Today we will hear a statement from the Chancellor announcing a much heralded statement offering up to £50 billion of near cash to the banks in return for some of their mortgages.

How is this done?
The government itself will borrow the money, by issuing bonds – IOUs – on the taxpayer.It will lend this money to the banks. It will secure these loans with banks’ mortgages. It will require a discount on the mortgages – in other words it will accept the mortgages for say 90 pence for every pound of mortgage. This discount will give us, the taxpayers, some protection against mortgages within the packages of loans that go wrong and are not repaid, and against failure to pay the interest on some of them. After the transactions the banks have £50 billion more of government bonds which can easily be sold in the market for cash, whilst the government has security of around £55billion of mortgages. The interest received on the mortgages should exceed the interest on the loans. The government/Bank will ask for top up of security if the values of mortgages continue to fall.
The taxpayer will not be out of pocket if the government judge it correctly, but the taxpayer will be at some small risk until the transactions are unwound once the crisis has gone away. At some point the government and taxpayer have to get rid of the mortgages again and repay the borrowings with which they have paid for the loans based on them.The exact arrangement is more akin to loans to the commercial banks, which gives the taxpayer more protection than buying the mortgages.

Good news or bad news? Will it sort out the mortgage market?
This transaction will of itself help in alleviating the shortage of cash in markets, and on its own should lead to new lending by the mortgage banks. As the mortgage banks acquire more cash/short term government bonds so they can lend more money to people seeking mortgages. It was a shortage of cash to meet depositors requirements and the lack of confidence in Northern Rock that led to the run on the Rock. If money and government bonds had been available like this in September 2007 there would not have been a run on the Rock.

However, it has to be seen in context. There are at least three other considerations which will limit the impact this helpful proposal will have:

1. At the same time the authorities are tightening regulation of the banks, demanding that they keep more cash on deposit at the Bank of England for any given amount of lending. Every pound of additional cash they have to keep cuts the value of this package, as it becomes a circular process. The authorities demand more cash for security from the banks. The banks do not have such cash. The authorities then give them the cash to meet the tougher requirements. No-one can borrow an extra penny, as the new cash is frozen.
2. The larger banks are international. Whilst the money will be offered to the UK subsidiary and intended for the UK mortgage market, in practise international banks look at the balance of their global business. Not all of the extra money, after allowing for bigger reserve requirements, will necessarily find its way into the UK mortgage market.
3. The UK market still has the problem of Northern Rock, which remains a negative influence on reviving the mortgage market because the government nationalised it. If instead of nationalising Northern had been offered this kind of support, it could now be offering new loans on a significant scale. Because it is under strict controls to repay the £24 billion taxpayer debt, and under strict surveillance not to be too competitive as a subsidised bank, it cannot play an important role in reviving the mortgage market in the UK.

So will it work?
It is a helpful package. Whether it is enough depends on how much further the authorities go in tightening reserve and cash requirements, and how quickly they want the Northern Rock money back.

THE £50 BILLION PACKAGE FOR THE BANKS WOULD HAVE SAVED NORTHERN ROCK IF INTRODUCED LAST AUTUMN.

If the government and Bank of England can make £50 billion available to the banks today to get the mortgage market going again, why couldn’t they have done that last September to prevent the Northern Rock crisis?

This latest move completes their extraordinary U turn from wrongly saying there would be no bail-outs or help for the banks last September, to now adding a £50billion money market package to the £100 billion nationalisation of Northern Rock. British taxpayers uniquely in the world have double trouble – we are paying for the credit crunch twice, just as we seem to pay twice for everything else this government attempts. We are likely to lose money on the nationalisation, and have very overstretched public accounts thanks to this double borrowing whammy. The irony of the UK position is the government is seeking to sort out overlending by the mortgage banks by overborrowing itself!

If £50 billion had been made available last September there would have been no run on Northern Rock. That unhappy institution would not now be owned by taxpayers, responsible for shedding at least one third of the staff and fighting a legal argument over competition law with the EU. It would not now be running its business down and struggling to repay a massive £25billion loan from the taxpayer. Instead confidence could have been restored with this kind of package last autumn.

The latest scheme - £50 billion of government debt to swap for mortgages – is a better way of helping than clumsy and expensive nationalisation. The reported timings are clever – one year bonds to avoid proper balance sheet accounting for the government, three year duration for the mortgage banks to get the government through the next election before the reckoning. The £50 billion scheme, if properly designed, will be better value for taxpayers than the nationalisation, and will help all banks in the UK, not just one. It is not without its dangers, but at least it does not make the taxpayer responsible for all the staff, loans and liabilities of all the other banks in the way we are for Northern Rock.

The history of the Northern Rock crisis can be followed on www.johnredwod.com, under the Northern Rock tab. Items are in chronological order.

Governments are changing their position over banking regulation. When the credit crunch first struck, they were cautious and said there was no point in seeking to bolt the stable door after the horse had gone. As banks were now trying to recover from a weak position and were risk averse there was no need to strengthen controls over risk taking.

As the credit crunch has carried on its weary way there is a growing impatience as regulators feel they ought to be saying something as a prelude to doing something. We are now in to “This must never happen again” territory, allied to a view that there must be seen to be a toughening of regulation after the problems of sub prime and beyond.

There is the usual regulatory syllogism. Banking is a well regulated industry. Banking has just got into a mess. Therefore we need more regulation.

It does not flow. The truth is that the detailed regulation of banking under Basel 1 encouraged banks to put risks off balance sheet and to securitise. It was their enthusiasm for doing this that led to the well publicised problems at certain institutions. Left to their own devices to assess capital adequacy, they might not have gone so far in those directions – the regulatory sums allowed them more leeway and gave a sense of false security. No self respecting banker would be seen to have substantially more capital than the regulator thought was necessary. Northern Rock was discussing how to reduce its capital surplus under current rules before the run began.

There are currently three preferred options on offer for re-regulation of the banks. Each one has a role to play when we are coming out of the credit crunch, but each one if imposed too strictly and too soon could make getting out of the crunch more difficult.

1. More transparency. Usually more transparency, more published information about the state of a company, is a good thing. It acts as discipline on the company, and allows others to assess how much business to do with that company. However, when there are fears about bank weaknesses, a sudden rush to publish more may fuel the fears rather than reassure. Different banks will have taken a different line on how to value assets, how to assess liabilities, and how much capital cover they need. Changing the numbers or flooding out new numbers at or near the low point of the cycle could damage.

2. Mark to market. Some say the way to ensure clarity and comparability over banking numbers is to require all banks to mark the values of their assets and liabilities to market. That means that if they hold bonds, shares and bonds in securitised vehicles, packages of mortgages or the like, these should have a market value and that should be used in declaring the bank’s position. Again, this is a good idea in normal times, but in these conditions it could lead to a rush to the bottom. If bank A has to mark its holdings down a lot by marking to the new lower market prices, then it may have to start selling some of the assets to buttress its position. This could drive the market price down further, leading to more weakening in its balance sheet position. If the bank intends to hold the assets until maturity or for a reasonable length of time, making them mark them to market now could be disruptive. They need to be examined in private on a case by case basis where they wish to deviate from marking to market, if necessary in conjunction with the regulator to see fair play. There is no necessity to value a bond or mortgage at a low market price if the bank can and will hold it to maturity and get full repayment.

3. Require more regulatory capital to allow for the risks of a future credit crunch and difficulty in raising money market funds. Again this would be a prudent decision, but at the moment when banks are working hard to ensure proper balance sheet rations and liquidity for current tough conditions, an added requirement would be far from helpful and would delay recovery.

