Don’t blame the FSA

This morning the FSA takes the regulatory blame for Northern Rock and admits it made mistakes.
I think it is a case of mistaken identity. It was the Chancellor and the Bank of England that presided over the collapse of Northern Rock, not the FSA.
Remember what happened. In the summer of 2007 money markets dried up in an unprecedented way. Some of us went hoarse telling the Bank of England they needed to make more money available so the money markets could function.
Instead, in September, knowing Northern Rock could not borrow all it needed from the money markets, the Chancellor and the Governor of the Bank made speeches saying banks had lent too much and if they got into trouble it served them right. There would be no bail out.
There was then a run on Northern Rock, as small depositors sought to take their money out. (All this was obvious at the time – see the tab on Northern Rock for my contemporary comments on the Bank’s inaction and the Chancellor’s moral hazard speech).
Fortunately for Northern Rock, after huge damage had been done, the Chancellor and the Bank changed their minds and intervened to protect depositors.

I would not conclude from this that the FSA had got its stress testing wrong – or that the FSA needs more staff. I would conclude that both the Directors of Northern Rock and the FSA did their jobs in the belief that money markets would continue to function, and that the Chancellor would avoid comments that were damaging to regulated banks. These beliefs were not unreasonable. Northern Rock raised money in three main ways – from the money markets, from retail depositors and from securitisation. So do most banks, to differing degrees. As we have seen, other institutions can get into difficulties if money markets seize up, as with Bear Stearns.
What was wrong was that the Bank of England kept the markets so short of funds in August and September, and what was wrong was the speech and interviews of the Chancellor blaming the banks at the very point where a crisis of confidence was about to erupt.

The correct response to this crisis is not to appoint more staff at the FSA and let the FSA take the blame. The correct response is to strengthen the banking arm of the Bank of England, and reconnect the Bank more directly to the full working of the money markets, with a remit to keep the markets reasonably liquid. The Bank has as its main responsibility the setting of interest rates. In recent months the rates it has set have often become academic, as market rates have deviated from them under the pressure of the credit crunch. The Bank needs not only to set rates, but to enforce them.

The questions to be asked today are not about the FSA but about the Chancellor and the Bank.
Does the Chancellor now accept that his no bail out speech was a mistake?
Does the Bank now think it should have made more liquidity available to markets last summer?
What action is the Bank going to take now to ensure that the rates it sets are the rates the market follows?
Will the government restore the powers and duties in banking and money markets to the Bank of England that it took away in 1997?


  1. Chuck Unsworth
    March 26, 2008

    "The correct response to this crisis is not to appoint more staff at the FSA and let the FSA take the blame. The correct response is to strengthen the banking arm of the Bank of England, and reconnect the Bank more directly to the full working of the money markets, with a remit to keep the markets reasonably liquid."

    I'd agree entirely, but which is the 'correct' political response?

  2. Neil Craig
    March 26, 2008

    "The correct response to this crisis is not to appoint more staff at the FSA and let the FSA take the blame"

    Nice one.
    The normal response to a failure of government regulation is increasing regulation. This is a good deal for both politicians & the FSA. The politicians get somebody else to take the blame & the FSA get to expand their empire.

  3. APL
    March 26, 2008

    JR: "Don’t blame the FSA"

    In the same way you don't blame an infant for doing something stupid, one usually has hope that a child might grow mature. The FSA is a hopeless case and should be abolished.

  4. MOppenheimer
    March 26, 2008

    Well, having just written on this topic, I don’t think I could agree with you more. I am slightly perplexed why David Cameron did not make a better job of making the case as to why it was / is a bad idea to split the regulation of banking between the FSA and the BoE. I do agree with the sentiment that the government must take responsibility of this failure, but so too must the FSA. I sincerely hope this is not the last we here from you and other Tories on this issue as I think in light of recent events the status quo can’t remain.

    Reply: I am pleased to say David cameron did at PMQs yesterday state that it is now Conservative policy to give powers back to the Bank of England to control money markets and regulate banks.I suspect it is something the government will inch towards as well.

  5. Robert Davidson
    March 26, 2008

    My first response to your post was one of horror, but on reflection I think you are closer to the truth than most commentators.

    The immediate problem was liquidity, and a B of E operating in the way it was before BG's tripartite mess would have done a better job at managing it.

    The second problem is potential insolvency. We still don't have any real insight as to the size of this issue as the necessary audit work on the loan book has either not been done or not published. If NR has made bad credit decisions and there are unrecognised losses then the management and shareholders have to take the pain. There is nothing the FSA can do to undo bad commercial choices. Trying to substitute a regulator's assessment of what is or is not good business is no way to run a dynamic economy especially if the regulator suffers no pain for getting it wrong.

    In short you conclusion of putting the B of E back into its old role and scrapping the FSA seems to make sense.

  6. Iain
    March 28, 2008

    You are probably correct in your analysis but I am not prepared to be so forgiving to the FSA, for the FSA seems to have been guilty of failings it wouldn't tolerate of the companies it regulates, after all failing to keep proper records is a serious breech of FSA rules subject to heavy fines, yet something they have been found guilty of with NR.

    So who fines the finer?

  7. Damian
    March 31, 2008

    I disagree with your premise about the FSA as it is very obvious that their stress test model is flawed and several of their banking team have left. Northern Rock was at some stage going to fail given the increasingly poor quality of its book, buying so much business when house prices had diverged so far from any sustainable trend was setting itself up for problems, problems already visible in 2006 in the USA. The refusal of loans to banks is nothing new in the London market nor is significant difference in terms, a trip back to the heady days of 'Competition and Credit Control' would enlighten in this respect. Indeed Brown's prudence and stability economy have much in common with this 1970s period, October 1973 even to come?
    The Bank of England has been marginalised by Brown and though with 20:20 hindsight an argument that extra liquidity might have helped it's not obvious that it would as banks weren't going to lend and the BoE would have had to underwrite NR's questionable mortgage book. That is the Chancellor's job.
    Rates are set by the market; the Bank should not interfere bar loans to stabilise short term. To do so will be reminescent of Canute. Brown has set up a terrible situation in which rates should rise significantly as demand for money will rise (public and private sectors) and to flood the market with money will weaken sterling and hike prices. That the Tories hadn't criticised Brown in 1997 or for using CPI and setting the target too high suggests a political electoral rather than a good husbandry bias.
    The way the Fed has bailed out the US system is terribly flawed it should not have reduced rates but just provided liquidity. The hiatus now with Bear Stearns is a nonsense and just crowns the terrible flawed reign of Sir Alan Greenspan. A revisiting of 1987 with its change from Volcker, 40% boom in DJ-30, and huge bailout in October and subsequent asset inflationary policies is wince making.
    It would be better for Cameron to outline a very diffficult period c/o Brown for the UK, which he is beginning to do.
    BTW: I sense that some greater scrutiny needs be made of the insurance takeover game or we will be facing in a few years to a number of Equitable Life type calamities; new owners like some leveraged Private Funds finding difficulties in supporting liabilities. After all insurance companies are themselves primarily Hedge Funds.

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