It is a pleasure to open today’s debate on Northern Rock and banking reform. The Treasury Committee was quickly off the mark with this investigation. On 20 September, the Governor of the Bank of England and his colleagues came to the Treasury Committee ostensibly to consider a report on inflation, but in particular to discuss the issues surrounding Northern Rock. In the intervening period, we produced two reports, “The run on the Rock” and “Financial Stability and Transparency”.

I thank my colleagues on the Committee for their commitment and hard work in producing those two reports in the past few months. The reports are unanimous, and to date they have been well received by Parliament and the outside world. I also want to put on the record my thanks and those of my colleagues for the hard work of the staff and for the leadership of the Clerk of the Committee, Colin Lee. A tremendous amount of work was involved, but the staff stuck to the task. One measure of their success was that the report was out in time for the Government’s consultation exercise at the end of January.

The Committee examined what went wrong with Northern Rock and recommended changes in banking law, regulation and practice, with the aim of ensuring no repetition of the Northern Rock saga. My speech has three parts. First, I will present the Treasury Committee analysis of why Northern Rock needed state support in September and how the tripartite authority responded to that. Secondly, I will briefly examine the available information on the extent of state support to Northern Rock. Thirdly, I will consider banking law and regulatory changes, which are reflected in the Treasury Committee report and in the Government’s proposals.

Turning to the first item, what went wrong? Undoubtedly, Northern Rock employed a reckless business strategy, and the executives and the non-executives did not live up to their responsibilities.

Did my right hon. Friend find any evidence on how the executives reported their actions to the shareholders? Did his Committee identify any weaknesses in communications with shareholders?

With regard to the executives, I have mentioned that the business strategy was reckless. The non-executives gave the chief executive, Adam Applegarth, his head, and no company should aspire to that model.

The other aspect of what went wrong with Northern Rock was that it relied on the wholesale markets—in other words, it drank from one well, which was a reckless business strategy. The non-executives should have been asking questions such as, “Why are we doing so well?” In the first six months of 2007, Northern Rock was responsible for 19 per cent. of all new mortgage lending. Both the execs and the non-execs did not address basic questions.

Many of us are receiving representations from former Northern Rock shareholders who say that the Financial Services Authority’s failure to recognise the dangers in that business model ought to be a factor in the consideration of what compensation should be paid to shareholders. What is the right hon. Gentleman’s view on that?

I do not want to get into pronouncing on the shareholder issue; today, I am focusing on our Committee’s report. However, I am coming to the FSA and its failings, so I will take up what the right hon. Gentleman has mentioned.

The FSA failed because early warnings were ignored and there was an inappropriate FSA response. The Committee was concerned about the resources used in supervising Northern Rock, particularly in the light of what we called the “outlier status” of the business model. For a year or two beforehand, there had been murmurings about the type of model that Northern Rock was following. My own opinion is that the FSA gave its best regulators to the large banks and its less well-accomplished ones to the smaller banks and the building societies; it thought that it had to keep its eyes on the big banks and it let the former building societies go. The FSA has learned that lesson; from my personal discussions with FSA officials, I can say that the point has been well taken.

There were also shortcomings in the legal framework. There was no special administrative system, such as that in the United States of America, for failing banks. Furthermore, a legal uncertainty seemed to prevail with regard to the European Union market abuse directive. That issue needs further examination—not only at a UK level, but at a European level.

One basic question that the Committee asked itself was whether Northern Rock was a systemic bank. We concluded that it was. It had grown over the years, certainly since demutualisation, but it was not a huge presence other than in its heartland area of north-east England. In essence, it was systemic because it identified weaknesses within the tripartite system for dealing with failing banks. Depositors could get only £2,000 of their money in full, so when a run started, they were likely not to get the full amount and also likely not to get it soon. As the Governor of the Bank of England stated during his appearance before our Committee, once a run had started it was logical for people to queue up for their money. The Northern Rock run was a message to consumers that other banks might be weakened by the crisis and that they, too, could lose deposits. There was a spectre of contagion, and it comprised a systemic risk.

I well remember getting a phone call at home one evening from a constituent who told me that he and his wife had their money in Northern Rock. They had not had much money for most of their married life, but had received some lately and put it all into Northern Rock. He asked me for advice on whether he should take it out; that was a rather awesome task for me. I told him that because the Government were supporting the bank, he should keep it there. However, there was a real concern among people, who took a logical stance, about the future of Northern Rock and of their deposits.

The Committee concluded that the Chancellor was right to authorise the support operation for Northern Rock because of its systemic nature. The Northern Rock failure identified to the public a lack of protection for depositors and further weakened the confidence in which financial institutions were held in the public eye. A run on other banks and a more widespread systemic failure could have been possible.

The Committee also identified a failure of the tripartite authority in respect of the handling of an announcement about the problems of Northern Rock and the support being provided to it by the authorities. The announcement that public funds were being injected into Northern Rock should have reassured the public; perversely, however, it led people to see the bank as fatally injured—hence the run. That was compounded by a lack of speed as regards the support operations announced by the tripartite authority. Everyone was aware that a leak was possible, yet when the decision to proceed with the support operation on Tuesday 11 September was made, it was not to be announced until Monday 17 September—that was far too long a period. In my opinion, no journalist can be blamed for the leak. Rumours were circulating prior to the press statements, and a leak to the press was a matter of when, not if. The Committee concluded:

“In failing either to make an announcement earlier in the week or to put in place adequate plans for handling press and public interest in the support operation, the Tripartite authorities and the Board of Northern Rock ended up with the worst of both worlds.”

That was exacerbated by the failure to prepare for the Government guarantees for the Northern Rock depositors. The Committee says:

“It is unacceptable, that the terms of the guarantee to depositors had not been agreed in advance in order to allow a timely announcement in the event of an adverse reaction to the Bank of England support facility.”

Had such preparations been made, Northern Rock might not have been as weakened by the run as it was.

The second issue is the extent of state support and the accountability for that public commitment. Concerns have been expressed regarding the lack of transparency in the state support appropriate to maintain the bank, given that we are being asked to approve the revised spring supplementary estimate, page 22 of which shows that the first two commitments are there, but with no moneys against them. Public accountability is very important, and those columns should be filled in by the Government, not just left blank. In the initial stages of the crisis, and prior to public ownership, the Treasury incurred contingent liabilities relating to its underwriting of the Bank of England support operation and the guarantees that it offered to Northern Rock—the first two elements in the spring supplementary estimate. I am making a plea for the Treasury to be more forthcoming in reporting such contingent liabilities.

The third and final area to which I wish to refer is banking reform. Banks must be allowed to fail, because market discipline must form the core of banking regulation in the United Kingdom. If the likes of Northern Rock take unacceptable risks and the market turns against them, they should be allowed to go to the wall. The profits from banks cannot be private while the risks of their failure are public. However, that failure must happen in an orderly manner. In the case of a company, the shareholders must be the key losers. Small depositors should not lose out, nor should they lose the banking services needed to operate in our modern economy. Those who are financially excluded in this society are socially excluded, so it is important that they do not lose out.

The right hon. Gentleman has uttered the usual incantation about not privatising the risks and ensuring that we have the profits in the public sector, but that is not quite the case for a bank, which is a very different kind of organisation. Because of the risk of contagion in the entire banking system, the risk in relation to depositors must ultimately be in the hands of the state, in some form or another, whether through the Bank of England or the Treasury, or in some other way. The depositors need to be looked after, and to that extent there must, if we are to have a working banking system, be some opportunity for intervention to take place. The right hon. Gentleman seems not entirely to recognise that banks are different organisations from the average public or private company that is about to go down.

I could devise a great headline for that intervention along the lines of, “State Support Essential for Organisations that Made £40 Billion in Last Fiscal Year”. The hon. Gentleman should get real and understand that banks have to operate in the market like everyone else. The depositors, however, need to be protected because they cannot do due diligence with regard to the Royal Bank of Scotland, Barclays, Lloyds or whatever. We all recognise that.

That point leads me on neatly to the depositor protection fund, which is a key way in which small depositors can be assured in times of crisis that their funds are there and can be made available quickly. The Treasury Committee recommended a pre-funded system for that process. The benefits we identified were that it would reassure depositors that their money is there and that they can have it, and prevent banks from being called upon in times of crisis to bail out their insolvent competitors’ depositors. On the pre-funded aspect, funds should be allowed to build up in good times so that they are available when things take a turn for the worse.

Why did we recommend pre-funding for banks? It is obviously the case that banks have a responsibility to provide funds that assist in the maintenance of consumer confidence in the industry. We acknowledge that the Government might have to provide funding for the depositor protection scheme in case of a systemic difficulty, but a single bank—this is a lesson for the future—should not require Government support. We must put in place a mechanism to ensure that.

It could be said that this is not the time for banks to pay into such a fund. The hon. Member for Sevenoaks (Mr. Fallon) and myself went to the United States in December—[Interruption.] We did so with the approval of the entire Committee, to talk to the Federal Reserve, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation and others, and we took the opportunity to meet the American Bankers Association. I felt that the ABA would disagree fundamentally with us about a pre-funded scheme, but it encouraged us with respect to such a scheme, saying that it was important for consumer confidence. The support of such an organisation, which represents American banks, is a big plus in terms of having a pre-funded scheme.

I have listened carefully to what my right hon. Friend is saying, and having read his report, I understand the rationale. However, will he make it clear whether he is referring specifically to the proprietary banking sector, or would he include the mutually based building societies in such a scheme?

That is still to be worked out. We are looking at the banking sector at the moment, but the Government’s consultation is open on that matter. I suggest that my hon. Friend contributes to that process, because I know that he is interested in the mutual sector. The Committee suggests that the Government provide initial funding through a loan that the banks pay back as they become less constrained. There is a role for Government in the process.

The report, “Financial Stability and Depositor Protection”, is out for a consultation exercise, and it is clear that the Government and the Committee agree on a number of issues. The first thing we agree on is the need for a prompt, corrective action system. If such a system were in place, it would prevent a failure in the first place. Secondly, we agree on the need for a bridge bank authority, which would allow failing banks to be taken into public ownership and allow them to be let out of that ownership, as and when it was convenient. That system exists in America, and it works very well.

Does my right hon. Friend agree that there should be some control or regulation over non-executive directors of banks? In the case of Northern Rock, the chairman’s only qualification seemed to be the fact that he was the son of Viscount Ridley. The problems that Northern Rock experienced call into question the role of some of the non-executive directors.

The prompt corrective action mechanisms should take care of that. I will not follow my hon. Friend down that lane, other than to say that the Committee recommended that chief executives and chairmen of banks should have professional financial qualifications, which the Northern Rock chairman and chief executive did not have. For the life of me, I cannot understand it, but it caused a bit of a stir in the City. It would be wise for a chief executive or someone who chairs a large company to have appropriate qualifications. The whole Committee made that point.