Stephen Lewis (Insinger de Beaufort)has recently written a good piece examining the IMF’s claim to be the obvious choice for a new world super regulator role over the banks. He shows how the IMF in the run up to the recent credit crunch was reporting that systemic risk was low, and was not warning people that we were about to enter the worst conditions in money markets for at least 35 years. He too is concerned, as an experienced analyst of money markets and a City expert, that overdoing the extra regulation at this point could impede recovery. This is becoming a serious and long running credit crunch. The work of the authorities around the world should concentrate on rebuilding confidence and liquidity. That should not include subsidising banks or taking on unreasonable risks from the banking sector, and it should certainly not include nationalising banks. It should include taking action to make markets more liquid and buying assets from banks at prices that mean the taxpayer does not lose.

The originate and distribute model, where banks arrange loans and mrotgages and then sell on packages of these loans to others, was a way designed to reduce the risk to the banks, and a method to allow them to extend more credit. As Mr Lewis argues, this was not such a bad idea when done sensibly. It would be a pity if such practises were made impossible in future, as it could limit credit growth more than is desiarable.

Today someone of the radio told us that the credit crunch was easing in the UK wholesale markets, and intensifying on the High Street.

That’s what you should expect to happen. Banks and Building Societies are getting the message from the money markets that they cannot carry on lending so much. That’s why they are withdrawing their attractive mortgage offers, putting up rates and demanding larger deposits. They need to rebuild their margins (make more profit and protect themselves from loss) at a time when they cannot borrow cheaply in large amounts on the money markets, and cannot sell the same volume of mortgages on to others in the way they could in 2006. They need to husband cash and make more profit to deal with the write offs on past business and to combat the changed conditions they are experiencing for raising money to lend on.

As they withdraw their High Street offers, or ration them by price and deposit requirements, so their demand for extra funds from the money market declines. As a result, money market rates have started to come down, to get closer to the Bank of England’s rate that has been an academic irrelevance for much of the time since the crisis struck.

Some of the money market reaction is a question of timing. Banks and mortgage companies need to be more careful at a quarter or year end, and can relax a bit mid month. Some is more fundamental, reflecting the big decline in credit being offered to consumers, reducing the banks’ total need for cash.

It is by this mechanism that the credit crisis will move from hitting the financial sector, to hitting the consumers. All those who took pleasure in some well paid City types getting into difficulties and maybe facing cancelled bonuses or something worse, will now see that this is a crisis that will hit others too who were nothing to do with the credit explosion. The first casualties of the UK credit crunch will be first time buyers who will not have access to the same proportion of the selling price of a property on the same favourable terms as their predecessors in 2006/7.

There is a two way pull in the UK housing market at the moment. The price falls of the last few months have been small on average. The epicentre of the decline so far seems to have been some new flats in some city centres where developers had done well with their selling prices not so long ago, and where there is now excess supply. Some say the continuing pressure from new households, and the shortage of new build will keep prices up. They point out that interest rates are still much lower than in the last housing price decline. Others point out that whilst interest rates are lower, house prices are so much higher so mortgage payments are also very high. A one percentage increase in the mortgage on the base of say a 5% rate is a 20% increase in interest cost for the individual or couple concerned. If that is charged on a high house price and mortgage that can be very painful to the mortgage holder.

Whilst it is true that there are more people who want to buy a home here, that only keeps the market up and prices rising if it can be translated into effective demand through such people obtaining mortgages. There are always more people who want a first home or a bigger and better home than there are homes available. Prices sort out the imbalance in the market, limiting most people’s ambitions by the reality that the house they might like most is simply too dear. We are entering a period when more people are going to have more limitation placed on their ambition to own a home or a better home, because there is going to be a painful shortage of mortgage funds.

In these conditions prices on average are likely to come down. That is also part of the painful process of adjusting after a long period of inflationary credit has been let loose in the system. Falling house prices bring other economic problems in their wake. If fewer people move the demand for carpets, curtains and new furnishings will take a knock from that source. If people feel less rich because their main asset is no longer appreciating, then they will spend less on luxuries. As people pay more interest on the mortgage, so they have less income to spend on other items, as the mortgage interest is like a tax – you have to pay it or else. It’s all part of the economic slowdown most economists are now forecasting.

PS: Since writing this post I have seen the Halifax house price index for March. That shows a 2.5% fall on average in March 2008, taking the annual average increase down to just 1.1% despite the strong start to the last twelve months. It also reveals that the West Midlands and Wales are leading the market down, with London overall still up. I can’t see house prices suddenly reversing this downturn in the national average that has shown up so strikingly in the last month in this index.

Just as we have seen a rush by mortgage companies to put their rates up, so they are not left as the cheapest on offer facing a deluge of applicants, so we are now seeing a rush to withdraw mortgage products altogether as mortgage companies struggle with the volume of demand.

Individual companies are right to stress they are withdrawing products and increasing prices because they are inundated in the wake of Northern Rock’s withdrawal from the market, not because they have run out of money. The system as a whole, however, is cutting back on its volumes because it is rightly being more cautious about how much money it can raise from different sources. The Credit Crunch is having a real impact at last - it means less money for banks and Building Societies as a whole to lend, which means fewer mortgages, lower proportions of the house value being advanced and higher interest rates (relative to market rates).
This in turn will mean lower house prices.

The rest is covered by yesterday’s post entitled “Are all mortgages wicked?”

Today a leading mortgage company has announced it is withdrawing for the time being from making any new mortgage advances. This follows hard on the heels of the government’s decision to halve the amount Northern Rock has lent on mortgage over the next couple of years in order to repay the money owing to taxpayers.

In recent days mortgage rates have been rising, even though the Bank of England’s message on interest rates has been to keep them the same. As one or two mortgage companies find they are offering the lowest mortgage rates, so they are inundated with people seeking a good value mortgage. They are forced by the rush into putting up their rates, only to leave another mortgage company exposed to the rush. It is going to be a difficult time for people seeking a mortgage, and a more difficult time for those with a variable rate mortgage, facing higher interest payments as a result.

Today Parliament will be debating mortgages on a Liberal Democrat motion. The LDs have been saying for some time that people in the UK have borrowed too much, and have been urging action to curb private sector borrowings. Presumably they wanted higher interest rates sooner, to choke off some of the mortgage demand, and probably want tougher regulations to make it more difficult for people on low incomes or with few assets to borrow.

I certainly opposed Gordon Brown’s decision to tinker with monetary policy by changing targets for inflation from the RPI to the CPI. It meant the Bank of England had to set lower rates in the run up to the 2005 election than if they had kept the old target, and did mean more credit was extended. If the government had stuck with the RPI, and had kept a better control over its own borrowings, we would be better placed to weather the current financial storm.

I do not, however, share the LD view that things should be made a lot tougher for those on low incomes or with no cash for a deposit to buy a home. Home ownership is rightly much sought after, and is an important part of an English person’s liberty. Once someone owns a home they make decisions about their private space in a way tenants cannot, and they have an asset which usually goes up in price which brings them greater financial independence as the years progress. There can be little worse financially than facing old age with no home that you own – it means you pay the highest rents of your life at the end of your life when you have least income.

So what should the authorities do about the move from boom to bust in the mortgage market? They should not rush to regulate to dictate terms to mortgage companies., Saying now people cannot in future borrow 125% of the value of their property, or saying to those without deposits they have to save for one first would be seeking to bolt the stable door long after the horse has gone. Yesterday’s problem was too much borrowing. Today’s may easily become too little if the government is not careful.

