Bursting bubbles

Bank Of England Advisor 'We've Intentionally Blown The Biggest Government Bond Bubble In History'

A key Bank of England policymaker has warned of the risks to global financial stability when "the biggest bond bubble in history" bursts

Blacklisted News,

13 June, 2013

In a wide-ranging testimony to MPs, Andy Haldane, Bank of England director of financial stability, admitted the central bank's new financial policy committee is taking too long to force banks to hold more capital and appeared to criticise the bank's culture under outgoing governor Sir Mervyn King.Haldane told the Treasury select committee that the bursting of the bond bubble – created by central banks forcing down bond yields by pumping electronic money into the economy – was a risk "I feel acutely right now".

He also said banks have now put the threat of cyber attacks on the top of their the worry-list, replacing the long-running eurozone crisis.

"You can see why the financial sector would be a particularly good target for someone wanting to wreak havoc through the cyber route," Haldane said.

But he described bond markets as the main risk to financial stability. "If I were to single out what for me would be biggest risk to global financial stability right now it would be a disorderly reversion in the yields of government bonds globally." he said. There had been "shades of that" in recent weeks as government bond yields have edged higher amid talk that central banks, particularly the US Federal Reserve, will start to reduce its stimulus.

"Let's be clear. We've intentionally blown the biggest government bond bubble in history," Haldane said. "We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted."

The Bank of England later issued a statement, describing Haldane's remarks as his "personal view" and stressed that if it raised interest rates – stuck at record lows since March 2009 – too quickly the consequences might be severe. "Any attempt to return interest rates quickly to more normal levels would recreate recession conditions," the Bank of England. Haldane said the FPC was on alert to any bubbles created by the help to buy mortgage guarantee scheme for first-time buyers and house movers, stressing the scheme should be temporary. Referring to the US, he said: "Fannie Mae and Freddie Mac were temporary schemes and 75 years later they were still in place and blowing the world up."

He said the FPC, which meets quarterly at the Bank of England to spot the next financial crisis, had not been "entirely free" of political interference over the way the bailed out banks Royal Bank of Scotland and Lloyds Banking Group had been forced to raise more capital.

A member of the FPC since it was created by the coalition in 2011, Haldane admitted the body had "lacked clarity and decisiveness" in setting capital levels for banks after first starting making recommendations on capital in 2011 but not concluding the shortfall was £25bn until March 2013.

"With hindsight that was too long a period of uncertainty," Haldane said.

He had argued more capital should have been put into the major banks and that the Treasury's refusal to put more cash into RBS and Lloyds had "constrained" options available to the FPC.

In his written evidence he seemed to refer to the management style of the outgoing governor. Haldane wrote that one of his personal objectives as "to contribute making the bank a more conversational, less hierarchical, more diverse, somewhat humbler organisation as a way of improving its accountability credibility and the quality of its decision making".

Andrew Tyrie, the chairman of the Treasury select committe, later raised comments made by Haldane and Donald Kohn, an external member of the FPC who also gave evidence, about the need to give the FPC power to limit the risks banks can take through the so-called leverage ratio. Haldane described this ratio as "the most robust measure of bank capital adequacy".

International regulators are setting a leverage ratio at 3% by 2019 – which allows banks to leverage their capital 33 times – and the FPC had wanted the ability to be able to adjust this ratio to limit the risks banks run.

"Mr Haldane told us that 'a 33 times leveraged banking system sends shivers down my spine, if it were to be a long-run goal for financial stability'," said Tyrie. "The government should accept the banking commission's recommendations without further delay and grant the FPC this power," Tyrie said.

Haldane said: "For the FPC not to have been given directive powers over this instrument is a significant structural flaw in the current macro-prudential regime."