The communications strategy is another matter on which we agree with the Government. We welcome the Government’s commitment to that in the tripartite authority. If there had been a half decent communications strategy in place at the time, perhaps matters would not have worked out as badly as they did. When the announcement of lender of last resort was made, the City and the wider public interpreted it as the financial equivalent of the last rites and evidence that the company was on its death bed, instead of viewing it as the tripartite authority supporting a solvent bank with a good loan book, as the FSA and the Governor of the Bank of England said. The communications strategy was disastrous and the Government and the tripartite authority need to get that right.

Of course, banks are going to be solvent. Their problem, because of liquidity, is making their assets able to pay their deposits quickly enough. All banks that borrow short and lend long face that problem. Does the right hon. Gentleman agree that it is amazing that the FSA paid little if any attention to banks’ liquidity?

Given that the hon. Gentleman is an esteemed member of my Committee, I must agree with him. We took evidence on that matter—indeed, the Committee went to Sweden to examine the position there. There was a banking crisis in Sweden in 1991 and the state intervened. The Swedes did not suffer the same liquidity crisis as we did recently because they were aware of the problem. It was astounding that we did not plan for that. Neither did we have plans in place for adequate stress testing. The inadequate stress testing was another example of failure on the part of Northern Rock and the FSA. We need to put those mechanisms in place.

Let me consider the Government’s consultation. I make a plea to them not to allow the financial firms to dominate the debate. I say that in the light of Professor Buiter’s comments to our Committee. He said that the FSA regime could have become a “soft touch” rather than a “light touch” one. I do not hold with that point of view, but I do not want one sector to dominate. We must acknowledge that the banks have an incentive to keep the special resolution regime in the FSA rather than the Bank of England’s solution, which the Committee is examining.

The Committee approaches the recommendation from the angle of depoliticisation. Our proposals are intended to ensure that the Chancellor does not need to be involved in many of the decisions about failing banks, except when taxpayers’ money is at stake. The Government suggestion of a Cobra-style system may mean too much political involvement. In 1997, there were laudable reasons for moving the Bank of England and the FSA away from the Treasury. As regulators, they need to act in the overall best interests of markets and consumers, not politicians.

The Treasury Committee therefore disagrees with the Government about where the powers should reside. We believe that the new powers should reside not with the FSA but with the person who takes up the new post of head of financial stability and deputy governor of the Bank of England, and I shall outline the reasons for that. There is a need for creative tension and grit in the system. I remind hon. Members that the deputy governor in charge of financial stability was on holiday in France for a week in August when the financial turbulence occurred. That does not say much for application.

Secondly, when asked, “Did you do your job?” every one of the tripartite authority members who came before our Committee replied, “Handsomely.” But if they all did their job so handsomely, how did we end up in the biggest financial mess since 1880-odd? That is the question that perplexed the Committee. When we asked the Governor of the Bank of England who was in charge, he said, “Well, can you define ‘in charge’?” That indicated a real lack of leadership. If we do not get some grit into the system, we could find ourselves in the same situation again.

Some people will say that that would include overlap. Perhaps there will be overlap; but I would suggest that the tension created could be more beneficial than detrimental. Giving the FSA too much power emphasises the conflicts, but there is already a conflict. The FSA is in charge of prudential regulation, yet it is meant to support consumer interests. That is a conflict of interest. Added to that is the fact that the FSA has a role as regulator, yet also needs to find a private sector solution and oversee the special resolution regime. That is a bit like a surgeon who tells the people he is about to operate on that he has a part-time job as an undertaker, saying, “If the operation doesn’t go well, we’ll look after you well after that.” Let us look into those conflicts of interest and see whether we can get them sorted out.

Does the right hon. Gentleman agree that one of the main lacunae, which he has just identified, was the lack of practice, among the three members of the tripartite authority, of working together on what we identified in the report as war-gaming? Does he agree that if that had taken place, some of the grit that he would like to see might have been identified?

I agree with the hon. Gentleman entirely. Again, he is a member of the Committee and contributed greatly to the report. There were no war games taking place. Back in 1997, when the system was established, perhaps it was suggested that it would work because there were four individuals involved: the Governor of the Bank, Eddie George—Lord George—and his deputy, Howard Davies, and the permanent secretary at the Treasury, Terry Burns, and his deputy, Steve Robson. They all knew one other, and might have thought, “If anything goes wrong in the system, we’ll be able to sort it out, because Eddie knows Terry, who knows whoever else.” However, when the players change, the system must be robust, but it was not robust, so war games are an essential element in ensuring that it becomes so.

When the right hon. Gentleman’s Committee looked into the matter, did it come to any conclusion about what fair figures should go into the estimates for the actual costs incurred so far, for the contingent guarantees and for the cash costs of the advances, as it would help this debate very much if we had some figures?

That certainly would help the debate, but the Treasury Committee does not have inside information. All of us on the Committee have realised that if we overstretch ourselves, we can make fools of ourselves. We have not overstretched ourselves; therefore our report has been well received. I do not want to get into crystal ball gazing; what I am asking is for the Ministers on the Front Bench to fill in the blanks and to fill them in soon. Then we can have a decent debate on the issue.

To get back to my point about the overlap, some might say, “This is going against the efficiency in regulation over recent times,” but perhaps there is a push back from that. I remember being most impressed during my visit to Washington by the role of the Federal Reserve. There is overlap in regulation there, and we would not want to replicate that in this country. However, once the Federal Reserve has its eyes on something, people perk up and start to listen. One of the tragedies of the situation is that both the FSA and the Bank of England sent out messages to the financial community with their financial stability reports about possible problems in liquidity, but nobody took them on, because there was no mechanism for feedback. In our latter report on financial stability and transparency, the Committee said that those warnings needed to heeded at board level and that a message needed to go back to the FSA or the Bank from the board level saying, “We have looked at the situation.” So I hope that that step is taken rather quickly.

On the efficiency in the market, perhaps we have been overwhelmed by the benign economic conditions and there has been too much complacency in financial institutions to prepare for the bad times, as well as the good times, and the war games and other aspects relate to that. The Government have also said that the Bank of England will have a statutory responsibility, and the Government reforms call for the Bank to have that for reasons of financial stability. I suggest to the Government that that is all well and good, but what instruments are at their disposal to meet that statutory responsibility?

We need to fill in the individual responsibilities of the authorities, so that they stick to their mandates and so that, with the special resolution regime, we do not get into situations such as the one that we got into with Northern Rock. All that needs to be filled in, because future Treasury Committees could face problems in the financial markets and ask future Governors of the Bank of England why they did not fulfil their duty to protect financial stability, and I do not want them to be told, “Well, it’s because Parliament did not give us adequate powers to achieve it, and the FSA did not listen to us when we asked for action.” That is what the recommendations of our Committee are about.

This unanimous report has been well received, and it has cross-party support. The Treasury Committee was the first to the line when the crisis blew up. We have engaged the public in providing a detailed understanding of what went on, and I should like to find from today’s debate that that detailed understanding is translated into a detailed prescription, so that we never again have a run on a bank, as we had with Northern Rock.

I will not follow the Chairman of the Treasury Committee, the right hon. Member for West Dunbartonshire (John McFall), in a detailed analysis of what went wrong after the events at Northern Rock, although I want to add my tribute to the way that he led the inquiry and drove us forward to produce a report that has been warmly received, not just on both sides of the House but more widely in the City and beyond.

The debate today is timely. We are in a financial banking crisis, and I do not think that we are near the end of it. We see a loss of confidence in commercial banking, the freezing of the bond markets and, perhaps still to come, the probable unravelling of the carry trade. I start from the position that there is probably no financial crisis that the Government or politicians cannot, if they try, make worse. We should be extremely wary of every temptation to try, not least because not all but some previous regulations certainly contributed to our present discontents.

Basel I drove the search for yield off balance sheets. The Sarbanes-Oxley Act drove the search for yield across the Atlantic, fired up the City and all our financial services sectors and perhaps made every British building society consider itself the next Morgan Stanley. Some aspects of Basel II may well be unhelpful in binding the extremely conflicted credit rating agencies into the regulatory structure. The answer may not necessarily be instant, knee-jerk regulation.

It is just worth looking at the Government’s consultation paper. It comprises 29 proposals for new legislation, 11 different rule changes for the Financial Services Authority to consult on and a further 23 significant operational changes to the ways in which banks operate—plus a whole load of other stuff, dealing with Scottish and Irish banknotes or the composition of the Court of the Bank of England, which may not directly help us to unfreeze the bond markets but seems simply to have been stuck in there.

Of course, we have to deal with the failure of Northern Rock. Why did it fail? Who failed? The answer is that they all failed: senior management made mistakes and the non-executive directors failed to check them; the regulator failed to supervise the firm and the tripartite committee failed to keep it out of trouble; and the Chancellor at several key points failed to act promptly and decisively. Even so, I am wary of wholesale legislative reform.

The first general point—and our Chairman, the right hon. Member for West Dunbartonshire made it—is that regulators must do their job. The FSA did not do its job, as the report makes clear. Of 3,000 staff, only three were directly employed in looking at Northern Rock—the only significant UK bank without a London office. The ARROW—Advanced, Risk-Responsive Operating FrameWork—process, under which Northern Rock was supervised, was conducted once every three years; and the chairman and chief executive lacked any formal banking qualification. We should recall that this was one of the fastest growing UK banks.

Like the Chairman of the Treasury Committee, I do not necessarily think that we ought to be impressed by the need for tidiness. When we asked the tripartite committee how its members did their job, we found that, as the right hon. Gentleman said, they all liaised and consulted and all did their little bits. Some degree of regulatory overlap would be useful and, so far as the larger banks are concerned, I would like the Bank of England to be given some overlapping power, like the Federal Reserve, to go anywhere, see anybody and ask any questions.

Secondly, there are obvious gaps that need to be filled—for example, the special resolution procedure, where risk is systemic, and an easily understood compensation scheme for depositors. Those should have been put in place years ago; indeed, the Governor wanted them put in place years ago, and it is for the Government of the day to explain why they were not.

Thirdly, it is clear to me at the end of this inquiry that the Bank of England should be at the centre of all this. Of course I accept that the Chancellor has to authorise in the last resort the expenditure or commitment of public funds, but I believe that he should do so on the Bank’s advice and that the role of the Bank should be paramount. It is the Bank that should have overall supervision of liquidity; it is the Bank that keeps day-to-day watch on the money markets; it is the Bank that should have working knowledge of the bigger banks’ operations. That is why I would like to see the Bank of England with its authority restored as a properly independent central bank, not simply the interest rate-setting arm of the Treasury. In the end, it is the Governor—not the Chancellor and not the chairman of the FSA—who should be the ultimate guardian of our financial system. That is why our report proposes new ways to strengthen the Bank’s role.

Beyond that, there is plenty for the FSA to be getting on with to raise its game: greater emphasis on liquidity management, more transparency and much more rigorous stress testing, as has already been suggested. We may need to look much harder at the whole issue of external validation. It would be fair to say that the Select Committee was unimpressed with the role of the credit rating agencies, which seemed to us hopelessly conflicted. One credit rating agency had taken over £3 million in fees from Northern Rock alone.

