Critics of Gordon Brown’s ‘tripartite’ regulatory structure want authority restored to Threadneedle Street, says Richard Northedge.
Critics of Gordon Brown’s ‘tripartite’ regulatory structure want authority restored to Threadneedle Street, says Richard Northedge. But is the Bank’s track record tarnished?
The simplistic initial analysis of the financial crisis — that the tripartite oversight structure of the Treasury, the Financial Services Authority and the Bank of England had failed — has developed over two years into a more complex argument. Now the blame is directed at chancellors Brown and Darling along with the regulatory body they created, the FSA, while the central bank is increasingly seen as an innocent bystander caught up in others’ failings. If the Bank had been monitoring the financial sector, say its supporters, there might have been no banking crisis and thus no recession.
Governor Mervyn King has not yet called publicly for a return of the banking supervision role that was snatched from the Bank and given to the new FSA as soon as Brown and Darling (then Chief Secretary) moved into the Treasury, but he is demanding more powers. And even if he will not say it himself, many in the City and on the opposition benches are calling for bank monitoring to return from Canary Wharf to Threadneedle Street. King is suddenly the hero of the hour: publicly airing his differences with the Chancellor at last week’s Mansion House dinner has only added to his standing.
Yet canonising the Governor is somewhat simplistic too. The Bank has made its mistakes. Indeed, bank regulation was transferred to the FSA in 1997 because the collapses of Barings and BCCI, like Johnson Matthey previously, happened under the Old Lady’s supervision. There are those who argue with hindsight that the move was also provoked by Brown’s inner urge to divide and rule, but there is no doubt that the Bank’s record was tarnished.
Nor does the Bank emerge spotlessly from the current crisis. Even when the FSA realised Northern Rock was in trouble, King was reluctant to mount a rescue: he cited ‘moral hazard’, the bankers’ equivalent of Darwin’s ‘survival of the fittest’. Nor had the Bank’s deputy governor who sat on the FSA board, Sir John Gieve, blown the whistle; MPs accused him of being asleep in the back shop, not even reading the Rock’s accounts.
While the Bank was not responsible for monitoring Northern Rock, it was accountable for the financial stability of the system and, as we now know, the Rock was the first of a nexus of dominos whose falls destabilised the banking sector. The Bank was directly responsible for monetary policy, however, and thus for the cheap money that fuelled the borrowing binge and subsequent crisis.
And despite its intimate involvement in money markets, it failed to prevent the liquidity crisis that was at the crux of the credit crunch and was tardy (and mean) in following the US Federal Reserve and European Central Bank in injecting vital new funds when the system seized up two years ago.
And while we’re listing the Bank’s lapses, let us not forget its failure to keep inflation within target range. Should we really be considering investing this institution with renewed powers?
Indeed, in the early days of the crisis when scapegoats were being sought — and Brown was enjoying his premiership honeymoon — King was cast as the villain, a theoretical economist distant from the intricacies of investment banking and the realities of a run on a retail bank. Brown’s perceived delay in reappointing him for a second five-year term was seen as reflecting doubts about his performance.
King kept the job, however — losing a Governor would have turned a crisis into a catastrophe — and he has steadily enhanced his standing while the FSA changed chairman and the Chancellor became mired in recession. Having stood up to Darling over the choice of a deputy to replace Gieve, King used his Mansion House speech both to criticise the Chancellor’s fiscal policy and to demand new regulatory powers.
This year’s Banking Act turned the Bank’s oversight of financial stability into a statutory responsibility. King believes that if he is going to be blamed for the next bubble, bust or bank collapse, then he needs sufficient powers to prevent them. The new legislation gave the Bank tools such as the ‘special resolution regime’ that was deployed to merge the troubled Dunfermline building society into the Nationwide; but now King wants ways to prevent banks becoming too big, too highly geared, too fragile, or just too great a danger to the financial system.
He thinks banks that are too big to fail are too big to continue, and says it is nonsensical to allow retail and investment banking to coexist in single institutions that the state has to bail out. He is not being specific about the detail of new powers but he is quite clear he wants them, and his gain would be the FSA’s loss.
