Stephen King: The longer-term consequences of the sub-prime crisis have yet to be seen

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I suspect Mervyn King, the Governor of the Bank of England, did just about enough in front of the Treasury Committee on Thursday to save his neck. His success may, in part, have been down to his ability convincingly to spread the blame. Legislation was inadequate to deal with a bank run. Deposit insurance arrangements were sadly lacking.

The Bank wanted to lend to Northern Rock on only a covert basis but was discouraged from doing so. The tripartite arrangements to deal with financial emergencies perhaps did not work very well. And Sir John Gieve, Deputy Governor of the Bank of England, responsible for financial stability, was on holiday.

Given the Deputy Governor's performance on Thursday, perhaps his earlier absence was a blessing in disguise. As for the other excuses, they're all perfectly reasonable. The idea that deposits were partially protected only up to a little more than £30,000 was ludicrous, and was surely a key factor behind the run on Northern Rock.

Yes, the Bank should have been able to lend to Northern Rock on a covert basis, although only time will tell whether this excuse rings true (the Bank claims that the EU's Market Abuse Directive prevented covert help, although voices in Brussels have suggested otherwise). And it does seem that the UK Takeover Code offered insufficient flexibility to allow a takeover in a short enough space of time to prevent panic on the streets.

However – and I'm afraid it's rather a big "however" – while bank runs don't happen terribly frequently (the last in the UK leading to a collapse involved Overend and Gurney in 1866), I'm not sure that infrequency necessarily absolves the authorities of blame.

There are two issues. The first relates to the tripartite arrangements. When Gordon Brown gave the Bank of England its independence in 1997, he simultaneously removed its banking supervisory powers.

The incoming Government wasn't convinced the Bank had been sufficiently effective in the past (Barings and BCCI were the obvious concerns). Meanwhile, the increasingly blurred distinction between banks, insurance companies, hedge funds and others made regulation of banking activity alone something of an anachronism. The Government responded by creating the Financial Services Authority.

All of this appeared sensible enough at the time. It seems, though, that the splitting of responsibilities may seriously have impaired the co-ordination of policy actions to head off the Northern Rock crisis.

From the evidence provided on Thursday, it looks as though the Bank wasn't really aware of what the Financial Services Authority was up to in August and, perhaps, didn't even really care. After all, the Bank's stated position was to avoid moral hazard.

This high-mindedness would work, only if the FSA was able to resolve Northern Rock's difficulties by finding a buyer. It failed to do so. Meanwhile, the Treasury only really stepped in at the last minute, when Alistair Darling spotted the queues on high streets up and down the land. So who, ultimately, is accountable for what happened? At this stage, it's all too convenient to pass the buck and, therefore, for each member of the policymakers' trio to deny responsibility.

This brings me to my second issue. The FSA's failure was arguably the Bank's responsibility too. Consider the problems facing financial markets in August and early September. As the asset-backed commercial paper market dried up, banks suddenly – and unexpectedly – found themselves having to fund conduits and special investment vehicles, some of which were rather too full of dodgy sub-prime assets.

Moreover, banks didn't want to lend to each other because any one of a number of institutions might have been replete with sub-prime elephant traps (remember this was not a problem confined to the UK: two German banks, IKB and Sachsen, fell victim to the sub-prime curse). Banks all became hoarders of cash, which in turn led to much higher money market interest rates and, eventually, to the woes that befell Northern Rock.

If, though, the banks chose to hoard liquidity, they were hardly going to be in the mood to splash out some loose change on the purchase of Northern Rock. The FSA's failure to find a willing buyer, therefore, partly reflected unusually tight money market conditions. And those conditions, arguably, reflected the Bank of England's reluctance to add liquidity at a time when neither the Federal Reserve nor the European Central Bank was burdened with similar misgivings.

On this interpretation, the problems were exacerbated by the Bank of England's refusal to come down from the moral high ground. Admittedly, liquidity injections might not have worked and perhaps money market rates might not have come down, in which case the FSA might still have failed to find a buyer for Northern Rock. We'll never know.

What's odd, though, is that the Bank of England last week thought it right to add liquidity – after the Northern Rock problem had been partially resolved through the Treasury's decision to guarantee deposits – even though it had chosen not to do so before. Horses and stable doors spring to mind. By refusing to deal with elevated money market rates earlier in the crisis, the Bank in effect tied the FSA's hands behind its back.

Ultimately, central banks have two important roles to perform. Their main day-to-day job is the achievement of lasting price stability, often with the help of an inflation target. On rare occasions, they also have to be lenders of last resort or, more broadly, guardians of the financial system.

The Monetary Policy Committee is stuffed full of people very well qualified to achieve the first of these objectives. Arguably, none of the members has any great experience of the tremors within financial markets that, on occasion, threaten meltdown. They're a mixture of academics, former civil servants and corporate economists with very little direct experience of seeing financial turmoil "from the inside" (their biographies can be found at http://www.bankofengland.co.uk/about/people/index.htm).

While it's easy enough to blame greedy bankers for the problems we've seen in recent months, policymakers might benefit from a better understanding of the incentives on offer within the financial system, which sometimes turn rational individual behaviour into collective madness.

As things have turned out, a major crisis has been avoided. Nevertheless, we're unlikely to return to the conditions that prevailed in the first half of the year. Lenders are already tightening their credit standards. It'll be more difficult to find a mortgage at eight times annual salary. Self-certification mortgages will increasingly be frowned upon.

Lenders may even demand some collateral before lending to would-be house purchasers, suggesting that the days of 100 per cent (or even 120 per cent) mortgages are numbered. In response, the housing market will soften, consumer spending may head south and the public finances will come under pressure.

The crisis associated with Northern Rock may have been resolved, but the longer-term economic consequences have yet to be seen. In a few years' time, Northern Rock may be regarded as a watershed not only for the UK economy, but also for this Government's economic reputation.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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