Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1720 - 1739)

TUESDAY 18 DECEMBER 2007

MR MERVYN KING AND SIR JOHN GIEVE

  Q1720  Mr Dunne: Was it the case that that precise confirmation from the Bank of England was in limbo, if you like, over the week leading up to the date on which you decided that would not be provided?

  Mr King: No.

  Q1721  Mr Dunne: And, therefore, that the bidders were being encouraged to continue their discussions in the hope and expectation that you might come through with that confirmation?

  Mr King: It certainly was not my understanding. When I spoke to the Chancellor, when there was communication between my office and his, he also shared my view, and it was my advice, that it would be most peculiar for either the Bank or the Government to make a £30 billion loan to a going company to buy another one when that would have to be made public long before you could actually be sure the bid was going to go ahead, and I think the bid was then withdrawn. It was not withdrawn; it never materialised.

  Mr Dunne: I need to move on because I am short of time.

  Chairman: I think we will have a last question, Philip.

  Q1722  Mr Dunne: Okay, Chairman. Do you believe that it is important for the confidence of the financial system in this country that central bankers serve their full term?

  Mr King: I have no idea. In general, I think central bankers should be appointed and serve whatever part of that term they wish to see through.

  Q1723  Mr Dunne: If you were offered a second term, would you expect to serve it in full if your health allowed?

  Mr King: What a depressing thought. That is something we will return to after Christmas.

  Q1724  Chairman: Have a good Christmas.

  Mr King: Thank you very much.

  Chairman: Okay, Phillip.

  Q1725  Mr Dunne: I do have some other questions. Can I have a very quick question in relation to your statement today and the operation of monetary policy? Is it your expectation that the concerted action by the Bank of England and the other central banks, which was announced last week and is being implemented today, effectively marks a new direction for monetary policy and recognises the difficulty of effecting spreads, which we talked about when we last met, thorough reductions in short-term interest rates?

  Mr King: It is hard to say whether it would turn out to be an important step. I do think what was valuable was the demonstration that the central banks were all facing the same problem and recognised that there was no easy way through. Indeed, the difficulty we face is that even the operations we have put in place cannot be guaranteed and, indeed, are unlikely to bring about a significant reduction in spreads, except in so far as the operation can improve the confidence of the banking sector in believing that the central banks acting together will try to ensure that there is not a serious downturn in the world economy and, hence, that they should be less concerned about the capital position of other banks than they might have been in recent weeks.

  Q1726  Mr Mudie: Governor, in your October financial stability report you were commenting on the business model of banks, and you projected three scenarios. Which scenario would you prefer the banks to adopt?

  Mr King: Sorry, the scenarios in the—

  Q1727  Mr Mudie: One of them is redesign the securities so they are transparent and keeping that business; the second one, which I cannot believe you would accept, is regard the present situation as a temporary set-back and carry on as before once the market has settled; and the last one is to settle back and go towards a more traditional model of banking.

  Mr King: I certainly do not accept the second one, because I think it is very unlikely that we will come back to that. I do think that the originate and distribute model has real value, and I would not want to see it disappear. Indeed, in some ways what happened was that it was not a proper originate and distribute model because many of the assets did not actually fully disappear off banks' balance sheets, they were still kept on through the links, through conduits which had to be supplied with liquidity facilities and special investment vehicles. So, I would like to see perhaps a mixture of a return to a more traditional banking operation. There is a real place for securitisation, but I do think that what is most important is that we need to recognise that banks can be rather dangerous institutions at times. They have extraordinarily highly levered balance sheets, and a mixture of appropriate regulation and careful management of their liquidity position by banks is a sine qua non of any healthy financial system, but in reserve we must put in place those three changes that I mentioned in my opening statement because I think they are fundamental to having a banking system where we can have confidence that, if problems arise, we have a method of dealing with them.

  Q1728  Mr Mudie: If problems arise. That takes us to Mr Ainger's questions. As Governor, if you have a desired model, do you see yourself as having a proactive part in ensuring that financial institutions adopt that model or is it that you are just there to clear up the mess?

  Mr King: I think the Governor does have a role in speaking out, as I did in the Mansion House in June, but I have to give some serious thought now to how far we can ensure that our general views and comments are really taken on board. I do believe that the experience of the last few months has been a chastening one for not just London but for all the major financial centres in the industrialised world, and they will learn lessons. Our task, I think, as an institution that will be here long after any of us are around, is to make sure that institutionally we keep coming back to remind people that these risks and problems can occur.

  Q1729  Mr Mudie: Do you think your only weapon is making a speech? I do not mean to decry making a speech but can you not be more proactive than that?

  Mr King: We have no other policy instrument.

  Q1730  Mr Mudie: Using your influence.

