The Alchemists: Three Central Bankers and a World on Fire (32 page)

To Weber, the Governing Council had so thoroughly ignored its own rules and orthodoxies that those principles were now in question.

Shortly after the Governing Council meeting Sunday evening, Weber convened a conference call of the Bundesbank Executive Board. He and colleague Andreas Dombret were still in Basel, the other board members in various locations in Germany. Officially he wasn’t supposed to tell anyone of what the Governing Council had just decided, but this was so momentous that he posed a quite serious question to the board members: Should we do it? Should the Bundesbank follow its marching orders from the ECB and buy billions of euros’ worth of Greek and Portuguese bonds, violating its long-cherished principle of not using the printing press to fund governments?

If they had answered
nein,
it’s nearly certain that the euro would have unraveled within days, the ECB would have lost all credibility, and Germany would have been forced to reinstitute the Deutschmark as its currency. The global financial markets would have entered a tailspin more dramatic than what followed the Lehman bankruptcy. Staring at that precipice, the Bundesbank concluded it was better to hold its nose and violate orthodoxy than to unleash such dangerous consequences. But that the action was discussed at all suggests the world came closer to financial catastrophe that night than all but a few insiders knew at the time.

Weber, as he had threatened in his Friday morning e-mail, decided to ignore the principle of ECB secrecy further still and make his discontent known to the world. Trichet only obliquely acknowledged the internal dissent. “
On some decisions there was unanimity
,” he said in a Bloomberg Television interview on May 10. “On bond purchases we had an overwhelming majority.” Weber wanted his opposition known more explicitly than that. His staff arranged a Monday morning interview with
Börsen-Zeitung.
“The purchase of government bonds poses significant stability risks,” Weber told the Frankfurt-based financial publication. “And that’s why I’m critical toward this part of the ECB council’s decision, even in this extraordinary situation.”

And Weber was just the most prominent of the German critics. As
Die Welt
wrote the day after the announcement, “What was carved in stone the day before no longer has any validity, and nothing symbolizes this more than the ECB’s loss of independence.” People who worked with Trichet said that he took the criticism from German economists and journalists that followed the bond-buying decision personally. The consummate European, who had spent a career winning respect as a hard-nosed, German-style central banker, was deeply hurt that his dedication to stable prices would come under doubt.

Trichet was also furious at Weber’s open insurrection, people close to him said. To the Frenchman, it was an affront not only to the rules of the ECB and the idea of European unity, but also to the obligations that central bankers, the Boys in Basel, owe to one another.

The King’s Speech

T
he official name of the gathering is “The Lord Mayor’s Banquet for Bankers and Merchants of the City of London.” Everyone knows it, however, simply as the Mansion House Dinner, for the official residence at which it occurs, at the intersection of Threadneedle and Lombard Streets. For the grandees of British finance, it’s among the most important events of the annual calendar, an evening on which they don tuxedos, drink wine, and hear what the chancellor of the exchequer and the governor of the Bank of England have to say about the state of their world. For the speakers, it’s the highest-profile speech of the year, the one they use to broadcast their biggest ideas, ensuring that they’re heard not only by the financiers in the room, but also by the many more around the globe who know to pay particular attention to what happens at the lord mayor’s Corinthian-columned Georgian palace each June.

So it seemed rather odd, just two days before the 2009 dinner, when Mervyn King’s aides told Alistair Darling’s that the governor’s speech wasn’t yet finished. “
This I found curious
,” Darling said in his memoir. After all, King was known for his thoughtful, carefully reasoned speeches. He didn’t leave them to the last minute. When Darling finally received a copy of the talk, a couple of hours before it was to be delivered, he saw why King had been keeping it under wraps.

“
It has been a quite a year
,” King began, on a note of understatement. “A year to remember, but not to repeat.”

He gave a
tour d’horizon
of the crisis and its aftermath and expressed his view that “fiscal policy too will have to change,” to develop a “clear plan to show how prospective deficits will be reduced.” He then said a few things about how Britain’s regulation of the financial industry ought to change to reflect the lessons of the crisis. Noting that the Bank of England had rather limited powers to oversee the financial sector, a legacy of the Labour government’s 1997 reforms, he offered a rather deft metaphor to make his point: “The Bank finds itself in a position rather like that of a church whose congregation attends weddings and burials but ignores the sermons in between,” he said with a twinkle in his eye. “Experience suggests that attempts to encourage a better life through the power of voice is not enough. Warnings are unlikely to be effective when people are being asked to change behavior which seems to them highly profitable.

“So it is not entirely clear how the Bank will be able to discharge its new statutory responsibility if we can do no more than issue sermons or organize burials.”

The Bank of England, in other words, can’t just tell banks what to do. It needs some real power. Got that, Mr. Chancellor?

