Oral evidence: Re-appointment of Dr Donald Kohn and Martin Taylor to the Financial Policy Committee, HC 1044Tuesday 3 February 2015
Oral evidence, 3 February 2015.
Witness
Martin Taylor, Member, Financial Policy Committee, Bank of England, gave evidence.
Chair
Thank you very much for coming to give evidence to us this morning, Mr Taylor. You are as familiar to most of us as Dr Kohn is. Why don’t I begin by asking the same set of questions that I asked Dr Kohn except, rather than going through them one by one, why don’t you—and I noticed you were taking careful notes, or at least I assume that is what you were doing—why don’t you tell us what you were writing?
Martin Taylor
I was writing answers to the sort of questions I thought you were going to ask me. Let me say, first of all, that I very largely agree with what Don Kohn said but perhaps give you some more observations of my own. He, of course, was a member of the interim FPC and I think it was then that the code of conduct was established. When I joined the statutory FPC in April 2013, the code of conduct was a given, “Here is the code of conduct. Please read and follow”. We have debated the code of conduct since when there have been emendations to it. We have simply been asked if we were content with the emendations, but I do not feel that I am an author of the code of conduct. It is like the acquis communautaire when you join the European Union.
Chair
Just to follow that very interesting remark, clearly most countries when they join the acquis communautaire are pretty vigorously opposed to bits of it and bitterly regretting that they were not there at the start in order to prevent particular bits emerging. Are you giving us that same sense here? Is there any bit of this code of conduct that, had you been there, you might have spoken up about?
Martin Taylor
It is a very austere document, Mr Chairman. You are familiar with it yourself, I think.
Chair
I have it in front of me, particularly the section marked “Communications” on page 2.
Martin Taylor
That was certainly one of the things that sprang to my mind.
Chair
It concerns you.
Martin Taylor
Well, it was one of the differences between us and the Monetary Policy Committee, for the reasons that you have given. First of all, compared with us, they have a very much more restricted field of operation. They are doing an enormously important job but they decide interest rates and they decide the Bank’s balance sheet and they vote every month on these matters, soon to be eight times a year if you agree. It is well established over the life of the MPC that members who dissent from the majority view are expected to explain to the public why. So it is a different way from the way we operate. There are very many other important differences between us and the MPC. They are concerned with the most like path—
Chair
I was asking a question there—
Martin Taylor
I am sorry. Did I not answer it?
Chair
—which was not: what is the difference between you and the MPC? I am sorry to interrupt, but my question was: was there any part of this acquis communautaire that concerned you and that you might have wanted written differently?
Martin Taylor
It did not concern me and I did not object to it. I just noticed the communication point because it seemed so different from the habit on the MPC and the difference comes down to consensus against voting, as you have discussed. Let me give you an example, if I may, of when I think consensus has worked very well as a technique on the committee. If you look at the housing intervention, in order to make the interventions that we made last June we started worrying about this area about nine months before and the first question we had to answer was whether this was an area with financial stability implications, something that we should get involved in. The second was whether the timing was right for intervention. The third was which of the very many potential instruments in our toolbox we should deploy. There are something like a dozen ways in which we could have come at this. The fourth, having decided which tool to use, was the calibration of the tool. Now, you could not get to that sort of determination by voting at every stage and I think it went very well. I do believe the present rules allow nuance, which is a question you asked Don Kohn. I made a speech in November on the leverage ratio where I went out of my way to stress some nuanced areas relative to where the committee as a whole was, but they have been referred to in the record. One was around and there were different views round the table. One was around the use of alternative tier one, CoCos and the new leverage ratio, and the other I did say that if we had gone for a simpler one-size-fits-all leverage ratio we would have had a much higher number. In a sense, as Don Kohn said, 3% was acceptable as a minimum provided one believed, and I do believe, that the FPC would be vigilant about the time variant component and moving it up as circumstances demand.
Chair
You do think that the 3% with the countercyclical capital buffer and the SIFI and all the rest is equivalent to the 4%, but you in fact wanted 4.06% as I recall when you were a member of the Vickers Commission.
Martin Taylor
4.05% or 4.06% was the number for the ring fenced bank, supposing that 3% was taken as the Basel base, and we were proposing—
Chair
I should not have teased you with—
Martin Taylor
Not, not at all. I am in awe of your memory. We are not opposed to voting and when we come on calibrating numerical things like the CCB it is quite likely that some people will not want to raise it. Some will want to raise it by more than others and we should say so.
Chair
My question was a simpler one. Do you think that the Vickers approach that you required has been met in full by the decisions now taken by the FPC on leverage?
Martin Taylor
We have not yet calibrated the mark-up for ring fenced banks. We will do that this year, but Vickers did not see time variance of leverage. The proof will be whether we and our successors do this and do it intelligently, but at the moment all of these indicators are at their minimum.
Chair
Do you have the remit letter in front of you?