  Mr King: In the end influence comes down, I think, to making an argument which convinces people. Our task is not to tell people what to do; FSA are the regulator. If by giving speeches which are sufficiently compelling and through the financial stability report and the work from John's team we can convince people that what they were doing was to take risks that they did not fully understand, then maybe we will bring about some improvement, but I do feel that in the last few years we are seeing a certain degree of hubris, and it is never easy to persuade people suffering from that to think deeply about risk. Alan Greenspan was not very successful in getting across the idea of irrational exuberance. We have to keep plugging away and trying, but I think trying to win the argument is our main weapon.

  Q1731  Mr Mudie: I think he got out in time though!

  Sir John Gieve: Can I just mention three ways in which I think we can have influence. First the FSR, for which I am responsible, is a good analysis, widely recognised as such, but we can probably do more in the market. For example, talking to analysts, and so on, who themselves comment on banks to try and ensure that they are aware of our view of the vulnerabilities. We can do, and are doing, a lot in the international policy arena, so through Basle and the FSF, which I have spoken about, to change international policy. And thirdly we can consider whether we can take this analysis down a level; we have been deliberately careful under the MOU not to get involved in assessing individual institutions because that has been the FSA's job, but there is a question about whether it would be helpful for us to go a little bit further in drawing out the lessons for particular institutions where that would help the FSA in their task of identifying vulnerabilities.

  Chairman: Thank you. Jim and then Mark to finish.

  Q1732  Jim Cousins: Governor, you told us this morning you think this is a crisis at the heart of our main financial centres, and we have seen in the last week or two co-ordinated action by a group of central banks to put cash support into the banking system. Why did it take other central bankers to force you to give up the principle of the penalty rate?

  Mr King: It did not, and we have not given it up, in the sense that the auction this morning that was conducted did produce an effective penalty rate. Those Banks who obtained money against wider collateral paid an interest rate of around 60 basis points above Bank Rate; so the mechanism for doing it did, in fact, produce exactly that; but the nature of the problem in the last four to five week has changed quite markedly, and when that changes we too will change. When I sent my document to you in September before coming on 20 September,[4] I made very clear in it that the judgments we were making about the nature of operations are ones that we looked at almost daily, and in the last four or five weeks there has been a palpable sense of—I use the word—fear in financial markets about the capital position of banks, and that was a point where I think all of us in central banks decided that, collectively, we needed to take action. That had not been done before; no central bank had acted in concert with others in August or September—there appeared no need to—but now there was a collective feeling that we ought to do that together, and we have.

  Q1733  Jim Cousins: Do you think more action by central banks or other international financial agencies will be required. This is not the end.

  Mr King: It is not end, and I do not know. I do not think the provision of liquidity in this form is the be all and end all. It is not a simple answer. I very much doubt that of itself it will lead to a significant reduction in these spreads in the inter-bank market, but I think the demonstration that central banks are working together is important.

  Q1734  Jim Cousins: Governor, I must put this to you. Do you not think that your colleagues in central banks will start to have worries about our central bank because of its communication failures and because of the leaks with which it has become associated?

  Mr King: I do not think it has become associated with leaks, and I do not think there are communication failures. I said to you that I wish I had spoken out in August. I felt that there were enough people speaking in August; it did not need more; but I wish I had spoken out in August. What we have been trying to do is to clarify how these money market operations work, and they do not work by injecting extra liquidity into the system, they work by substituting one maturity for another or, in some cases, using different ranges of collateral, but it is not a case of injecting additional liquidity. We are the only central bank that injected a significant extra amount of liquidity.

  Q1735  Jim Cousins: You told Radio 4, "It became evident that many of the funders of British banks around the worlds were no longer willing to fund British banks." Do you not acknowledge that your own performance and your own judgments are now a market factor which is affecting us all?

  Mr King: No, I do not accept that. I certainly accept that the fear of Northern Rock has led to difficulties for the British banking system. As I have explained, I think the real cause of that was the fact that it entered August 9 with a very weak liquidity position and that after August 9 the authorities together had no effective tools with which deal with a bank in that position. That is why the changes, I think, are so necessary in the long-term. Those were the causes.

  Q1736  Jim Cousins: Sir John, you have heard all the discussion about the nationalisation of Northern Rock and you have a considerable knowledge yourself of Northern Rock. How easy would Northern Rock be to denationalise?

  Sir John Gieve: As you know, plan A is to complete the Virgin or Olivant approaches.

  Q1737  Jim Cousins: I know about plan A.

  Sir John Gieve: Plan B: if we are forced down the road of nationalisation, it would clearly be, as Mervyn said, as a temporary measure to then relaunch it in some form. I do not know whether it would be easy or not. We are concentrating on the bids we have got rather than the bids we might get in those circumstances.

  Q1738  Jim Cousins: Do you think there could be a problem with denationalisation?

  Sir John Gieve: I am pretty sure that if the bank either went through an administration process or was nationalised, it would be possible to pass many of its activities to other institutions in the private sector.

  Q1739  Jim Cousins: How many of its employees?

  Sir John Gieve: I really could not say.


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