MPs yesterday attacked the Bank of England and the Financial Services Authority for failing to prevent the Northern Rock crisis as the House of Commons Treasury Committee launched a inquiry into the events that rocked the British banking system.
The committee quizzed Mervyn King, Governor of the Bank, for more than two hours on his handling of the crisis that engulfed Northern Rock last week.
Labour and Conservative members of the committee said no one was in charge as Northern Rock was engulfed by the liquidity crunch.
"How do we get to the situation where the effort to rescue Northern Rock is the equivalent of shouting 'fire' in a crowded cinema?" the committee's chairman, John McFall, asked Mr King.
After emergency Bank of England funding was announced last Friday, only a public guarantee of the Northern Rock's deposits by the Chancellor on Monday stopped customers withdrawing all their funds from the mortgage bank.
MPs expressed grave concern about lack of action to stop Northern Rock taking on too much risk, and the Bank's failure to help it before emergency funding was required. Mr King defended the arrangement that shares responsibility for banking regulation between the Bank, the FSA and the Treasury.
But his answers and those of his colleagues seemed to expose lack of coordination between the Bank and the FSA as the credit freeze took hold. The Bank of England's supervisory powers over banks were transferred to the FSA in 1998.
Asked why the Bank did not turn its attention to Northern Rock in July when it began monitoring markets for strain, Mr King said: "We don't monitor individual institutions."
Sir John Gieve, the deputy governor for financial stability and also an FSA board member, said: "I am sure that as part of supervision of Northern Rock the FSA team asked them to do different stress tests."
But Michael Fallon, the committee's senior conservative, criticised the FSA for letting Northern Rock cut its risk-weighted assets under new capital rules, allowing the bank to announce a 30 per cent dividend increase on 25 July.
Sir Callum McCarthy, FSA chairman, will appear before the committee on 9 October. Mr Fallon said after yesterday's session Sir Callum was "a guido – an official suspect".
The committee dealt out rough treatment to Sir John, who revealed that he first learnt of strain at Northern Rock on 14 August and then went away for two weeks for a funeral and a week's holiday in France. George Mudie, a Labour member of the committee, said Sir John had spent too much time talking about what he was not able to do.
Mr King said restoring the Bank's supervisory powers was not the answer to ensuring good regulation. Separating banking supervision from that of other financial institutions was not feasible, he said.
He blamed legal restrictions for his inability to organise secret funding for the former building society. Mr Fallon expressed surprise that Mr King only learnt recently from the FSA and the Treasury that he could not do this.
Mr King's five-year term as Governor ends on 30 June, and his handling of the crisis has cast doubt on his reappointment by the Chancellor and the Prime Minister. His steady performance under tough questioning won approval from City observers.
Alan Clarke, UK economist at BNP Paribas, said: "The Governor came out of it quite well. He came out with some perfectly sound arguments.
"I'm not so sure about Sir John Gieve, though – he seemed to be asleep at the wheel."
Banks have hoarded money to make sure they can meet obligations triggered by the credit crunch. Mr King has refused pleas from banks to make easy money available to let them lend to each other as normal in the key three-month market, saying he would only do so if there was a threat to the financial system.
But in an apparent reversal the Bank said on Wednesday that it would lend £10bn to banks for three months secured against mortgage-backed securities.
Mr King said the injection did not deviate from his tough stance because it was a response to the Northern Rock crisis at a penalty rate and was limited in size. He also denied suggestions of interference by the Treasury.
Asked whether his reputation had been damaged by the crisis, Mr King said: "You will have to make those judgments, not me."
Mr McFall said the committee would also question the Chancellor, Alistair Darling, and possibly the management of Northern Rock.
Five question for Mervyn King
John McFall: Who was in the lead in this crisis and did that change in the last few days?
Mervyn King: How would this have played out if we hadn't had the Memorandum of Understanding [between the Bank, the FSA and the Treasury]? It doesn't change the instruments available to the authorities... It clarifies responsibilities. It is right and proper that in the end the Chancellor has to approve any risk to the taxpayer.
Mr McFall: No one knows what they are doing. God help us if we get this when there is a weak economy. Are you your own man? Were you leant on in this situation?
Mr King: The operation we carried out was designed in the Bank. Of course we would discuss it with the chairman of the FSA and the Chancellor. I would never do anything unless I thought it was the right thing to do.
Michael Fallon: Why have you just discovered that these legal instruments are inadequate?
Mr King: I pressed strongly for the ability to conduct a covert operation. I was told the legal advice [to the Treasury] was that it wasn't possible. I wanted to conduct a covert lender-of-last-resort operation that would not have caused the run we saw on Northern Rock.
Mr Fallon: Who was in charge?
Mr King: We are each responsible for various responsibilities we have been given under the Memorandum of Understanding... I don't have the authority to put the taxpayers' money at risk.
George Mudie: You just watched, letting the train hit the buffers.
Mr King: We didn't see much point in blowing up the train before it hit the buffers.