Martin Taylor
No, I don’t. I have the paragraph concerning consensus on accountability.
Chair
Could you turn to the last few sentences of that. That is section (v), is it not?
Martin Taylor
I just have the paragraph, I am afraid, Mr Chairman. Perhaps you could read it to me.
Chair
“Recognising the requirements in the Act to achieve consensus wherever possible, communication by individual members regarding Financial Policy Committee decisions needs to be coordinated and consistent where decisions are reached by consensus. Where consensus cannot be reached and a vote is taken, as required by the Act, the balance of arguments should be reflected in the record of the meeting. In such circumstances, members should be free to explain their differences and will be publicly accountable accordingly”.
Martin Taylor
Yes.
Chair
Are you entirely happy with that?
Martin Taylor
It has an implication that, absent such circumstances, members should not be free to explain their differences, but I think there is an intermediate level that in fact we are operating on. I have operated on it and Don Kohn in his answers to you in the questionnaire was operating on it. That is where consensus was reached but the record reflected the richness of the debate, so it was visible to the reader of the record that not all members set out with the same view.
Chair
You are going to watch like a hawk the record before it is published?
Martin Taylor
We are responsible for drafting it. The whole committee drafts it.
Chair
I think you had better watch like a hawk that it accurately reflects any difference or nuance of view. We can rely on you to do that, can we?
Martin Taylor
This whole debate and conversation that we are having among ourselves—and it is very helpful that you have made it more prominent—has brought home to me the importance of the record and that it should be a less arid and more nuanced document than it might be.
Chair
Do you think the consensus approach enhances the committee’s accountability to Parliament or not?
Martin Taylor
Has it enhance the accountability? It arguably makes the accountability even more important.
Chair
Do you think it makes our life easier or more difficult?
Martin Taylor
I should be very unhappy if I thought we were making your life more difficult.
Chair
People get unhappy all the time, Mr Taylor, but I am only talking about the consensus decision and the way it is interpreted in the code of conduct.
Martin Taylor
I am worried about that.
Chair
Does it make it more difficult or not?
Martin Taylor
It has not made it more difficult so far.
Chair
May I just explain why I have asked this question? I asked this question because in another of the remit letters the Chancellor has written, “This approach will further enhance the committee’s accountability to Parliament”. That struck me as requiring a bit of explanation.
Martin Taylor
I did not pick up that sentence, I am afraid. I would be interested to have it construed for me.
Chair
I have read the whole sentence except for four more words “and the wider public”. I think that is even more implausible. It strikes me it does not enhance accountability at all. Accountability is best served with as full and public explanation as possible in most cases and probably here, too.
Martin Taylor
All the external—
Chair
Whereas in this case—I am sorry to interrupt—we are restricting, broadly speaking, to the minutes, are we not?
Martin Taylor
Yes.
Chair
Except for a few nuances in your speeches.
Martin Taylor
I hope you do not feel we are being obstructive. I do not think we are.
Chair
Not yet.
Martin Taylor
No. When it comes to it, if we are, you should certainly—
Chair
After all, we are still building a framework.
Martin Taylor
We are building a framework, as my colleague said.
Rushanara Ali
I wondered if you wanted to give your reflections on the situation in Greece and on some of my questions earlier and whether you agree with Dr Kohn’s assessment or not.
Martin Taylor
How dangerous. I should start by saying all efforts will be made to avoid a breakdown. It is not always clear whether, like efforts that have been made in the past, these efforts solve the underlying problems or simply put a sticking plaster on where we have arrived at. If there were to be an accident and Greece were to withdraw, it would depend enormously on the response and the way that the ECB in particular handled the rest of the peripheral countries.
Rushanara Ali
How would you describe the underlying problems?
Martin Taylor
I do not know whether Jesse Norman is going to ask me again about the Governor’s Dublin speech. As you watch this play out, we have great moments where people say, “We have to have QE or the eurozone will be in difficulty”. We get QE and then we have to get a solution to the Greek debt or the eurozone will be in difficulty. Let us hope we get a solution to the Greek debt, but I do think the fundamental structural issue of the absence of risk sharing makes a genuine monetary union very difficult. If you do not have a genuine monetary union what you effectively have is a bunch of national currencies fixed at par and that is a vulnerable configuration. I have no wisdom to sort this out.
Rushanara Ali
Do you share Dr Kohn’s view about the risk levels not being too significant for the UK?
Martin Taylor
It depends on the response. There are very many levels of risk. If you simply say, “Is the British economy or the British banking system heavily exposed to Greece”, the answer is no. Obviously its exposure to other peripheral countries is higher, though much lower than it was when the crisis was last at this kind of level.
Rushanara Ali
Yes. Which ones in particular would you say?