Darling got it all too well, as he sat on the dais trying with mixed success not to let his annoyance show to the hundreds of bankers staring at him. “
Everyone knew what he was getting at
,” Darling wrote later. “It was a naked attempt to wrest powers from the [Financial Services Authority, created in 1997 to regulate British banks]. As such—and all those present knew it—it was a direct challenge to government policy, and therefore to me.”

The British press, always quick to shine a spotlight on conflict among high government officials, didn’t disappoint. “King clashes with Chancellor over how to regulate banks” was the headline in the
Independent.
“King launches shot across Darling’s bow over City regulation,” said the
Guardian.
“
Put your books in order
, and soon, King warns Darling,” blared the Conservative-leaning
Daily Telegraph,
which focused on King’s remarks about fiscal policy in its story about the governor’s “fiercest rebuke yet to the Chancellor.” If King wanted to stick a proverbial knife in Darling’s side, he succeeded.

For the chancellor, struggling with the aftermath of a massive financial crisis and working for a wildly unpopular government in what would prove to be its final year in power, King’s comments were typical of the governor he’d been working with for years. “This was another occasion on which I felt that Mervyn had decided that, because of the government’s weakness, he had license to roam in a way he would never have done if he had thought he would still have to deal with us after the next election,” Darling wrote.

“This is dangerous territory for any Bank Governor . . . he was coming perilously close to crossing a line between legitimate comment and entering the political fray.”

•   •   •

C
entral bankers in modern democracies end up playing a role that is bigger than their official responsibilities would suggest. Their job isn’t merely to set monetary policy and oversee banks. They are also their nations’ economists in chief. Ideally, they should be persuasive voices for sound economic thinking, steering politicians away from bad decisions and guiding them toward good ones. At the same time, they’re supposed to stay aloof from politics and leave their countries’ major choices to those officials who were actually elected. Threading the needle is among their greatest challenges.

They might simply appear at the side of a finance minister or president, as Ben Bernanke did during the debate over bank bailouts in 2008. They might lend tacit support to a policy, as Alan Greenspan did with George W. Bush’s tax cuts in 2001. Or they might take a more assertive role in guiding their nations’ policies, as Jean-Claude Trichet did repeatedly starting in 2010. Each of these actions comes at a cost: In each case, the idea of the central banker as a neutral arbiter or member of a high priesthood committed only to technocratic decisions is damaged.

In 2009 and 2010, King, his tongue acid, his elbow sharp, took a consistently aggressive stance toward the politicians—or at least toward the politicians who happened to be in charge. The concerns over deficit spending and bank regulation King expressed in the Mansion House speech put him squarely at odds with the Labour government—and in almost exact alignment with the Conservative Party, which was gearing up for a campaign to return to power in the 2010 general election. The consequences of King’s apparent political alignment would shape both Great Britain’s economic fortunes and the governor’s legacy.

Like the rest of the Western world, Britain emerged from the 2008 panic deeply scarred. After fifteen years of prosperity, during which London had reemerged as a great center of global commerce, the question haunting Britain was what would come next. Unemployment had risen from about 5 percent just before the crisis to nearly 8 percent by the time of the Mansion House Dinner. The nation’s massive banking sector was in shambles, and its government debt was exploding, from 44 percent of GDP in 2007 to 69 percent in 2009.
Queen Elizabeth II was sufficiently alarmed
that she summoned King for a meeting in March 2009—the first time she’d sat down with a governor of the Bank of England in her then fifty-seven-year reign. After a conversation with the queen, King said later, “one must never breathe a word to another mortal.” But in answer to a question she’d posed publicly, of why, if the looming crisis was so big, nobody saw it coming, he suggested that “
everyone did see it coming
but no one knew when. It’s like an earthquake zone. You should be trying to build buildings in ways which are more robust.”

The day of the Mansion House speech, Britain could borrow money on global markets for a decade for less than 4 percent. But to King, the nation’s finances were more precarious than the bond market made it appear. The market for U.S. Treasury bonds is the largest and most liquid in the world; a pension fund or sovereign wealth fund from the developing world can always buy or sell Treasury bills, even on a massive scale. That has allowed the U.S. government to borrow more money for longer periods than might seem justifiable based on its finances. (In the summer of 2009, U.S. government debt was 90 percent of GDP.) Japanese bonds, meanwhile, are bought primarily by the nation’s own citizens as a savings vehicle, almost as a patriotic duty. That allows Japan, too, to borrow on much larger scale than its fiscal situation would seem to justify. (That same summer, Japanese government debt was 210 percent of GDP.)

