Mervyn King, the former Bank of England governor, at his home in Kent. He has set out a plan for responsible banking in a new book

Bankers have not learnt the lessons of the Great Crash, warns former Bank of England governor Mervyn King

By Charles Moore, The Telegraph, 26 February 2016

Barack Obama used to talk about the audacity of hope. Mervyn King was Governor of the Bank of England during ‘the biggest financial crisis this country has faced since 1914’. Its lesson, he says, is that we now need ‘the audacity of pessimism’. Only when we fully understand how badly things went wrong – and why they are still wrong today – can we start to put them right. His new book, entitled The End of Alchemy, suggests how.

I meet Lord King in his modest office at the London School of Economics. Typically, he is just off to the West Midlands for a dinner for famous sons of Wolverhampton. He is a proud provincial boy, not a City slicker. I ask him to recall the moment he first understood the depth of the problem facing the world. Back in September 2007, when « it was already clear that Northern Rock would need support, » King recalls, he was in Basel for a conference. There was alarm in the United States because sub-prime mortgages were collapsing. The central bank supervisors at the conference insisted that sub-prime failure could not bring down the system. But King talked to his friend Stan Fischer, then Governor of the Bank of Israel. They shared their fears: « If the only thing that goes wrong is sub-prime, ok. But what else could go wrong? What if the unimaginable happens? » It did.

Over the next two months, says King, he became obsessed with the need for more equity capital in the banking system. The banks resisted at first and « the politicians were susceptible to pressure from the banks ». But « we limped along till the bankruptcy of Lehman Brothers’ in September 2008. Then ‘the banking of the entire industrial world was at risk of collapse ».

Britain – without a proper « bank resolution regime » which, says King, « could have solved the problem of Northern Rock in a weekend, without fuss » – was enormously vulnerable. Whereas US banking sector assets were worth only 80% of its GDP, Britain’s were worth 500%, a terrifying ratio. New Labour, having turned its back on nationalisation, had to revert to it: « It must have been galling for them. »

In Mervyn King’s mind, the credit crunch was brought about by something profoundly wrong. Bankers had been encouraged to take enormous risks with the customers’ money, enrich themselves and then dump the losses on the taxpayer. Huge pay increases for senior executives had produced a « very damaging culture when clever people started to say to themselves: ‘I’m smart, I can make money out of people who don’t understand this’. »

But financiers’ greed alone didn’t cause all this. Economists had not allowed for people’s “honest misjudgements;” central bankers had failed to spot the symptoms of trouble in the years of prosperity and kept interest rates so low that people lost their understanding of risk; politicians had mistaken steady growth for permanent stability, boasting about an end to boom and bust.

Citizens have to be protected from the risks that banks always want to take with their money. “This form of alchemy, » says King, « should not be outlawed, but it should be priced.” When the Bank of England was lender of last resort in the 19^thcentury, it worked quite well because 30% of the banks’ assets were short-term government securities which the Bank could access as collateral. In 2006, before the crash began, that figure had fallen to less than one per cent. So when a bank went wrong, it was utterly bust and the burden fell upon everyone.

That problem still hasn’t been solved, King thinks. But he has a suggestion. Instead of lender, the Bank should be what he calls “pawnbroker” of last resort. Banks’ risk-taking is objectionable only when they can evade the consequences. So the King plan says: “Car drivers have to take out third-party insurance before they can drive. Banks should do the same. They should have to take enough of their assets to the Bank of England that if things went wrong depositors could be paid off overnight. Then no bank run could ever develop.”

In speaking about all this, Mervyn King is careful not to place individual blame (or praise), including to himself. Historians, he says, will work out who got what wrong. So anyone searching his book for accounts of the late-night tantrums of Gordon Brown or the arrogance of Sir Fred Goodwin will be disappointed. He is kindly Professor King, giving wise advice, not Governor King, titan of the financial establishment, settling old scores.