Martin Taylor
The larger the country on the whole the larger the exposure, but there is also, of course, exposure through the banking systems of the stronger countries in the eurozone which themselves are exposed to the south. I think if there were to be, God forbid, a withdrawal followed by contagion, it would need the most vigorous intervention by the central bank to keep the European banking system on the right side of panic, if I could put it that way.
Rushanara Ali
Just one more question. Is it inevitably that a country like Greece has ended up in this situation given the level of unemployment and so on, that the reaction to the austerity plans and so on has led to that? Also, do you have any views on how the eurozone should be taking into account some of the social effects of the previous crises and the responses?
Martin Taylor
If your question is a version of am I surprised that Greece has elected a new Government, no. It is hard to be surprised by that after what people have been through there. Unfortunately, this is one of those tragic situations where everybody is convinced of the rightness of their position.
Rushanara Ali
Sorry?
Martin Taylor
Everyone is convinced of the rightness of their position, both the debtors and the creditors, and it will need great statesmanship to bring this ship safely into harbour.
Rushanara Ali
Do you feel confident that a deal could be made?
Martin Taylor
I don’t think a deal would solve the problems of the eurozone. I think it would solve this week’s problem.
Rushanara Ali
This week’s?
Martin Taylor
Yes. I am sure somewhere there is a way of accepting that money that will not be repaid will not be repaid.
Rushanara Ali
You would share the view of our Chancellor when he described it as, “A Greek exit from the eurozone is the greatest risk to the global economy”, then? It seems very different to what I heard from Dr Kohn and yourself.
Martin Taylor
I would not quite put it the way the Chancellor put it. I think a Greek exit from the eurozone with uncoordinated follow up could indeed have pretty much uncontrollable results. What can we do at the FPC? We have raised the banks’ capital. We have encouraged them to reduce their exposures in this area. The Bank has put in place new liquidity arrangements, which means that, were there to be a crisis, it would be easier for our banks to fund themselves.
Rushanara Ali
Why do you think he takes a much dramatic position? Are there any underlying reasons for that or is it just a reaction?
Martin Taylor
I read the context as being he was receiving a Greek visitor and he wanted to say, “Let’s solve this problem. If we do not solve this problem the consequences will be dire. Let’s solve it”. I don’t know what happened in the private meeting.
Jesse Norman
Sir Martin, can I ask you a question just to pick up on the line I started with Dr Kohn, which is whether or not you have a view on the Carney speech advisability, criticism of the foreign politicians trespassing into fiscal areas? You have a view on most everything, Sir Martin, so I would be surprised if you did not have a view on this.
Martin Taylor
I did not see the speech before it was given. He was speaking, of course, in a eurozone capital and he had probably been asked to talk about the eurozone. Central bankers do not usually criticise other central bankers.
Jesse Norman
Politesse extends that far at least.
Martin Taylor
Politesse certainly extends that far. Sometimes it is hard for a central banker to criticise his own Government publicly, but a friendly central banker from another country could do the job on your behalf. That is how I read it.
Jesse Norman
That is a very polite way of saying there is a kind of confraternity of central bankers in which they mutually criticise each other’s political leaders.
Martin Taylor
It is not a bad idea, is it?
Jesse Norman
By the way, thank you for laying open the workings of the monetary system commercially. I was not aware of that.
Martin Taylor
One of the important things the speech said was that central bankers cannot fix the problem. Going back to what I was saying to Rushanara earlier, the idea was around that the ECB, by unleashing a €1 trillion QE, could somehow fix the eurozone problem. All it was trying to do was to get its inflation target back on, which is maybe a necessary condition but not sufficient.
Jesse Norman
That is very helpful and interesting. One way of thinking about the speech is that not only was the ECB discharging its democratic, or not depending on how you see it, mandate in seeking to launch QE at least in some form, but also there is an underlying overlap of interest, because it is buying sovereign Governments time to decide at what level they want to think about further fiscal pooling or risk-sharing.
Martin Taylor
If I were in the ECB, I would feel I had been buying time for Governments for very many years.
Jesse Norman
Indeed. In a way this is an indicator that the central bankers are running out of patience with the inability of Governments to act on this issue.
Martin Taylor
Yes. I am very anxious that my comments should be taken as personal comments rather than those of a Bank of England official, because they are absolutely not and I have no authority to discuss this. However, one of the tragedies of the European situation seems to me to be that there are two absolutes in the German mind that are in deep conflict. One of them is the need to be pro-European at all times and the other is the need for monetary and financial rigour at all times. When these come into conflict, the easiest way to resolve it is to claim that monetary and financial rigour is pro-European. It seems to me that the debate in Germany, which maybe has not been happening as much as it should, is beginning to happen and this conflict needs to be laid bare. It is opening up and one just hopes that Germany will come to a coherent solution. I am sure they will.
Jesse Norman
That is a fantastically interesting answer. Thank you for that. Unlike the Governor, we regard you as fully capable of speaking in your own person at all times, I would say. Just for the avoidance of doubt, what is your view on the argument about whether or not the creditor nations should come to some kind of reduction of Greek debt?
