Bank chief: We failed to spot dangers of debt

Its deputy governor Sir John Gieve conceded that the Bank did not understand the dangers posed by the £1.4trillion credit bubble that built up through soaring house prices and a consumer spending binge.

He called for new controls on bank lending to stop "crazy borrowing" accumulating to such unstable levels, adding: "This is a major storm, the like of which we haven't seen for 100 years, and I would be surprised if we weren't learning some lessons from it and we are."

He also warned about growing levels of bad debt in the mortgage books of Northern Rock and Bradford & Bingley now owned by the taxpayer.

In a Panorama interview tonight, Sir John said the Bank underestimated the impact that the bursting of the credit bubble would have on the real economy. "We didn't think it was going to be anything like as severe as it's turned

out to be ... Why didn't we see that it was so serious? I think that's because we, perhaps, we hadn't kept pace with the extent of globalisation."

Sir John, who is to stand down in March from his role in charge of financial stability, admitted that the Bank did not have the right tools to rein in the explosion in credit. The Bank relied solely on changing interest rates to control the economy and sharp increases had not been an option.

He said: "If we'd used interest rates to try and address this asset-price credit growth, we would have been holding down the level of activity elsewhere in the economy, in manufacturing, in other services, holding down the level of employment at a time when consumer price inflation and earnings were stable and reasonably low.

"And people would have said, This is a wilful reduction in the prosperity of the country'. "

In the interview with the BBC's Business Editor Robert Peston, Sir John said: "I think that one of the main lessons from this is that we need to develop some new instruments which sit somewhere between interest rates, which affect the whole economy and activity, and individual supervision and regulation of individual banks.

"Maybe we need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand ... I think we need to complement interest rates, which are a blunt instrument — you set one interest rate for the whole economy — with something which is more financial-sector specific". The Bank used to have a much greater range of powers to rein in lending but many of these were abolished during the financial deregulation of the early Eighties.

The admissions from the Bank come on the eve of possible official confirmation that Britain is now in recession. Government statisticians are due to release revised estimates of GDP growth earlier in the year. If the second quarter figure, which was initially estimated at 0 per cent, is tweaked downwards, the figures would then meet the formal definition of recession — two consecutive quarters of economic contraction.

Sir John conceded that the knock-on effects of recession could have a major impact for the taxpayer, which now owns huge swathes of the banking system. Asked whether the taxpayer is likely to lose out, he said: "Well I think it'll be a mixed picture. I mean I think there are some [lending] books, Northern Rock, Bradford & Bingley, which the taxpayer is now holding which clearly have a level of defaults in them. I'm not quite sure how that will balance out against the residual of the capital. As for the more mainstream banks, yes I think they've got a commercial future and I'm sure that in time they will, as for example the Swedish banks have after their crisis, revive and start building and growing as commercial entities again."

In a separate interview for the programme, Barclays chief executive John Varley said it will take up to two years for bank lending to homeowners, consumers and businesses to start growing again.