Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1780 - 1799)

THURSDAY 10 JANUARY 2008

RT HON ALISTAIR DARLING MP, MR JOHN KINGMAN AND MR CLIVE MAXWELL

  Q1780  Peter Viggers: In October, Chancellor, you told this Committee that you fully expected to get back the money lent to Northern Rock. Do you remain as confident now, although state guarantees extend to about half the total liabilities of Northern Rock?

  Mr Darling: Yes, one of my objectives is to make sure we do get our money back. When we reach a conclusion, whatever that conclusion is, one of the priorities, in addition to protecting depositors, is to make sure that we get our money back.

  Q1781  Peter Viggers: Well, you are aiming to, but are you confident you will?

  Mr Darling: Yes, I very much hope we do, as I said in October.

  Q1782  Peter Viggers: Professor Willem Buiter characterised state support for Northern Rock as "open-ended breastfeeding". To what extent were you in control of the way in which public financial exposure has extended since September and to what extent were you carried along by events?

  Mr Darling: I am aware of Professor Buiter's view and I think, put shortly, he takes the view that we should have let Northern Rock go under. That is what I think he said fairly consistently at the time. I disagree with that. Again, as I said to you last October and since, the reason that we decided to offer lender of last resort facilities was because we believed that there was a wider systemic risk to the financial system. Now, that is the only consideration and that has always been the case as far as lender of last resort facilities are concerned, and I believed there was a serious risk of contagion and, therefore, we offered that support. Having offered that support, we need to see that through. Over the last few weeks, we have been working intensively by giving the company breathing space to try and reach a solution and I hope we will be able to do that, but I think it was the right thing to do and I do not agree with Professor Buiter's analysis which of course starts from the proposition that we should have let the bank go under.

  Q1783  Peter Viggers: The interest premium reflecting government support for the Bank of England lending facility to be paid ultimately to the Treasury has been rolled up and subordinated as tier two debt. Why did you accept this lower status for amounts and what are the implications of doing so?

  Mr Kingman: Well, we took that decision in the context of our wider aim which is to create a period in which there is stability for the bank. The position you describe is correct, that is to say, the premium over and above base rate is rolled up. The amount involved is not gigantic in the context of the sums involved in Northern Rock, it is well under £100 million in the period that we have given that agreement.

  Q1784  Peter Viggers: You made your advances and guarantees to a company which was controlled by a board whose model had completely failed. What steps did you take to ensure that the company acted in accordance with your wishes? What guarantees and controls did you take over the company?

  Mr Darling: Firstly, the money that has been advanced has been advanced against the security of the company's collateral, but you raise a point which brings me back to the first point I made in response to Mr McFall's point about why I think the FSA need greater powers and that is this: that the company is owned by its shareholders and the shareholders appoint the directors, the Government does not appoint the directors, but, when you get to a situation like this where you offer support for the good of the financial system on behalf of the public, I think there does need to be the availability of powers to the Government to take greater control, and that is what I am proposing with the reforms which I shall publish later this month. At the moment, the problem we have got is that the company is owned by its shareholders and the directors are answerable in law to the shareholders, so the security that we have got is either in terms of security over the company's assets or that we lend money in terms of premiums and other guarantees.

  Mr Kingman: I would just add that we have, as you would expect, lent rather a large sum of money to this bank and taken very significant loan protections, as you would expect in this sort of situation, which means that a whole variety of commercial decisions they have to take require the authorities' agreement. That is obviously not a fantastically sustainable way to run the business and any solution will have to protect our interests in an ongoing way, but allow genuine commercial decision-making.

  Q1785  Peter Viggers: Did you use your leverage of the advance of money as fully as you could have done? The Board was left, for instance, with the opportunity to declare a dividend or indeed to declare bonuses, so why did you not use your leverage as lenders?

  Mr Darling: Well, I think, if I remember rightly, they thought again about the question of issuing a dividend, but the position is, as I have said, we have lent money and we have explained the security of the Bank of England and, therefore, ultimately the Government has, but you are right, we do not run this company. I think that one of the things that is unsatisfactory at the moment is that, when you get into a situation like this, we do not have all the levers at our control that we would like, hence my proposals for a restructuring facility with the FSA so that, were we to get into the situation again, we could at a far earlier stage say, "Look, support is coming" or provide support where, without having to pass special legislation or use the insolvency laws which are quite complex and were actually not designed for a situation like this, we can actually take the powers that we need. At the moment, the Board is there, it is answerable to its shareholders and it is not the Government's Board, if you like.