He is proving himself to be a tough negotiator; he is also setting out a tough regulatory agenda. His opposition to big banks and organisations that straddle retail and investment banking — demanding they demerge, downsize or close down — contrasts with the more relaxed view of Lord Turner, the FSA’s chairman since last autumn. King wants a Dangerous Banks Act that allows him to put down such beasts: Turner is happy for them to live so long as they are caged or muzzled.
King’s hawkish stance wins support from those ready to blame the FSA and its light-touch regulation for the crisis. Conservative shadow chancellor George Osborne wants banking supervision transferred back to the Bank; even Lib Dem Treasury spokesman Vince Cable, a Bank critic, wants to increase its role. But in a recent paper for the Centre for Policy Studies, Sir Martin Jacomb — a City grandee, former director of the Bank, and regular Spectator contributor — goes further. He wants the whole FSA transferred to the central bank. He envisages King heading a holding company with three ‘subsidiaries’: the MPC setting interest rates, a committee responsible for stability, and the FSA supervising individual banks.
Certainly making Canary Wharf monitor banks while Threadneedle Street oversaw stability created the crack in which the credit crunch incubated. Jacomb subscribes to the view that Brown’s real aim was divide-and-rule, but even if it is mere cock-up rather than conspiracy, it is a cavern into which other potential catastrophes can slip unnoticed. Turner sees better communication as the solution to that problem; others prefer to remove the gap entirely.
However, returning supervision to the Bank, never mind putting the whole FSA under King’s control, could strain Threadneedle Street’s management capability considerably. There is no army of regulators waiting with sharpened pencils to start the job: the department responsible for monitoring banks was moved to the FSA lock, stock and barrel — with its respected director, Michael Foot — when responsibility was transferred 12 years ago. Returning the department would only lumber the Bank with the team that failed to identify the problems at HBoS and all the other banks that have had to be rescued.
It would also be a reverse takeover, since the FSA employs nearly twice as many staff as the Bank, and it would mean King having to take command over consumer issues such as endowment policy mis-selling and financial education that the FSA concentrated on at the expense of spotting the black holes in our biggest lenders. Further, marrying the central bank and the investment regulator would not only run counter to practice in other major countries these days, but would also bring together the advisory role of the FSA and the balance-sheet operations of the Bank of England — exactly the sort of union King opposes in the financial sector he wants to oversee.
And there must be doubts whether the pre-1997 culture of banking regulation can be recreated. Those who oppose the FSA’s formula-driven method of monitoring, in which ratios count for more than relationships, hark back to a time when the Governor had merely to summon a banker to his parlour — or bump into him at his club — and raise an eyebrow to persuade him to curb lending or boost capital.
King’s eyebrows had already been plucked before he was appointed but probably the last governor for whom this signal system worked was Robin Leigh-Pemberton, or Lord Kingsdown as he became after leaving the Old Lady in 1993; and even his brows gradually lost their power as City banks passed to foreign owners ignorant of such subtleties. And some banks failed in that era too, even if the collapses were not systemic.
However, it is the crashes that are remembered. How many failures the Bank or the FSA quietly averted we may never know. But we can look back on the telecoms disaster of 2002 that never happened, when Governor Eddie George’s team watched the world’s phone companies load themselves dangerously with debt and gently brought them back to solvency and stability without systemic collapse.
Perhaps the Bank would have done the same with the banking sector if it had the information, the remedies and the remit. Its own regular stability reports showed it recognised the problems but it either failed to shout loudly enough for fear of causing the panic it was trying to avoid — or it was too polite to play back-seat driver to the FSA.
But hindsight is a wonderful thing: when exactly would the Bank have deflated the borrowing bubble? Could King really have told would-be homebuyers that they could not have the mortgages they wanted and which Northern Rock and others were so willing to offer? The message of King’s moral hazard is that banks must be allowed to make mistakes and should be stopped only when they threaten the system.
With a general election looming, the future of bank regulation has become intertwined with politics. Darling and Brown are defending and strengthening the FSA they created; its opponents are Labour’s political enemies but their dislike of Labour’s regulator should not translate into blind support for the Bank of England. The Bank has to put a convincing case for why it can do better: King must tell us exactly what tools he wants and how he would use them.
After that, all he needs is the good luck that nothing else goes wrong on his watch.
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