‘It is somewhat ironical,’ the chairman of the Financial Services Authority told the Treasury select committee investigating the Northern Rock crisis, ‘that one of the responses is to try to seek from the rating agencies even more work and even more assessment.’ The paradox intriguing Sir Callum McCarthy was the suggestion that credit-rating agencies, having failed to predict Rock’s troubles, should now also produce liquidity reports on banks.
MPs on the select committee — about to produce a report that will be highly critical of the financial regulator — may themselves think it ironical that, having equally failed to foresee Rock’s fate, the FSA is being rewarded with an expanded role. Chancellor Alistair Darling proposes allowing it to gather more information on banks and to take management control of those that fall into difficulties, bypassing current insolvency procedures.
Increasing the FSA’s workload is perhaps Darling’s subtle punishment for allowing the biggest banking crisis for a generation, but the result is to reprieve an agency that has proved itself unfit for purpose. The blame for Northern Rock’s problems starts with the bank’s own board, but the regulator is there to curb overenthusiasm and it failed — both in the prevention and the cure.
Before the Rock’s money ran out, the FSA was looking in the wrong direction. It was focused on protecting the public against abuses on retail products such as misselling — when last year’s problems were in the wholesale markets. When it did look at banks, it examined the asset side of the balance sheet although the real dangers were on the liability side — the inability to raise money, not the risks of lending it. And it concentrated on capital rather than counting the cash: just a month before the credit crunch, the FSA approved a capital-adequacy ratio for Northern Rock that allowed it to raise its dividend by 30 per cent — even though there was no money in the coffers to pay it.
Once the problems became evident, the FSA was slow to ask the Bank of England to step in as last-resort lender, and slow to realise the risk of a run. Finally, it took too long to comprehend that the same credit crunch that caused the problem would also hinder a market solution — as Darling and would-be bidders for the Rock have latterly discovered.
But however great the regulator’s failings, there was never a realistic possibility of the Rock bringing down the FSA. Darling was chief secretary to the Treasury when Gordon Brown, as chancellor, created the new watchdog, transferring banking supervision to it from the Bank of England. It was a move made in haste, without even consulting the Bank governor, but even now there is no debate about whether a single super-regulator is the way to keep the City in check.
There are cultural problems in expecting one regulator to supervise everything from car insurance to hedge funds. Protecting the consumer from sharp practices is very different from exercising prudential regulation, yet the FSA is charged with both. But while it supposedly polices banks at the micro level, responsibility for financial stability remains with the Bank of England because only the Bank has the reserves to bail out even a middle-sized lender like Northern Rock.
The Bank was annoyed when supervision was snatched from it in 1997 but the decision was a direct result of the Barings collapse, only the latest of a series of such mishaps on the Bank’s watch. As the FSA is now finding, there are no thanks for averting a crash but buckets of blame when one happens: in hindsight the Bank may well be pleased to be rid of this role, not least because another failure would undermine its credibility in executing its task of controlling inflation.
The FSA’s predecessor was the Savings & Investments Board, an umbrella watchdog that covered a litter of regulators for specific sectors. It had its crises and failings but there could be sackings or censures at the alphabet soup of sub-regulators — Lautro, the PIA, et al. — while the SIB’s reputation remained intact.
Creating a single regulator with a single chief — executive chairman Howard Davies — was dangerous because his head was too important to roll if he cocked up; but Davies was able to mop up the SIB’s old mistakes and leave before his own actions could backfire. Giving the FSA a separate chairman and chief executive solved that potential problem, but the bull market in shares that started when McCarthy was made chairman gave him a honeymoon too, as the equity investor’s protector. In the end it was a credit boom, not an equities slump, that caught McCarthy out.
The FSA this month rearranged its deckchairs, belatedly beefing up its wholesale markets division. But it’s not enough. Luckily McCarthy’s term ends in May: Darling must appoint a big gun from outside, someone who can restore international confidence in London as a financial centre and who can make this monster of a watchdog work.