We also looked hard at the role of the auditors. I do not understand how auditors can give a full, fair and firm opinion but exclude any treatment of the off-balance-sheet vehicles. I find it troubling that Northern Rock’s auditor earned nearly three times as much in non-audit fees—in consultancy fees—for arranging the securitisation of Northern Rock’s off-balance-sheet vehicles, as it did for the audit, which of course excluded them. I find that troubling.

I conclude by raising two wider but related issues. The first is what we mean by financial stability and the systemic risk to it, and the second is the extent to which we can still regard banks as market institutions rather than public utilities. When I posed the first question on Second Reading of the emergency legislation a few weeks ago, I did not get an answer. I think that we need one, however, so let me put it a different way. In the 1970s, the Soviet Union had financial stability and Hong Kong probably did not, but I know which market we would probably all prefer to invest in. Financial stability is something we all say we are in favour of. In Juvenal’s great phrase, “Laudatur et alget”—it is praised, but cold-shouldered. We say we want it, but we certainly are not content with it. We do not expect our bank to deliver it. We do not expect our pension fund to deliver simply stability. We do not expect our investment manager to deliver stability. We expect them, on the contrary, to search continually for better yield in this era of low inflation—to achieve higher than average rates of return, even as inflation disappears globally.

Indeed, if something then goes wrong with that search for yield, we do not restrain ourselves from trying to establish, as we heard from the Liberal Democrats, an attempt to prove regulatory failure. If we do not get the yield we expect—if something goes wrong and our investment seems to sink—our constituents will try to secure regulatory failure and then demand a form of compensation. That is why we have to be extremely careful about the concept of financial stability and how we define systemic risk to it, otherwise, there is no bank, no building society and no investment that can be allowed to fail if enough of our voters are committed to it. At the end of all this, I would prefer a definition of exactly which financial institutions are systemically important. I would like that defined, perhaps by the Bank of England in its financial stability report, but certainly by an authority independent of Government, not by shifting political calculations and emergency meetings of Ministers, so that it is clear to everybody which financial institutions cannot be allowed to fail and which ones still can.

The second related question is, what are banks today? Was Northern Rock, for example, really a bank? It had remarkably few depositors. It seemed to me much more of a finance house—a rather poor Tyneside imitation of Morgan Stanley—borrowing money from around the world and betting on future movements of interest rates. To what extent are all our banks and building societies really market institutions? Are they instead public utilities, still dependent on implicit public subsidies when they fail?

I am following the hon. Gentleman’s argument closely. Does he agree that the critical factor is the depositors? If the depositors and the need to protect them are taken out of the equation, we arrive at something that one could probably allow to fail.

That is certainly one way of defining it. Very big UK banks may be in the system which, for other clearing and operational reasons, one would not want to see fail. However, I think the hon. Gentleman agrees that we must have a clearer definition of what systemic risk actually is.

Is not the problem with defining which banks can and cannot fail that we are giving an implicit Government guarantee and therefore creating an unlevel playing field which those that do not have that guarantee will complain about?

They certainly will, but one starts from a position that includes the very large, major UK banks and works outward from there. I do not envisage the risk to be very large. What needs to be clear is that the House would be prepared to see the vast majority of banks and almost all building societies fail provided, of course, that the depositors were properly protected; otherwise, we will not have a market financial system at all.

Let us not forget that banks have been extremely profitable in recent years. Some of the British banks are world-class players. They have been extremely profitable for UK plc and for their shareholders, but they have also been profitable—very profitable—for their senior managers. That profitability, and some of the vast salaries involved, may now need to be priced a little more realistically. I should like the capital and liquidity requirements laid down for those banks to be readdressed. The House must never again be put in the position of suddenly having to commit more than £100 billion of public money.

There are lessons from Northern Rock. There are lessons for the regulator that failed in its duty, for the tripartite arrangement that could not deal with the consequences, and for the Government who fatally dithered; but, ultimately, there are lessons for us all.

It is important for us not to confine our thoughts about the future regulation of the British banking industry to an attempt to ensure that a crisis such as that at Northern Rock does not recur. There are more fundamental problems affecting the industry, along with its opposite numbers in Wall street and other financial centres.

It has been notable in recent times that the representatives of the British banking industry, whether appearing on television or radio or contributing to articles in newspapers—backed up by their supporters’ club consisting of most of the financial commentators—have been making very gloomy predictions about the economy, about profits, about jobs, about growth, and about the likely impact on taxation in this country. They say that it is all being caused by the credit crunch, but scarcely ever go on to acknowledge that they themselves are solely responsible for the credit crunch— the banking crisis that we face. Their usual targets when things go wrong are public sector pay, trade union militancy, alleged failures in public services, the national minimum wage, which they say will cripple the British economy, and part-time workers seeking security of employment, who will apparently ruin the economy. However, not even the failure of Northern Rock will damage the British economy in anything like the way the banks are damaging it.

The credit crunch—the financial crisis, the banking crisis, the international banking crisis—was caused because United States financial institutions lost fortunes on what, after things all went wrong, they started to call “sub-prime mortgages”, or, in plain English, “lending money to people who could not pay it back”, which has generally been frowned on by bankers in the past. Having lost their money, the banks packaged up the loans in new financial instruments with the wondrous title “collateralised debt obligations” and sold them on to a collection of mugs hitherto known as “international bankers”.

CDOs are rather like pre-prepared and pre-packaged supermarket salads, with different assets all chopped up and mingled together, but these packages contained very few genuine assets. The remaining elements were worthless, or rather worse than worthless: they were liabilities. A CDO was a bit like a pre-packaged Caesar salad in which there is one anchovy and all the rest is lettuce, apart from the fact that the package containing the salad is transparent. There was nothing transparent about the CDOs; however, they were sold on as top-quality and bought by idiots as top-quality, and the credit rating agencies invariably gave them triple-A ratings. They were risk-free. The banks bought them out of recklessness or stupidity, or perhaps they were deceived, but what is more likely is that they suffered from the worst form of deception—self-deception—and it is they who have got us into this mess.

On top of that, does my right hon. Friend agree that it is scandalous that most of the people who were arranging the various financial packages also took huge commissions?

They took huge commissions and in the case of some of the American banks when they lost, let us say, $15 billion or $20 billion the chief executive was asked to leave but was given $20 million to help him on his way, so there was in fact no punishment within the system, but there was a reward for grotesque failure.

My right hon. Friend assigns motives to the banks, but he has missed out one of them: greed. Does he not agree that the basis on which they bought these securities was that someone would be prepared to pay them more than they paid, so it was about simple greed? They were not interested in what was in the security. Instead, they were interested in only one thing: can I sell it on—or, in other words, can I pass the parcel and make a lot of money before the music stops?

I entirely agree, and I think the hon. Member for Sevenoaks (Mr. Fallon) made the same point in slightly different terms. It is clear that people were behaving like a collection of greedy lemmings. The problem with that is that it is not only they who go over the cliff; does everybody else. If I may mix my metaphors, the lemmings who go over the cliff have a $20 million parachute, but the rest of us go crashing down to the bottom without the benefit of anything to cushion us.

I do not accept the point the hon. Member for Sevenoaks made in comparing Northern Rock unfavourably with Morgan Stanley, however. Has Morgan Stanley done a good job in this situation, as it has lost $9 billion on sub-prime mortgages? By many standards, the people running Morgan Stanley were just as stupid, ignorant and greedy as those running Northern Rock.

Another problem is that no one knows what the real exposure is of any of the American banks that committed the original stupidity or the people who then stupidly bought up the liabilities thinking—apparently—that they were assets. Consequently, banks are now frightened to lend to, or borrow from, each other because they fear default as they do not know the extent of one another’s exposure.

Over the past couple of months, however, we have not been hearing from the paid representatives of the banking industry about this fundamental problem that threatens people all over the world. Instead, they appear on television shows to say, “Oh, wouldn’t it be horrid if we forced non-dom rich foreigners actually to pay some tax?” or “Oh, don’t make people who disguise their income as capital gains actually pay anything like a fair share of tax.” Those two issues, both to do with personal taxation, have been a godsend to the bankers because they have used them to distract everyone’s attention from the fundamental problems they have dragged us all into.

The banks have failed the global economy, the credit rating agencies fell down on the job and the monoline insurers failed in their job, so we now have the credit crunch. Sadly, the banking industry is not paying the price of its own failure. If people in other industries now lose jobs as a result of the credit crunch, it will be the fault of the banking industry—of the overpaid and greedy people who were running it worldwide.

I have been listening to the right hon. Gentleman’s tale of woe. May I make a few corrections? First, collateralised debt obligations and collateralised mortgage obligations have been around for 30-odd years. Secondly, they have allowed a huge number of home owners in the United States to have their own home for the first time—such people possibly would not have even dreamed of that 30 or 40 years ago—through the ability to transfer risk. The issue is not the quality of the product or the characters involved in that industry, but the pricing of the products in recent years and the extent to which the activity occurred. That is a fundamentally different question.

The hon. Gentleman has not changed the terms of the discussion one jot by that statement. The banks got it wrong and dropped every single one of us in it. It is a tale of woe, because some people will lose their jobs and have their homes repossessed as a result of what has gone wrong, and the banks should take responsibility for it. If the Chancellor has to raise taxes in his Budget on Wednesday, it will be the fault of the banks that messed up the British economy—[Hon. Members: “Oh, come on.”] Of course it will. Even the people who write in the financial pages say that the credit crunch will lead to problems for the Chancellor in raising the taxes he needs to provide public services.

That is why what happens to banking regulation is not just a matter for the banks or the political wing of the banking industry known as the Tory party. The issue affects everybody, and this time everybody must have their say about what goes on. The regulations must be in place in future to protect everybody, not just a charmed circle in the City. We cannot leave the debate about the future regulation of the banking industry to the failures who are running it now. Interestingly, they are exactly the sort of the people who talk about keeping the state out and not wanting the state to interfere. Apparently it is only the British state that they do not like, because some of them are going cap in hand to the Chinese communist state and its sovereign wealth funds, to the Singapore state or the Dubai state. No one in this country has ever been consulted on whether it is a good idea that major considerations about this country’s future banking policy should be affected by the interests of foreign Governments. Generally speaking, even the Tory party has been against that sort of thing, but it is what is happening.

We should not rush into a new regulatory system, because we need carefully to examine how we regulate the banking system. As my right hon. Friend the Member for West Dunbartonshire (John McFall) pointed out, we must have a system in which banks are allowed to fail. The basis of the competitive capitalist system is that people who get it wrong lose out and go down the pan. Our system is that when someone who produces useful IT equipment, builds ships or runs a road transport system gets it wrong they go broke and lose their job, but when someone in banking does the same they do not go broke and do not lose their job, and when someone at the top of the industry loses their job, they get a huge pay off thank you very much. We need a system that allows banks to fail, apart from in respect of depositors. We do not want a system containing 1 million loopholes—that is what this House, for at least the past 30 years, has managed to create in relation to banking regulations.

