Twists and turns in a week of drama

It was one of the most dramatic weeks in the financial markets for many years. Only this time the focus was on Britain rather than further afield.

The discussion on the Northern Rock crisis shifted from the mortgage bank itself to the Bank of England. Many argued that the Threadneedle Street institution had lost credibility with its apparent U-turn on how to respond to the run on Northern Rock. There were calls for reform of the financial regulation system, and some commentators contended that Labour’s economic credibility had been damaged.

Since the start of the latest round of the subprime crisis in early August the Bank had stood out against intervening to bail out banks that encountered difficulties. In contrast to America’s Federal Reserve and the European Central Bank, the British central bank argued that such intervention would cause a “moral hazard”. It would only encourage banks to take irresponsible risks.

But last week the Bank reversed its position with the announcement of its willingness to inject £10 billion into the money markets. Some commentators even argued that it had already reversed its position at the end of the previous week when it declared that it would support Northern Rock. This came only a day after a written statement to the Treasury committee by Mervyn King, the governor of the Bank, holding to his “moral hazard” position.

Many critics argued that, in retrospect, it had been a mistake to remove the Bank’s traditional function of financial regulator back in 1997. It would make sense, they said, for the lender of last resort also to be responsible for regulation. The implication was that the Financial Services Authority should be merged into the Bank.

Meanwhile, on the other side of the Atlantic, the Fed announced a half-point cut in interest rates. The move was broadly in line with market expectations.

But Alan Greenspan, until recently the Fed governor, had earlier unsettled the markets by stating in an interview that American house prices are likely to fall more than is generally expected.