King, BOE Face `Crisis of Confidence' After Rescue (Update3)

By Brian Swint and Jennifer Ryan

Sept. 17 (Bloomberg) -- Bank of England Governor Mervyn King has spent the past month trying to stay above the fray as the U.S. subprime-mortgage collapse roiled credit markets. Now he's getting dragged in, whether he likes it or not.

Two days after King, 59, told lawmakers on Sept. 12 that central banks should avoid giving the impression they will help lenders that made bad decisions, the Bank of England provided emergency funds to Northern Rock Plc in the biggest bailout of a British bank in three decades.

``It's a crisis of confidence, and the bank is confused,'' said Patrick Minford, an economics professor at Cardiff University who advised former Prime Minister Margaret Thatcher. ``They want to be hands-off, but in this situation they can't be. I don't think this has done King any good.''

King's credibility is in question for his refusal to emulate other central banks and take early action to help cash-strapped lenders. With Northern Rock's failure, he is finding himself subject to the same charge of excessive caution being leveled at U.S. Federal Reserve Chairman Ben S. Bernanke, whose office adjoined King's at the Massachusetts Institute of Technology in the 1980s.

``There's no doubt that had the Bank of England acted early, Northern Rock would not have had the same problems,'' said Stephen Bell, chief economist at hedge fund GLC Ltd. in London. ``The idea they can't do anything about it is clearly wrong.''

Talking Down

King, a former London School of Economics professor whose five-year term ends June 30, initially underestimated the threat posed by rising defaults on mortgages to U.S. borrowers with poor credit histories. It was ``not an international financial crisis,'' he said Aug. 8; the next day, credit markets seized up as concern about exposure to subprime losses made banks reluctant to lend to each other.

The European Central Bank has loaned cash to banks in seven special auctions since then, and the Fed responded to criticism its response was too slow by cutting the rate at which it lends directly to banks on Aug. 17. Economists predict the Fed will reduce its benchmark rate tomorrow by at least a quarter point.

King held back until markets forced his hand. Last week he said that too much help ``encourages excessive risk-taking, and sows the seeds of a future financial crisis.'' With three-month money-market rates close to a nine-year high, the bank on Sept. 13 made its first additional cash loan to banks. The next day, it rescued Newcastle, England-based Northern Rock after rising credit costs left the U.K.'s third-largest mortgage provider unable to make new loans.

Hard Line

``Is this the right environment to be so sanctimonious and to take such a hard line?'' asked James Knightley, an economist at ING Financial Markets in London. ``If you play this moral high ground, it could backfire.''

Northern Rock's customers have ignored assurances that their deposits are secure. While Chancellor of the Exchequer Alistair Darling said today their deposits are ``backed by the Bank of England,'' customers have removed at least 2 billion pounds ($4 billion) since Sept. 14., the British Broadcasting Corp. reported.

Northern Rock shares fell 29 percent today and have lost half their value in the past two trading sessions.

The criticism of King could hardly come at a worse moment if he wants to be reappointed. The only member of the Bank of England's Monetary Policy Committee to vote on each rate decision since 1997, King has been overruled by his colleagues twice in the past two years and in March was forced to write a letter to Brown after inflation accelerated to a decade-high of 3.1 percent. It has since receded: Consumer prices rose just 1.9 percent in July.

Extended Growth, Surging Debt

Nor is the timing helpful to Prime Minister Gordon Brown, 56, who as chancellor of the exchequer gave the bank rate-setting independence 10 years ago.

While Brown and the Bank of England have overseen Britain's longest period of economic growth in two centuries, consumer debt has also surged over the last decade: Households are now shouldering a record 1.3 trillion pounds in debt. In addition, the Bank of England's benchmark rate of 5.75 percent is the highest among the Group of Seven nations, and London house prices fell the most in three years in September, a report from Rightmove Plc showed on Sept. 14.

Now Brown presides over an economy increasingly vulnerable to rising credit costs just as he considers whether to call an early general election to capitalize on the improved prospects for his Labour Party since he succeeded Tony Blair as prime minister in June. Former Federal Reserve Chairman Alan Greenspan said in an interview with the Daily Telegraph published today that the U.K. ``is more exposed then we are'' to tighter credit conditions and that the housing market is ``going to turn.''

`End of Year'

King said Aug. 8 that the discussion with the government about a second term for him is ``a matter for the end of the year.''

King's defenders say the Bank of England's stance on the credit turmoil, which he outlined in testimony to U.K. lawmakers last week, will be proven wise over time. ``King is an intellectual colossus, and I'd have no qualms about reappointing him,'' said Geoffrey Dicks, chief U.K. economist at Royal Bank of Scotland Group Plc in London. His statement ``was almost a gem.''

King, an architect of the bank's inflation-targeting strategy, has won plaudits for helping end the U.K.'s decades-long fight with rising prices. He became chief economist in 1991 and was named governor in 2003.

``King has faced lots of tests and come out of them very well,'' said Minford. ``He's done a good job. But on this one he's made a wobbly call and will have to retrieve it smartly.''

Last Updated: September 17, 2007 04:21 EDT