The Bank should cut interest rates, to offset some of the unplanned increase in rates we have seen in recent weeks. It needs to try to get control back over the general level of rates in the markets. The authorities should not introduce new and more mortgage regulation. In a global market it is difficult for such regulation to bite if done nationally, whilst the consequences will be harmful to those seeking UK based loans, making them still scarcer and dearer.

It is probably necessary to cut Northern Rock’s mortgage book because the bank is now nationalised and must not be seen to competing successfully to lend more money. It is certainly necessary to get the taxpayers money back in reasonable time. This will place a continuing strain on the mortgage market, as other lenders find the £50 billion to replace the Northern mortgages destined to be repaid. In these conditions the Bank needs to do all it can to keep the mortgage market reasonably liquid, without putting more taxpayers money at risk without more than adequate collateral and protection. The Bank should also be sympathetic to the idea that the banking sector should not have to write down all their good quality shorter term paper every time some financial institution has to dump some of it at distressed prices to raise cash, for that way leads to a race to the bottom with continuing dangers for some financial institutions.

It is important amidst all the puritan commentary telling us it serves people right, that they have borrowed too much and the financial sector has been greedy and irresponsible, to remember that people still need homes and home ownership is the best way of organising and financing that. The important task is to get rid of the froth in the market without causing a slump, for that would just put more people into misery and prevent the rising generation buying a home as soon as they would like.

The taxpayers’ misery – and the government’s discomfort – have now begun. The nationalisation of Northern Rock will be costly to taxpayers and damaging to the government’s reputation.

Last night the government brushed aside Conservative proposals to handle Northern Rock in a different way and to avoid the taxpayer taking on responsibility for all the jobs, mortgages, loans, properties and bills.

Instead, the government announced a one third cut in the workforce, and a halving in the size of the business, along with confirmation that the bank will lose money in each of the next three years. That prospectus for the nationalised business suited no-one. MPs from the North East, along with the rest of us, did not want to see such large reductions in the workforce. MPs who care about the taxpayer do not wish to see taxpayers having to foot the bill for the job losses and the other losses in the business.

The government refused to tell us what the forecast losses amount to, implying they will be significant. They refused to tell us how the taxpayer would be asked to pay for these losses, implying they have not thought through how the revenue subsidy will be injected in to the business. Their numbers of course did not add up, as the size of the business is going to be reduced by more than the workforce, implying further job losses to come later.

The Chief Secretary contented herself with claiming that the Opposition had no alternative to nationalisation, declining to answer my points about how the Bank of England and the Treasury could have acted as Northern’s bank manager, lending them the minimum necessary to see them through and managing the repayment of the loan in a timely way.

The government seems to be in denial. It thinks nationalisation is the answer, when it will turn out to be a whole new load of problems. Every staff member dismissed, every loan that goes bad, every customer upset now stretches up to a Minister who is in ultimate control of the destiny of the company. They do not seem to have a plan to handle the complex management problems, and are refusing to own up to the magnitude of the cash requirements of their new acquisition.

Last night the Opposition were right to ask them to think again. We were right to offer them a better way of handling a distressed bank. It is a pity for all of us they turned us down and made silly political points instead.

It is good news that the Bank of England is thinking about its role in modern markets, and that the US and UK authorities are to review how to handle banking liquidity and regulation in future.

This agenda should include:

1. Have the Basel regulatory arrangements encouraged too much off balance sheet lending?

2. How can a market in securitised good quality loans be restored? Should the authorities buy in or accept as collateral more of these loans, whilst protecting taxpayers against losses?

3. Has the UK Government burdened British markets with too much off balance sheet borrowing of its own? Can this be curbed?

4. Do the leading Central Banks have enough capital of their own to keep markets liquid enough?

5. Shouldn’t Central Banks try to keep market interest rates in line with their announced main interest rate by open market operations?

There is nothing wrong with the idea of banks bundling up loans and selling them to others in the market. That is healthy and helps the growth of the world economy. The danger arises if the banks themselves continue owning large quantities of corporate bonds or securitised papers in conditions where they find they cannot sell or value these assets at a realistic price. Market seizure for bonds or loan packages forces banks to cut their lending and to write down the value of these assets on their balance sheets in moves which can become a vicious circle.

The Central Banks need to find a way of keeping the high quality bond and securitised paper market in line with their chosen interest rate generally. That should be the main issue facing the US/UK Committee.

Meanwhile, the UK Government needs to ensure rapid and orderly repayment of the Northern Rock loans and needs to consider whether that is sufficient to give the Bank of England the financial firepower it needs. It also needs to cut its own appetite for borrowing, which is now in danger of crowding out other borrowers from the market. The Bank needs some of its old powers - and information - back from the FSA so it can understand banks’ positions more quickly and respond in money markets appropriately.

I am glad to see the Telegraph today giving front page prominence to the rise in mortgage rates this week. See yesterday’s blog on interest rates and the MPC for the background.

This morning the FSA takes the regulatory blame for Northern Rock and admits it made mistakes.
I think it is a case of mistaken identity. It was the Chancellor and the Bank of England that presided over the collapse of Northern Rock, not the FSA.
Remember what happened. In the summer of 2007 money markets dried up in an unprecedented way. Some of us went hoarse telling the Bank of England they needed to make more money available so the money markets could function.
Instead, in September, knowing Northern Rock could not borrow all it needed from the money markets, the Chancellor and the Governor of the Bank made speeches saying banks had lent too much and if they got into trouble it served them right. There would be no bail out.
There was then a run on Northern Rock, as small depositors sought to take their money out. (All this was obvious at the time – see the tab on Northern Rock for my contemporary comments on the Bank’s inaction and the Chancellor’s moral hazard speech).
Fortunately for Northern Rock, after huge damage had been done, the Chancellor and the Bank changed their minds and intervened to protect depositors.

I would not conclude from this that the FSA had got its stress testing wrong – or that the FSA needs more staff. I would conclude that both the Directors of Northern Rock and the FSA did their jobs in the belief that money markets would continue to function, and that the Chancellor would avoid comments that were damaging to regulated banks. These beliefs were not unreasonable. Northern Rock raised money in three main ways – from the money markets, from retail depositors and from securitisation. So do most banks, to differing degrees. As we have seen, other institutions can get into difficulties if money markets seize up, as with Bear Stearns.
What was wrong was that the Bank of England kept the markets so short of funds in August and September, and what was wrong was the speech and interviews of the Chancellor blaming the banks at the very point where a crisis of confidence was about to erupt.

The correct response to this crisis is not to appoint more staff at the FSA and let the FSA take the blame. The correct response is to strengthen the banking arm of the Bank of England, and reconnect the Bank more directly to the full working of the money markets, with a remit to keep the markets reasonably liquid. The Bank has as its main responsibility the setting of interest rates. In recent months the rates it has set have often become academic, as market rates have deviated from them under the pressure of the credit crunch. The Bank needs not only to set rates, but to enforce them.

The questions to be asked today are not about the FSA but about the Chancellor and the Bank.
Does the Chancellor now accept that his no bail out speech was a mistake?
Does the Bank now think it should have made more liquidity available to markets last summer?
What action is the Bank going to take now to ensure that the rates it sets are the rates the market follows?
Will the government restore the powers and duties in banking and money markets to the Bank of England that it took away in 1997?

There has been a lot of comment on the state of the economy, the Credit crunch and the banking problems over the week-end. It is time to re-examine the views of this blog, and the responses from many of you.

