Saturday, March 21, 2009

Treasury KISS

The National Audit Office Report on the Nationalisation of Northern Rock gives us a shocking insight into HM Treasury's lack of preparedness for the financial crisis.

The stark fact is that when Northern Rock got into difficulties in August 2007, there was absolutely no official plan for dealing with it.

No secret blueprint locked in the safe.

No action list.

No disaster recovery team.


They had to make it up as they went along.

Worse, it was the Treasury's cack-handed support operation, along with the associated media coverage, that actually triggered the pavement panic.

Which in turn led Darling/Brown to panic into a full deposit guarantee for Crock customers. Which naturally led customers of other banks to panic, panicking Darling into giving a full guarantee to anyone who had lent any money to any UK bank. Which finally ended up putting taxpayers on the hook for bank liabilities equivalent to nearly five times GDP (see here for BOM's commentary during black September 2007).

So why - you may politely enquire - didn't HMT have a plan? After all, by early 2007, any fule know that the Crock had gone crackers, and was dicing with depositor confidence (as we've said before, even dim-witted Tyler had withdrawn his cash by then). Didn't anyone at HMT, the Bank of England, or the FSA see there was a problem?

Well, it turns out they did see something along those lines (para 4.3 in the NAO report):

"The Tripartite Authorities had identified weaknesses in the arrangements for dealing with insolvent institutions posing a systemic risk some three years before the crisis at Northern Rock. Since 2004, the Tripartite Authorities have conducted exercises to test their preparedness to deal with a range of scenarios, ranging from the simulation of a cyber attack on financial infrastructure and the impact of flu pandemic to various financial crises.
One of the first scenario exercises, in 2004, tested the options available if a major financial institution got into difficulty for liquidity reasons. The report of the exercise noted that thinking was relatively undeveloped as to how the resolution of an insolvent firm with systemic repercussions would be handled and by whom."
So in among their usual implausible doomsday scenarios such as UFO attack, they did at least include the elephant in the room risk - a bank running out of money. And they also recognised they were not equipped to handle it. Which ought to have scared the pants clean off their spotty mandarin behinds.

But in that case, WTF didn't they do something to prepare? After all, this was three years before the crisis broke, and by 1936, even Stanley Baldwin had acted to rearm.

The answer is very simple:

"At that stage, improving the existing arrangements was not considered within the Treasury to be a priority, in the benign economic environment then prevailing."

In other words, Brown's Treasury had fallen for its own propaganda: it actually believed it had abolished boom and bust, and discovered the secret of eternal life. It didn't need to waste time thinking about how it would organise a funeral.

As has been reported, the NAO also uncovered a raft of other HMT failures.

Like how the Crock was allowed to advance a further £800m of crazy 100%+ mortgages even after HMT had stepped in to prop it up.

And like how HMT hired Goldman Sachs to find a buyer on the basis of a "success fee", without ever bothering to specify what actually constituted "success" (Goldman eventually got paid £4.8m, out of the total £27m paid to HMT's advisors, with a further £42m in advisory fees paid by the Crock itself - all of which has now been picked up by taxpayers).

What this highlights is that, when it comes to the financial markets, HMT cannot be trusted to make sensible judgements. Whether because of political pressure (don't you dare call time on the boom), or because of incompetence, they have shown themselves to be incapable of making the right calls.

Whatever the shape of future financial regulation, we should make absolutely sure we Keep It Simple Stupid. Expecting HMT to do the right thing when the time is right is courting further disaster.

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