Rock debacle will reverberate for years

OUTLOOK

By nationalising Northern Rock, the Government hopes to achieve closure on one of the most embarrassing and traumatic episodes of its eleven-year rule, yet I fear its problems with the Rock are only just beginning.

At a stroke, the Government has blown its rules for governing the public finances to smithereens, driven a coach and horses through any remaining pretence of fair competition in the mortgage and savings market, subjected its rules and systems for dealing with troubled banks to international ridicule, and profoundly damaged the City's reputation for "can-do" financial innovation.

In the end, the combined brainpower of the City's finest failed to find a private-sector solution to the travails of this relatively unimportant regional mortgage bank, or at least that's the message that the Government has sent to the rest of the world by rejecting two perfectly viable private bids and nationalising the Rock instead.

Financial services is meant to be one of the few industries in which Britain excels. That's not the way it looks after the Northern Rock debacle, with the Government incapable of properly regulating its showpiece industry and the industry itself equally incapable of solving its own problems in a market-driven manner.

The Government's depiction of itself as a hapless victim of events beyond its control, with no ultimate option but to nationalise as the least worst solution, is simply not credible.

The bottom line is that this is an almighty mess which nationalisation in the manner proposed, with an "incentivised" Ron Sandler determined to run the Rock as a going concern for ultimate resale to the private sector, will more than likely make worse.

The opposition can hardly be faulted for opportunistically jumping on the Government's embarrassment. It's what Tony Blair and Gordon Brown used to do all the time and with devastating effect while they were in opposition. Mr Brown supported Britain's membership of the ERM, yet that didn't stop him pouring scorn on Britain's humbling retreat.

After a certain number of years in power, all governments become accident-prone. There is a steady build-up of negative news which saps and undermines their reputation for economic and operational competence. Never mind whether the Chancellor and his colleagues are directly responsible for having to take 110bn of mortgage funding on their books at a time when the housing market is showing signs of growing distress, they are going to get the blame anyway.

Sir Richard Branson was behaving with as much good grace as he could muster yesterday, yet it is with good reason that behind the faade of resignation he's spitting tacks with anger. He seems to have been led up the garden path by an indecisive Government incapable of backing the private-sector solution it claimed to be seeking. Months of work and effort have gone down the drain.

John Kingman, the senior Treasury mandarin on the case, had been pushing for nationalisation all along, but the Government, wracked by memories of the economic failure associated with nationalised industries, was desperate to avoid it, or at least that was what it pretended. In the event, both the Virgin and management bids seemed to satisfy virtually all the demands made of them by ministers, yet still the Government wouldn't sign up.

Why was this? One possible explanation is that from the beginning the Prime Minister was more settled on nationalisation than he admitted, but needed to satisfy the public that all other options had been exhausted before pushing the button. Virgin and others were merely used to show that procedure had been followed. Yet my understanding is that the decision - taken at the last moment some time on Saturday night or Sunday morning - was more overtly political.

The thinking was that either Virgin would fail with trying to revitalise the Rock, in which case the Government might end up having to nationalise anyway at a later stage and at greater cost to the taxpayer, or it would succeed, laying the Government open to the charge it had lined Sir Richard's pockets at the taxpayers' expense. Hedge fund investors in Northern Rock scarcely helped matters by promising both to block the Virgin bid and sue the Government if it nationalised. In fact, the first of these two threats was just sabre- rattling by the hedge funds. When push came to shove, they would almost certainly have backed the Virgin proposal, yet it was not a risk the Government felt it could take. Ministers would have looked stupid if they had opted for Virgin only to have shareholders turn them down. In threatening the Government, the hedge funds may have overplayed their hand.

As it is, we seem to have arrived at the worst possible outcome. To the fury of rivals, the Government says Mr Sandler will be allowed to operate the bank at arm's length as a going concern. Mr Sandler has already declared himself open for business both for new deposits and new mortgages.

If that's not unfair state competition, I don't know what is. Rivals already have to compete with the state-guaranteed deposits of National Savings. Now there's a second state-backed organisation jostling for position in the market. Yet if alternatively Northern Rock is perfectly capable of competing for this business without infringing European rules on state aid, what on earth is it doing in the public sector at all?