Bank of England non-execs – you can’t even use them to wash your socks

According to the television executive Michael Grade non-executive directors are like bidets – no-one is sure what exactly they are for, but they add a touch of class.

Reading the recently released minutes of the Court of the Bank of England for the period of the banking crash in 2007-9 it is clear that ‘class’ was all they added. The Court was stuffed with the great and good – Lloyds TSB Scotland’s Lady Susan Rice, former BBC economics editor Peter Jay, TUC general secretary Brendan Barber, plus assorted knights and dames – but their attitude to the major crisis looming around them was one of detachment.

Playtime is over: Newcastle Eagles basket ball team wearing Northern Rock logos

Playtime was over for Northern Rock in 2007

The minutes show they were taken by surprise by the collapse of Northern Rock in 2007, but don’t appear to have asked the obvious questions: why did it happen and who is next?  My special interest, having written HUBRIS, is the collapse of HBOS, but it wasn’t even mentioned by the Court until June 2008, when it was reported that the bank’s rights issue “was being monitored.”

This is extraordinary. The very next paragraph in the minutes reports that the “Tripartite system” – the Bank of England, Treasury and Financial Services Authority – after some strained relations, was working well.

Yet we know from Alistair Darling’s account of his time as Chancellor that after Northern Rock his officials showed him a paper naming HBOS as one of the banks next at risk. It wasn’t difficult to spot – HBOS shared Northern Rock’s business model of going all-out for high market share of low-margin mortgage business and had the same fatal vulnerability: critical dependence on the wholesale funding markets.

Either no-one in the Treasury shared that paper with Bank executives, or if they did, the Bank’s officials kept it from the non-executives and the non-executives didn’t ask the key questions.

The HBOS rights issue, when the bank tried to raise £4 billion to shore up its eroding capital base, turned out to be the biggest flop in corporate history. Less than 10% of the new shares were bought by investors and the underwriters were stuck with the rest. The share price plunged. Prime Minister Gordon Brown was quick to spot the implication of this: if HBOS’s balance sheet continued to deteriorate, there was no way it could raise more capital in the market. Government would have to step in.

The Court did not meet again until September. By that time HBOS was bust and Lloyds TSB was negotiating the terms of a fire-sale takeover. There is no mention of this in the Court minutes.

Fire-fighting had been handed over to a sub-committee of three – Governor Mervyn King, chairman Sir John Parker and ex-investment banker Amelia Fawcett – called in the Bank’s Orwell-speak ‘Transco.’ On October 1 it approved a £10 billion loan to HBOS (now codenamed ‘Fox,’ while Lloyds was called ‘Lark’).

It was noted that the Bank’s exposure to Fox and Lark was likely to be around £180 billion, without any further deterioration in funding conditions. This was very large. A plan was needed for that to be reduced in the near future. Given the gravity of the situation and the need on financial stability grounds to avoid the failure of Fox, it was stated that it was not possible to rule out the possibility that the Bank might at some point have to lend to Fox on an unsecured basis.”

Considering that £180 billion was twice the balance sheet total for the Bank at the time, that is a masterly piece of understatement.

By the Court meeting on 15 October, Gordon Brown had already announced the Government’s wholesale rescue of the banking system, with the recapitalisation of HBOS, Lloyds TSB and Royal Bank of Scotland and huge amounts of liquidity pumped into the market by the Bank. These events were reported to the Court in the briefest and blandest of terms. Yet they had huge implications for the Bank, for the banking system and for the UK economy, which is still suffering the consequences.

We have had to wait five years to find out what the non-executives of the Court did not know and what they did not do. We have had to wait even longer to find out how the FSA managed to miss the disastrous state of HBOS. Its promised report (now to be published by its successor, the Financial Conduct Authority) was scheduled for 2014. We are still waiting.

What the belated publication of these Bank of England minutes show is that the Court served no useful purpose in the run-up to the financial crisis. Like the non-executives of HBOS itself, they were not told the true state of affairs and they did not ask.

At least you can use bidets for washing your socks.

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2 Comments

  1. Ray,

    This is a great piece. People like Lady Susan Rice have got a lot to answer for.

    There are some serious discrepancies between the just-published minutes revealing how little the Court of the Bank of England was told, or knew, and the Plenderleith Report, which was published in October 2012.

    Here are some excepts of the Plenderleith Report, which focused on the Bank of England’s decision to extend “emergency liquidity assistance” (ELA) to both RBS and HBOS in October 2008.

    REVIEW OF THE BANK OF ENGLAND’S PROVISION OF EMERGENCY LIQUIDITY ASSISTANCE IN 2008–09,

    Report by Ian Plenderleith

    In relation to the specific vulnerabilities of the two banks to which the Bank eventually extended ELA, the Bank [of England] was able to identify in advance, and to monitor, the increasing liquidity strains that HBOS was experiencing during 2008. ….

    Since the funding difficulties being experienced by HBOS were identified at an early stage, well in advance of its need for ELA crystallising in October 2008, the Review suggests that, where there is advance awareness of such strains, the Bank [of England] might consider acting pre-emptively to provide bilateral liquidity support before the need becomes immediate…..

    the Bank had acquired sufficient experience, and expertise, from its support operation for Northern Rock and from its operation of the SLS, to be able to respond rapidly and effectively when the need to extend ELA to HBOS and RBS arose….

    As noted above, the run on Northern Rock marked a step-change in the level of the Bank’s engagement with individual banks and it is clear that the Bank, and indeed the other members of the Tripartite, were fully aware of the vulnerabilities of HBOS prior to its need for ELA in October 2008. By September 2007 the Bank was receiving what it felt were more appropriate data from the FSA, at any rate on banks identified as more vulnerable, including daily liquidity reports from the FSA on HBOS (as well as on Alliance & Leicester and Bradford & Bingley).

    Work undertaken within the Bank in November 2007 identified a number of key risks that meant that HBOS was likely to be particularly vulnerable to a change in market sentiment. These included: the risk of reputational contagion from association with other mortgage banks, given that HBOS was the UK’s largest mortgage bank; HBOS’s reliance on wholesale funding at around 50% of total funding, and within that its reliance on securitisation as a source of funding; and its commercial property exposures. At that stage, HBOS was nonetheless viewed as being somewhat less vulnerable than Alliance & Leicester and Bradford & Bingley because of its more diversified business model…

    From late-2007, the Tripartite authorities began contingency planning to map out possible options for resolving HBOS should the key risks facing it crystallise. There was heightened monitoring of HBOS from March 2008 after the emergency sale of Bear Stearns on 16 March and after an unfounded market rumour that HBOS was receiving emergency assistance from the Bank caused a sharp fall in HBOS’s share price on 19 March. At this stage the Bank was considering in detail the consequences of HBOS, like Northern Rock the previous September, being unable to fund itself in the markets…

    I can’t seem to paste any more excepts but I’m sure you get the drift. According to the Plenderleith Report the Bank of England DID know what it was doing!!

    Ian

  2. Ray

    Good point Ian, I had forgotten Plenderleith, which was one of a trio of reports commissioned by the Bank to justify its behaviour during the crisis. Plenderleith suggests the Bank was on top of the HBOS situation from 2007, but HBOS was not discussed in any meaningful way at all by the Court (‘Nedco’) and not by the three-person transactions committee (‘Transco) until 1 October 2008, when it was asked to approve a £10 billion injection.

    This suggests either Mervyn King and other Bank executives bypassed the non-execs and told them nothing until they had no choice, or that Plenderleith is whitewash intended to make the Bank look more prescient that it actual was.

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