Mervyn King should have hiked rates to deflate the bubble
SIR Mervyn King, the governor of the Bank of England, is not one for mea culpas. His speech last night was an extraordinary defence of his record in office – and a largely unfair attack on his detractors, ignoring their intellectual arguments and questioning their motives. He did admit that he should have done more but his main argument was that he didn’t have the right tools to act. His concession was that he didn’t “shout” loudly enough about the rise in risk.
Those who believe that the crisis was a case of pure, unprompted animal spirits in the City will have seen all of their prejudices reinforced; but those who believe that blunders from central banks were one of the key factors encouraging lenders and borrowers to act stupidly were left disappointed by King’s analysis. His claim that this was a bust with no boom was especially unconvincing.
The Bank could (and should) have jacked up interest rates at the height of the bubble; it didn’t need extra powers to deflate the housing boom and thus rein in the insane expansion of Northern Rock and others. Higher UK base rates would also have made it harder for HBOS’s crazed commercial property lending. The need to target a faulty consumer price index measure of inflation need not have constrained him excessively – higher rates could have been justified to prevent a bubble turning into a crash and hence disrupting the price level. Increasing UK base rates would not have been a panacea: this was a global bubble, fuelled by lower long-term borrowing costs set in the bond markets and heavily influenced by global East-West imbalances, the actions of the Fed and China’s currency manipulation. But the Bank could have done far more even with the tools it had (and did King really oppose Labour’s decision to strip the Bank of its regulatory powers in 1997?).
King is also wrong to emphasise, at this stage in the cycle, the need for increased capital requirements. He is right that Banks need to hold enough equity against their loans to make sure they are cushioned against losses. But the new, ever increasing capital requirements have now gone too far: they are making a whole range of loans unviably costly and reducing the supply of credit beyond what is prudent. Normally, in a downturn, banks should reduce their reserves; and they should increase them in an upturn. We are doing the opposite, which is madness.
Bailouts are immoral. The fact that we had a system that actually encouraged them was unforgivable. Astonishingly, the authorities didn’t have a Plan B in case a bank failed – it was simply assumed it would be bailed out. This created enormous moral hazard. We need – and King is right about this – special bankruptcy procedures for banks that allow them to be wound down in a controlled manner, wiping out shareholders as well as bondholders while protecting innocent bystanders and taxpayers. But King is wrong to dismiss the applicability of such resolution procedures for the largest, universal banks. He remains excessively attached to the Vickers report, a mixed bag of a document which doesn’t represent the best way forward. All in all, not King’s most enlightening speech.
BACK BORIS
Follow me on Twitter: @allisterheath