The Bank’s review of its conduct needs to ask could the bubble have been forseen in say 2005? If so what action could they have taken to rein it in before it became damagingly large?
There were several commentators and the Opposition parties saying in the middle of the last decade that the government was allowing far too much debt to be extended. Meanwhile, the Bank of England cut interest rates sharply in 2001, cut them further in mid 2003, raised them modestly to mid 2006, only to cut them a little again. As we advanced in 2007 the Bank belatedly started to take the inflation threat more seriously, and hiked rates to 4.75%, finally reaching 5.75% in 2008, by which time the crunch was obvious to its critics.
It is a fair comment to say the Bank did too much too late on interest rates. It by general agreement did too little for much of the gathering boom. It should have sent a stronger signal against credit and money expansion in the middle 2000s than it did with higher rates, when others were worried. It then raised rates too much and kept them too high in 2008, when the banks were already in serious trouble and the system was deflating.
The FSA for its part put forward more and more detailed rules affecting banks, but was lax over the amounts of cash and capital banks had to hold. In the 1980s and early 1990s when I was a financial regulator as a Minister, it was thought prudent to keep a commercial bank balance sheet to less than 20 times its core capital. By the time the Credit Crunch hit well over 30 times was thought normal and acceptable.
When I asked regulators in the 2000s why they thought banks could gear themselves so much more than before, I was told that thanks to a wide range of new fianncial products they could carry more risk with the means to offset it through futures, options and derivatives. It did not prove to be like that. Indeed, as some of us feared, the large positions in special instruments often increased the exposure to dangerous markets, and increased the geared impact of a fall in markets.
There was no new paradigm which allowed banks to magic more money into the system without extra risk.
The Banking regulator and the Competition Authority made the problem worse by allowing or even encouraging mega mergers so large banks emerged with hugely geared balance sheets. Some of us argued against allowing the RBS/ ABN Amro merger. Many more of us opposed the LLoyds/HBOS merger. The authorites allowed these through, ensuring that if a bank did collapse it would be a very large one. They thought it cut banking risk. Some of us thought it concentrated banking risk, and meant strong banks would be pulled down by weak ones within the new enlarged groups.