But the pound isn’t the world’s reserve currency the way the dollar is, and Britons don’t invest in their own government’s bonds the same way the Japanese do. Investors would readily dump UK government bonds—or “gilts,” for the gilt edges the securities once had—if they concluded that the nation’s finances were at the breaking point. The low interest rates that Britain was paying to borrow money were little solace. Market sentiment, as the financial crisis had shown, can shift quickly and unpredictably. The British government would need to borrow £175 billion that year to fund itself, and nearly as much for years to come. If global investors were to suddenly cut off the taps, the result could be disastrous. Parliament, King argued, should act now to prevent Britain from being threatened with a debt crisis down the road.

The governor had come a long way since the earliest days of the crisis, in the second half of 2007, when he led a restrained, even timid response and didn’t want to get involved with bank regulation. Like the Federal Reserve and the European Central Bank, the Bank of England had by this time thrown out the rulebook. King had viewed bank supervision as a messy, legalistic job, and his apparent contempt for bankers had only deepened after the industry’s failures became more apparent. But it was clear that the Bank of England would need to play a greater role in overseeing the banks. The Financial Services Authority, created in 1997 under then chancellor of the exchequer Gordon Brown, had fallen down on the job in the run-up to the crisis, focused more on dealing with narrow problems like stock market scams than the bigger picture of whether the British financial sector was sound.

In the tumultuous eighteen months that followed the Northern Rock failure, the Bank of England was the only institution with the power and resources to step in as lender of last resort. Yet its institutional knowledge of the inner workings of the banking system had atrophied in the years of King’s reign, when the bank focused instead on theoretical macroeconomics. Parliament had passed a law earlier in 2009 stating for the first time that one of the objectives of the Bank of England would be to “
contribute to protecting and enhancing the stability
of the financial systems of the United Kingdom,” though that law included little in the way of new powers.

It had been famously said that the governor of the Bank of England could direct the activities of British banks simply by raising an eyebrow, but King wanted something a little more concrete. If the Bank of England were going to stand behind the banks, it needed some real control over what they might get up to.

A week after the Mansion House event, King went before Parliament’s Treasury Select Committee for his regular report on the state of monetary policy—but it was the simmering hostility between him and the government that was on the minds of his audience. King didn’t back down from his statements at the lord mayor’s dinner. On fiscal policy, he said, “
I do not think we can afford to wait
until the Parliament after next before taking action to demonstrate credibly that the United Kingdom is going to reduce its deficit and that fiscal policy will be credible.”

The Conservative opposition immediately seized on his statements to bash the government. It was “demolition day for Gordon Brown’s tax and spending policies,” said George Osborne, the shadow chancellor of the exchequer. King’s comments, he continued, “demolished for good any claim that this discredited government ever had a credible plan for the recovery.”

Darling was in the process of working up the government’s plan for financial reform—a white paper outlining the strategy was due out the following week—and signs were pointing to a divided set of regulatory responsibilities, with the Financial Services Authority sharing power with the Bank of England as well as the Treasury. Relations between King and Darling were sufficiently toxic at this point that, asked if he had consulted on the white paper, King replied, “It all depends on your definition of consultation. I have not seen a draft of it, no. . . . I do not know what will be in the white paper. Whether anybody else does, I don’t know.” (By contrast, during this same period Tim Geithner’s staff was making plans for its own financial reform, and Bernanke and the Federal Reserve were heavily involved; some Fed staffers were even detailed to Treasury to help with technical issues.)

“I have a good working relationship with Alistair Darling,” King assured the members of Parliament that morning. “There is no problem with that working relationship whatsoever.”

Hardly a person present believed him.

When he wasn’t trying to use the bully pulpit to guide Parliament, King had his usual job to attend to—even if his working relationship with his own Monetary Policy Committee was also becoming problematic. In March 2009, he and his colleagues had agreed to push their main benchmark of the price of money, known simply as Bank Rate (no “the” please, we’re British), down to 0.5 percent, the lowest it had been in the 315-year history of the Bank of England.

They might have gone lower still, except they worried that because many building societies made loans tied to Bank Rate, they would stop lending at all if rates fell too low. Instead, they joined the Fed and the Bank of Japan among those central banks experimenting with quantitative easing, or using newly created funds to buy longer-term government bonds in hopes of pushing more money out into the economy. They started with £75 billion; two months later, they increased that to £125 billion.

This early phase of the crisis had been a time of peace on the Monetary Policy Committee, a result of both a clear-cut sense of what needed to be done and a desire to project unity in the face of panic. Even the pre–Lehman Brothers feud between King and Danny Blanchflower died down, in part because the latter was getting his way on cheaper money.

Blanchflower’s term on the MPC ended in May 2009. Yet by August, conflict between King and his committee members flared again—with a nearly unprecedented result. The British economy had pulled out of its nosedive over the summer, but it didn’t seem to be climbing with any vigor, and the risk of deflation hadn’t fully receded. Everyone on the nine-member MPC thought it was time to ease policy more. The question was, by how much?