  Q1786  Peter Viggers: To some, it has seemed that the Treasury has been flat-footed and carried along by events in the last six months. Could that be connected in any way with the fact that you had a completely new ministerial team in the summer and that scarcely anyone in the Treasury has more than ten years' experience going back beyond 1997 of Treasury activity?

  Mr Darling: The only point I would agree with you is that unfortunately neither the Treasury nor anybody else has that much experience of banks getting into these sorts of difficulties. You are right, that in the early 1990s there were some difficulties. We have had BCCI, we have had Johnson Matthey and we have had Barings, but that was a long time ago and we have been fortunate that, until last year, we had not had the sort of experience we have had with Northern Rock. In relation to Northern Rock, and we need to keep sight of this, the difficulty that Northern Rock got into was primarily the responsibility of that company which had a business model that was completely exposed when the money markets dried up. I think it was three-quarters of their lending depended on them being able to get access to the wholesale markets, and that is what the problem was. In relation to the action that we took subsequently when Northern Rock got into difficulty, as soon as it was clear that it was not going to be able to achieve funding, we took action immediately to put in place lender of last resort facilities and, since that time, what we have been doing is trying to find a solution. As I said to Mr McFall, I would like to find a private sector solution, if that is at all possible, but that may not be possible at the end of the day because, whilst the conditions in the money markets are now much better than they were before Christmas, it is still a challenging time, but I hope we can find that solution and I will do my level best to do that. However, given the current economic conditions which are unusual, it is not surprising that a solution that might have been available had this happened two or three years ago is not immediately available just now. You cannot look at what is happening to Northern Rock in isolation from what is going on in the general markets at the moment and, as you know better than many, the conditions in the markets at the moment are very difficult right across the world.

  Q1787  Mr Fallon: Chancellor, in underwriting the rest, almost all now, of Northern Rock's balance sheet just before Christmas, you have given the taxpayer almost all the liabilities, but no control at all over the assets. That is the position, is it not, that you have got no control over the bank's expenditure and its current activity?

  Mr Darling: We have issued it a guarantee because it is the logic of what we were doing in the first place and, as I say, we are working towards a solution and part of that solution will include the return of the money that was lent by the Bank of England.

  Q1788  Mr Fallon: Is it true that securitisation designed by your advisers, Goldman Sachs, to securitise the taxpayers' lending would then have to be guaranteed itself, triple A, by the Government?

  Mr Darling: Well, Goldman Sachs, as you know, have been hired by the Treasury to advise us last autumn and just before Christmas we said that we had asked them to look at funding options. Those discussions are continuing and we have not come to a concluded view. I did not hear it myself, but I think there was a speculative piece on the BBC this morning, but all I can tell the Committee is that we are looking at all of the options available, I very much want to find a private sector solution, if I can, and, when I have got something to report, I will report to the House in the way that I have done.

  Q1789  Mr Fallon: Under which of these options would the level of taxpayer support start to fall significantly before Easter?

  Mr Darling: We have not reached a preferred option yet. We are still having discussions and we have had intensive discussions over the last few weeks with Goldman Sachs as well as with the company and with the prospective bidders and, as I say, when we have a proposal, then we will come to the House and set it out.

  Q1790  Mr Fallon: Chancellor, this has been going on for four months now. It is four months since you bailed out this bank. You have committed over £25 billion of taxpayers' money with no guarantee that we will get all of it back, no timetable for repayment and no clear outcome in sight for the Northern Rock Board or the people who work for it. Is it not the position here that you have got neither a policy nor a clue?

  Mr Darling: The position is that we are operating in extremely difficult circumstances, the markets are subject to huge uncertainty and, as you will know, on a couple of occasions this autumn it has been quite clear that many institutions have found it difficult to borrow and to lend, so these are not normal conditions. It is not surprising, therefore, that, whereas a couple of years ago Northern Rock might have got into difficulties and then fairly quickly somebody would have come along and said, "Okay, we'll take it", that has not happened because these are not normal conditions. What I have endeavoured to do over the last few months is to make sure that, having intervened, we see that through and we try and reach a solution. Now, I agree with you that we will reach a stage, and I said last October that I was going to give the company until the middle of February to come back with proposals and we are reaching a stage where we are going to have to reach a conclusion one way or another, but I will defend to the hilt what we have done over the last few months because I think it was the right thing to do and indeed at the time it was widely supported, although I quite accept that some of those who supported it at the time are now running away from the support they once gave us.

  Q1791  Mr Fallon: If the bank has to be nationalised in the end, are we guaranteed to get all of our money back?

  Mr Darling: As I said earlier on, one of our objectives is to get our money back.

  Q1792  Mr Fallon: All of our money?

  Mr Darling: Yes, to get all of our money back. That has always been my position, and I also said in the House of Commons last October that we would do that at an appropriate time, but our intention is to make sure that we get the money back. That must be the basis on which we proceed.