Martin Taylor
The debt has already been restructured. It looks to me unsustainable. I have not made a special study of Greek debt. If the creditor nations do believe they are going to get their money back, we are in an even worse situation than I think we are. Sometimes it is not expedient to acknowledge that you are not going to get your money back because you lose all hold over the debtor and there is, of course, the huge issue of contagion, because the Greeks are not the only highly-indebted nation struggling with high unemployment and low growth. That is why, whatever happens, Greece is not the end of this.
Jesse Norman
Just very quickly then, you sound as though you are cautiously, subject to suitable levels of popular obfuscation, in favour of reducing in a way that allows Greece to start to grow, which seems to be where a lot of expert opinion is. If they cannot pay it they are not going to pay it and, therefore, why not reorganise the fiscal straitjacket?
Martin Taylor
Yes, reorganise the fiscal straitjacket. Here I am back to my reading of the Carney speech. I think Europe needs to go further than that because simply reorganising things fixes the problem this time around, but does not address the underlying cause.
Jesse Norman
There has to be underlying structural change?
Martin Taylor
I think so.
Jesse Norman
That is very helpful, thank you. There are so many questions I would love to ask, but the one I just want to pick up is on the work that you did as part of the Vickers Commission, which memorably identified the implicit subsidy to the banking system as being anywhere up to £50 billion a year, as I recall. How far you think that has fallen and whether you think the FPC or the Bank should commission a further piece of work to estimate where the implicit subsidy presently lies.
Martin Taylor
There is a chart that the Bank has used in some publications since measuring the implicit subsidy, but it measures it by a highly conventional way, which is taking the difference in credit ratings of the banks with and without implied Government support and then calculating the value of that to their debt servicing cost. The problem with it is that it is a highly procyclical measure. For example, if you take it back to 2006, it showed that the implicit subsidy was zero. It was then enormous after the crisis. When the house had burnt down, people would have paid anything to insure it, and it has come down—
Jesse Norman
Yes. It is like Casablanca, “I had no idea of the implicit subsidy. I am shocked, shocked, shocked”.
Martin Taylor
Yes. It has come down again. Part of the reason it has come down again, no doubt, is because of the “too big to fail” work and part of the reason is that the banks are better capitalised, but part of the reason also is the general feeling that economic conditions are less menacing, I am sure.
Chair
Isn’t the main reason Germany is taking the position it is that it wants, as you have implied in one of your answers, but this the further structural and supply side reform in Greece, that at the moment it removes the tourniquet on the debt side its shock is going to get is much less? That conundrum you have said is very straightforward where there is two policy objectives in conflict. It is very clear why they are maintaining it.
Martin Taylor
I was going beyond the Greek situation and looking at the whole eurozone, but I agree with you. If you are going to allow restructuring, you want to get some bang for your buck beforehand.
Chair
If they are going to for maximum restructuring, the next question must be: can the Greek economy recover at current exchange rates, even after the restructure, the maximum reasonable amount you could possibly to get?
Martin Taylor
Let us see when we see the numbers.
Chair
That is the question. What is the answer?
Martin Taylor
I think I am going far beyond my precise competence, Mr Chair.
Chair
You are taking the Fifth. That is fine.
Alok Sharma
Could I just return to this point on contagion? When I asked Dr Kohn whether he would quantify the risk of contagion to the rest of the eurozone of a Greek exit, I think he was reluctant to try to quantify that. However, from what you have said earlier, you deem the risk to be significantly higher than perhaps that implied by Dr Kohn. Would you agree with that?
Martin Taylor
I think the size of the risk depends on the way the rest of the eurozone and particularly the ECB handle it. It depends on what happens and how the exit is handled and the more violent and uncontrolled—
Alok Sharma
Let us go forward. Let us say there is what would be described as a managed exit. What is a managed exit and, therefore, what is the risk of contagion?
Martin Taylor
The problem with any exit, apart from the technical difficulty of handling it and the legal issue about which currency liabilities are denominated in after it, is the question of redenomination risk, which was very present in 2012, declined and has come back again as people are frightened of an exit, will rise very sharply. Something has to be done to make the financial markets believe that this is the last such exit and that Greece is a special case. I suppose the question is whether that can credibly be achieved.
Alok Sharma
Just going back to the Chairman’s point about whether any of this stuff is going to work, we are talking about debt swaps and all the rest of it. Do you think we are just having this sort of constant situation with Greece where every few months we come back and there is another restructuring? What do you think is required in terms of a restructuring that will mean that Greece does not keep coming back?
Martin Taylor
As I understand it, one of the difficulties is that the Greek debt servicing costs have already been reduced very greatly by the last restructuring. I suppose, if you push out all principal repayments for a very long time, you get Greece off the treadmill of how they are going to meet the €5 billion in July and how are they going to meet €4 billion. That is spooking the markets right now. They are supposed to be running a primary surplus. The new Government claims it can collect taxes more efficiently than its predecessors. Those would both be helpful.
