Examination of Witnesses (Questions 1860
THURSDAY 10 JANUARY 2008
MP, MR JOHN
Q1860 Chairman: Chancellor, you mentioned
that you do not want to stifle financial innovation, and I think
that is a working aim, but we are in this situation because of
reckless financial innovation in that the bottom line is that
no-one any longer trusts the rating agencies' judgment or the
creditworthiness of complex structured instruments, and that in
itself some are suggesting is putting a hole Basel Pillar I. Is
it not the case that forcing the rating agencies to clean up their
act is a necessary condition for Basel II to get on track again?
Mr Darling: There are two things
would say about credit rating agencies. Firstly, they should always
be regarded as a source of advice rather than the final word as
to what you do. I think there may have been some cases where people
have taken the word of a credit rating agency and that is it,
but the second thing is, of course, questions have been raised
in relation to how effective, how diligent they have been, but
if you take the root cause of the present crisis in America, for
example, in the housing the market in particular, the root cause
is institutions, on advice (and we do not know, obviously, how
much they relied on credit rating agencies, substantially or not),
lending money to people who, frankly, were never going to be able
to pay it back when the interest rates went up, and it must have
been within their contemplation that interest rates at 1% were
going to go up at some stage.
Q1861 Chairman: But at the core of
that is complex structured products?
Mr Darling: That is right. One
of the issues that needs to be looked at, for example, is that
credit rating agencies do advise companies in relation to the
very instruments they are then going to raise, and these are issues
that need to be sorted out, particularly at an international level.
Q1862 Chairman: It would be reassuring
if you were to give us an undertaking in terms of Basel II that
this issue is going to be looked at.
Mr Darling: It is. It is being
looked at at the IMF level, it is being looked at the Forum for
Financial Stability as well.
Q1863 Nick Ainger: Chancellor, you
were talking just now in response to the Chairman about the root
cause of this problem being the miss-selling of mortgages in the
United States which then spread throughout the whole financial
community, through CDOs and SIVs and so on, but in fact it should
not have been a surprise, what happened in the summer, because
both the Bank of England and the FSA gave specific warnings that
there was a threat to a liquidity problem. In January the FSA
quite clearly said that "market liquidity remains abundant
at the moment, but it is still important for market participants
to consider how they would operate in an environment where liquidity
is restricted". The Bank referred specifically in its Financial
Stability Report in April to impaired market liquidity, all as
a result of the subprime mortgage problem. It would appear, possibly
other than Goldman Sachs, that virtually no bank appears to have
taken any cognisance of those two quite clear warnings in the
UK and it would appear from our meetings in Brussels and in Frankfurt
that, in fact, European banks did not really take note of similar
warnings that they were given. What can you do in the work that
you are planning ahead now to address these problems?
Mr Darling: One of the things
that I think we can do is to strengthen the role of the IMF in
relation especially to these international global problems, that
there is a more formalised way of bringing to people's attentions
that there are problems mounting and that people ought to start
making plans against the situation deteriorating. You are right
that the Bank of England has issued general warnings; the FSA
itself has. The questions that arise from that are twofold: at
an international level, how do you make sure that a report or
a speech by a central bank governor that actually is beginning
to sound warning bells is acted on? The second thing is, of course,
enforcing regulation. You need to ensure the FSA, having flagged
this up in general, then starts to look, in particular, at institutions
that they were concerned about.
Q1864 Nick Ainger: Presumably the
risk committees that banks have could formally look at the report
that either the central bank or the regulatory authority has provided,
flagging up a particular warning and then they would have to formally
respond to that warning. Is that a way that it could be done?
Mr Darling: I think that is something
that you would have to think fairly carefully about. For example,
suppose that the Governor of a central bank made a speech in which
he said, "I think there is trouble ahead", are we then
saying risk committees of banks all around the world would have
to look at the speech and then say, "Do we do something?"
or are we saying that there would be an expectation, a supervisory
requirement, only if it is something slightly more formal than
Q1865 Nick Ainger: I am not suggesting
that. On these two occasions, in January it was in the FSA's financial
risk outlook. It was not a speech; it was actually there: a carefully
worded report. The same was true of the Financial Stability Report
of the Bank of England in April, again, clearly identifying this
problem, and yet nobody reacted, it would appear, other than one
or two institutions.
Mr Darling: One of the things
we need to reflect on is how do supervisors, having expressed
a general concern or even a particular concern, then make sure
that it is acted upon? I suspect that is an issue here, it is
an issue around the world, but for the past few years, as you
know, we were talking about these things, as you say, you refer
to specific warnings. The question you ask yourself, if you were
to go back to American where the immediate problems stem from,
why was it there that someone did not start asking questions about
their exposure to these houses where it was quite obvious that
the house was not worth what people thought it was and there was
no income to go with it?
