He loved Cambridge, but economics was too much ?harking back? to Keynes. It was in postgraduate work at Harvard that he ?learnt that economics could be a serious discipline?. Being a bright young man, he gave ?excessive weight? to economic models. ?You feel, 'My models will make a big difference.? As I get older, I give more weight to history. Alfred Marshall [the founder of Cambridge economics] was absolutely right that you should do the mathematics but then burn the paper and write it down in words.? Maths and models should be ?aids to thinking, not substitutes for it?. He thinks people should have remembered that during the financial crisis. Tell me, I say, what a layman should read to understand that great disaster in which we are still embroiled. There are two books, he says. One is Walter Bagehot?s 19th-century classic, Lombard Street, with its ?wonderful description of the people who made the money markets work ? they?re exactly the same now ? and his popularisation of the idea of the lender of last resort?. The other, about the credit crunch itself, is The Big Short by Michael Lewis. It explains, says Mr King, why a few people did not believe that the lending in the US subprime market was going to work but ?how difficult it was for them to make the bet they wanted to make and how the great banking machine was all geared to do the opposite?.
Now, the Governor is off on why all this has a moral dimension: ?The more I?ve thought about how labour markets work, the more I?ve realised that there are hardly any jobs whose tasks you can describe exactly. Nowadays, most jobs have the property that employees can choose to do them well or badly, so employers need to think about the long-term welfare of the staff not just pay today.? It follows that moral attitude is vital. Industry often understands this well. Nissan in Sunderland asks all its workers for ideas to raise productivity, and, says Mr King, it benefits.
The Governor makes a point of visiting manufacturing and service industries all over the country. Such firms pay far lower rewards than financial services but have ?an incredibly successful record. They care deeply about their workforce, about their customers and, above all, are proud of their products?. With the banks, it?s different: ?There isn?t that sense of longer-term relationships [hence the demise of the local bank manager]. There?s a different attitude towards customers. Small and medium firms really notice this: they miss the people they know.?
He also thinks that there is ?too much weight put on the importance and value of takeovers?. They make short-run profits but ?it doesn?t make sense to destroy a company with a reputation?. Since the Big Bang in the late 1980s, Mr King goes on, too many in financial services have thought ?if it?s possible to make money out of gullible or unsuspecting customers, particularly institutional customers, that is perfectly acceptable?. Good businesses ?keep a clear vision of who their customers are, and are run by people who don?t think they should simply maximise profits next week?. But in the past 25 years, banks have increasingly ?taken bets with other people?s money?.
That is bad enough, but it gets much worse ?if the rules of the game are that they get bailed out if it all goes wrong?. In this weird atmosphere, banks eventually stopped trusting one another. ?Financial services don?t like the word 'casino?, but instruments were created and traded only within the financial community. It was a zero sum game. No one knew which ones were winners when the crisis hit. Everyone became a suspect. Hence, no one would provide liquidity to any of those institutions.?
Northern Rock could have been avoided if Britain had not been ?the only G7 country not to have had a statutory resolution process. We had been war-gaming one, but the legislation wasn?t ready?. In Mr King?s opinion: ?If we had not stepped in for RBS and HBOS, all the British banks would have suffered runs. They didn?t understand the nature of the risks they were taking.? But was the Governor himself blameless? Has he ever given the Queen the answer to her famous question: ?If these things were so big, why did no one see them coming??
He says he did have a meeting with the Queen last year. I smile at the thought ? King and Queen, as it were. What did they say to one another? I think the Governor would like to tell me more, but he reins himself in: after conversations with the Queen, he reminds me, ?one must never breathe a word to another mortal?. He thinks her questions are good questions. His answer to Her Majesty is that ?everyone did see it coming but no one knew when. It?s like an earthquake zone. You should be trying to build buildings in ways which are more robust?. But he does include himself in the criticism. ?I wish I?d spoken out more forcefully about the build-up of leverage.?
He does believe, however, that the Bank?s remedies have been right. ?Quantitative easing? is a new phrase, but ?it is really very traditional monetary policy. For the first time in my life, the amount of money was growing too slowly?. What was done in 2008 and 2009 ?prevented a repetition of the Great Depression?.
The Bank pushed out money and ?bought private not public sector paper?, so that non-bank institutions could benefit. It stayed away from choosing which assets to favour. Some central banks, however, went further and were seen to ?intervene in the credit allocation machine. It?s made life more difficult. It?s seen as quasi-political, quasi-fiscal, We deliberately stayed away from that?. But although Mr King thinks the worst of the crisis was handled correctly, he does not think we are out of the woods. ?We allowed a [banking] system to build up which contained the seeds of its own destruction?, and this has still not been remedied: ?We?ve not yet solved the 'too big to fail? or, as I prefer to call it, the 'too important to fail? problem. The concept of being too important to fail should have no place in a market economy.?
I quote to him the recent remarks of Stephen Hester, the chief executive of the largely publicly owned RBS, in which he seemed simultaneously to say that RBS should pay little tax because it had made little profit, but also that it should pay big bonuses because its investment arm had made big profits. Wasn?t there some sort of contradiction? Mr King nods. The remark illustrates, he says, the clash between the needs of high-street banking and the ambitions of investment banking. The key question, in his view, is not why an individual bank says it needs to pay bonuses (the reason cited is always the need to keep talent), but: ?Why do banks in general want to pay bonuses? It?s because they live in a 'too big to fail? world in which the state will bail them out on the downside.? They are tempted to excessive risk and excessive payments: ?It is very unproductive to single out individuals. Bankers were given incentives to behave the way they did. That?s what needs to change. We must resolve this problem.? He has high hopes that the independent banking commission will do so. In the Governor?s mind, this is not ultimately a technical but a moral question. It goes to the heart of whether people are ready to accept life in a free economy.