I have argued:

1. The US and the UK will avoid recession but will experience a slow down, sharp in some areas and sectors. Some are trying to talk us into recession, by claiming the US is already in one, but the numbers tell us otherwise. It is quite clear that the Fed, the Treasury Secretary and the President will do everything they can to avoid recession in the US.
2. Inflation will remain unpleasant for the first part of 2007, but in a year or so will have reduced. Most of you disagree strongly, believing the current inflation will persist, and if the authorities do too much by way of cutting rates and making money available will trigger a faster one. I see no evidence that inflation is passing from energy and commodities into wages. We instead seem to be entering a period when real wages will be squeezed, limiting the second round inflationary effects.
3. The authorities need to do more to make the markets more liquid to ease the banking problems. So far the Fed has been very active, doing all it can. The Bank of England seems to be reluctantly coming round to the same conclusion. The ECB is half way there, making cash available but not cutting interest rates. Many of you dislike the advice I am giving, but the authorities seem to be moving in the direction I think is right.
4. The banks will gradually be recapitalised by rights issues, new share issues, and money from the cash rich parts of the world – Asia and the commodity producers. This is gradually happening.
5. UK house prices will fall, along with commercial UK property prices and US house prices. Some think UK residential property price falls unlikely because we are building so few new houses whilst new household formation is greater. I still stick to this view, because the mortgage market is tightening substantially. I accept there is no need for Florida style falls as we do not have the same over building problem and did not have the same degree of excess in sub prime mortgages.

Today Anatole Kaletsky has written one of his thoughtful pieces. He states that the banking crisis is a liquidity crisis, not a solvency crisis. A liquidity crisis is when banks need more cash to pay out depositors and other creditors than they have readily available, and find it difficult to sell their other assets quickly enough to raise the cash. A solvency crisis is when banks do not have enough total assets to meet all their liabilities, so they need to raise substantial new capital.

I agree with him that Northern Rock and Bear Stearns both were liquidity crises – depositors and creditors lost confidence in the institutions and demanded more cash than the institutions could immediately lay their hands on without official help.
The one thing we have to remember, however, that is not in his article, is that a liquidity crisis if badly handled by the banks and the authorities can become a solvency crisis. If Institution A is experiencing a run on its cash, it needs to sell assets quickly to raise more money. This, in poor markets, can drive the price of these assets down to unusually low levels. All banks then have to mark down the value of their assets on their balance sheets, as even high quality assets can no longer be sold for good prices in such conditions. This can lead to some institutions no longer having sufficient assets to cover all their liabilities, so they need to raise more capital or they get into trouble.

This is why some of us recommend that the authorities should help the markets by intervening to keep the price of high quality financial assets up to realistic levels. If the Central Banks stand by and watch as well run institutions are forced to sell high quality assets for well below their normal value, they are allowing more serious problems to emerge in the banking system as a whole. It is in everyone’s interest that high quality mortgage debt, high quality bonds and corporate debt should sell at realistic prices, related to the current structure of interest rates. In a liquidity crisis the price of good quality assets can be driven down too far, putting pressure on well run financial institutions.

Today the Regulators start their search for the bear raiders who spread false rumours yesterday.
Meanwhile, the Bank of England should repeat that as the apex of our large and strong banking system, it will make enough liquidity available on a continuing basis so the markets function better and bear raiders have less chance to peddle their unpleasant trade. The authorities must use all their powers to protect decent institutions from false rumour and from artificially frozen markets.
The US authorities have responded postively and quickly. The Bank of England and the ECB are also important players. A strong united front from the Central Banks, facing the bears down and reassuring depositors by showing that they will do whatever it takes to support the many good banks there are in the system is what is now needed.
The UK government needs to act with and through the Bank of England. Ministers took the decision to throw so much resource into saving and nationalising Northern Rock, so they need to show the Bank of England that it by areement work with Treasury resources to keep the rest of the banking system liquid if needed. We do not want the authorities restricted in their actions because of the amount of Northern Rock support already on the books.

The oddest thing about this slowdown and credit crunch is the delayed reaction – or the lack of reaction – of the UK housing market. Shares have slumped. Commercial property prices have fallen substantially. Retailers have complained about the squeeze on their customers. Yet house prices are still slightly up on a year ago, and the last few months have seen only small declines in the national figures.

When I last wrote about this I ventured that high Stamp duty. Home Information Packs and higher mortgage and transaction costs were encouraging people to sit tight and not move. The market was short of supply, just at the point when otherwise it might have gone down. Fortunately unemployment has not been shooting up, and people have been able to meet their mortgage payments even though their budgets are under more pressure. There has been an uneasy equilibrium created by inertia and the new impediments to selling and buying.

We may still, however, be in a for a slow but painful decline in house prices. There is plenty of evidence that new buyers are finding it more difficult to obtain a mortgage. Gone are the deals offering total borrowings in excess of the house price, and gone are the days when you could get by without a deposit. US interest rates may be plunging, but UK general rates are much stickier, and banks and building societies are keen to rebuild margins by charging more for a mortgage relative to the general level of interest rates.

There are those who say they do not think lower interest rates will make any difference to the Credit Crunch – indeed that seems to be the fashionable position. They link this with fears about inflation in the UK getting out of control if any action is taken to cut rates. This is a strange misunderstanding of the position.

Lowering the general level of interest rates could be crucial to avoiding the slowdown of the housing market becoming something worse – a price crash. As part of the Credit Crunch is the banks’ unwillingness to accept mortgages as good assets when lending to each other, anything that makes it more likely more of the outstanding mortgages can be serviced and repaid by their owners would be good news. Surely more people will be able to afford the mortgage if the mortgage rate comes down, than if it stays up or even goes higher? In the USA the authorities have grasped it. They are fighting the battle of the bulge of the sub prime. If too many sub prime mortgage holders give up on the mortgage, then the losses will multiply through the banking system and more credit will be destroyed. The UK may not have had such an extreme version of sub prime lending as the USA, but similar dynamics apply in our housing market.

If the UK house price slide gathers pace, then more people will be in negative equity. Once the house is worth less than the mortgage, more people are inclined to give up on it. If more people lose their jobs, more will struggle to pay the high mortgage bills they currently face.

Meanwhile, it is difficult to see how we can become alarmed by inflation against the current background. The public sector is at last taking a tougher line on public sector wages. There is no evidence of inflationary pressures building up on private sector pay, as the market for goods and services is still competitive enough to make passing on big cost increases difficult. Private sector bonuses, especially in the financial sector, will be well down, deflating total remuneration. We have a few more months of bad figures to live through from the impact of raw materials prices and energy. The authorities need to be fighting against too sharp a slowdown from the Credit Crunch, rather than fearing an inflation that seems unlikely to get out of control.

A quick haggle, a visit to the lawyers, and a bank is bought and rescued over a week-end in New York. That’s the way to do it. It makes the UK’s attempted private sector rescue of Northern Rock look ham fisted, long winded and ultimately unsuccessful in comparison. The US authorities have once again acted decisively, with vigour and purpose, to prevent the banking collapse getting out of control.

This week we can expect further interest rate cuts in the US following on the 25pt reduction in the discount rate announced overnight. All this US activity is producing two main lines of criticism of the US authorities which we need to consider.

The first is the criticism that inflation is not under control, so cutting interest rates in premature and dangerous. It is difficult to hold both this view, and the view that the US is now in recession or is about to go into recession. The Fed clearly fears the forces that are restraining activity and cutting jobs more than it fears the inflationary forces that are evident and left over from the easy credit days that have now gone. Whilst I remain sceptical about the claim that the US is now in recession, it does seem that the impact of the housing crash and the drying up of credit means the threats to activity levels are more important than the threats of further price increases. I back the Fed’s judgement that their main enemy today is too little credit and activity, not too much.