Alok Sharma
Finally, long term, do you think it would just be better if the Greeks left sooner rather later so the rest of the eurozone can pick itself up and keep carrying on?
Martin Taylor
I would revert to my previous answer about what I think is needed to reform the eurozone and make it function as a proper monetary union. If it cannot do that it will not be just be Greece who will be better off out of it, but if it can then Greece would be better off staying.
John Thurso
The only Greek I remember is, “O, Rhododáktylos Ēṓs” which I think translates as, “Oh, rosy fingered-dawn”. May we wish for that and then return to what the FPC does. Can I come back to the question of indicators? You heard the discussion I had with Donald Kohn. Can I just ask whether you have anything particular on that that you would like to add before I put some questions?
Martin Taylor
Only that I am suspicious of mechanical means. The ones that seem to me to be the most useful are if you go back in time—let us go to a period that we keep revisiting, when we know things were going badly wrong, 2005/06, before the crisis exploded but everyone was feeling great—and look at the indicators then that were beginning to flash red, and they are, as Dr Kohn said, mostly credit indicators. I think if we saw that happening again we would clearly be on the case. We do look at the balance of payments numbers and we do look carefully at things in the balance sheet, but we are dealing with tail risks. The MPC spends its time thinking about a central path for the economy, what is most likely to happen and how to steer it. We spend our time dealing with things that we hope are not going to happen, that are right at the edge, and it is a different kind of thinking. One of the things we should be looking at are things you would expect to be happening that are not or things that you think the market will be worried about but sort of was not. I think it was the Governor in fact in an internal meeting who drew attention a few months ago to the fact, when we were all worried about the geopolitical crisis coming, “Why isn’t the price of oil going up? There is something funny happening in the oil market.” He was right. It was just before it dived and that was a good example of an FPC indicator; the dog that did not bark, if you like.
John Thurso
The reason I ask is that, when we were holding hearings right at the beginning when the FPC was being mooted and we were talking to people who were going on to the shadow body at the start, one of the things that we discussed was how do you know when there is a problem coming and what indicators could you look at. I remember a metaphor. It was like flying a plane; you only need about three or four instruments to know whether you are up, down, going right, left or whatever, and then there is an array of other dials that warn you about things. At the time, the thinking was you should concentrate on the ones that are direction of travel and height rather than the warning ones, but what I understand from listening to both of you is it is far more subtle than that and the direction of travel is the MPC, and it is all the myriad warning lights that you are more concentrating on. Is that broadly the analogy?
Martin Taylor
I think that is a good analogy for what is going on. I think that is very fair and, of course, we are constantly asking ourselves, “If these disagreeable things were to recur, how badly affected would we be? First, can we do anything to stop them or make them less likely, and secondly, can we make sure that if we cannot affect them, as we cannot affect Greece, that at least we have made the system resilient enough to survive a shock?”
John Thurso
You used a very interesting phrase in one of your answers, “Sorting out what is significant from what is really interesting”. Do you feel the FPC is able, through the developing indicators, to begin to sort out what is significant from what is just interesting?
Martin Taylor
We try. It is very difficult to think in a way that allows you to see things that other people are not noticing; things that you kick yourself for missing afterwards. I have no reason to believe that central banks have any particular advantage in doing this, except that we are put in a small room and asked to do it and we try.
John Thurso
The problem is not simply for you internally, but it comes back to the problem we were discussing earlier, which is the external perception. It is back to our old “taking away the punchbowl” analogy. In 2006 we all thought that it was going to go on forever. There were odd people going out there and saying, “There is a lot of debt around” and so on, but everybody said, “Oh, do not worry. They have restructured it such that it is going to be all right in the future”. In 2007 we had Northern Rock; 2008 we had all the rest, and very sudden, very quick. In 2006, if you had said to the public, “If we do not cane you on mortgages, pull back credit and slam on the brakes, we are going to be in a really bad place” nobody would have believed it and no politician would have had the courage to enact it. The absence of big red warning lights that are clearly understood could mean that the job that the FPC and the bank have been set becomes remarkably difficult. Developing indicators is not simply about internally what you would look at, but externally we can understand what you are looking at. How do we deal with that?
Martin Taylor
I completely take your point that, if the FPC has these powers and therefore these responsibilities, it is essential that it should be able to explain why it is using them in the way it is. I think we have come a certain distance in the last year or two. I think the housing intervention was a critical one. It was important to make the intervention, but what the public noticed, if it noticed anything at all, was not some technical movement on loan to income rates on mortgages. It was the fact that the Deputy Governor and then the Governor were making speeches about this and were saying there was a risk and they were going to do something about it. I think people were more affected by the mood music and the feeling that the Bank of England was intervening than taking a very detailed interest in what the intervention was. That does not worry me.
