The European Union's market abuse directive (MAD) made a useful excuse for Mervyn King, the Governor of the Bank of England, as he defended his role in the Northern Rock debacle last week, but it is also a complete red herring.
So too are the recriminations between Brussels and London over whether MAD prevented the covert rescue of Northern Rock that the Bank of England claims to have been in favour of.
The Bank's legal advice was that MAD made covert operations illegal; Brussels says that there are exemptions covering distressed banks. Yet which view is correct matters not a jot. Equally irrelevant is the suggestion that the main mischief came from Treasury and Financial Services Authority officials, who gold-plated the directive when it was enshrined in British law, making it much tougher than originally intended.
The reason why debate around the role of MAD is so much hot air is because even if the Governor had been allowed to mount a covert rescue, it almost certainly couldn't have succeeded. The idea that even quite small acts of market or selective assistance can be kept secret for more than a few nano seconds in today's supercharged capital markets is naive, let alone an operation as big as this one.
Eventually, the Bank of England's support for Northern Rock would have leaked out. What's more, it would almost certainly have come out in a disorderly fashion that would have provided a field day for insider traders and hedge funds.
The following anecdote explains the nature of the problem. At the beginning of the credit crunch, there were a couple of uses of the Bank of England's standing facility for overnight lending. The Bank didn't want the identity of the borrower known because of the danger of stigmatising the offending party. This might in turn deter use of facility. Yet within hours the borrower had been widely named in markets as Barclays.
On the second time the facility was used, the Bank made a bigger effort to keep the name sec-ret. Rival banks were warned on pain of goodness knows what that they were to keep their mouths shut. To a man they all then took great pleasure in relaying that they had been sworn to silence, but just in case you were wondering, the offending party was again Barclays.
What's the world coming to? There's just no controlling these people any longer.
If the Bank can no longer act covertly, even if it wanted to, then much of the purpose of the lender of last resort function is undermined. There's not a lot of point in acting as lender of last resort if it triggers the very crisis it is meant to prevent, which is what occurred with Northern Rock. Whoever leaked the story to the BBC's 10 O'Clock News before it could be officially announced in a planned fashion should be taken out and shot. The effect was to turn the obvious danger of a run into an absolute certainty.
In the search for culprits, then, MAD comes a long way down the list of suspects. First among these must be the Northern Rock board itself. Directors can't have stress-tested the business model against a serious credit crunch, or if they did, they must recklessly have chosen to put profit before safety.
If it were not for the fact that it would leave Northern Rock in an even deeper mess than it is already, all these directors would already be history. It is all very well the Chancellor, Alistair Darling, suggesting heads should roll, but he seems to have forgotten that one of them, Sir Derek Wanless, is an adviser to Mr Darling's own government. If Sir Derek cannot control Northern Rock, one wonders what his recommendations on the National Health Service are worth.
Next in line comes the Financial Services Authority, which as the responsible prudential regulator obviously failed to ensure that Northern Rock was adequately stress-testing. The FSA operates a system of risk-based regulation deliberately designed to allow companies that overstretch themselves to go to the wall. Yet with Northern Rock it should perhaps have been more exacting, given the threat to wider stability that it posed.
Nor is it altogether certain that the Northern Rock debacle has tested the system of split responsibility for banking regulation between the Bank and the FSA to destruction. The present arrangements at least allow for a degree of transparency. In the old days, when the Bank was responsible for the whole shebang, mistakes made in prudential oversight would all too frequently be covered up for through covert lender of last resort operations. That's no longer possible, which must be an advance.
To the extent that Mervyn King and the Bank are in the dock at all, their fault lies not with the immediate handling of the Northern Rock crisis itself but in failure to address the credit crunch more generally by following the lead of the US Federal Reserve and the European Central Bank in flooding the banking system with cheap liquidity.
The UK press almost to a man supported this tough-cop stance in its early stages. The language of the commentaries is littered with phraseology such as "the Bank, rightly, takes the view that". Never mind the Governor's subsequent U-turn, the financial press is equally guilty of it, though in fairness to commentators such as myself, we didn't know about the seriousness of Northern Rock's position. The Governor did.
It is impossible to know whether earlier action would have spared the Government's blushes in being forced to provide a blank cheque to underwrite the deposits of the entire UK banking system. The most that can be said is that it might. At the heart of allegations of regulatory failure is the ghastly precedent the Government has been forced to set. How could it have come to such a pretty pass?
The embers are going to take many months, perhaps even years, to rake over, but was it really necessary for the Chancellor to throw out the aston-ishingly high figure of £100,000 as the amount in individual savings which a reformed deposit insurance scheme might be prepared to underwrite? This is double that offered by US deposit protection insurance, generally regarded as the gold standard for such arrangements.
Bankers are already complaining about the the size of the suggested guarantee, which, though there is general support for better deposit insurance, could prove ruinously expensive to finance. If the levy were based on size of deposits, it would mean big banks subsidising smaller ones. If, alternatively, it were risk-adjusted, it might make smaller banks unviable. Reforming insolvency law so as to place depositors at the top of the creditors' queue is also likely to prove problematic. Many larger depositors have more in common with wholesale creditors than retail savers.
In the meantime, the tug of war between long and short investors in Northern Rock continues apace, with the share price still gyrating wildly on a daily basis. Is Northern Rock worth anything at all? I'm suspicious of the unholy alliance of hedge funds and big banks which argues that it is not.
The big banks have a powerful vested interest in seeing Northern Rock put into runoff, or broken up and taken out of the equation altogether. That's one less competitor to worry about. Short-selling hedge funds, which have already made a killing out of Northern Rock, have a lot to answer for too. Once they've reduced the value of Northern Rock equity to zero, who will they pick on next?
The history of corporate scandals is that the situation is nearly always a great deal worse than directors at first pretend. Those who exit at the first sign of trouble tend to lose the least. Yet the extreme bearishness that surrounds this company, and the vested interest of those who spread this view, makes it tempting to believe that Northern Rock may well be worth something after all. Take care, though. This one is for the brave only.