In a mostly excellent speech in the Northern Rock debate, the right hon. Member for Hitchin and Harpenden (Mr. Lilley) said:

“No Spanish banks have any of the problems”—[Official Report, 19 February 2008; Vol. 472, c. 206.]

That is because Spanish banking law—not an old Spanish custom that appears to prevail in the City of London, but the new Spanish banking law—will not allow banks not to consolidate off-balance-sheet debt. Spain’s new law requires that all debts and obligations be consolidated, recorded and transparent. Lo and behold, the Spanish did not get substantially involved in mad mortgages in the United States.

I gather from the Financial Times that the Spanish law has another merit. It has a counter-cyclical arrangement designed to ensure that banks’ capital and lending capacity is not reduced during an economic downturn, and that excessive credit is not made available during an upswing. We might discuss what financial stability is, but by and large it is a sound idea for the economy as a whole. It seems that the Spanish system has been fairly sound, which might be why the socialist Government have been re-elected with a bigger share of the vote and more members of Parliament.

There might be better methods than those used in Spain, but certain aspects of the Spanish system might be of benefit if they were applied here. We certainly need to do better than we have in the past, and we need more effective regulation. What has gone wrong affects every family in the land. We hear a lot about choice, whether it is the parental choice of schools or patients’ choice of hospitals, but nobody has had any choice in this case. The banks have lumbered us all with this problem. None of us volunteered for it: the banks created it, and they need to be constrained and restrained if the interests of people in this country are to be protected.

We have a choice in the next few months. We can either rein in the banks so that they are never again allowed to drop us in it, or we can allow them to bring about the financial ruin of all sorts of people, companies and neighbourhoods. That is our choice—we either do it properly and get it right, or we let things stagger on. If we listen to the representatives of the banking industry, staggering on and feathering their own nest will still be their theme.

I start by congratulating the Chairman of the Select Committee, the right hon. Member for West Dunbartonshire (John McFall), and his colleagues on producing a timely and substantial piece of work. Perhaps most remarkably, given the wide dispersal of political views on the Committee, they reached a consensus while being hard-hitting. That was a substantial outcome.

Rather than go back over who said what to whom when, and who was to blame, it might be useful to be more forward-looking. I shall first ask some of the questions that I do not think the Select Committee asked, and that it certainly did not answer. I shall then turn to the policy implications of its conclusions.

There were two important sets of questions on which the Select Committee did not focus properly. The first was the nature of the assets of the bank that we have taken over. The major theme of the Committee’s criticism, which was right as far as it went, was that the bank’s managers and directors made one massive mistake: over-relying on international wholesale markets. The Committee stated that the Financial Services Authority was negligent in failing either to pick that up or, if it did pick it up, to do anything about it. That criticism is fair. However, the Committee largely seems to have taken at face value the assumption that the bank’s assets were basically sound. In paragraph 13 of “The run on the Rock”, the Committee approvingly cites a quotation from Mr. Sants, stating that Northern Rock had had

“high quality assets—there is no suggestion here that this is an organisation taking on poor quality assets”.

Northern Rock also got a glowing testimonial from the Governor of the Bank of England, who is quoted at some length. Among other things, he said:

“What I would say about Northern Rock…is that most of the staff that worked…on the lending side, all the evidence shows, did an excellent job in appraising the loans that they were making, and that they monitored very carefully and did not lend money to people who should not be borrowing from them. The lending side was handled extremely well.”

The issue is left there.

I wonder how that came to be accepted. I have worried about this from the outset of the Northern Rock affair. The worry centres on the so-called Together mortgages, which are one of the main products of the bank. We know that there are 200,000 of those out of 900,000, which is a big chunk. Those mortgages varied, but the basic principle was that they were well over 100 per cent. of the value of the property—they were usually something like 125 per cent. It seems that the bank was lending a fairly conventional 95 per cent. mortgage to its borrowers and adding on a 30 per cent. unsecured loan, which was typically £25,000. A lot of that happened when the housing market was at its peak last year.

I wonder how that could possibly have happened. The Governor of the Bank of England and the chief regulator concluded that this was straightforward and uncomplicated and that the assets were perfectly sound. That does not ring true. The Select Committee pointed out that managers were asked to undertake a stress test to see what would happen if house prices fell by 40 per cent. and concluded that the bank was safe and would have survived. I cannot understand how it could possibly have passed that test. Nothing we know about the bank leads us to believe that it would have survived that test, but it has become written into the orthodoxy that it was perfectly sound and secure.

Is it not correct that there are two separate items in the mortgage book? There are traditional long-term mortgages, and I know from once applying for a Northern Rock mortgage that they are very difficult to get. There was also the activity described by the hon. Gentleman. His point was backed up by my constituents who worked in the Sunderland processing centre; in the last 12 months, mortgages were being given without any reference to payslips or anything else simply to get the market share up, which was Mr. Applegarth’s key thing to boost the share price.

The hon. Gentleman makes exactly my point, but he has developed it in a very helpful way.

The way that some might look at it is that what matters is the person’s ability to pay the interest and to repay the capital. As long as they do not lose their jobs or mess up their family budgets, it will be quite possible for them to service those debts and repay them even if house prices have fallen. I understand the hon. Gentleman’s point that it is not helpful because the security is undermined if there is a big reduction in the market value of properties. In such conditions, it is more likely that people will lose their jobs, but 40 per cent. of the mortgages will not go wrong just because house prices have fallen by 40 per cent.

That is a helpful correction. However, the point in answer to both the right hon. Member for Wokingham (Mr. Redwood) and the hon. Member for North Durham (Mr. Jones) is that we now know that over the past few months the Northern Rock management has refused to accept any individual voluntary arrangements. Northern Rock is the only bank that has refused to do that. It is clearly worried about the security of the people who have been lent to. There have been complaints from the Insolvency Service that that is bad practice and against policy. Northern Rock is the only bank that is taking that extremely aggressive approach towards the people who have borrowed from it, as it is worried about conditions such as those described by the right hon. Member for Wokingham.

We also know that whenever borrowers have got into any kind of difficulty—for example, when they have failed to make one month’s mortgage payment—the bank has immediately come in to get a first charge on the property. That behaviour is much more aggressive than that of any other bank around, so why is it doing that? There is clearly a lot of worry in the bank about the quality of its assets.

The question then arises of what happened to all those mortgages. The answer is that we do not know. They may have been dealt with entirely separately, as the hon. Member for North Durham said. One possibility is that they were bundled together and sold, through the Granite vehicle, on the market. A more likely possibility that follows on from what the hon. Gentleman said is that the mortgages were separated, with the good, traditional mortgages being sold off through Granite—sold through intermediation into markets—and all the unsecured loans being left behind in Northern Rock, which is now a nationalised bank. If that is what happened, the outcome is worrying. It has been worrying all along, both when Northern Rock was nationalised and when it was not, but that is what we are left with.

I have been trying to secure a proper, independent audit, as have hon. Members from different parties. Clearly, the FSA failed in that task. We need to get a proper understanding of how good the assets really are. The honest answer is that we do not know. I hope that the Select Committee goes further into the issue in future.

I agree with much of the hon. Gentleman’s careful analysis. He made the point that ultimately we do not know the quality of the asset book, but he suggested that the fact that Northern Rock was being very aggressive in relation to arrears was somehow a reflection of poor security. It may actually be a reflection of good market practice; it may be ensuring that it protects its interests. That may reflect well on its approach for the future—a subject that I am sure he will come to later in his speech.

It may well do so, and as we now own Northern Rock, it may be protecting the taxpayer by taking that approach. None the less, an awful lot of people in distressed situations are being treated far more harshly by the bank than other borrowers. We simply have to take note of that. The hon. Gentleman is quite right: we do not know the answers, and I hope that the Select Committee will go further into the subject.

There is another set of questions to which we still do not really know the answer. They are about the Granite vehicle. As many hon. Members will remember, the issue surfaced in the last stages of debate on the Banking (Special Provisions) Bill. The Select Committee refers to the issue in its report, and it obviously heard evidence on the subject, but there are big outstanding questions about what is really going on and how Granite will operate in future.

My first major group of questions is: what are the circumstances in which the Granite vehicle will have to be topped up in future with new mortgages from Northern Rock bank? How will that happen? What mortgages will go into it, and what is the scale envisaged? How will that affect the nationalised company that we have acquired? The other question that I have is: in the documentation relating to Granite, what is meant by the “pass-through event”? I have no idea what the phrase means, but it refers to circumstances in which Granite is effectively closed down and has to pack up. Presumably, in those circumstances, the bondholders lose their money and a complicated set of legal and financial processes are engaged. I hope that in its future work, the Select Committee will help us to understand the issue, because the Government have not been very enlightening and the Select Committee does not say much on the subject.

Those are two sets of questions that we ought to pursue further. Then there are the policy issues that arise from the Select Committee’s work. The Committee is rightly damning about the FSA, but I am left asking, “What does it mean for the future of the FSA and the way in which it carries out regulation?” If it has been excessively indulgent in supervising the bank, what will it do in future if it sees banks behaving in a rather high-risk way? Is it supposed to intervene to stop them immediately? Is it supposed to issue a formal instruction, such as, “You must stop lending”? Is it supposed to have a quiet word in the ear? In future, will much more explicit, complex, prescriptive rules be applied to banks through the regulator, as the hon. Member for Sevenoaks (Mr. Fallon) suggested, and will we have a much more regulated system? If the system were much more regulated, what would it mean for the concept of banking as we have traditionally known it? Banking would then become much more like supplying electricity and water; very tightly controlled conditions would apply. That raises the question of what the banking system is for—something that the right hon. Member for Holborn and St. Pancras (Frank Dobson) mentioned. It is fine to criticise the FSA and its failures of regulation, but I am still not clear what the implications of doing so are for the way in which the FSA operates in future.

The second set of recommendations by the Select Committee, and probably the most important, relate to deposit protection. There is general agreement that there must be proper deposit protection, that the American model in general is the best available, that it must be, in practice, 100 per cent. protection up to a limited sum—£50,000 seems about right—and that that is the direction in which we will proceed. I have one worry about that, which was not dealt with by the Select Committee; that is, what happens to competing institutions, such as insurers, who do not have the same quality of compensation? They are competing with banks in many respects. There is the outstanding problem of Equitable Life, whose investors were just as exposed as investors in Northern Rock and who have not been compensated and presumably will not be. Why should one set of financial institutions have a fundamentally different type of compensation mechanism from others?

The hon. Gentleman referred to the US style of deposit insurance enacted by the Federal Deposit Insurance Corporation, which was mentioned earlier. Is he aware that the system in the United States is not exactly parallel, and that in the States there are still more than 1,000 deposit-taking institutions? Some of those are very small, and the concept of deposit insurance may be far more relevant—for example, at the Montana state bank—than it would be at Lloyds in the UK. The hon. Gentleman is comparing apples and oranges. There is a case for deposit protection, but the US example is not quite all it is made out to be.

If the banking industry in this country develops in the way that it could develop and as some of us feel it ought to develop, which means becoming much more competitive and having a much wider range of deposit-taking institutions, the models would become closer and the analogy would be more directly applicable.