The second common criticism is that by cutting so far so fast, and by using so much of its financial fire power at this stage, the Fed will have nothing left if it fails to work. This is an even more bizarre argument. It is saying if you use your umbrella in the wet and the wind today you may damage it, so it will not work next time. If you take that view everytime the weather’s bad what is the use of the umbrella? The Fed has good reason to suppose this is just the kind of crisis it has to respond to strongly by cutting interest rates and putting liquidity into markets. If they get it right they will make a relapse less likely. If they do not try with what they have there will be a very serious banking crisis.

Since last August I have been commenting on how different the approach of the US authorities is to the approach of the UK authorities. It has taken just four days to rescue the assets and what remains of the business of Bear Stearns. More than six months have passed and we are still a long way from finding a private sector rescuer for Northern Rock. The Treasury and the Bank now have much less flexibility to deal with any other financial catastrophe, because their balance sheets are stretched by taking on the Rock. Meanwhile the Fed is well on the way to laying off its problems with the Bear.

The budget looked insignificant and irrelevant the day it was announced. It looks absurd this morning.

The near collapse of the 5th largest investment bank in the US and the rapid action taken by the US authorities to avert a crash in the wider mortgage and banking markets matters to us as well as to Americans. We are all in this together. If major US institutions run out of money or stop trading, London based financial institutions will take some of the hit.

Those who think this is just a worry to highly paid people in finance who have good times for too long should also think again. If the banks run out of money, in the end we all run out of money. Many businesses and individuals need access to borrowing to keep trading, to buy homes, to buy new equipment. Borrowing will be getting even scarcer if the authorities do not sort out the banking problems.

We still have very different attitudes either side of the Atlantic. In the US, the President, the Head of the Federal Reserve Board, and the Treasury Secretary are all of one mind. This is a serious crisis in the mortgage and banking areas, and everything has to be done to prevent a collapse. We have seen big cuts in interest rates already – we should expect more. We have seen big sums offered to markets to buy up good quality paper that the market no longer trusts – we should expect more when needed. We have now seen direct lending to a bank in trouble, and should expect similar support if market bear raiders try it on with another institution.

In the UK we have had lectures from the Chancellor and the Bank Governor that the banks have been guilty of bad lending and there will be no bail outs. We had a steely performance last summer, until the Northern Rock problems got out of control, when they announced a comprehensive bail out for one mortgage bank, leading to its eventual nationalisation. In the last week the Bank of England did join in concerted central bank operations to make more money available to distressed markets, but it was on a modest scale, suggesting a friendly intent but a lack of conviction in what they were doing. It may also show that after Northern Rock, where UK handling has led them to take on more liability than I think they need have done, they are short of fire power.

The problem remains at base a simple one. We all know that banks have made too many loans, and that some of those loans will turn out to be bad ones where the borrowers will be unable to repay the money. The trouble is no-one knows just how many loans will turn out to be bad, and which of the banks has too many of them. Whilst banks are increasing their provisions against bad debts in the future, and raising new capital to strengthen their balance sheets, fear stalks the markets. People are now worrying that perfectly good loans and mortgages will turn out to be worthless. Investors are dumping investments in good loans as well as bad, driving the value of all a bank’s loans down.

That is why there is a serious threat to the world banking system. Banks only work because most people trust them, and most depositors are happy to leave their money in their accounts knowing they can get their money out when they want it because not everyone will want their money at the same time.. They work because they can play a numbers game, knowing they will do well if say only 1 in 100 loans goes bad, and still survive if 4 in a 100 go wrong. If depositors no longer believe they can get their money out, and if investors believe large numbers of usually good loans will go wrong, the system breaks down. The authorities prime duty is to make sure we never reach such a self defeating set of attitudes. It is after all in the end our own ability to save and spend, to make payments and earn interest that is at stake here. The US authorities once again did the right thing this week. They have shown they understand the gravity of the threat to the system, and showed they are resolute in defending people’s money. Next week they are likely to continue their good and essential work to reassure markets, and therefore move to underpin everyone’s bank account.

Listening to the deafening silence of the Chancellor this week, I was left asking myself “Doesn’t he know there is a credit crunch?”. Yes, he said he understood there were storms in the world economy, but then he raised a children’s umbrella and plodded on. He should show some urgency in tackling the overspending and overborrowing in the UK public sector. He should produce a statement on how the Bank of England’s powers in money markets will be urgently restored, learning the hard lessons of the combined failure to avert the Northern Rock crisis last summer. Behind the scenes, instead of playing silly politics with drink and green issues, he should be devoting his sole attention to international collaboration, to make sure the world authorities get ahead and remain ahead of the pack of bears seeking to make money out of bringing down other financial institutions and financial products.

The world system does need to cut its over borrowed state, but in an orderly way at a sustainable rate.

Inflation is too much money chasing too few goods. Today inflation in the UK and the US is being driven higher by increases in the prices of energy, raw materials and basic foodstuffs, and in the UK by the costs of government. Much of the international inflation comes from excess liquidity in the oil exporting economies and from the demands of Asian economies which have built up large surpluses through successful exporting. The US and UK economies have bigger problems from the way credit has dried up, leading to job losses in the US and a sharp slowdown in the UK economic forecasts.

This makes high interest rates in the US and UK economies an inappropriate response to the inflation – something the US authorities have understood. There is clearly no excess liquidity in the US or UK private sectors. Asset prices on both sides of the Atlantic are falling. US house prices, shares and commercial property are either in freefall or are showing signs of distress. UK commercial property has fallen sharply, UK shares are down and most residential property prices are now static at best.If we had too much domestic liquidity you would expect some or all of these values to be rising, not falling.

Energy prices have risen partly because the emerging economies have need more and more of the limited supply, partly because the dollar and the pound have been weak currencies, and partly because despite global warming theory it has been a very cold winter in many parts of the northern hemisphere where much of the effective demand for energy resides. Food prices, especially grains, have soared. This is partly because the Asian customers want more and better food, but partly because the weather has been so bad affecting crop yields and partly because some global warming theorists have favoured using grains for fuel, diverting them from food.

The big pools of liquidity built up in Asia, Russia and the other commodity producing areas have helped power the prices of precious metals and other commodities, both to fuel demand for industrial products, and to satisfy new holders and hoarders of them.

The UK’s inflation rate has been increased by the inefficiency of the public sector, and the liberal use of higher charges and taxes to tackle what is more truly a problem of spending badly.

The correct response to the commodity price inflation in the west should be to ignore it, all the time there is no transmission from the higher metals, energy and food prices to wages and asset prices. So far there is some sign that some of the extra costs are being passed on by business, but no sign that either the US or the UK is about to have a worrying round of wage inflation. Passing the price increases on just shifts more of the pain from companies to the individuals who buy the products. It looks as if this inflation is going to lead to a reduction in the spending power of consumers in the UK, as neither the government nor the business sector are willing to take the hit. Indeed, the government is keen to divert attention from its own role in the inflation, by calling in parts of the private business world for punishment talks when their prices have gone up, as it is currently doing with the energy suppliers.

In the UK everything points to the need to cut the costs of government, not by doing less in the services that matter but by doing things better where they need doing. I set out in yesterday’s blog the need to cut UK government borrowing as part of our response to the present economic crisis. Today the message is reinforced by the inflation figures. The government has done the right thing in at last telling the public sector – including MPs – that this year’s pay rise has to be below inflation. It needs to do much more to get value for all the spending it is committing.