  Q1793  Mr Fallon: You have changed your wording.

  Mr Darling: No, I have not.

  Q1794  Mr Fallon: You have said it is a hope, an objective and now you have said it is an intention. Is it a guarantee that we will get it back?

  Mr Darling: What I have said on many occasions is that I intend to ensure that we get our money back, and that is what I have said. I may have used a different formulation, but it adds up to the same thing, no matter how much you want to play with words, Mr Fallon.

  Mr Kingman: It is worth remembering, and I think it is a point John Gieve mentioned in his evidence to you, that this bank has positive net assets, in fact significant positive net assets. It is assessed by the FSA not only as being solvent in a balance sheet sense, but also meeting the FSA's capital requirements. So there is, on the assessment of the FSA, significant positive value in this bank.

  Q1795  Mr Breed: Right at the beginning of the session, Chancellor, you indicated that part of the new legislation you are thinking about would include powers for the FSA to seek or obtain information from banks as part of their supervisory regulation. What information can they not currently get under their existing powers that you are going to give them new powers to get?

  Mr Darling: I will ask Clive to comment on this in a bit more detail, but I think what we need to do is to have better visibility of what institutions are doing re arrangements for looking after the depositors, the systems they may have if they need to pay money out and also to get information and, having got information, to be able to talk to the Bank of England about it because, as you know, there can be difficulties if I get information from you for a perfectly good reason and I cannot then pass it on to somebody else, another supervisor in this case because you are talking about the Bank of England, so it is to clarify the law in some cases where the FSA say there are gaps there, but also to make sure that we have got the information we need when the appropriate circumstances arise so that we can take prompt action.

  Mr Maxwell: To give an example of an area where I think the FSA feels that the information it has been getting from banks has not covered everything that it would like would be around liquidity risk. In publishing its discussion paper in December, it set that out as one of the issues it wants to tackle and it can do some of that through its rule changes and we will also look at legislative changes, if they are necessary, to facilitate it doing that.

  Q1796  Mr Breed: So for ten years or so they have not felt the necessity to have information concerning the liquidity of banks?

  Mr Maxwell: They have had information about liquidity, but it has been around a different sort of liquidity regime, around the sterling stock regime which was a different sort of regime. I think there is a widespread recognition across most countries in the world that liquidity regulation needs to change and that has been looked at internationally by the Basle Committee and in Europe, and the FSA will need to make sure it gets more updated information, more rapid information about liquidity as part of implementing a regime like that.

  Q1797  Mr Breed: Well, either they did not understand it or they did not consider it important enough.

  Mr Darling: I think it is true to say, as Clive has just been saying, that it is relatively recently that regulators are beginning to focus on the fact that liquidity is just as important as capital adequacy. Again, I said this when I spoke to you last October, one part of the work that we are doing at the international level for financial stability and the IMF is to make sure that regulators focus on the liquidity problems because this is unusual, the present difficulty across the world. Previous people have been driven because people did not have enough capital, but the problem we have got just now, ironically in many cases, is that there is plenty of capital now, but it is just frozen, it is a liquidity problem, so I think the answer to your question is that 10 years ago, if you had said, "What's the big problem?", people were really focused on capital adequacy rather than on the whole question of liquidity.

  Q1798  Mr Breed: The Governor of the Bank of England told us, "At present, we cannot allow a bank to fail unless it is clearly insolvent", and the BBA commented that, "it is difficult to envisage the UK authorities allowing the failure of a retail deposit-taker", but does that not fly in the face of the usual sort of thinking in the financial markets that banks actually must be allowed to fail?

  Mr Darling: The test that we apply, and this has always been the case as far as the Bank of England was concerned under the present Governor and previous governors, is that, if it failed, would it have an adverse effect on the viability of the financial system. It is the systemic risk that you look at rather than any other factor. If you look back at the banks that went down in the 1990s, Barings, the consideration there was that it was not a retail bank. It had some retail deposits, but it mostly was not, therefore, it was not going to affect the system generally. BCCI went down for reasons that were nothing to do with the financial system in general, but the way in which that bank was operated, as we well know. Looking further back, there were banks that failed before that in the 1970s and Johnson Matthey in the 1980s, so the test is whether it will affect the wider financial system, and that is what we need to look at.

  Q1799  Mr Breed: But, with the depositors secured or looked after, why was there the necessity then to protect the shareholders and others in respect of any potential failure of Northern Rock?

  Mr Darling: We are not protecting shareholders and, as I said earlier on, shareholders know that, when they buy shares in general, they can go up and they can go down.


 
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