In the States, the movement is more in the opposite direction. As banking consolidation happens in the States, more and more people are questioning the need for the FDIC to be there for very large institutions.

No doubt we could continue this conversation all afternoon. The one conclusion that we drew from the events of last year is that if there is no such structure, the old system of compensation was not adequate, partly because it did not cover 100 per cent. but more particularly because it was not timely—the payouts were not rapid enough. That is the lesson that was learned, and my understanding of it is that the American system is much better in that respect. Clearly, there are differences and we should be careful about blindly copying that system, but I am trying to make the more general point, reinforcing the views of the Select Committee.

If the problem of compensation can be resolved or the answer improved, one of the options to look at is what the Department of Trade and Industry, as it then was, used to do with insurance companies when it was the insurance regulator. If it felt that an insurance company was over-trading or not liquid enough, it would stop it writing all new business and put the company into run-off, which meant that the assets and the liabilities both had to be managed in the interests of all the counterparties to try and salvage as much as possible.

We are talking about slightly different things. Is not the purpose of deposit protection to prevent a panic run on the industry? That is what it is designed to achieve. The right hon. Gentleman is right in saying that if the institution itself gets into difficulties, there are various ways of handling it, including closure. I entirely understand his point.

The third set of questions that arise from the conclusions of the Select Committee are about how banks should be regulated in the broadest sense of liquidity. There was an interesting passage in “The run on the Rock” which I had not understood previously, about what happened when the Northern Rock bank managers discovered that they had excess capital—that they had over-complied with the capital adequacy requirements. As I understand it, they simply blew it on a big payout to their shareholders.

That raises the question what those capital adequacy ratios are for. Common sense suggests that in a boom period, as those bank managers were, with a massive expansion of lending and a booming housing market, the requirement should have been tightened rather than relaxed. Similarly, a period like the present, when the market is going down, should be the point at which it was relaxed. I ask, and I do not know the answer, whether it is possible to design a system that is counter-cyclical, and whether that is compatible with the rules of the European Union, under whose auspices these institutions now operate. That is the kind of mechanism we should consider.

Albeit from different standpoints, the right hon. Member for Holborn and St. Pancras and the hon. Member for Sevenoaks have both asked what banks are for in the new world and what they should look like. Mr. Don Cruickshank raised those questions seven or eight years ago, when he pointed to the apparent anomaly that the industry is ultimately underwritten by the state but makes well above average profits in terms of the rate of return on its capital over a long period of time, which, from his point of view, is unacceptable.

There are two ways to resolve that situation. The first is to treat the banks as utilities by making them highly regulated and highly controlled. That would directly or indirectly control their profits, which is what the right hon. Member for Holborn and St. Pancras wants. The alternative is to say that provided deposits are protected, the banks should compete and the industry should be treated like any other. I am more sympathetic to the latter approach, but getting there will be difficult. We need a clear understanding and commitment from the Government and the Financial Services Authority about which of those two models they are going for, because simply adding a new layer of regulation to the existing system will not help.

I understand the hon. Gentleman’s point, but it assumes that if banks were allowed to go broke, subject to looking after the depositors, they would behave differently without further regulation of their activities. I am not confident that that is the case in view of the number of apparently reputable banks that have lost a fortune either directly or indirectly in the sub-prime mortgage scandal in the United States.

If some of the banks were to go bust, lessons would be learned. Historically, banks, like any other set of companies, have short memories, so the pattern returns after a generation. However, I take the right hon. Gentleman’s point.

I am delighted to contribute to this discussion as the Member of Parliament for Norwich, South, where 25 per cent. of my constituents work in financial services. I must also point out that the headquarters of Virgin Money, which was directly involved, is in my constituency.

I begin by paying tribute to the report, which is first class. In particular, I pay tribute to my right hon. Friend the Member for West Dunbartonshire (John McFall). The Committee has done an outstanding job on both the principal report and “Financial Stability and Transparency” by clarifying the issues, which will hopefully enable us to avoid problems in the future.

The main reason why I want to contribute to the debate is to support the banking reforms proposed by the Select Committee in paragraphs 314 to 317, which deal with the role of the proposed deputy governor and head of financial stability. I support that role, which is the right way forward. Before I discuss those reforms, however, I want to discuss one or two other specific aspects of the report.

On moral hazard, the report describes the controversy among senior people in the world of financial services about the extent to which moral hazard should or should not be taken into account and dealt with. I am nearer to the view expressed by the Governor of the Bank of England, even given all the proposals, that moral hazard is a real factor. That relates to our earlier debate about the responsibility of shareholders and of businesses for business practices. The right hon. Member for Holborn and St. Pancras (Frank Dobson) and the hon. Member for Twickenham (Dr. Cable) discussed the responsibility of considering mortgages in terms of the sub-prime issues. It would be a serious mistake to relax the regulatory obligation, and indeed the competitive obligation, on financial services businesses to be responsible in their practices, and we should have mechanisms to make that clear.

As the report indicates, there are failings in the existing system. The responsibility of the institutions to their shareholders is not at all clearly set out, and many shareholders are simply ignorant of the business practices that were there. But fundamentally, despite the real sadness for many small shareholders who owned shares side by side with major hedge funds, the report’s comments on financial stability and transparency indicate the range of issues and the importance of companies taking responsibility for their own acts.

I accept the report’s recommendations about the need to protect depositors better; a number of other contributors to this debate have referred to that. At the beginning of all this, there was insufficient clarity about the importance of protecting the depositor in contrast to the importance of the role of the shareholder. That is an important distinction that the report brings out well, but it was not brought out so well during the public debates at that time.

That brings me to my second point, which is about the role and effectiveness of the Financial Services Authority. I do not have a great deal to add to what the Treasury Committee Chairman said, except to emphasise the point that it is the key role of the FSA to offer proper judgments in matters such as this, rather than simply going through process and procedure. The report mentions two aspects—that of the rapid expansion of the business and that of the declining share price of the company. They should have made the FSA judge more carefully what was happening in the organisation. The hon. Member for Twickenham referred to the quality of assets in relation to such issues. The FSA has learned lessons from this whole debacle, but the fact is that it should not have needed to learn them from a debacle. The lessons should have been learned before.

Thirdly, I want to comment on what the report calls

“the support operation and stopping the run”

and on the ability to plan to deal with such crises. It is clear that the tripartite system did not work as it should have. Paragraph 280, on the overall operation of the tripartite system, and paragraph 289, which is about the communications system in particular, are powerful and, to an extent, damning. I hope that the Government will deal with them fully in their final response to the issues.

Essentially, there is a serious criticism of the preparation and work that were done. I hope that the contrast that I draw will not seem too extreme: my experience as Home Secretary in the period of the 7/7 disaster—the explosions in central London. Whatever the causes and circumstances at that point, tremendous, fully prepared emergency service co-operation immediately came into operation, as I and the current Chancellor saw from close by. That co-operation involved the taking of responsibility and a clarity of command and control issues that was impressive to see.

I shall give an illustration from the communications side. Some hon. Members may recall that early in the afternoon on that 7 July, there was a major press briefing in which all the services spoke together to the country. They said, “This is what we are doing and this is how we are dealing with the circumstances.” The key point, shown so well when contrasted with the run on the bank, is that the people themselves were players in the events as they emerged. It is critical to communicate effectively with people. The report has drawn that point out well. As I said, there are serious points in paragraphs 280 and 289. It is important that the Government give a lot of attention to those in their response; I am, by the way, absolutely sure that they will.

My fourth and main point is about the section of the report entitled “Dealing with failing banks”, which addresses some of the criticisms made by the hon. Member for Twickenham. The section says that the FSA has to find a way of dealing with issues of the type that we are discussing and change its practices and procedures. The section tries to address those issues. It makes a whole string of proposals in respect of an improved legal framework and procedures. I broadly support those, and the Government have already constructively responded to them to try to find the right solution to the problems.

The section also deals with the question of the European Union market abuses directive, which I found confusing at the beginning when evidence was given to the Committee but which is now fully explained in its report. I want to add the rider that in the modern era it is almost impossible to try to run covert operations in relation to this area. One can see why that was how it worked as recently as 20 or 30 years ago, with the tradition of the Governor of the Bank summoning all the players into a quiet room somewhere in the square mile and saying, “We’re going to sort it out like this, this and this.” However, predicating a system on the operation of such a covert system is very difficult to achieve, irrespective of the detailed formulation in the market abuses directive or in other legislation, and the Committee was right to acknowledge that.

I particularly want to reiterate the point made by the Chairman of the Select Committee when he called for leadership in these matters. If the command and control systems are to be got right as between the various aspects of the tripartite system, if the preparations are to be got right, and if there is to be an authority that means that financial institutions, Government agencies and so on will operate in a co-ordinated way, that requires leadership and authority that people accept, and no ambiguity of any kind about where the buck stops in such a situation. That is why the Treasury Committee is right to recommend, as it does in paragraphs 314 to 317, the establishment of a new post of deputy governor and head of financial stability.

There can be arguments about how that is carried through in detail, what is precisely the right way to do it, and whether the Committee has got it right in every aspect of those paragraphs; I do not commit myself to the specific detail on each point. However, there should not be argument about the need for an individual who is responsible for taking decisions in this field—someone who is publicly known to be responsible and to whom people, including the Chancellor and Prime Minister, will naturally turn for advice in these situations.

I mean no disrespect to the FSA in saying that I fear that if the FSA is chosen as that vehicle, the individual concerned will not have the authority that would go with the role of a deputy governor of the Bank of England. I know that it is a difficult question and that there are plenty of arguments to the opposite effect. However—I have talked to the Chairman of the Select Committee about this—the reason why I was keen to speak in this debate was that I wanted to lend my support to the Committee’s proposals. In such circumstances, when we are dealing with potential crises that can be deeply destructive of this country’s economy and political structure, we need clarity, and that is what it recommends.

On the overall position, although I was personally extremely sceptical about the possibility of a private sector solution to these events as they emerged, I am sure that it was right to look, even briefly, such solutions. Nevertheless, I have been of the view from the very beginning that public ownership and rundown was the best strategy, and I am concerned that leaving the key question—“rundown or going concern?”—as an open matter will make it more difficult to resolve the situation than in other circumstances. The principle of a level playing field for all financial services institutions guarded by the institutions of the state, the law, EU law and so on is very important for all the people who have investments in a wide range of financial services institutions. There must be no question of one particular financial services institution being picked out for public sector support in contrast to others. That is a controversial point, but I think that it is what will, and should, ultimately emerge out of this state of affairs, and it is where we need to go in future.

I look forward to the Government’s response to this excellent report. I hope that the Select Committee will continue to give attention to these matters and will consider one or two of the questions raised earlier in the debate.

This has been a very interesting debate. My hon. Friend the Member for Sevenoaks (Mr. Fallon) was absolutely right to identify the need to avoid at all costs the knee-jerk reaction of rapid regulation that might unravel and be regretted in future. That was implicit in the Treasury Committee’s report.

