Jeremy Warner's Outlook: Rock is a disaster that never happened

A largish mortgage bank came to the very edge, but before it could leap the Government acted to drag it back

You have to go as far back as the early 1990s and "Black Wednesday", when Britain was forced into ignominious exit from the ERM, to find a financial crisis within these shores quite as dramatic as the one we have just witnessed.

A week that began with angry savers queuing round the block to withdraw their money, and the Government, in an unprecedented move, writing a blank cheque to guarantee the deposits of the entire British banking system, ended with the Governor of the Bank of England being forced to fight for his job before hostile MPs. Yet, despite their drama, the long-term consequences of these events may not be as significant as commentators, in the hysteria of the moment, generally assume.

This certainly wouldn't have been the case had the outcome been different, and Northern Rock had been allowed to collapse, prompting similar runs on other banks. Then the consequences would have been extreme, perhaps even more so than the ERM debacle, which destroyed the Tory party's reputation for economic competence and permanently damaged Britain's relationship with Europe.

Consider what actually happened. A largish mortgage bank came to the very edge, but, before it could leap, the Government acted to drag it back. The Bank of England, the Financial Services Authority and the Treasury are all obviously at fault in allowing events to spiral out of control in the way they did. What happened is a profound embarrassment for all concerned. No one comes out of it well. But in the end, Northern Rock didn't go bust, and it remains improbable that taxpayers' money will have to be called on to prop up either this mortgage bank or anyone else.

The final outcome, then, is one of regulatory success, not failure. Though plenty of faults and misjudgements in the system have been highlighted by the events of the past few weeks, it ultimately withstood the test.

Obviously, it sets a terrible precedent for the Government to have to underwrite depositors in this way. The whole thing could have been much better handled throughout, but the bottom line is that it looks as if disaster has been averted.

That means the inquest is going to be less exacting and messy than if the outcome had been altogether less benign. What will now take place is the sort of buttressing of safety standards you get when it is realised that the train has narrowly missed a serious derailment. If the derailment actually occurs, complete with loss of life, then the consequences for all involved are plainly going to be much more extreme.

For this reason, I think it quite unlikely that either Mervyn King, Governor of the Bank of England, Sir Callum McCarthy, chairman of the Financial Services Authority, or even the Macavity- like Hector Sants, chief executive of the FSA, will be pressurised into resigning.

The fall-guys are, instead, expected to be lesser souls, including the Bank deputy Governor, the luckless Sir John Gieve. He is the bank chief directly charged with financial stability. Unfair though it may have been in some respects, his public mauling by MPs almost certainly sealed his fate. Whether Mr King gets a second term, or even wants one, is anyone's guess. Much depends on how he redeems himself from here on in. He's asked MPs to suspend judgement until they have heard evidence from the FSA and the Treasury.

Only then can they gain a proper understanding of what went on. But whatever the outcome in regard to Mr King's position, it is of little long-term or wider consequence. If Mr King goes, the waters will close over his head, and things will carry on much as before. There is, by the way, no obvious successor internally, and, though it is possible to think of lots of people outside the Bank who could do the job well, it is still too early to speculate on external candidates.

If the Government is reluctant to see Mr King go early, it is equally impossible to imagine ministers considering anything that reunites banking supervision and monetary policy under one roof. The separation of these two functions, with an independent Bank responsible for monetary policy and banking supervision going to the Financial Services Authority, was one of Labour's key institutional reforms when it came to power. Up until a few weeks back, it was generally thought a triumph.

The reasons for stripping the Bank of its previous responsibility for banking supervision are instructive. In part, it was punishment for a series of regulatory bungles, including BCCI and Barings. Subsequent inquiry found varying degrees of negligence in the Bank's handling of both these collapses. But it was also because it was thought that the Bank's credibility as an independent monetary authority would be undermined by any failings in its regulatory functions.

Ironically, removing supervision from the Bank and placing it with the FSA doesn't seem to have prevented the blow to credibility struck by Northern Rock. This is because over-riding responsibility for financial stability was left as a matter for the Bank. Though there were important practical reasons for this – as the monetary authority, the Bank had to remain in charge of the money markets – it was a fudge which the tripartite arrangements enshrined in the now-famous Memorandum of Understanding have failed adequately to address. The confusion in responsibility and chain of command that resulted from these arrangements may have been a large part of the mischief with Northern Rock.

But it goes deeper than that. Sir Eddie George, Mr King's predecessor as Governor of the Bank of England, famously considered resignation when he learned banking supervision was being removed from his watch. Among his concerns was that it might diminish the Bank's authority in the City. Mr King, by contrast, was only too happy to let the FSA take responsibility. To his mind it allowed the Bank to devote itself full-time to its primary purpose of controlling inflation. Financial stability became very much the junior partner, a bit of an after-thought.

This in turn may have instructed Mr King's high-minded refusal to provide the markets with the liquidity they needed when the credit crisis hit. Critics claim Mr King didn't understand the City's needs. When it came to the crunch, he was too divorced from reality, too academic in his approach, to appreciate that principles of moral hazard have to be set aside in the interests of wider stability when the money markets seize up.

Likewise, the FSA, with its focus on consumer protection, had become too concerned with form- filling and compliance to notice the danger to the system posed by some of the more extreme business models that had come to operate in credit markets.

All these critiques no doubt contain an element of truth. There is almost open schadenfreude at both the European Central Bank and the US Federal Reserve at the mess the Bank finds itself in. Mr King had appeared to rebuke both these banks when he questioned the wisdom of providing markets with liquidity. The judgement of the moment is that they acquitted themselves much better than Mr King in so doing.

No longer will the Bank of England with any credibility be able to look down its nose at the perceived inadequacies of the European banking system. The ECB is judged to have acted pre-emptively and firmly, while the Bank, sitting slap bang in the middle of all the financial wizardry of the world's most successful international financial centre, is somehow seen to have failed. Perception, regrettably, is nine tenths of reality.

So while the wider economic and political ramifications of Northern Rock may not be profound, there will be intense soul- searching at both the Bank and the FSA which in time will result in significant cultural and procedural change. Radical institutional reform seems to me unlikely. The Government has too much vested interest in the current structure to tear it apart. But within the confines of the Bank of England and the FSA, it will feel like an earthquake.

j.warner@independent.co.uk