Q1866 Mr Love: Chancellor, you indicated
earlier on that all opportunities are open in regard to Northern
Rock, including the possible nationalisation. Right at the beginning
the Chairman asked you about the Human Rights Act. What influence
will the Human Rights Act have on the way you respond to shareholders'
interests in Northern Rock if you have to nationalise it?
Mr Darling: The Government is
legally obliged to obey the law. There is no surprise there. When
we introduced the Human Rights Act, I think at the end of the
last decade, we were very aware of that and so we have to take
that into account, but, as I said to the Chairman earlier, equally
I am quite sure that people who have been buying Northern Rock
shares since September were fully aware of its present circumstances.
Q1867 Mr Love: I want to ask you
specifically about the consideration that shareholders will receive,
but let me put it to you in this way. Can you reassure the Committee,
if nationalisation becomes the only option, that when you consider
buying the shares from shareholders you would take into account
either the market position of their shares or, indeed, what shareholders
would have received should one or two of the private sector options
have been a possibility? In other words, will you relate what
the shareholders receive to the market, rather than to perhaps
what some people think would be a generous solution really to
the Human Rights Act?
Mr Darling: We have to give regard
to the Human Rights Act, but I will take into account all those
things that I am legally obliged to take into account whatever
solution we may reach.
Q1868 Mr Love: Can I ask you about
the issue of the intervention of the FSA in the future when a
financial institution is in difficulty. I wondered whether you
have given any consideration as to whether or not that should
be based on the judgment of the regulator or whether there should
be specific criteria or rules that they would have to follow in
order to justify any intervention?
Mr Darling: I think there would
have to be clear rules because the law can only operate on the
basis of certain things happening. As I said earlier on, I am
not in favour of legislation which would give the state the arbitrary
power to intervene in a bank when there is no possible justification
for doing so. Inevitably, you have to have some degree of discretion
because you cannot legislate for every conceivable possibility.
You can think of 101 reasons why a bank might get into difficulties
and pose a systemic risk. I think it is important that we provide
as much certainty as possible, precisely because of the point
that I think Mr Cousins was making; we want people to be able
to invest in this country with certainty, where they know what
the rules are, just as if they invest in America or Canada or
wherever they know what the rules are there, and they understand
that and they are quite happy with that. We do need a degree of
certainty. We cannot just give people blanket sweeping powers
but, on the other hand, you do not want to get into a situation
where you find the one thing that you had not got down in the
Act happens and you are back to square one again.
Q1869 Mr Love: I accept what you
say that you need a balance, but in the reality of the situation
these are always very fast-moving circumstances. You do not have
a lot of time to sit back and make judgments, and therefore following
the situation may well be the best judge at that particular time
rather than depending on rules.
Mr Darling: What you need is a
legal framework. If you take everything that we have been discussing
this morning, whether it is in relation to the lending to Northern
Rock or supervision, inevitably there has to be a degree of judgment,
especially in relation to supervision. For example if you take
Northern Rock as it was, there has to be a degree of judgment
as to at what point do you intervene. The FSA accepts that perhaps
looking at it now they should have said to Northern Rock , "You
cannot carry on in a situation where you have got no plan B."
Q1870 Mr Love: My final question
Chairman. You have indicated that although things have improved,
the credit crunch is still having an impact. Is it yet having
an impact on the real economy rather than the financial sector?
Mr Darling: I think it is very
difficult to be sure as to what the ultimate effect will be. I
can just say this: that last October at the Pre-Budget Report
I down-rated our forecast for growth for this year because I was
sure that it would have some effect, but my cause for optimism
that we will get through this is that our economy is fundamentally
strong. This last year it was the fastest-growing economy of any
developed country. We have very low levels of unemployment. 1975
is the last time it was as low as this. We have got over 29 million
people in work. Crucially we have got low interest rates and inflation
is at or near our target of 2%. There are a lot of reasons to
be more optimistic. It was a completely different position to
the one that we were in 15 years ago where interest rates were
high and three million people were unemployed. We are in a very
much stronger position. Having said that, we are going through
some difficult times. Right across the world there are problems.
I mentioned the housing market in the United States for example
and whilst, if you look at the money markets, the conditions are
better nowand I think a great deal of that was due to the
action taken by central banks just before ChristmasI think
this year is going to be difficult. However, provided we stick
to the course we have set I remain optimistic.
Q1871 Chairman: Chancellor, we have
almost kept to time. We hope with our report to keep strictly
to time and that it works in with your consultation exercise.
We thank you for your evidence this morning and we look forward
to that consultation exercise.
Mr Darling: Thank you very much.