A shaky rock

With the nationalisation of Newcastle-based Northern Rock, Britain seems to have taken a great leap back into the dark ages of dirigisme even as the world "" including former Communist countries "" have been distancing themselves from state ownership with growing rapidity. Though shareholders and prospective buyers express outrage, several commentators in Britain have argued that the government had little choice, given that neither the Virgin Group nor the bank's management, who were the two private bidders for Northern Rock, came up to scratch. This argument is valid, but only from the short-term point of view given that the savings of millions of depositors are at stake. But equally, with trading in this former FTSE 100 stock suspended with the government takeover, Northern Rock's shareholders now find themselves up the creek without a paddle. Thus, even as Northern Rock's depositors, who are partially protected by deposit insurance in any case, are untouched, the fate of shareholders remains uncertain. The government has promised to appoint an independent valuer to compensate them. But the warning that it should not be required to compensate shareholders for any value that is dependent on taxpayers' support is hardly likely to raise investor confidence. The "taxpayer support", of course, refers to the £25 billion bail-out by the Bank of England in September last year, when the bank found itself facing a liquidity crunch following the US sub-prime crisis.

As with official responses elsewhere to the sub-prime crisis, September's bail-out and this month's nationalisation raise afresh the issue of moral hazard. Should governments and their central banks rescue financial institutions from the folly of their business decisions? The irony about Northern Rock's September rescue is that the Bank of England had argued that the bank's balance sheet was fundamentally sound "" it had sufficient assets to cover its liabilities and had not been party to the spaghetti bowl of low-priced mortgaged lending that had precipitated the sub-prime crisis. The "loan", it was said at the time, was extended to help the bank tide over difficulties in raising funds from nervous institutional lenders, to replace maturing money market borrowings. In that sense, Northern Rock was an innocent bystander, so to speak, in the sub-prime maelstrom. This much is true, but the counter-argument is that bank managements are paid to deal with risk "" indeed, this is an integral part of management in any industry anywhere in the world. Ironically, far from reassuring anyone, least of all the depositors, Northern Rock's bail-out prompted a run on the bank that saw the exit of its chief executive and the entry of prospective buyers, so it is not clear how more government control will help.

Northern Rock's special leverage is that its location in Britain's heavy industry belt, with its powerful labour unions, makes it a vital cog in the Labour party's electoral considerations. In the 1960s and 1970s, India was often criticised for the alacrity with which governments nationalised sick companies, ostensibly to save jobs but actually to protect vote banks. The UK's Labour government of the 21st century does not seem very different.