john gieve : rebuilding confidence in the financial system speech by sir john gieve, deputy governor of the bank of england, at the bba ’ s 12th annual supervision conference, london, 28 october 2008. * * * we are publishing today our bi - annual financial stability report, and so i want to start my presentation by looking at the wider context of the debate on supervision, on which this conference is focusing. the word unprecedented is used too frequently. but the instability in financial markets over the last year – culminating in the seizure of money markets in recent weeks ( chart 1 ) – has been the most severe in living memory. it did not come out of the blue. the price of risk especially in credit markets had fallen to unsustainable levels by summer 2007 and many banks and other institutions had become reliant on sustained liquidity in new markets which had never had been tested by a downturn. in the july 2006 fsr, for example the bank warned of “ uk banks ’ increasing dependence on wholesale funding ” and, in april 2007, we noted that : “ if uk banks were unable to securitise existing assets, new lending would need to be financed through other wholesale sources, which may be difficult or costly to access during times of stress. ” so it proved. but the bank was not alone in pointing to the vulnerabilities in the financial system in 2006 and 2007. other commentators and authorities gave similar warnings. and many market participants were also expecting a correction at some point ; but they generally felt they were well placed to handle it. in fact the severity and breadth of the downswing has surprised markets, commentators, and policymakers alike. in the light of subsequent developments, a number of commentators have concluded that the problem was simply a lack of attention and short memories. i don ’ t think it was quite as simple as that. i am with mark twain who said " history doesn't repeat itself, but it does rhyme. " while the current crisis has some similarities to previous downswings – in the early 90s or of the 70s for example – there are some significant differences too. for example the last three recessions in the uk ( in the 70s, 80s and early 90s ) were preceded by sharp rises in consumption and activity and earnings to well above sustainable rates. as chart 2 shows that was not true of the last few years when consumption, output and earnings all seemed unusually stable. again in previous recessions, stress in the banking

but potent interconnections between firms in the global financial system. policy response for most of the last year, the bank has adopted a twin track approach, as part of the tripartite partnership with the fsa and the treasury. the first track has been to provide liquidity to the market in order to give most banks time to make the necessary adjustments – including by raising capital. that has involved an increasing range of measures including long term repos on a wide range of collateral and the introduction of the special liquidity scheme which allows banks to swap illiquid assets for treasury bills for periods of up to three years. the recent dollar swaps and further extensions of the sls and eligible collateral are further steps in that direction. and we recently announced a more permanent structure of money market operations including the introduction of a discount window. the second track has been to work closely with the fsa and treasury to limit the repercussions from the failure of banks which do not have an independent future whether through arranging mergers or managing closure. northern rock was the first in line and led to a lot of criticism of the tripartite. i think we have learned a great deal over the year and have shown more skill and speed with subsequent cases including bradford and bingley recently. but in the last 6 weeks it became clear that this case by case approach was not enough either at home or internationally. despite the provision of additional liquidity to the system, market conditions got worse over the summer as worries grew about the downturn in the broader economy and its consequences for bank losses. once again the triggers for a further downward lurch came in the us. first fannie mae and freddie mac were taken into conservatorship and then, the following weekend, lehman brothers proved unable to find a buyer and filed for bankruptcy. that shook markets which had expected it to be saved by the state, if necessary, as had been the case with bear stearns earlier in the year. within a day, aig had to be rescued following rumours about the size of its losses on cds contracts and pressures grew on the remaining securities dealers. later in the week, secretary paulson announced his initial $ 700 billion plan to purchase assets to support the banking sector. it didn ’ t entirely still the doubts. the pressures were also felt in europe. at the end of september dexia, fortis and hypo real estate all had to receive emergency capital injections, mostly government supplied. in the