Northeren Rock: Pulling the plug

The market has said what it thinks of Northern Rock. The British government should listen

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EVERY banker knows John Paul Getty's dictum: “If you owe the bank $100 that's your problem. If you owe the bank $100m, that's the bank's problem.” What then of a bank that owes taxpayers some £24 billion ($49 billion), with another £18 billion or so of deposits underwritten by the public purse? Northern Rock, it seems, is everyone's problem.

The bank, once Britain's fastest-growing mortgage lender, is now a wreck. Having turned to the Bank of England for an emergency bail-out in August, it is unable to repay its loans unaided. Its debt to the central bank is growing. A mortgage book that was the envy of the industry looks less robust by the day. Its share price plummeted this week to less than £1, down from more than £12 at the beginning of the year.

The government finds itself in a deeply unenviable position. It is propping up Northern Rock's liabilities, yet the bank's assets belong to its shareholders. European rules prohibiting state aid to industries require ministers to cut the lifeline by March, or come up with a plausible reason not to. The Treasury is desperately casting around for buyers to take the bank and its problems off official hands, but none of the financial world's best and brightest is willing to assume full responsibility for it. All bidders so far have valued the bank well below even its current market capitalisation; all have asked for public-sector credit lines or loans.

There can be no good ending to this sorry saga, which had its origins in slack supervision, bad central-bank calls and a panic-stricken rescue that left offending bank bosses in charge for too long. But some outcomes are better than others.

Any solution must have two main goals in mind. The first is maintaining the stability of the financial system. For all that the first panic of the credit crunch seems past, there are too many uncertainties abroad to ride rough-shod over fairly fragile sentiment. The second is to get the taxpayer off the hook as fast and as thoroughly as possible. Depositors are protected by the guarantee the government has extended. It is hard not to feel sorry for the 145,000 retail investors who still hold Northern Rock stock; but they are entitled to no such guarantees and they must be aware that share prices go down as well as up.

There are three broad options confronting Alistair Darling, the chancellor of the exchequer, who will, in the end, decide Northern Rock's fate. The first is to sell the bank. The main bidders propose pumping more capital into Northern Rock, organising private lines of credit, repaying part of the government's loan quickly and keeping at least some jobs. Such a deal would annoy the bank's shareholders, who would be bought out for some variation of a pittance; but if Mr Darling could find a private-sector buyer with a firm promise to repay taxpayers quickly, it would be a tidy solution.

The problem is that no such private-sector buyer seems to exist; everybody relies on Mr Darling underwriting the deal for a considerable amount of time. Such a subsidised sale would give the bank's new owners most of the upside, should gains emerge, while leaving the taxpayer with most of the risk, if losses ensued instead. This asymmetry is more than galling: it might well create a perverse incentive for the bank's new owners to gamble even more recklessly than its old ones. And other banks would rightly complain of unfair competition.

A second option is to force the bank into bankruptcy. This too holds few attractions. Deposits would most likely be frozen for weeks or even months. News of savers struggling to get their money back could spark runs on other banks. In the resulting firesale, Northern Rock's assets would probably fetch less than they are worth. And administration would trigger the winding-up of Granite, a vehicle that holds half the bank's mortgages as collateral against bonds issued. If it is liquidated, its cash would be used to pay those bondholders first. Some £7 billion in extra assets that it holds could be tied up for years.

Take it over

This newspaper has, to put it mildly, never been a fan of nationalisation. But with Northern Rock this increasingly looks like the least bad option from a taxpayer's point of view (unless a credible buyer appears). And, in any case, the damage is half-done: in effect the state already owns a chunk of it.

Were the government a distressed-debt hedge fund, it would be trying to assume control, squeeze out existing shareholders and get back the money it is owed. State control, with a view not to running the bank (a terrifying thought) but to running it down, would allow value to be extracted for taxpayers through the orderly sale of assets. Bankers could take some comfort from the government's ability to pace disposals according to the mood of the markets. And nationalisation would let the state retain any future gains by going slowly—or even entering into a private-sector partnership—in the somewhat unlikely event that credit markets, house prices and Northern Rock's reputation recovered soon.

To be sure, nationalisation would be messy. Shareholders might well sue. The lesson from other crises (France, Mexico, Sweden, Japan and so on) is that emergency state ownership should be brief and at arm's length; Mr Darling might meddle, keeping unprofitable parts of the business open to safeguard jobs in the relatively poor (and Labour-voting) north-east. Nevertheless, nationalisation looks the best choice of a bad lot, for it aligns risks and rewards most closely and keeps control in the hands of those who have most invested. But there should be no illusions that it is anything but a mercy killing.