The right hon. Member for Norwich, South (Mr. Clarke) made a very interesting contribution, drawing a parallel with the events of 7/7, when he was Home Secretary. It would be difficult to have the clear command structure among people in financial services that there was for the armed and emergency services on that day. It is a little idealistic to assume that we could put such a structure into place, however it worked. The Select Committee and the Treasury will continue to debate the issue.

There have been more spectacular banking crises than the one that affected Northern Rock in recent months. The phenomenon of a run on a bank was, after all, almost commonplace in Victorian times. More recently, the collapses of Bank of Credit and Commerce International in 1991, and of Barings only 13 years ago, show that even a highly regulated banking sector is never immune to mismanagement or to fraudulent activity. The fiasco of Northern Rock is a modern-day, sorry catalogue of poor judgment and woeful indecision.

I agree with relatively little of what the right hon. Member for Holborn and St. Pancras (Frank Dobson) said about the City, but some elements of his comments were right. Certain enormous incentives for the banking industry have allowed some of the problems that have emerged in the credit crisis to come into play. It is not for the Government to regulate on the matter entirely, and the right hon. Gentleman recognised that implicitly, but some perverse incentives in the banking industry have contributed in bringing us to this pass.

Some have been keen to point the finger of blame entirely at the actions—or inactions—of the Treasury and especially at the erstwhile Chancellor of the Exchequer. In truth, responsibility for what happened at Northern Rock should be more widely spread. First and foremost—it was absolutely right that the right hon. Member for West Dunbartonshire (John McFall) referred to this—the senior management of the Bank, in particular its former chief executive, and the array of non-executive directors bear some responsibility. Collectively, they should have realised that the aggressive growth in Northern Rock’s turnover strategy depended on continued economic blue skies and liquidity in the money markets. Northern Rock’s strategy was so diametrically opposed to those of its competitors that alarm bells should have been ringing about its sustainability among the well-remunerated non-executives—a roster that included some well-known City names.

Once the credit crunch hit in early August, the Bank of England should have been far more fleet of foot. Reference has been made to the role of the Financial Services Authority, but I believe that the Bank of England was at fault to a certain extent, particularly with regard to its amenability or otherwise to Lloyds TSB’s proposal to take over Northern Rock before the public became aware of the nature of the crisis. That would, no doubt, have required substantial Treasury guarantees, but UK taxpayers would almost certainly have been in a more favourable position than the one in which they find themselves now, several months on.

One of the biggest, longer term casualties of the whole affair will be the Governor of the Bank of England, who has played an important part in overseeing this debacle. His credibility in the City has been severely damaged, and it is difficult to see how he would be the right man to lead any restructuring of the Bank of England, which is my party’s preferred approach.

This episode, coupled with the rapid internationalisation of the ownership of financial institutions in the City, puts into perspective some of the harking back to the pre-1997 arrangements. The City is a club no more and the Bank of England’s role as judge and jury is probably best confined to the past. Meanwhile, as a number of hon. Members have pointed out, the Financial Services Authority lacks clout and respect among leading City institutions, meaning that banking reform should be informed by 21st century requirements, rather than by a return to some bygone era.

We must remember, however, that the difficulties for Northern Rock did not start last September—they only became public in that month. Once the crisis was out in the open, queues began to develop outside branches of the bank. At that stage, the possibility of an autumn general election, and the fact that the bank was a large, almost iconic employer in Labour’s north-eastern heartlands, resulted in a catalogue of ill-advised Treasury decisions. To a large extent, this crisis was driven by political considerations, which has not been helpful. I accept that simply allowing Northern Rock to collapse was never an option. As the right hon. Member for West Dunbartonshire said, banks are different from other companies in that they have depositors as well as shareholders. Although the value of a shareholder’s investment can, in principle, be allowed to diminish to zero, the entire competence of the banking system depends on banks’ depositors being assured that they will be compensated—in my view, fully—in the event of a collapse.

I know that the hon. Gentleman genuinely and firmly holds his view about politically inspired decisions. I would like to understand his point, which I do not think that he makes flippantly, but it would be interesting to know which decisions he thought were wrong and politically inspired.

And whether they were supported by the Tory party. [Laughter.]

Order.

I shall try to make this a solo rather than a duet.

It is fair to say that, when the crisis emerged—I admit that it informed some Conservative policies, too—we were in the cauldron of a likely pre-election campaign. Consequently, we went down another path when we might have moved more quickly to nationalisation, which, many people realised by November and December, was definitely on the cards. I have some sympathy for the Government’s position. They wanted to look for a private sector buyer and perhaps they looked for too long. There was also an implicit recognition that, when we had come to such a pass, things would not get better and were, indeed, likely to get worse. However, in those few weeks in September, decisions were driven by a political agenda. I am not necessarily being naive; a political agenda has its part to play at any time, but let us bear in mind the potential imminence of an election and the fact that the building society had great strength and roots in the north-east of England—perhaps if it had been in the south-east of England, there might have been less of a rush towards Government activity.

Is not that a bit unfair? The institution was not simply a northern bank but a bank with queues outside the door, and there was a genuine fear that other badly placed banks would be caught up in the contagion. That made the Government take action. The decision was nothing to do with northern heartlands; systemic risk brought it about.

There is some fairness in that, and I discussed systemic risk earlier. The agenda of a 24/7 media makes things difficult. The media got hold of the problem with floods not when they occurred in Hull and Sheffield but when they affected holiday homes in the Cotswolds. Suddenly, floods were a massive national issue in a way they might not have been previously. That reflects the media timetable.

What decisions by the FSA, the Treasury or the Bank of England were influenced by political considerations?

The hon. Member for West Bromwich, West (Mr. Bailey) must be proud of his football team’s success at the weekend, although there is a heavy match against Portsmouth in the FA cup semi-final to come. [Interruption.] I am trying to show that I have some knowledge of culture, media and sport, if not necessarily of Treasury affairs. However, I have tried to make the point that there was feverish activity in September and October, when, without the perceived imminence of a general election, more long-term decision making might have occurred.

I am grateful to my hon. Friend for allowing me to offer him a suggestion. The decision not to advance a lender of last resort facility to the one credible private sector bidder that made overtures about acquiring the bank in August and up to the first week of September could be described as a political decision by the Chancellor.

That is fair to say about one of the Chancellor’s many minor decisions.

The “temporary” nationalisation of Northern Rock has been forced on the Government as an implicit recognition that, economically, things are likely to get worse in this country before they get better. No one should assume that uncertainty in the financial markets is a short-term phenomenon. Speaking to people in the City, I have detected that whereas confidence was renewed in January and early February, there has been a recent slump in confidence, although I appreciate that much of that can ebb and flow. However, there is little doubt that it will take less than five years at the absolute minimum for taxpayers to extricate themselves from Northern Rock without net losses.

The Government should be resolute in resisting the claims of shareholders for compensation. That applies particularly to the hedge funds that piled into Northern Rock stock in the autumn hoping for quick speculative returns. They gambled and they lost. Regrettably, however, we cannot draw distinctions among the different classes of shareholder, however much we might wish to protect the interests of small, loyal Northern Rock investors or former employees and suppliers who may have held stock for some years. No more taxpayers’ money should be expended on bailing out Northern Rock shareholders, beyond that which will be determined by arbitration.

Hon. Members in all parts of the House in the months to come will doubtlessly be inundated by pleading on behalf of well orchestrated, high profile shareholder groups, as they battle, perhaps even in the courts, for compensation. The temptation to make common cause with such groups should be resisted. We now need to give the new chief executive, Ron Sandler, the breathing space to make plans for the future that are economically viable, rather than simply politically expedient. The likeliest and wisest way to proceed involves the parcelling and sale of parts of the Northern Rock business, as market conditions allow in the months and, potentially, years ahead.

There is no easy fix. Politicians need to appreciate that if taxpayers are to stand a realistic chance of recapturing their guarantees and loans in full, we almost certainly face a long haul.

I, too, congratulate the Treasury Committee on its work—as I am not a member of the Committee, perhaps I am better placed to do so. It produced a comprehensive report on a detailed and arcane subject, which was not made easier by the fact that the issues were unfolding as it did its work. The nature of the Committee’s conclusions does it great credit.

Before coming to the substance of my remarks, I should like to declare an interest. I am chair of the all-party group on building societies and financial mutuals and make my comments as a committed supporter of the building society and mutual sector. However, although I am predisposed towards the sector, I recognise that companies in the financial services market are extremely important and that they complement the building society sector. It is in the interests of the consumer that the public have confidence in both sectors.

In 2005 and 2006, the all-party group conducted an investigation into the consequences of demutualisation for building societies, in a report called “Windfalls or Shortfalls?” The purpose of our investigation was to find out exactly what benefits, if any, had arisen from demutualising and who had enjoyed them. I will not go into the full range of our conclusions, except to say that the advantages that building societies enjoyed in not having to pay dividends to their shareholders was passed on to the consumer, hence building societies tend to dominate in the best value tables.

Interestingly, the one company that stood alone and bucked the situation was Northern Rock. In its evidence to the Committee—it did not give verbal evidence, but it sent a letter—its deputy chief executive, David Baker, said:

“Since 2000 we have been able to tap into Residential Mortgage Backed Securitisation markets to fund a growing proportion of our lending.”

He gave a figure of about 37 per cent. by 2004. He continued:

“These funds have been raised increasingly abroad in Europe, USA and more recently in the Far East. Our wholesale funding had followed a similar trend and about 75 per cent. of all our new funding is now raised abroad.”

He went on to say, most conclusively:

“We do not believe this would have been possible had we been a mutual building society.”

In view of the consequences of the model outlined by David Baker, I am sure that investors in building societies throughout the country will be profoundly relieved by that statement, and I emphasise it because it is of particular importance that there are regulatory obstacles to building societies funding a proportion of their lending through the wholesale market. That has provided a protection and security to building societies that has not been so evident in the banking sector.

Does the hon. Gentleman not remember a Bill that received Royal Assent last year at the behest of building societies to increase the proportion of funding that they could get from wholesale markets?

I well remember the Bill; indeed, it was proposed by an Opposition Member, and I supported it in the Chamber. The Bill allowed greater flexibility to be exercised, but it also introduced an FSA regulatory process for wholesale lending to building societies, and it was never envisaged that that would reach the 75 per cent. proportion that was evident in Northern Rock. Whereas the situation is more relaxed for building societies than it was before that legislation, regulatory restrictions still apply to the amount that building societies can borrow from the wholesale market.

Northern Rock—its staff almost boasted of this—had “an extreme business model”, to use the FSA’s phrase. As I have said, it was disproportionately wholesale-funded. There was an absence of suitable insurance, and there was no plan B—no stand-by facility, whereby alternatives could be found if the existing sources of funding dried up. Ultimately, the blame for that must lie with the directors—the chairman, the chief executive and the non-executive directors—because they alone had devised that model, and in doing so they knew that they could aggressively seek new mortgages. The hon. Member for Twickenham (Dr. Cable) outlined some of the mortgages that they boasted of securing. Again, they boasted about them in the evidence that they gave to the building societies group. The fact is that they were using a model to borrow money to lend aggressively in mortgage packages that were somewhat doubtful and the sources of which were very vulnerable.

