about market developments,
the FSA are represented on my Financial Stability Board and I
think those did ensure that we shared the information we had and
we discussed the issues. It does not mean we always agreed, of
Chairman: Thank you very much.
Q1674 Peter Viggers: A central ingredient
of our present difficulties is securitisation, the banks have
it, of originating and distributing loans and other assets, and
in your October Financial Stability Report you stated that this
model has been shown to have significant flaws. Would you calibrate
those for us?
Mr King: Let me make a brief comment
and then ask John, because he is in charge of the Financial Stability
Report. The securitisation model, I think, will return, but not
in the way in which it has been operating in the last few years
in which an enormous superstructure of derivative instruments
has been built on top of securitised assets, the whole complex
structure of CDOs and CDOs of CDOs, and so on,.. I suspect there
may be less demand for it. I think they will still exist for those
people who genuinely believe they really understand the instruments,
and there are those in specialised financial institutions who
do that, but I rather think that pension funds and others may
come to recognise that securitisation is fine but just follow
the basic maxim: only invest in what you understand. John.
Sir John Gieve: I think the key
thing that the FSR has shown up is that some unintended incentives
were set up in the originate and distribute model as it applied
to credit products. So you find the originators of mortgages had
a strong incentive to go for volume rather than quality and an
awful lot of bad loans were made; I think the rating agencies
had an incentive to take on as many ratings for as many products
as they could; I think the investors had an incentive, because
of the different yields, not to look at the fine print of what
those ratings actually offered and, instead, just to go on the
label; and, finally, I think the banks had an incentive to use
off-balance-sheet vehicles for a lot of their operations. The
market will correct some of these and the role of the authorities
will be to step in where official action is also necessary to
Q1675 Peter Viggers: Yes. Banks do
not trust other financial institutions, and you, Governor, said
that part of your role is to "dispel that sense of fear",
but is not the problem that that fear is justified?
Mr King: Certainly at present
it is justified to be cautious about where the losses on many
of these complex and opaque instruments will ultimately come to
reside. That is why I think we need a little bit of patience to
get through the period, perhaps the end of February, March, when
financial institutions will have had to reveal most of those losses
marked to market and take whatever resulting steps are necessary
to rebuild their balance sheets, and at that point I would hope
that we will have made a big step forward. But, as I said in August
and when I came to see you in September, the most important step
that is required here is that the private sector (and it can only
be the private sector) needs gradually to restructure and re-price
many of those complex instruments which people are now very reluctant
to lend against or buy, and that will take time, but the process
is slowly beginning. There are risks to the world economy in the
meanwhile if it results in a banking system that is reluctant
to lend to industry, and it is our job to try and take steps to
minimise that, but the resolution of the problems in the financial
sector will hinge on the restructuring and re-pricing of instruments
and the revelation of losses and the rebuilding of balance sheets.
At that point, and at that point only, will you see inter-bank
spreads, these LIBOR spreads, return to normal levels, and it
is very instructive that, whatever view you take on how central
banks have conducted their money market operations, there may
be room for disagreement, but whatever central banks did, these
three-month LIBOR spreads are absolutely identical now in the
euro area, sterling and dollar, and that tells you that it does
not have a lot to do with the provision of liquidity and money
market operations, it has a great deal to do with the factors
that you mentioned.
Q1676 Peter Viggers: The weapon available
to you, of course, is credit, and it is rather like pushing on
a piece of string, whereas what we need is someone to sort out
the rotten apples?
Mr King: Yes, and that will gradually
happen, and I think the regulators and, indeed, the banks themselves
have a very strong incentive to see this happen, but it does require
auditors to go through a careful process of working out and validating
the valuations which banks themselves put on their assets, and
this will gradually happen over the next few months.
Sir John Gieve: I think the fear
consists of two things. One is that we do not know yet what the
price is of what has already happened, the subprime crisis, and,
if you like, where the losses lie and whether it will require
recapitalisation. But there is also a fear about the future of
the economy, particularly in the US, and the possibility that
if that goes into recession there will be a further round of losses.
I think that part of the central banks' job is to provide some
confidence that the economy will be managed in a responsive way
going forward. We may not be able to do much about the subprime
losses, which are in a sense still being worked out, in the past.
Q1677 Peter Viggers: No doubt the
situation will shake down, but should there be a role for leadership
here and who should take it?
Mr King: Central banks have discussed
this a great deal amongst themselves, and I think the conclusion
we have all reached is that actually the resolution of the re-pricing
of instruments is something which has to be conducted in the private
sector, and the accounting bodies and the regulators have their
important role to play in trying to make sure that the banks,
as soon as is feasible, reveal the size of the losses and take
steps to rebuild their balance sheets, and you can see that beginning
to happen, and I think we just need a little bit of patience to
see that process through. Meanwhile, as John says, the challenge
facing central banks, and one of the reasons for our co-ordinated
action last week, was to try to ensure that the sense of confidence
in how the future policy will be conducted is sufficient not to
add this further fear that there will be a layer of extra losses
coming down the road.
Q1678 Mr Breed: Teasing out a little
bit more what you said about these asset-backed securities, is
it not now clear that far too many banks were irresponsible in
lending vast sums of money against so-called asset-backed securities
where they had no idea whatsoever of the underlying value of that
Mr King: I do not want to make
generalisations about what banks did or did not do. I think what
is very clear is that in the United States there was some pretty
extraordinary lending in the subprime mortgage market where people,
without a great deal of sophistication, were encouraged to take
on loans that perhaps they could just about afford to buy a home
that they never thought they would ever be able to afford and
they were encouraged to think that they could afford it, but only
when the policy rate set by the Fed was 1%, and once interest
rates got back to a more normal level of 5%, they clearly could
not afford it.
Q1679 Mr Breed: That might have been
the genesis of the problem; that does not absolve our banks from
lending vast amounts of money against asset-backed securities
the underlying value of which they had no idea or ability to calculate.
Mr King: I think a wide range
of purchasers of those assets should ask themselves questions
about whether they really did understand what they were buying,
but they are accountable to their shareholders, their trustees,
whoever, and I think those people will have a lot to say about
the decisions that were made to take on board these assets.