John Thurso
There is a direct read-across from whatever the indicators are saying and your decisions, to your powers, and particularly your powers of direction, because if your powers are never used they quickly become what is known as the nuclear option. They become like the powers of direction of Secretaries of State over the Crown Estate, but the fact is they are never used, they are a threat; whereas I think Parliament intended you had powers that you would use and, of course, you cannot manufacture a situation where you need to use your powers. Is there not a danger, if they are never used, that the norm becomes that they are never used?
Martin Taylor
The powers of direction we have had so far have been quite limited and there has not been a reason to use them. The powers of direction that seem to be on the way, particularly loan to value and debt to income, and on the leverage ratio too, are powers where we would be inclined to use direction rather than recommendation if only for reasons of speed. If we have powers of direction, we can get things moving much faster; whereas sometimes if we make a recommendation to a body, it has to go through six or nine months of consultation before acting. I think there is a reason for the powers of direction here, which is not that we believe the body we would make a recommendation to would not be inclined to act, but that it would be able to act much faster. Maybe these are not nuclear options.
John Thurso
My worry is that, because the power is such a powerful one, you would think long and hard before using it and, the longer and harder you think, the less often or the less likelihood of use there is and, the longer it goes without a use, the more likely it is that it never gets used.
Martin Taylor
I follow that but take the example of the housing intervention, which was done by recommendation as it was all we had. We deliberately placed the calibration outside where the market was, so nobody had to give up a mortgage that was in the pipeline because of the Bank of England’s action. It was a warning to the banks saying, “We do not mind where you are now, but if you carry on like this for another three or four months you will get to a place we are very uncomfortable with”. So it was asking them to change course gradually.
John Thurso
If we are all to worry intelligently, what should we be worrying about?
Martin Taylor
The financial stability report is full of things to keep you awake at night.
Mark Garnier
Can I go back to the leverage ratio? In fact, some of the questions I was going to ask you have covered earlier, which was very helpful, but I will do a few of the same ones I did for Dr Kohn. Regulatory capture: given the fact that banks are so delighted, and indeed the share price of Barclays went up 8% of the back of your recommendations, how do you feel about the accusation of regulatory capture of the FPC by the banks?
Martin Taylor
I think the reason the Bank’s share prices reacted so positively was that there were stories in the market that we were going to do something of unbelievable austerity, which, by the way, we had not planted and there was no reason to believe that. I think that people were in a position of regulatory anxiety, where they said, “If the FPC were to put the ratio here, it would cause a bank like Barclays or the big building societies to have to make a sudden and rather rapid change in their business models”, and so there was certainly relief when that was not the case.
Mark Garnier
The market had factored in a leverage ratio of 4% or 5% or 6% and it came in at 3%.
Martin Taylor
I think it factored in a 4% probably, but, if you read the paper carefully, you will see that if we put the buffers on, it is 4.7%.
Mark Garnier
It is interesting they had factored that in, because in a funny sort of way, if the market is factoring in a certain level, the market is taking a view on what possibly it thinks should be the right level and you came in significantly below that market anticipation. As we discussed earlier, 4.06% or whatever was your Vickers level. The PCBS was 4%. Obviously we have the risk-weighted, so 35% as well on top of that, which is something that was not talked about in the past. Nonetheless, if the market believed that 4% was a reasonable level, why were they wrong? Why was the FPC right?
Martin Taylor
The Vickers was 4% for the ringfenced banks, and that was based on the assumption that the minimum Basel level would be 3%.
Mark Garnier
But the PCBS was 4% overall.
Martin Taylor
The PCBS was 4%, I agree, but the PCBS also was assuming a single point ratio, a single number.
Mark Garnier
That is true.
Martin Taylor
I would agree with you that if we had had a single point regime, it would probably have been 4%.
Mark Garnier
The difference was the 35% risk-weighting element and not the single point?
Martin Taylor
Yes.
Mark Garnier
That is helpful.
Martin Taylor
What is also very important, Mr Garnier, is that the insistence that the buffers should be fed with pure equity capital. We want more equity in the banks when we put the buffers on, so the question that had concerned me about using CoCos in the numerator of the leverage ratio.
Mark Garnier
CoCos cannot be used?
Martin Taylor
CoCos can make up to 25% of the base 3%, so they can be 75 basis points.
Mark Garnier
The rest has to be—
Martin Taylor
The rest has to be pure equity.
Mark Garnier
Okay, that is very helpful.
Martin Taylor
That is probably slightly more severe than the market was expecting.
Mark Garnier
That is interesting. The market is perhaps not as intelligent as it thought it was when the share price of Barclays went up 8%?
Martin Taylor
I think it is very difficult for the market sometimes to respond in five seconds to a very technical 100-page paper.