I mention that in particular because we have all been subject to shareholder pressure to get Government compensation. Indeed, one of the issues that must be examined is that of the Bank of England’s moral certainty and the belief that it should provide liquidity to underwrite bad business practices—or not. It seems to me that the fundamental stance of the shareholders is basically that it should, but the Bank of England took a hard-line position and it did not. My right hon. Friend the Member for Norwich, South (Mr. Clarke) supported that, as the issue of moral hazard is obviously crucial in the robustness of the banks’ business models.

Similarly, the Financial Services Authority has attracted criticism because although it recognised that the business model was extreme and inappropriate, it did not challenge Northern Rock either to change it or to provide an alternative source of funding, should things go wrong. Those areas of concern must be taken up in any Government inquiry in order to understand what regulation, if any, is appropriate to change that approach. Ultimately, when it comes to compensation and the role of the shareholder, it must be that the balance of culpability for this fiasco has to lie with the directors and the company. The public cannot be expected to underwrite either through the Bank of England or as taxpayers the business decisions of a board of directors.

What should be done? With a spectacular failure such as this one, there is a danger of issuing emergency regulations that are just window dressing and provide no substitute for dealing directly with the actual problem. The hon. Member for Cities of London and Westminster (Mr. Field) might not have said that the whole thing was political, but he did emphasise the role of political decisions. However, neither his answer to my intervention nor the intervention of the hon. Member for Ludlow (Mr. Dunne) provided a very convincing basis for making that allegation. In respect of the comments of the hon. Member for Cities of London and Westminster about the local football team, I should make it clear, speaking as a resident of West Bromwich, that I am a Cheltenham Town supporter—and my team was considerably less successful on Saturday!

We need to ask whether the existing regulatory framework is sufficient and whether the problem was simply the result of its not being properly applied. I think that there is considerable evidence to demonstrate that most of the regulatory framework was actually in place and, had it been properly applied, it might have prevented the problem. Comments were made earlier about the small number of FSA staff who were charged with dealing with Northern Rock. I note that it states in this morning’s The Times that five FSA members have resigned. It seems that there is a problem with staff turnover. How far that contributed to the lack of adequate monitoring and supervision of Northern Rock, I am not in a position to say, but it is obviously an issue that must be addressed. There is little point in implementing a whole set of new regulations if those fundamental problems are not dealt with at the same time.

The second question is about the Bank of England and the balance of responsibility on the moral hazard. The refusal to provide the necessary liquidity in the market is said to have contributed to the problems, but the Bank’s overall responsibility for the preservation of the robustness of the banking system has also been emphasised. I believe that there is a debate to be had about that.

Will my hon. Friend comment on the Bank of England’s behaviour in finding what every hon. Member in the Chamber thinks was the best solution—a market solution? Is there evidence of the Governor or any staff member of the Bank of England speaking to either of the two private sector firms that showed an interest in August, before the September collapse? Why is the FSA hit by such savage criticism when that sort of behaviour goes unnoticed and unquestioned?

My hon. Friend asks an interesting question. My understanding, bearing in mind that I was not on the Treasury Committee, is that there was conflicting evidence on that and that the Committee could not come to a hard conclusion. If the Committee, having asked people the questions, could not come to a hard conclusion, I hope that he will forgive me if I duck the issue. I do not know the answer to his question, but the subject is perhaps worthy of further investigation.

The Committee went on to propose a range of other potential regulations or policies that would help to prevent such an event from happening in the future. They include deposit protection, pre-funding and insolvency procedures. Those need to be examined closely and the industry needs to be consulted. I am a little concerned, however, that much of the source of inspiration for those—the hon. Member for Hammersmith and Fulham (Mr. Hands) raised this issue—is the American model.

I was given to understand that about 10,000 financial institutions carry out banking functions in America, many of which are much smaller than institutions in this country. As a result, insolvencies are much more common and a process for dealing with those has been developed. It could well be that good, hard lessons can be learned from the procedures implemented there, but I would be a little wary of assuming that we can necessarily graft on to our own body of regulation regulations that are derived from a totally different financial services market, which has a far greater number of players and many more smaller players. I mention that as a cautionary note.

I underline and support comments about a communications strategy. They were well made. In today’s communications world, with 24-hour coverage, intense speculation about the smallest announcement, moves or sub-text within a balance sheet means that a coherent position has to be taken by the tripartite authorities when a problem is obviously arising. That is one of the problems that arose between 10 and 17 September last year. As a result of not getting a coherent message, media speculation was rife. That reinforced the natural sense of concern and worry of the depositors in Northern Rock and was a contributing factor to the queues that lined up outside that bank. There may well be a need for new regulation. However, that regulation must be proportionate and focused on the institutions where it is relevant.

To return to my comments on building societies, I would not wish a body of regulation designed to deal with possible problems from a Northern Rock-style financial model to be imposed on building societies, which are based on a totally different model. The danger is that a new regulatory framework could be introduced that might be relevant to current circumstances but could prove a big problem for perfectly sound, well-run companies that have delivered value for money for, in some cases, hundreds of years

In what will be a tighter and an illiquid mortgage market, we shall need to find whatever means we can of assisting the first-time buyer. If we introduced a set of regulations that might involve making the liquidity position of a range of financial institutions considerably more difficult than it is already, we could be working against our wider social objectives. There is a balance to be struck. I hope that the Government’s consultation exercise will be deep and probing, and that the outcomes will reflect that balance. I hope that they will secure changes in regulation that are proportionate to the problem highlighted by Northern Rock without in any way damaging the wider financial services sector, particularly the building societies sector.

I pay tribute to the hon. Member for West Bromwich, West (Mr. Bailey). He made a powerful point, to which the Government would do well to listen, about the dangers of producing a system of regulation that might have prevented the problem we have just experienced, but would create new problems for very different sorts of building societies. I also pay tribute to the Treasury Committee and its Chairman, the right hon. Member for West Dunbartonshire (John McFall), for the valuable report that provides the substance for today’s debate. It is slightly surprising, however, that it is the only substance for the debate.

Last time we debated Northern Rock we rushed through legislation, having been told that it was essential to set aside the normal process of parliamentary scrutiny so that steps could be taken rapidly by the new management at Northern Rock which would bring about a new situation. We expected those steps to be taken rapidly, and we expected some illumination to follow, although we were not given it at the time of the nationalisation debate. We expected to know more about the competition rules and regulations, and the approach that we would have to adopt. None of that has happened. We could have had proper parliamentary scrutiny at the time, but we were denied it, not because of the needs of the business but because of the desire of the Government to escape the embarrassment of prolonged debate.

I do not intend to pursue that point, however. Instead, I want to examine some of the factors underlying the problem of Northern Rock and the problems of the banking system, both nationally and internationally. Let me begin by mentioning a mistake which is so basic that no one in the Chamber has made or would make it, but which was commonly made by many commentators at the time when Northern Rock’s problems were exposed. They said “The problem is that Northern Rock has been borrowing short and lending long.” Well, of course it had: that is what banks do. If it had not borrowed short and lent long, it would not have been a bank.

It is intrinsic to the nature of fractional reserve banking that banks borrow short and lend long. Banks tell depositors that they can have their money back on demand or at very short notice, but in practice only a fraction of the people who deposit money at any one moment want it back, so the banks need keep only a fraction of the money liquid and in reserve. In normal circumstances, they will be able to invest long-term in less liquid assets. That is the nature of fractional reserve banking, but it is also why fractional reserve banking systems, although stable in normal circumstances, are potentially and intrinsically unstable.

If everybody decides they want to remove their money—as they have the right to do, and as the banks have promised them they can—they cannot do so because the banks only have a fraction of the money on reserve. We can draw an analogy with bridges: if people walk over a bridge in the usual random fashion it might carry 1,000 people, but if all those people march over it in step, it will collapse. The banking system can operate if some people are putting money in and others are taking money out, but if they all decide to take money out, it collapses, as we discovered when people formed queues outside Northern Rock branches.

It follows that there are only two possible approaches. One is the extreme but rigorous intellectual one proposed by people such as Murray Rothbard, which I do not think has many supporters in this House—apart, possibly, from the right hon. Member for Holborn and St. Pancras (Frank Dobson)—which asserts that fractional reserve banking is intrinsically fraudulent and that it should not be allowed or sustained. As a result, banks would find that they had to keep 100 per cent. of their assets in liquid reserves and would cease to be fractional reserve banks. I would not propose that view, but if we do not accept it, we must instead have a lender of last resort who is prepared to step in and prevent a bank from failing if there is the remotest chance of that bank failure spreading to other banks and causing people to want to withdraw their money simultaneously—to march in step rather than put money in and take it out in the usual random fashion—and that must be accompanied by deposit insurance. I think that the Bank of England might momentarily have forgotten that intrinsically it has to operate as a lender of last resort, and have thought instead that moral hazard overrode that position so it had to let Northern Rock go belly up. That cannot be allowed to happen; the lender of last resort is so important that it must at times override the concerns about moral hazard to protect depositors and to prevent the contagion of other banks—but not, of course, to protect the shareholders. There is no obligation on the Government or central bank to prop up the value of shares; people have put their equity at risk, and they know that they can lose it—and, as we are aware, there are, of course, equity risks in other areas.

Although we must accept this fundamental nature of the banking system, while we are looking afresh at our banking and mortgage finance systems, we might also look at the experience of other countries. The right hon. Member for Holborn and St. Pancras mentioned a point that I have previously made: the Spaniards have demonstrated that if banks are required to consolidate all their loans and operations, which we elsewhere have allowed them to take off balance sheet, they are less likely to go down the road that has led to the sub-prime crisis in most other countries. We might also look at what happens in Switzerland, Hungary and some other countries where mortgage loans are generally required to match more closely the term of deposits and bonds. That may result in slightly more expensive mortgages over their life, if short-term interest rates are on average a bit lower than long-term interest rates, but it produces a more stable system. There is a case for examining more closely what happens in countries that require that and which do not seem to have had these problems. They also do not seem to have had as much housing market inflation as our system has had.

The second fallacy that is frequently uttered in the public discussion of these issues is the suggestion that the credit crisis that we have experienced worldwide is caused by banks becoming more imprudent. If anything, the reverse is the case. The credit crisis has revealed the problem of imprudence at certain banks in certain cases, but it has not been caused by that. When the tide goes out we see who was swimming naked—we learn who forgot to put on their bathing trunks. The fact that they did not put on their bathing trunks did not cause the tide to go out. When the credit tide ebbed, we discovered which banks’ lending had been less prudent than others, but that less prudent lending did not necessarily cause the tide to ebb.

A third frequently made statement is that the problem was that banks chose to invest in risky assets when they should have put their money into safe assets. By and large, banks would have preferred to put their money into safe assets; they put their money into risky assets only because there were not enough safe assets with notable returns. Why were they being led in that direction? Why did they spontaneously and across the world start investing in more risky assets?