Today’s gales may be the last fling of an unpredictable winter in the UK. The parallel squalls on the markets need the authorities to realise they have a serious problem and get to grips with it if they wish to create calmer conditions.

Under this government you don’t get much for £1 billion these days. You can soon blow a £100 million on fees for advice on a financial matter, and can get through many times that on a centralised computer contract or good pay rises all round for public sector workers. I expect the political classes will soon be looking for a new unit to make it sound more reasonable.

So I have come up with a modest proposal. Why not account in “rocks”. We can’t be quite sure how much a rock is, but it is probably around £110 billion. It breaks down into 2 Granites, a smaller unit of account which works well offshore.

Recasting public spending, the total spend comes out at around 5 rocks. The Health Service is a snip at just 1 rock, whilst you can have all the armed services for a year for well under a granite and keep them mainly working offshore.

Total stated public debt is only 5 rocks. Even adding in unfunded pension liabilities, borrowings by a nationalised bank and railway, PFI and PPP you still come up with a very easy sounding 12 rocks of total public sector liabilities.

This could well catch on, and make it easier for the government to carry on spending as if we had all the money in the world.

(Based on a speech given to a dinner in the Great Room of the Grosvenor House Hotel on Tuesday night of this week)

I have posted the full transcript of the one hour debate we were allowed on Thursday on Northern Rock, because it illustrates just how damaged Parliament has been by the constant use of timetable motions that are unrealistic.

The Lords passed three amendments to Labour’s bank nationalisation Bill. One wanted the Freedom of Information Act to apply to Northern Rock, just as it applies to the rest of the public sector. One wanted a proper audit report on what we are buying, and a third wanted more detail on the competition arrangements. All three were perfectly reasonable requests. They did not seek to prevent the nationalisation of Northern Rock or some other bank. They were well within the spirit of the decision of the Commons to press ahead with nationalisation, taken a couple of days before.

It was clear these amendments would need a few hours of debate. Each one raised very different issues, worthy of a separate debate. Because the government decided to drive it all through in one hour, they ”grouped” all these amendments together, along with some government amendments. The Opposition offered to sit through the night, as urgency was part of the government’s agenda, even though we could not see the need for the urgency. Alternatively the House could have met on Friday again to discuss Northern Rock, and Friday’s business could have been transferred to a day next week. The government refused to co-operate.

As a result we had one hour. The Chief Secretary to the Treasury occupied half of this with her comments. She took a number of interventions. We needed to intervene for two reasons – firstly because she was not explaining her position clearly and convincingly, and secondly because we knew there would not be time for us to make speeches so several of us chose to make one of our points in this less satisfactory way. The Shadow Spokesman kept his remarks much shorter. This allowed Sir Stuart Bell to speak, and the Lib Dem Spokesman got a few minutes at the end. No Conservative backbencher could make a full speech, No Lib Dem backbencher, and only one Labour backbencher. The front benches had no time to return to the debate to deal with points raised by other MPs.

The Conservative government used timetable motions sparingly. We did so if the Opposition had spent many hours on the first clause or amendment to a Bill, and showed every sign of wishing to delay and prevaricate as much as possible. Most Bills went through with time unlimited, so the Opposition could choose what they wished to talk about, how many of them wished to speak, and for how long. It was a much more democratic way, and ensured that all important amendments and clauses were debated. The government benefited from this, because there are times when Parliament – and those who brief us – made important points that led to a modification or improvement of a measure.

Thursday’s performance reminded me just how much Parliament has lost by ruthless timetabling. There were good issues to discuss. Some of us had things to say. The government had not made its case satisfactorily on why we were to be denied access to information on Northern Rock, and why we were buying it without a proper audit report on what we were buying. The lack of time to discuss it was unreasonable.

There will be a cost to the taxpayer. Rushing into this purchase without proper consideration is likely to mean bigger losses and problems for taxpayers ahead. The Lords unfortunately did not sustain their pressure on the 3 points. The Lib Dems decided they agreed sufficiently with the Bill that they did not want to prolong the dispute even for a few more hours. Once they gave in there was no point the Conservative peers continuing, as they did not have the votes.

Sensible Ministers welcome Parliamentary debate, and listen to commonsense points made by others. Ministers who rush legislation through often live to regret it. The nationalisation of Northern Rock is not the answer, but the beginning of a whole series of new and difficult questions for the government. As Parliament was not able to ask them all and have them cleared up satisfactorily, they will now be determined by events. Events can be much rougher for Ministers to handle.

One day we will find out if Northern Rock is now going to be run down, or if there is a way for a nationalised bank to compete fairly and grow its business. One day we will find out if people are going to be sacked and if so how many. One day we will find out what the true profits and losses have been in recent months. One day we will discover how much cash taxpayers have had to put in, and one day we will find out the full extent of the financial arrangements put in place for the public servants at the top of this company. As so much of this is forbidden fruit at the moment for Parliament, the media will find it so much more tempting to pick it.

In Northern Rock’s 2006 Accounts they reported how well they were doing. They commented “ The low risk nature of Northern Rock’s balance sheet is reflected in the mix of assets…These assets are well funded through a well diversified range of assets.” They looked forward to further low risk growth, and told their shareholders that the new regulations under Basle II would mean they could reduce the amount of money they needed in their business to support the then level of activity. What a difference a year makes.

Last year they put aside £126 million for possible losses on their lending, most of it for the unsecured loans they had offered people on top of their mortgages. This represented just 0.15% of the amounts they had lent. This year I am sure the new management will want to look at this and step it up considerably. They may also wish to record losses on many other features of the Northern Rock business, as prudence would dictate lower values for some of the assets on the balance sheet, and putting money aside for redundancies and future re-financing costs. There is likely to be a lot of red ink spilled as Auditors and new management try to agree what is fair. The taxpayer will take the hit.

The media and political classes have suddenly alighted on the issue of Granite, the offshore financing company that has issued substantial amounts of paper to its investors, and which holds a lot of Northern Rock’s mortgages. In order to understand what is going on , we need to look at how a mortgage bank can raise money to finance its business.

Northern Rock prided itself on using four principal methods to raise money to lend to people, claiming this showed it was prudent and not too dependent on any one method.

The first is to collect money from savers, through so called retail deposits. If you or I put our few hundred pounds into a bank or building society we are letting them use our money to lend to people on mortgage. Some MPs now seem to think this is the right way to finance a mortgage business, and think it is the prudent way. 22% of Northern’s business was paid for by these deposits at end 2006. Paradoxically, it was this method of finance which led Northern Rock to borrow so much money from the taxpayer, because once the small savers lost confidence in the Bank they wanted their money back, leaving Northern short of funds. It is the ultimate example of borrowing short to lend long – many of the small savers place their money with banks like Northern in deposits where they can get their money out in a day, or with a month’s notice. Mortgage banks lend this money on for much longer time periods, usually safe in the knowledge that their depositors will not all want their money back on the same day, and confident that others will come along to deposit.

The second is to borrow from the money markets – so-called wholesale funds. 24% of Northern’s money came from this source at end 2006. Much of this borrowing is also short term, but banks can usually rely on being able to borrow it over and over again, so again it is usually safe to lend it out for much longer periods. This source of funding dried up in the Credit Crunch of September 2006.

