Banking crisis: Don’t blame the central banks

Back in November last year I found myself addressing a bunch of bankers in the Bahamas. The theme of my speech was that it would not take much to cause a drastic decline in the liquidity that was then cascading through the global financial system. I had in mind a geopolitical shock. It turns out that a purely financial catalyst - the dawning of reality in the US subprime mortgage market - could have much the same effect.

At the time, my audience was distinctly underwhelmed by my argument. I was dismissed as an "alarmist". One of the most experienced investors attending the conference went so far as to suggest to the organisers that they "dispense altogether with an outside speaker next year, and instead offer a screening of Mary Poppins". Presumably his thought was that he and his chums could blot out any thought of future financial crisis with a lusty chorus of "supercalifragilistic".

Yet the mention of Mary Poppins stirred a childhood memory in me. Fans of Julie Andrews may also recall that the plot of the evergreen musical revolves around a financial event that, when the film was made in the 1960s, seemed positively quaint, but which has unexpectedly returned to spook us this month: a bank run, something not seen in London since 1866.

The family that employs Mary Poppins is, you will recall, named Banks. Mr Banks is indeed a banker, a senior employee of the Dawes, Tomes Mousley, Grubbs, Fidelity Fiduciary Bank.

At his insistence, Mr Banks's children are taken by their new nanny to visit his bank, where Mr Dawes (Sr.), recommends that Mr Banks's son Michael deposit his pocketmoney (tuppence).

Unfortunately, young Michael prefers to spend the money on feeding the pigeons outside the bank, and demands that Mr Dawes "Give it back! Gimme back my money!"

Even more unfortunately, some of the bank's other clients overhear Michael's request:

Client 1: There's something wrong. The bank won't give someone their money!

Client 2: Well, I'm going to get mine! Come along, young man! I want every penny!

Client 3: And mine, too!

Client 4: And give me mine, too!

Banker: Stop all payments. Stop all payments.

His children having caused a run on his own bank, Mr Banks is duly sacked, prompting the following tragic lament:

A man has dreams of walking with giants.

To carve his niche in the edifice of time.

Before the mortar of his zeal

Has a chance to congeal

. He's brought to wrack and ruin in his prime.

Recent events on both sides of the Atlantic have made it not merely desirable but imperative that the world's leading bankers and their clients watch this movie - if, that is, they want to avoid Mr Banks's fate.

For it has not only been Northern Rock, the British mortgage lender, that has been menaced by a loss of customer confidence.

California's Countrywide Bank, came perilously close to suffering a run last month as nervous customers lined up outside branches, alarmed by the travails of the bank's parent company, Countrywide Financial, the largest mortgage lender in the US.

For the moment, however, it is not the managers of the mortgage banks who are facing "wrack and ruin in their prime", but rather the central bankers.

Last week Mervyn King, the Governor of the Bank of England, was subjected to a grilling by a Commons Select Committee. He has also been harshly criticised in the press.

His American counterpart, Ben Bernanke, had a smoother ride testifying before members of Congress on Thursday, but he, too, has been dodging media brickbats. Nor has the European Central Bank escaped unscathed. Its president, Jean-Claude Trichet, has been the target of remarkably forthright criticism by the new French President, Nicolas Sarkozy.

I am always suspicious when politicians and journalists start bashing central bankers. Secretly, deep down inside, legislators and hacks enjoy financial crises - almost as much as they misunderstand them.

What they would like most of all would be a crisis that exclusively wiped out hedge fund managers, private equity partners and senior investment bankers, whom they envy for their wealth.

But when ordinary folks - voters and newspaper readers - are suddenly faced with the loss of their savings, somebody has to be blamed. Round up the usual suspects at the Bank, the Fed and the ECB.

Yet consider the contradictory criticisms that were aired last week. The Bank of England stands accused of having delayed too long in injecting liquidity into the three-month commercial paper market.

Mervyn King, it is said, was unworldly in his insistence that such action, if prematurely taken, would merely encourage reckless behaviour and increase "moral hazard".

The Fed, meanwhile, is being criticised in some quarters for having done the opposite. By cutting the Federal funds target rate by a generous 0.5 per cent last week, Ben Bernanke is accused of having bailed out Wall Street's worst speculators.

So which is it? Because clearly the central banks can't be damned if they did inject liquidity speedily - as the ECB did, on an even larger scale than the Fed - and damned if they didn't. (Note that the Bank of England was by no means the most niggardly among the world's monetary authorities. The Swiss National Bank actually raised rates in the middle of the crisis.)

The reality is that the central banks are no more to be blamed for this crisis than the fire brigade is to be blamed for a blazing house. In each case, they are struggling to perform their proper role as lenders of last resort - as defined over a century ago by Walter Bagehot in his classic Lombard Street.

But they are doubly constrained: first by the increasingly complicated legislation that governs their actions and, secondly, by the vast scale and complexity of global capital markets.

The case of the Bank of England is especially hard. "Operationally" independent since 1997, the Bank is no longer responsible for supervising the banking system. That is the job of the Financial Services Authority.

The Bank's job is monetary policy and its inflation target is set by the Government. As for being a lender of last resort, as Mr King eloquently explained on Thursday, four separate pieces of legislation made it impossible for the bank either discreetly to provide Northern Rock with emergency funds or to broker a takeover of the bank.

The Fed, too, is far less mighty than is generally believed. Mr Bernanke's predecessor, Alan Greenspan, admitted last week that "the presumption that we [the Fed] were fully independent and have full discretion was false".

The Fed has a dual mandate. It is supposed to worry about price stability and economic growth. We know that Mr Bernanke was reluctant to offer a blanket bail-out to the financial system. But the risk that the credit crunch could lead to a recession could no longer be ignored.

There are indeed some tough questions to be asked as this crisis continues to unfold. Where was the FSA when Northern Rock was piling up those fatal short-term liabilities? How does the Chancellor of the Exchequer justify offering bank depositors a government guarantee of 100 per cent when existing deposit insurance is far less generous and other investors - notably those who put their money in now defunct private pensions - received no such relief? And how smart does his predecessor, the Prime Minister, now look for having stripped the Bank of its supervisory powers 10 years ago?

It's not over. Coming soon: more pressure on UK mortgage lenders, a deep downward spiral for the dollar and pain for Eurozone exporters.

No doubt these next links in the chain reaction will elicit yet more calls from the politicians and the press for the heads of the central bankers. But it was not the central bankers who put the "fragile" back into "supercalifragilistic".
 

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