Mark Garnier
Yes, fair enough, a very technical document. Just on a completely different subject. When Lord Grabiner gave evidence to this Committee, one of the questions that I specifically asked him about was the amount of information that is flowing to the Bank of England in terms of what is going on in the foreign exchange market. There was this discussion about Mr Mallett and whether he was passing information that he should have done up the chain or whether he was not and whether there is now a certain, and I use the term hesitantly, reputational risk with members of the foreign exchange market passing information to the Bank of England in terms of giving it intelligence about what is going on. I used the example in particular of the attack on the ERM in the 1990s. That is absolutely a time when the Bank of England needs a great deal of intelligence about what is going on in terms of how to respond to it and I suggested to Lord Grabiner that one of the secondary casualties of this debacle could be that the Financial Policy Committee is deprived of information that could be used in a financial crisis potentially. He said, “I can see that it might well be, yes”. How do you feel about what has happened with this foreign exchange incident and your access to intelligent information?
Martin Taylor
We sit a very long way away from all this, of course, though we are consumers of the bank’s market intelligence.
Mark Garnier
Yes, absolutely.
Martin Taylor
As I understand it, although there have been some moves to stop chatrooms being used in various ways—I have never been in a chatroom, so I do not know what goes on there—I do not believe that was a particularly important part of the bank’s information gathering. There are an awful lot of people to whom the bank speaks in the markets and that continues. Certainly we have not noticed any difference.
Mark Garnier
You are comfortable at this level that you would see early enough any potential kind of move on sterling, move on—
Martin Taylor
The Monetary Policy Committee is very sensitive to that because they are constantly watching the interest rate curve and the exchange rate. I am quite sure they would be very sensitive to any shortfall in information and we would pick that up quickly.
Chair
Of course, the Grabiner hearing began calmly but deteriorated somewhat when we did not feel we were getting answers to questions. In this hearing, we feel so far, at least certainly I do and I think a good number of colleagues, we are getting answers to questions and that is why perhaps it has gone on slightly longer than had been planned.
Steve Baker
I have listened very carefully to your fascinating evidence. You were talking earlier about a number of foreseeable sequences of events and the phenomenon of dealing with the current crisis. Is that, as I interpreted it, to be indicative of a general short-termism of approach everywhere?
Martin Taylor
I do not think so. In times of danger, horizons do tend to come in. We are a committee who are charged, after all, with looking at the long term as well. The “to big to fail” programme, I remember when the Vickers Commission recommended that the banks should comply by January 2019. This was in September 2011. There were sort of hoots of derision, “This is a date that is never going to arrive”. We are halfway there and the banks are saying, “Can we have more time?” We try to do both. You can’t help but worry about short-term things because of the availability of them. They are all over the place. They fill the space, but we need to look beyond as well. I think we do.
Steve Baker
The reason I am drawing you down this path is that, when the European QE programme was announced, I found this writing from an economist. It is just one sentence so I will read it, “I cannot help regarding the increasing concentration on short-run effects ... not only as a serious and dangerous intellectual error, but as a betrayal of the main duty of the economist and a grave menace to our civilisation”, which was Hayek. He has a fantastic rant at the end of the pure theory of capital. You were talking about tail risks as well and explaining that you deal with tail risks. To what extent do you consider the sorts of notions that Hayek was exploring, that the real effects of money creation are deep and long-lasting and in fact slow to manifest themselves in the way that they reallocate capital? Now, I watch you smiling. Part of the reason I ask is that, once again, QE has been announced. Capital markets have risen. Those who have benefited from capital markets rising have run around saying the world has been saved and, in the meantime, high levels of unemployment persist among ordinary people. I am rather concerned that Hayek might have been right. You have made a perfectly reasonable case, but I hear you explaining that we do seem to have grabbed those highly-available short-term problems. Are you satisfied that we take adequate account of these long-term real effects on the structure of the economy?
Martin Taylor
No, I am not. Talking of courage, if I may, Mr Baker, I thought of you the other day—
Steve Baker
Hurray.
Chair
We all do.
Martin Taylor
—as one does, because when we gave evidence here on the Wednesday about the FSR, you asked about the potential conflict between monetary policy and macroprudential policy and how it could be resolved. The next morning, the Swiss National Bank took the cap off and it seemed to me that that was a very good example of what you have been saying.
Steve Baker
Thank you very much.
Martin Taylor
Yes.
Steve Baker
I do not want to have too much déjà vu and I want to move swiftly. Is there anything you want to add in relation to the risks posed by credit default swaps and other synthetics in relation to leverage ratios or indeed on the current account deficit?
Martin Taylor
I think when credit default swaps are held to hedge a portfolio, i.e. when credit swaps refer to the risk that is in the portfolio, I have no problem with them. The danger of credit default swaps is, as George Soros has pointed out, they allow people to buy a long position to express a short risk or, put another way, they allow you to buy fire insurance on someone else’s house and then potentially burn it down.