The third is securitisation. 43% of Northern’s money came from this source by end 2006. The bank packaged up groups of mortgages, and sold them to a Granite offshore company. The buyers hold a piece of paper in a Granite company, and receive interest payments based on the mortgages within their company. This financing can be arranged for longer time periods, like the mortgages themselves.

The fourth comes from issuing bonds, where the bondholder lends money to the company for a fixed period. These too can be for longer periods than 1 and 2 above. Northern raised £6.2 billion in bonds, offering mortgages as security for those as well so the bondholders would get their money back if anything happened to Northern Rock itself.

Northern’s critics now tell us this was a risky business model, because it entailed borrowing short and lending long. All banking involves an element of that – that is how banks make their money because they can charge more for the longer term loans they make than they have to pay for the short term money they borrow. They can also, of course, charge more for the loans they make to reflect the greater risks of those loans. Northern’s collapse resulted from the sudden drying up of the money markets, followed by the swift withdrawal of too many retail deposits. Two of its four funding methods went wrong.

The sudden fascination with Granite is probably overdone. Northern took the prudent line on reporting Granite. It kept all the loans and all the borrowings on its own balance sheet. It did so because it manages the mortgages in Granite, and because it has to replace any mortgages that fail to meet the standards required, and because it has to top up the Granite companies with new mortgages if the mortgages are repaid too quickly. Northern also has securitisation arrangements through Dolerite Funding and Whinstone, on a more modest scale than Granite. These are also clearly shown in the last Accounts on the balance sheet.

The argument over Granite revolves around the government saying they are not nationalising the Granite companies and the Opposition pointing out that Granite is part of Northern Rock’s balance sheet with obligations from Northern Rock to Granite that will continue. In addition Northern has an £8.4 billion investment in Granite.

The bigger argument will become how much value can taxpayers put on all of this? The 2007 Accounts are likely to look very different from the 2006. I expect to see some hefty write downs in Northern Rock’s asset base. Valuing their share in Granite is just one part of a much more complex and difficult picture. The valuers also have to take into account the interests of all those who have made money available through securitisation to the Northern Rock business.

Yesterday saw another successful government attempt to stifle debate and prevent serious consideration of an important billon bank nationalisation. I was left with just six minutes to try to discuss all the wide ranging issues involved during the Second Reading debate on the principles, whilst the perfunctory two and a quarter hour committee stage left completely inadequate time for all the amendments we needed to consider.

It was a pity. It was a pity for the North East, and for all who wish to see Northern Rock given a chance of a decent future. It was a tragedy for taxpayers, who will now be required to buy a mortgage bank by a government that seems to have no concern for what it is buying, and no idea of how much it will cost taxpayers over the next couple of years.

I would have liked to have spent more time discussing the importance of Northern Rock to the North East, and how the North Eastern economy could be encouraged to branch out more into the usually profitable and successful world of financial and business services. It is good news that Northern Rock took root there. It is bad news that it should be Northern Rock that got into so much financial trouble, and bad news that there are few other large financial institutions anchored in the North East.

We had no chance to look at the way the Bank and government last summer failed to keep markets liquid enough. The Fed in the USA and the ECB in Euroland did a much better job supplying cash to their markets, so no European or US bank got into the problems Northern Rock faced.

We had no chance to discuss the impact of Gordon Brown�s decision to take banking supervision and government debt management away from the Bank of England. In the Conservative Economic Policy Review we warned that once times got more difficult in money markets the UK was uniquely vulnerable to a banking crisis because these reforms left the Bank of England unable to respond quickly in the way it could have done prior to the Brown changes.

Last August we stated in Freeing Britain to compete:

�We are concerned about the division of responsibility between the FSA and the Bank over banking and market regulation. Fortunately, conditions in the last decade have been benign internationally, with no serious threats to banking liquidity. We think it would be safer if the Bank of England had responsibility for solvency regulation of UK based banks, as well as having an overall duty to keep the system solvent. Otherwise there could be dangerous delays if a banking crisis did hit, with information having to be exchanged between the two regulators; and there might be gaps in each regulator�s view of the banking sector at a crucial time, where early regulatory action might have spared a worse problem�

If the danger was obvious from Opposition, why couldn�t the government see it? Why was the Chancellor lecturing the banking sector on how they had misbehaved, and telling them there would be no bail outs, on the eve of this crisis which triggered the biggest bail out ever mounted in the UK? Indeed, there were rumours about which bank was likely to get into difficulties first in the credit crunch; before the run on the Rock began. We did not repeat the rumours because we did not wish to make life more difficult for that institution.

At this late stage, I still urge the government to consider the serious alternative to nationalisation � the Bank of England acting as Northern�s bank manager, until Northern Rock can repay the state loans and refinance itself elsewhere. It removes all the hassle of a government having to take a public view on repossessions, new mortgage offers, staff numbers and pensions. It gives Northern Rock a better chance of a decent future, as it puts some real financial discipline into senior management that is usually lacking in a nationalised industry in the UK. It protects the taxpayer better, and gives more chance of saving and creating new jobs in the North East.

Nationalisation has proved a long and lingering run down for all too many businesses to fall under its spell. Last night there were no reassurances from Ministers about the future of Northern Rock jobs, and no statement of whether they will be running the Bank down or trying to build it up. I suspect they do not know, because so much rests on what the European Competition Commissioner will let a public sector Northern Rock do. It is a pity the government did not settle that first so they could tell Parliament and public, before committing us to such an expensive and a hazardous project as nationalisation.

I am a businessman by background. I have occasionally bought or sold companies. Never have I been asked to buy a company with so little information available on its assets, liabilities, past and possible future performance as today, when the government wants me to approve the purchase of Northern Rock for taxpayers. Never have I been asked to put my name to such a huge commitment before - placing the taxpayer at risk for more than �110 billion.

They will not tell me how much they wish to pay for the shares. That will be decided after they have announced the purchase and legislated for it! This is not the usual negotiating procedure between buyer and seller.

Because they are compelling sale by the shareholders, they leave taxpayers open to lawsuits. I doubt they will tell us how much of a risk that is, nor will we be given their legal advice to make our own decision about how likely a successful legal challenge for compensation might be.

We will not be told what is the true state of the mortgages that are the banks� main assets, and we will not be given a schedule of either assets or liabilities. There will be no accountant�s reports, no assessment of the term structure of the loans and assets, and no commentary on the likely movement in the bad debts.

We will not see management accounts for the last year, and we will not have budgets for the next couple of years. We will not even be told what the general outlines of the business plan might be, because they are awaiting clearance from Brussels for how much new trading they can undertake. They will have to be careful about what the bank can offer in the marketplace, as its privileged access to public money leaves it open to allegations of anti competitive trading if it gets the offer wrong.

We will not be given a report on the size of the deficit in the pension scheme and how that has been calculated, nor will we be warned that the pension deficit might be about to get larger in the light of recent regulatory and actuarial comments on how people are all living much longer than has been allowed for in many a pension fund calculation.

There will be no environmental report on the properties with an assessment of risk under Environmental regulation, which any purchaser would need these days. There will be no property report about the leases and freeholds, and the lease and maintenance obligations.

We will not see the main contracts of the very expensive senior staff to be able to review the bonus arrangements and to see how much it will cost taxpayers if we need to terminate some of their employments. We will not receive a Human Resources report on pay, morale and efficiency of the workforce we will inherit.

There will be no survey of customer attitudes or study of the value of the brand post the disturbing changes to it in recent weeks. There will be no report on the relationship with the Trust, on the ability of a public enterprise to sponsor one particular football team or on the extent to which a nationalised company can continue the social and community work Northern Rock performed in its profitable private sector days.