Greed.

No, it was not because of greed. It was because it was necessary that they be encouraged to do so. There is a systemic imbalance in the world economy. In China, above all, and in a number of other countries, the willingness to save and lend far exceeds the willingness to borrow and invest—it is extraordinary in such a poor country. That surplus of savings requires the rest of world, if there is not to be a deflation, to borrow more and save less than they would otherwise do in order to match that imbalance. That is what has happened: an outflow of savings from China has financed a huge deficit in the United States and other developed countries. That is the precise reverse of what one might expect to happen between rich and poor countries.

I have listened carefully to the right hon. Gentleman’s interesting speech. Does he accept that a number of banks will say that they did not think they were investing in risky products because they were all given good ratings by the ratings agencies and that the products’ weaknesses emerged only afterwards, when it was, by and large, too late for the banks then to do anything about those products—or rather when the banks would say it was too late?

The hon. Lady perceptively raises an issue that I am about to discuss. If she does not mind, I shall try to reach it by my own process, but as she realises, it is fundamental.

The imbalance of savings in China and elsewhere means that the rest of the world has to borrow and spend more, and it is encouraged to do so by decreasing interest rates. The reduction in interest rates means that people have to look around for things in which to invest all that cheap money, and there just are not enough high-yielding assets and opportunities in America, this country and other developed countries. Of course people look for the safest options and the best and most reliable yields, but they are being encouraged in this process.

If people had not spent and borrowed all that money, there would have been a deflationary tendency in the world economy, so let us not assume that there was an easy option—that they should just not have done it and they should have let the money pile up in their coffers. We would then have been complaining about the lack of spending, investment and borrowing to counteract the excessive piling up of savings in China and elsewhere.

Banks try to ensure that they have good collateral in circumstances in which yields are low; I come to the point that the hon. Lady was making. They think that bricks and mortar are safe, sound and robust. Bricks and mortar—buildings—may be solid, but the value of those assets is in itself a financial phenomenon, and it is partly driven by the weight of lending and borrowing that is taking place. People borrow money on the value of houses and that money then goes around the system, driving up the price of houses. When there is any check on that system, we suddenly find that the whole process is vulnerable, because the asset base used as collateral behind the loans that people have been encouraged to make starts to fall. That is what happened. The value of housing in the States fell, so the loans were not covered, and when people lost their jobs the mortgage institutions called in the loans and found that the value of the housing was not sufficient to cover them. That inherent instability means that when the whole party stops—when the spending stops driving up the value of the assets used as collateral to justify the loans—we find ourselves in a brittle situation.

I do not have a solution, but no one should pretend that the solution will be fiddling around with regulation. We will probably go through a difficult period; we may go through another cycle whereby the whole banking system is re-liquified by the central banks, and everyone thinks that that is jolly good and starts lending again. Unless and until the underlying problem of China’s saving too much and America’s running huge deficits is solved, we will be in an intrinsically unstable situation.

In the long run, we must move towards a situation where China uses its money to enrich its own people and America learns to balance its books and balance its own savings and investments rather than be the lucky recipient of poor countries’ money. Although the issues that I put before the House go far wider than the report, I hope that they will illuminate the further thought of hon. Members and the Committee on this subject and that the Government will take them into account when they think ahead, rather than imagine that a sophisticated system of regulation will solve the intrinsic problems of either the banking system or the world economy.

I, too, congratulate both the Chair and the members of the Treasury Committee. We know that my right hon. Friend the Member for West Dunbartonshire (John McFall) works us hard and works himself far too hard. He has steered us through, and achieved a consensus on, a very controversial matter, which is no mean achievement.

I also congratulate the Committee’s staff, about whom I would like to speak to the Deputy Speaker and the House authorities through this debate, if I may. The hon. Member for Twickenham (Dr. Cable) was a bit grudging about the Treasury Committee reports, but they would be even better if we had more staff. I am amazed at the quality of the reports and the amount of work that the Committee does with such a small number of dedicated staff, and I fear that we exploit their dedication. I think that view is shared by others. The Treasury Committee—this probably applies to Select Committees as a whole—is a very useful institution and a very valuable instrument, certainly in this place, where it is the Cabinet or nothing and where no debate and no policy examination is encouraged. I am not making a point about our Government, because this applies to every Government, but I almost think that the Select Committees are deliberately understaffed and under-resourced—and that applies to the Treasury Committee in particular.

The hon. Member for Twickenham was grudging, but probably right, about the report. The questions he asked were accurate, but I would advise his two colleagues sitting opposite me to have a quiet word with him. It would be wonderful if someone ever volunteered information to the Committee. I remember once asking bank representatives how much they made out of credit cards and their response was, “We don’t tell the shareholders, so we’re not telling you.” Even in respect of this exercise, I can remember an infamous occasion when I was more than bad tempered with a Governor of the Bank of England.

Remarks such as that from the credit card companies can be dangerous. They had come before us to discuss unfair penalty charges that they had imposed. We said, “The charges you imposed are all rounded up to the nearest pound. How much do you make out of that?” They replied, “We don’t make anything out of it.” They did not tell us anything, so we referred the matter to the Competition Commission. It is now with the Office of Fair Trading and in the courts, so they got themselves into trouble because of their truculence and stupidity. Does my hon. Friend agree that if they were a wee bit more open with us, that would help both them and the country?

I totally agree. I thought that my right hon. Friend was intervening to say that I was never bad tempered with anyone, let alone the Governor of the Bank of England. I am deeply disappointed that he did not. [Laughter.]

The real value of the Committee in the exercise came about because, as it happened, we had fixed a meeting with the authorities in September on another matter—I think it was to be with the Governor on a monthly inflation report. When the Northern Rock situation blew up, we were able to take the opportunity to raise the matter. We performed a valuable service because when three bodies are involved—in this case, the Government, the Financial Services Authority and the Bank of England—there is a tendency for them to fall out and for mistakes to be made. There is also a tendency for bureaucracy to win. Each understands that if there is a falling out and it speaks openly about what has happened, the other two will talk about what it has done. They conclude that the less they say, the better. In this case, we hit them hard, which meant that more information was put into the public arena than would normally be the case. However, the situation also underscored the problem that Select Committees have in getting people to volunteer information.

My right hon. Friend the Member for Holborn and St. Pancras (Frank Dobson) made what I would describe as a lovely old Labour speech of a kind heard too rarely in the Chamber now. He put the debate in a wider perspective, which is what it needs. We are facing a threat to the economy and to people’s standard of living and jobs, but not because of Northern Rock. It is interesting to see how many northern MPs are in the Chamber. The matter is now rarely mentioned in the papers, whereas until two or three weeks ago it was the staple diet of the financial pages. Northern Rock has been dealt with and dissected, but it is not the real problem.

I do not wish to cross swords with such an experienced and able member of the Opposition as the right hon. Member for Hitchin and Harpenden (Mr. Lilley), but although we reached consensus in the Committee and produced a unanimous report, varying shades of opinion fed into that consensus. On reflection, I think that Northern Rock had a very hard time. Some people would say it deserved that, but it was not the culprit and the cause of all our concerns. Those concerns were caused by the bankers and the banking industry that started the securitisation. We need responsible lending.

There was a lass in America—I think she was 85 or 92—who was sold a mortgage of $450,000. After a year, when she packed up her cleaning job, she defaulted. It did not need an experienced banker to know that there was no way she would repay the money, but still it was lent. The lender did that deliberately, and the debt was passed on and contributed to the contamination of the wholesale markets that paralyses them to this day.

I have had the deepest respect for the right hon. Gentleman for all the years I have been here—he handled the Maxwell crisis in an unparalleled manner. However, the behaviour in the Northern Rock affair was not new for the banks. I commend to him a book called “A Random Walk Down Wall Street”.

indicated assent.

I see that he knows it. The updated edition has a wonderful long chapter on banking difficulties. Taking securities and selling them on is not new behaviour. Often in their history, banks have found something that will make them a lot of money, which some poor sucker will buy on the basis that they can sell it on to another poor sucker. That is the way they do things. The problem is not about China, Africa or India. It is about high yields, as the right hon. Gentleman said, and nothing more. The Chancellor said that he wished we could have some “old-fashioned banking” that was sensible and tight. Such banking is epitomised by the hon. Member for South-East Cornwall (Mr. Breed), who is glaring at me—no, he is smiling at me. It involved bankers who cared about their customers and were happy with a steady profit, but that is not what the national bankers are like.

I wonder whether hon. Members remember the tulip bubble in Holland. A particular tulip became very valuable. The price went up and up until the last sucker said, “But this is not worth much.” The reply was: “No, but you’ve bought it.” By then, the rest were out of the market. “A Random Walk Down Wall Street” mentions all kinds of exercises like that.

Layman though I am on banking, I remember when all our banks were investing in south America. I was the leader of the council up in Leeds at the time, and I was trying to get some of the brass to come to Leeds and invest there. They would have got good yields, but modest ones compared with what they were being offered in south America. Of course, when the south Americans got all their brass, they said, “Bye-bye, we’re defaulting.”

I remember the high-tech bubble. People put their money in high tech, and why? Because of the yields. It was about greed. They did not question, they just bought, because they could sell at a great price. That attitude is what we are up against. If the Northern Rock situation has done anything for us, it should have allowed us to look past Northern Rock to what bankers are doing.

rose—

I welcome the hon. Gentleman intervening, because I need to work out where I am in my speech.

It is always a pleasure to help out the hon. Gentleman. Does he agree that his catalogue of historical tales shows that, in the City, it is always far better to be wrong in a herd than ever to risk being right on one’s own?

As always, the articulate hon. Gentleman is spot on. He is a valuable member of the Treasury Committee.

If I wanted to be controversial, I would say that one point of consensus in which I do not share is the heaping of blame on the FSA. Yes, it was lax in its regulation, as is spelled out in the report, but I do not like the way in which the other culprit, the Bank of England, has stolen off the stage without anything being said. It has a lot to answer for.

In an intervention, I asked my hon. Friend the Member for West Bromwich, West (Mr. Bailey) about the market solution that we all wanted. Why was it not pursued? We have had no answer. Why is there no evidence that anybody from the Bank of England met the prospective buyers, one of which is now known to have been Lloyds TSB? We have had no answer. Why did the Governor dismiss that point in this fashion: “Oh, I vaguely remember a telephone call that came through to my officials from the FSA”? At such a time, I would have thought that Eddie George would have had that bank in on the Sunday and closed the doors, and they would have gone out at the end of the day with a deal done on a market solution. But that is a judgment call, is it not? I do not think that Eddie George should have dismissed the situation by not taking a telephone call, by not speaking to those involved and by not bringing in people from the City; he should have been straining every sinew to get a market solution. Clearly, however, the Bank of England did not do that.

I think that the hon. Gentleman is at the crux of what started to go wrong with this chapter of errors. To what does he attribute the failure to engage with the single bona fide credible private sector buyer? Once that buyer’s initial interest had gone away, the Government were left with buyers of straw.