Over the past 30 years, he says: ?We changed Britain away from a sclerotic economy with inefficiencies and problems in labour relations. Everyone got to the point where we no longer expected government to bail us out. Everyone bought in to market discipline. We were all better off. It was working very successfully.? But now, people have every right to be angry, because ?out of what seems to them a clear blue sky?, the crisis comes, they find they do lose their jobs and there?s the sharpest fall in world trade since the 1930s. ?But, surprise, surprise, the institutions bailed out were those at the heart of the crisis. Hedge funds were allowed to fail, 3,000 of them have gone, but banks weren?t.? Could there be a repeat? ?Yes! The problem is still there. The 'search for yield? goes on. Imbalances are beginning to grow again.?
I want the Governor?s own estimation of how he is handling the hangover after the party. Is it true, as Ed Balls was reported to be alleging, that he is too political (which means, from Mr Balls?s mouth, too Tory)? Mr King tactfully refuses to accept that this is necessarily the shadow chancellor?s view: ?He was reported by the Financial Times as saying that. I prefer to read what people actually say. I don?t take newspaper headlines at face value.? His general point, though, is simple: ?It is inconceivable that the Governor has no view on the size of the deficit and the need to reduce it. It would be a dereliction of duty for me not to warn. You need a credible plan to reduce it, over the lifetime of a Parliament. But it is for ministers, not for me, to say how this should be done.?
He believes that the need to reduce the deficit is common ground between the parties and claims to have had ?a good relationship with all three chancellors on his watch?. What about with the man who was one door up from Alistair Darling in Downing Street? Mr King smiles thinly: ?That is for others to say ... we worked well together during the recapitalisation.?
He feels strongly that the independence which Mr Brown established works well. WikiLeaks caught him out saying that David Cameron and George Osborne, in opposition, were too inexperienced. That is not his view now: ?I think people learn very quickly on the job.?
Here we are though, I complain, with inflation 100 per cent higher, at four per cent, than the two per cent it is supposed to be. The mathematician in him laughs at that way of putting it: ?If our target was zero per cent and we had an inflation rate of 0.1 per cent, we would be infinitely above target!?. Yes, but he was always an inflation ?hawk?. Is he still? ?Yes. It?s odd to read that I am terribly doveish. Before the crunch, there were 14 occasions where I was in a minority in voting for higher rates. Since then, there has been one occasion where I was in a minority the other way.? He is emphatic that he wishes to get back to the target, and that they will: ?That is why I stayed at the Bank [for his second term].? After this, the worst financial crisis in living memory, ?if people can look back and say that inflation came back in line, that would be a very significant achievement?.
He does not use the word, but he is clearly talking about his legacy after he leaves in 2013. He also feels very sorry for the victims of inflation, especially savers suffering ?a sharp squeeze in living standards. It is deeply troubling for them. They were prudent before the crisis?. But if he were to put up interest rates too soon it would be, as he recently said, the ?futile gesture? from the Battle of Britain sketch in Beyond the Fringe. The squeeze on living standards is ?inevitable? because of overseas prices of oil and other commodities and deficit reduction, so surely, says the Governor, one cannot argue that ?what Britain needs is a deeper recession?. Of course, rates will have to rise at some point and there is a ?perfectly reasonable case for doing it now?, but it is a matter of looking ahead for 18 months to two years, a matter of calculating ?the balance of risk?. He says the squeeze in living standards has been ?sharp and prolonged? and they ?will be squeezed a bit more this year? before ?almost certainly? picking up after that.
We are moving towards the end, and I bring him back to the main message of the preacher. In a recent speech, Mervyn King quoted Tolstoy?s line that ?Happiness is less important than trying to live in the right way?. What is the right way? Mr King sees the task as one of getting back to where we were before all this. ?Britain is well placed to be an international banking centre, but we can?t afford to be if, now and again, it depends on the UK taxpayer.?
We must get rid of the idea that ?if something is growing rapidly, it must be good. Every supervisor should say: 'The banks I should worry about are not only the ones that are losing money but the ones who are making a lot of money.??? He goes on: ?What I?ve tried to do my whole time at the Bank is to set general rules. You can?t rely on the wisdom of individuals. Before I leave, I want to make sure that the right framework is in place for monetary policy, financial stability and banking supervision [a function the Coalition is now returning to the Bank].?
Does he enjoy it all? Wouldn?t this man of ideas be happier in his large library? His eyes gleam. ?I?m looking forward to getting back to my books [current reading includes Niall Ferguson?s book on civilisation and Chinua Achebe?s Anthills of the Savannah] and to watching cricket and playing tennis. But I wouldn?t have missed this for the world. Enjoyment is the wrong word, because of the pressure. I never expected to see a crisis of this size, but it is fascinating and a privilege to be doing this job.?
Since he is so uncomfortable with the culture of banking, wouldn?t he rather have been an industrialist? ?No, I admire people like John Rose at Rolls-Royce or John Parker at the National Grid?, but the job is ?an intellectual challenge first and foremost, where I must see issues clearly and speak about them openly?. Sort of like being a professor, only much, much more exciting.
We discuss bank notes. Mr King has decided that the next �50 notes should depict the inventive and manufacturing partnership of Matthew Boulton and James Watt. But he is even prouder of having picked Adam Smith for the �20. Smith provides the model of the right way: his economic theory in The Wealth of Nations was wise and true, but Smith?s other book, The Theory of Moral Sentiments proves, says Mr King, that ?there?s more to life than economics. The two must be taken together?.
