A string of problems would result if the UK government decides to take the nationalisation route to digging the troubled bank out of trouble.
If the UK government believes, like the poet Robert Frost, that “the best way out is always through”, then it would perhaps be right to nationalise Northern Rock. But taking control of the bank and its enormous liabilities would seriously exacerbate the Treasury’s fiscal and political problems, as well as aggravating the damage already caused to the City of London by a bank run.
The government would break its own “sustainable investment rule” that public sector net debt should stay below 40% of gross domestic product (GDP). Since Northern Rock’s £97bn mortgage assets would not count as public sector assets, and yet all of its liabilities would count as public sector debt, about £100bn would be added to public sector net debt, pushing the public sector net debt ratio up to nearly 44% of GDP. The Treasury has said this would be an acceptable temporary breach under the circumstances, but it would undoubtedly take severe flak.
Nationalisation fallout
The problems of nationalisation do not end there. Shareholders would demand compensation, something that the Treasury has suggested it would provide. But arriving at a valuation that is satisfactory to all parties would be all but impossible, especially because there is a danger that the government could fall foul of EU rules on state aid. There is also a fear that nationalisation could trigger repayments to Northern Rock’s bondholders, who own about £2bn of the bank’s debt, and that investors in the offshore securitisation vehicle Granite could call in their loans.
On the brighter side, in so far as one exists, Northern Rock need not be a constant drain on public resources. Prime minister Gordon Brown has indicated that its assets would eventually be sold back to the private sector and, as the recent sale of the £2.25bn equity release portfolio to JPMorgan showed, they can fetch book value.
The speed with which Northern Rock could be reprivatised, or more probably sold off piecemeal after nationalisation, would be critical in limiting the damage. It would be politically unpalatable, as well as fiscally and morally extremely hazardous, for the government to prolong its involvement in the business of lending to consumers and of repossessing the homes of voters. In all these circumstances, an immediate private sector solution must be the preferred option and was still possible as The Banker went to press.
