Northern Rock Nationalized

Posted by: Kerry Capell on February 18

The British government’s decision on Feb. 17 to nationalize troubled mortgage lender Northern Rock is a dangerous gambit. No doubt the government faced a tough decision: let the bank fail and risk wrecking havoc on the wider British banking system; agree to one of the two private offers on the table and effectively give either Richard Branson’s Virgin Group or a private equity firm a subsidy at the expense of taxpayers or nationalize the bank, effectively leaving the government responsible for $222 billion of Northern Rock assets and around 6,500 employees.

Prime Minister Gordon Brown and Chancellor Alistair Darling went with the latter. They say the move is temporary until global credit conditions improve. But the government could ultimately have a long wait. In the meantime, the government says it will appoint an independent valuer to decide the level of compensation but shareholders are expected to receive little, if anything, for their equity.

That should be good news for British taxpayers. However, if taxpayers are to get their money back, the bank has to be run as a profitable business but under the rules of nationalization its ability to do so is constrained.

Sure, nationalization may be the least damaging choice from a limited number of duds. Taxpayers wwere understandably not pleased about having some $110 billion (the amount of direct loans and guarantees from the British government)in liabilities heaped on them. But that figure could end up being substantially higher under the government’s new plan—as they could end up holding the bag for the bank’s entire balance sheet of around $220 billion.

Not only has the British government dramatically increased the risk to the taxpayer, it is also sending the wrong message. New Labour has long argued against state subsidies and protectionism. It implies that Brown is less comfortable with a market solution than the previous decade of Labour had led voters to believe. This perception could potentially jeopardize London’s hard-won image as the financial center of the world.

This nationalization may be different from those of the 1970s (it will be run at arms length from the government for starters). But even the conotations of Old Labour are damaging to the credibility of Brown’s government and Britain’s business environment. Says Jon Wood,head of Monaco-based hedge fund SRM which is Northern Rock’s largest shareholder with a stake of over 10%: It is is “a very sad day for the stock market, banking industry and the reputation of the UK as a financial center.”