Bank of England: wrong and powerless
The point of the Panorama I've made with Stephen Scott and Vivien White (which will be broadcast tonight at 8.30pm) is to convey quite how close we came in October to the collapse of the banking system.
It's a suspenseful story told in interviews with a quartet of the leading actors: the chancellor, Alistair Darling; the deputy governor of the Bank of England, Sir John Gieve; the chief executive of the Financial Services Authority, Hector Sants and the chief executive of Barclays, John Varley.
I hope the programme also gives a sense of the shocks generated by this near catastrophe and the tumultuous year that lies ahead.
For me, what stood out when interviewing this quartet was the revelation about how Royal Bank of Scotland and HBOS were - in October - only hours away from being unable to open for business.
Inevitably, in a 30 minute documentary, many fascinating contributions from interviewees hit the cutting-room floor (such as John Varley's remarks on how it will take between one and two years for the contraction of lending to stop - which you can read in the note I published on Saturday).
So here are some resonant and significant remarks from Sir John Gieve that didn't make it into the finished film; Sir John rarely gives interviews and is to stand down in March from his role in charge of financial stability at the Bank of England.
This is Gieve's explanation of how and why the Bank of England failed to curb the growth of the bubble in borrowing and asset prices which lies behind our current woes: "We didn't think it was going to be anything like as severe as it's turned out to be... Why didn't we see that it was so serious? I think that's because we, perhaps, we hadn't kept pace with the extent of globalisation. So the upswing here didn't involve the big increases in earnings and consumption and activity which we saw in previous booms. We saw the credit, we saw the house prices, but we did see a fairly stable pattern of earnings, prices and output."
As others at the Bank of England have told me, the Bank's Monetary Policy Committee believed mistakenly that the lending binge and asset-price surge were semi-independent from activity in the real economy, and that they would eventually moderate without wreaking devastating damage to prospects for households and businesses.
But, as Gieve says, the Bank had identified the bubble, even if it didn't fully understand quite what misery its popping could and would cause. So why didn't he and his colleagues raise interest rates to attempt to stem the growth in lending and the rise in the price of houses and other assets?
"If we'd used interest rates to try and address this asset-price credit growth, we would have been holding down the level of activity elsewhere in the economy, in manufacturing, in other services, holding down the level of employment at a time when consumer price inflation and earnings were stable and reasonably low. And people would have said, you know, 'this is a wilful reduction in the prosperity of the country'."
The mess we're in demonstrates for Gieve that the Bank of England does not possess the proper tools for dealing with incipient booms in assets and lending. The power to raise and lower interest rates isn't adequate for the task, he says: "I think that one of the main lessons from this is that we need to develop some new instruments which sit somewhere between interest rates, which affect the whole economy and activity, and individual supervision and regulation of individual banks.
"Maybe we need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand... I think we need to complement interest rates, which are a blunt instrument - you set one interest rate for the whole economy - with something which is more financial-sector specific."
So what might this new tool or instrument be? Well, it would have to be a mechanism to prohibit or at least discourage a lending splurge during a period of sustained economic growth, such as a formulaic stipulation that banks have to hold more capital relative to their loans and assets during the good years (which is precisely the opposite of what happened in the euphoric phase before August 2007).
And what about the price that we as taxpayers will eventually pay for the bailouts in 2008 of many of our biggest banks? I asked Gieve - who was intimately involved in these rescues - whether we would end up with a profit or loss on the nationalised and semi-nationalised banks. Would we as taxpayers get our money back?
"Well, I think it'll be a mixed picture. I mean, I think there are some [lending] books - Northern Rock, Bradford & Bingley - which the taxpayer is now holding which clearly have a level of defaults in them: I'm not quite sure how that will balance out against the residual of the capital. As for the more mainstream banks: yes, I think they've got a commercial future and I'm sure that in time they will, as for example the Swedish banks have after their crisis, revive and start building and growing as commercial entities again."
In other words, he says there is quite a risk of us making a loss on the Rock and Bradford & Bingley. But he's hopeful that we'll end up in the black on our massive investments in Royal Bank of Scotland, HBOS and Lloyds TSB.
ADDENDUM: It matters that we learn how to prevent a repetition of the economic mess we're in, partly for reassurance that we can plan on the basis that stability will return.
Which is why the frank admissions of what went wrong made by Gieve are significant, especially that interest rates are an inappropriate instrument for dealing with lending and asset bubbles.
What some may therefore see as worrying is that there is no sign right now of the Bank of England, or the Treasury or the Financial Services Authority being endowed with such bubble-busting powers.