Time to nationalise Northern Rock?

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A small UK mortgage bank relies too much on wholesale funding and is hit by a liquidity crisis. The Bank of England has to step in. The year is 1994 and the institution in trouble is called National Mortgage Bank, but that rescue, and others like it, carry lessons for the Treasury and the Bank of England as they ponder what to do with troubled mortgage lender Northern Rock.

On Friday, Virgin Group and other bidders submitted plans that would immediately repay some of Northern Rock’s billions in central bank loans. There are other proposals. Some suitors want the whole bank, some want parts, and others just want management control. Yet all will be keen to secure concessions from the government, such as continued guarantees to depositors, long-term loans, or low interest rates on the money Northern Rock has already borrowed. The Treasury should not be swayed.

Its best option is to engineer a sale of the Rock to another bank. This was the solution in 1995 when Barings Bank, ruined by rogue trader Nick Leeson, was sold to ING of the Netherlands for £1. No public money was involved, shareholders were punished for their bank’s mismanagement and the situation was resolved immediately. Yet given how much funding Northern Rock needs, no other bank is interested in a straightforward takeover.

The Treasury could subsidise a takeover, which is what the Japanese government did in 2000, when it sold Long Term Credit Bank to a consortium led by US private equity firm Ripplewood. Japan had first nationalised LTCB in 1998 – so its shareholders did suffer – yet it not only took on trillions of yen of LTCB’s bad debts but also gave indemnities to the buyer. That got rid of the stake quickly, but at great benefit to Ripplewood, and great cost to the Japanese taxpayer.

The goals for Northern Rock should be, first, to make sure that there is no rescue for existing shareholders that encourages banks to take too much risk in the future, and second, to minimise any loss to the public purse. Selling Northern Rock quickly comes a distant third.

If the proposals for Northern Rock prove unattractive, the government should therefore consider following the 1994 bail-out of NMB or the 1984 rescue of Continental Illinois in the US. In both cases the bank was effectively nationalised, and then run down or sold off over the next six or seven years.

In both cases that put public funds at risk – the Bank of England lost money on its loans to NMB – but in both cases the taxpayer kept all the reward from any recovery in exchange for taking the risk. What the Treasury must not do is be manoeuvred into a position where it is lending to a rump Northern Rock against bad collateral, financing a rescue without charging a penalty interest rate, or subsidising a bidder. Nationalisation would be bad – but it is better than that.

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