Steve Baker
One of the things that has concerned me is that colleagues explained to me the accounting around these instruments allow people to upfront profits on unrealised cash flows and, therefore, to exaggerate capital. Is that a phenomenon that has been considered when looking at these tail risks?
Martin Taylor
One of the things that most concerned me at the beginning of this century was the way that very long tail derivatives, swaps that could be 20 or 30 or 40 years, where there would be cash flows over a very long period of time, could be marked to market, and profits taken into the bank’s books on day one and probably half of it paid out to the staff and then the derivative is a kind of zombie lying in a drawer. I think that is a matter of deep concern and I have discussed that before this Committee and the PCBS in the past.
Steve Baker
Thank you. I feel sure that on that basis we might return to this subject later. Because you are both held in such high regard, it is almost possible to forget this is a reappointment hearing. Could I just ask you want you bring uniquely to the committee that would otherwise not be found there?
Martin Taylor
I cannot answer that question. What I would say is that the four externals bring very different things to the committee. We do not resemble each other and that seems to me to be the best thing you could have, rather than four all expressing the same thing.
Chair
Do you think it might be a good idea to have five? You almost said yes there. I could not help but read your—
Martin Taylor
No, I think—
Chair
I think your face was moving into the yes position.
Martin Taylor
What does the yes position look like? I must avoid it at all costs. I think the problem is the committee is already quite big. When I was a company chairman—
Chair
You could take one of the—
Martin Taylor
One of the Deputy Governors off.
Chair
After all, we do have a Deputy Governor of Inflation, haven’t we?
Martin Taylor
Yes. I would say that five would be helpful if I thought there was a voting issue where the externals were a kind of block who needed to be protected, as institutional investors think non-executive directors need to be in the majority on a board. I do not feel that way about the FPC. I do not think it works like that.
Chair
At least not at the moment.
Martin Taylor
Not at the moment.
Chair
No. I have one last question. If you go and talk to the banks, and you have just mentioned the banks are now pleading for more time to implement the ring fence requirements, they will say, “The compliance cost of all this is so huge”, and they are talking about much more than the balance sheet effect, and they are talking about the admin costs and all that; that they would much rather just take a hit with higher capital and higher RWAs. You are quite well-placed, and it is particularly relevant with respect to the question you were just asked, having been at the top of a major bank, to say whether you think there is anything in the criticisms and concerns that are now being expressed by the banking community.
Martin Taylor
It was obvious a few years ago that the banking industry needed reform and it was obvious that the banking industry was incapable of reforming itself and it, therefore, had to be reformed by outside pressure. The things that outsiders do are never perhaps what you would have chosen to do yourself. I think we have to go back to the fundamental reason for ring fencing and it had to do with two things. It had to do with making the banks more easily resolvable and resolution is still something that we and the Bank of England thinks about a great deal.
Chair
We are not yet there, are we?
Martin Taylor
Not yet. The second thing is making sure that the implicit subsidy that Jesse Norman referred to is cut, because the investment bank cannot benefit from the flows of the retail bank. I think these are as important as they ever were.
Chair
Was that a slightly elliptical way of saying the banks are wrong?
Martin Taylor
I have no doubt that this is costly for the banks. They will stress the administration and compliance costs, but it is also costly because it makes it more difficult to do some things that were bad habits that have grown up in the business model, like comingling or trading assets on the retail balance sheet.
Chair
Was that a yes or a no? I am sorry to be so tough at the finish.
Martin Taylor
If the banks were wrong? I understand why the banks are lobbying, but I think the lobbying should be resisted.
Chair
Yes. I am not asking you whether they are right to have a go at lobbying. I am asking you whether their judgment is correct, that it would be better that we get a higher level of protection on the two points you have just raised, which, as you say, is a key point.
Martin Taylor
I think it is essential we get this protection.
Chair
That we would get that protection?
Martin Taylor
We would get the protection, yes.
Chair
We would get that protection more effectively though higher capital, particularly through RDAs, than by going through all these compliance hoops with ring fencing? That is the question that I asked.
Martin Taylor
I am just trying to think how much extra capital, if I were a kind of financial dictator, I would require the banks to carry rather than have them subsidiarise their retail banks. It would be an awful lot of capital I would make them carry; an awful lot, probably more than they expect.
Chair
The banks probably are wrong?
Martin Taylor
Probably.
Chair
Probably. We got as far “probably”. Thank you very much indeed for coming to give evidence to us; it is now this afternoon by a whisker. It has been an extremely interesting and somewhat longer hearing that we expected and that was because of the replies and because a good number of them were very substantive and which will be of interest to a lot of people well beyond this room. Thank you very much for coming to give evidence. Oral evidence: Re-appointment of Dr Donald Kohn and Martin Taylor to the Financial Policy Committee, HC 1044 20