Bank of England Versus FSA and Government

By Julian Sudre

Perhaps the old Victorian approach of the Bank of England after all has been extenuated by the recent bail out of the fourth biggest lender in the UK – Northern Rock. Well not just so. While we have a case of hands-on US intervention versus hands-off UK intervention, the vulture press has seemed to swoop down on Mervyn King.

As usual, someone has to take the rap; the Pavlonian response was Mr King to be blamed for as it was for the McCann’s.

While some say that the Governor of the Bank of England was stitched up by the Clunking Fist of New Labour. By doing a U-turn and injecting liquidity into Northern Rock, the latter will be perceived as nationalised and certainly will undermine Gordon Brown's credibility as he was the one who created a fully independent Bank. So Has Mr King bowed to political pressure to pump £10 bn into the financial markets?. I for one, believe that the BoE shouldn’t have provided funds but instead should have ensured that the financial system runs smoothly.

In any event, we should note that the FSE is responsible for the supervisions of the banks, hence the next in the line of fire: “please step forward Mr Callum McCarthy”.

Mr King had certainly his hands full when it came to gauge how far to extend liquidity against a wider range of collateral on the one hand and the concern of moral hazard on the other – the danger of rewarding banks that had taken a riskier approach than others. But he went on to say that the moral hazard was limited by a cap on the amount the Bank was providing to individual banks and by the penal rate of interest.

He insisted that it would have been irresponsible to have offered a full guarantee on savers’ deposits before the run on Northern Rock since that would have undermined confidence in the banking system. This is seen as yet another indication of how the Bank’s Governor has misjudged the delicate psyche of the markets.

But according to Mervyn King, Northern Rock debacle was blamed of four pieces of legislations: The Takeover Code, the Market Abuse Directive, the Insolvency regime enshrined in Enterprise Act 2002 and the Financial Services Compensation Scheme.

So after feeding Mr Kind to the Lions, in two weeks time FSA officials will appear in Parliament. And since this is the FSA which is supposed to know whether individual banks might face a liquidity squeeze and does routinely deal with asset managers, insurance groups and bankers, this time the FSA did not demonstrate any visible awareness of liquidity challenges before the summer in the banking world. Meanwhile I have come away with the feeling that the Bank's Governor has been used as a scapogoat by the dead hand of the Tresuary.
At any rate, all things being equal, if the Bank had agreed to accept mortgage collateral at its lending window ealier as Mr Darling believes, that is taking a cue from the Feds or the ECB, the damages could have been avoided. This remains to be seen because Northern Rock got itself into trouble through over-reliance on short-term funding from the capital markets.

Of course, we know by now that the FSA was more in favour of relaxing rules but it undeniably was not felt enough to make an impact across the board. Today relations between the BoE and the FSA are poisonous, no less.

Now, let's wait with bated breath if the whole issue revolving around the snap decision to inject money was a pretext from Labour to force a loosening in monetary policy.