Bank of England Deputy Governor admits they made mistakes and points out a need for new regulatory tools

Sir John Gieve the current Deputy Governor of the Bank of England is due to step down next year and has given the kind of reflective and frank interview to the BBC that only people in his position are able to do with impunity.
In the interview he admits

1. The Bank knew there was an asset price bubble in the UK housing market
2. They also knew there was “crazy borrowing” going on against the asset price bubble
3. They thought that the resulting downturn would be less serious than it has turned out to be

He then goes on to say the problem is in part caused by use of interest rates to control the economy. He feels that interest rates are a “blunt instrument” which impacts to many sectors of the economy, so that raising rates to control a housing bubble impacts exporters etc etc at a time when inflation in the non housing sectors has been relatively benign.

“We need to develop some new instruments, which sit somewhere between interest rates, which affect the whole economy… and individual supervision and regulation of individual banks,” he said.

“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.”

The implication that I read into this is that the Bank are considering some kind of direct controls on bank lending in the future the type to be decided but by implication the tools that might be able to “sharpen” the banks control of the housing market are
a) A minimum lending rate for mortgages and/or
b) Some kind of constraint on the amount banks can lend by way of mortgages and/or
c) Some kind of minimum Loan To Value ratios and other controls

The full interview has yet to be broadcast, (it will be available on BBC iPlayer at some point later today after 9pm UK time), but the criticism I would have about the analysis revealed so far is that it is too parochial. The recession is in part caused by the collapse of the UK Housing Market, but that has been brought about by the reduction in the flow of credit to the market (just like the car market) it is a secondary effect. The primary event that caused the restriction in credit was the US sub-prime market and (from a UK perspective) uncontrolled exposure to that market through interbank lending/securitised assets.

We have been through a UK housing market cycle once every 4 to 8 years for the past 30 years and although they cause minor recessions they are just blips on the upward growth path. What makes this recession different has been the restriction in credit caused by the reduction in bank capital from bad debt write offs from loans to US mortgage institutions and investment banks re-packaging US mortgages. This recession has exposed some appalling lending by the now nationalised Bradford and Bingley and Northern Rock – but many of these marginal decisions are made bad decisions by a recession caused by exogenous events. It is perhaps now doubtful that in the ordinary course of events both institutions might have been able to trade out, but that is not to say that they would have triggered the crisis in confidence in the banking sector that the US sub-prime crisis caused.