In sum, Parliament will have none of the usual information directors would require as matter of course from acquiring management and their advisers before consenting to an acquisition. Perhaps for that reason Parliament is once again being railroaded and sidelined by the government. It is a farce to allow only one busy Parliamentary day to consider all stages of the Commons procedure for this bill. It means we have had no normal time to read the Bill and table amendments, and if we had there will be insufficient time to debate them. This is rushed debate on a botched nationalisation by a government which has not done its homework. The taxpayer is being put into a deal without knowing the price or the long term risk and cost. Ministers tell us all that taxpayers are risking is guarantee. Not so Ministers - the taxpayer is now liable for every broken window in a branch, every severance and pension payment, every mortgage and loan. If the assets cannot cover the cost of these things taxpayers will have to pay more tax to sort it out.

The Northern Rock crisis has undermined this government�s economic reputation, and deservedly so. They have made mistake after mistake in responding the Credit Crunch and the run on the bank. I have put the main blog entries on Northern Rock from this site together so people can remind themselves of the way the crisis unfolded from last summer. The main errors (highlighted at the time on this site) were:

July 2007 It was clear that credit was too tight and interest rates were too high for comfort. �If the central banks don�t back off soon it could be quite a collapse�. The UK authorities failed to supply enough liquidity to markets or to lower rates.

August 2007 The Credit squeeze became clearer in the markets, and some more City commentators came to appreciate the dangers. The UK authorities still did nothing.

September 1-13 The Fed and the ECB were taking action to relieve the squeeze, but the UK authorities still did nothing.

September 13th The Chancellor makes a stupid speech blaming the banks for poor lending and stating firmly there will be no bail outs of banks in trouble. This was an open invitation to anyone banking with a weaker institution to remove their money whilst they still could.

September 14th onwards Government and Bank of England become lender of last resort to Northern Rock and allow this to become public knowledge, encouraging a run on the bank.

Government fails to arrange a take-over for Northern Rock before the run develops, claiming the legal framework it has put in place does not allow it to.

Government allows the run on Northern Rock to develop, and only when it is very serious does it announce the biggest guarantee and bail out ever attempted in the UK.

Government lends around �25 billion to Northern Rock without being able to assure us it has taken sufficient high quality collateral to ensure taxpayers can get all their money back.
Government fails to set out terms for the loan, including the all important question of when it expects repayment. Government fails to tell us that it has carried out usual banking due diligence and leaves doubt about what power it has exerted to ensure proper monitoring of the loan, strong covenants, and a professional approach to repayment.

Government becomes involved in shareholder discussions and decisions about finding a new management team/new shareholders for the bank and raising new equity for it. These discussions fail to produce an answer acceptable to all concerned, but drag on from September 2007 until February 2008.

Government nationalises the bank, more than doubling the taxpayers� risk at a stroke and leaving itself open to endless legal disputes and rows about compensation and the way it will run the bank under its ownership.

What should the government have done differently? As this blog shows it should have

1. Made more liquidity available to markets and cut interest rates last summer, to prevent banks like Northern Rock being denied all access to market finance so it did not develop into the crisis we saw.
2. Not lecture the banks on their imperfections when the system was so distressed, as the Chancellor must have known when he spoke
3. Avoid any lender of last resort lending being made public, or cover the lending to one bank by requiring all banks to borrow something so the markets were not spooked about one individual bank � this could have been part of a general liquidity increase and sold sensibly to markets
4. When lending to Northern Rock understand the need to be a strong and firm lender. This meant limiting the sums, and limiting the time of the loan. It meant telling the Board of the bank that they only had so long to find alternative private sector money, and if they could not they had to start selling mortgages and running off their business book to meet the repayments required.
5. Staying out of discussion about new shareholders and new management to increase the chances of something happening, but keeping up the pressure on them to reach a quick solution by demanding early repayment tranches.

At every stage the government made the wrong call. They have now ended up with the worst possible of worlds, and will doubtless run this bank as badly as they have been running Network Rail and the Post Office. In the first case they doubled the costs of running the track quite quickly after nationalising it, and in the second case they have embarked on a large programme of closures having undermined its counters business by their own decisions.

Click here to see the archive of John Redwood’s previous postings on Northern Rock.

Mr Darling is already in a big hole, thanks to his misjudgements over monetary policy last August and September, the run on Northern Rock, the botched proposals on capital gains tax and the U turn on Non Doms. Now, the man in the hole has decided to more than double its size!

There are ten reasons why nationalising Northern Rock is a bad idea.

1. It more than doubles the amount of money the taxpayer has at risk,from a little over �50 billion to more than �100 billion
2. It means any bad loan Northern Rock owns, the taxpayer will own.
3. It means the taxpayer is now liable for any redundancy payments if Northern Rock has to slim its staff numbers.
4. The taxpayer may have to defend against writs from angry shareholders if the compensation terms are not sufficient.
5. The taxpayer becomes responsible for the pensions deficit for staff
6. The taxpayer has to pay compensation to shareholders at a time when public borrowing is already excessive
7. The Chancellor will have to explain mortgage foreclosures, staff redundancies and other bad news to Parliament each time it happens
8. The amount of total government borrowing will increase as a result of the big increase in the amount of money at risk, and the cash needs of the business.
9. The taxpayer will have to pay any losses, meet any write downs of assets and pay for all capital expenditure of the business.
10. The government and taxpayer may be accused of undercutting other viable financial businesses competing against this bank dependent on public money if they are not careful with their guarantees, subsidies and pricing.

What due diligence will the Chancellor do if any before committing the taxpayer to all these liabilities? What law suits if any is he anticipating from shareholders? What will be the cost of compensation to shareholders? What will his policy be on remuneration for his new state employees and how will that fit in with other public sector remuneration?

Tomorrow we need a statement from the Chancellor. There will be all too many questions, but I fear this botched nationalisation will not come with many convincing answers.

The Bank of England yesterday bowed to the inevitable and warned us that we will become worse off this year. Many people already feel worse off, after the huge increases in food and energy costs that we have experienced in recent months. There was no apology for leaving credit too loose a couple of years ago, and no public recognition that the Bank had kept conditions too tight last summer and autumn as the bakdrop to the Northern Rock crisis. There was no revision to the absurd line just before the Northern Rock crisis struck that banks had been foolish in their lending and there would be no bail outs!

The Bank is right that they are boxed in - boxed in by government spending that is too high, by a public sector whose productivity is too low, by past credit excess and rising prices, and by the more recent Credit crunch which is having a big impact on property. The Bank is partly boxed in by governemnt mistakes - the government should have reined back more on wasteful spending earlier, and cut public borrowing - and partly by its own erratic performance on money growth.

We now have a boom and bust approach to credit creation - boom in 2003-6, bust in 2007. We have had boom and boom in public spending. Now we see the government fighting to get to grips with the problem of over spending.

I am glad the Conservative leadership has responded to those of us who have asked that we should not match all of Labour’s spending plans in the future. We should keep all the teachers, nurses, doctors, police and armed services personnel, for they only cost under one quarter of publilc spending. We should not keep all the quangos, regional governments, ID cards, computerisation schemes, advertising budgets and management consultancy contracts. They do not represent value for money and they are squeezing the public needlessly.

I welcome the government’s decision to place the Northern Rock debt on the government’s own balance sheet. It always belonged there, as the Bank of England is wholly owned by the Treasury on behalf of taxpayers.
It is there as a reminder of the importance of getting this money back as quickly as possible. It does not help the government’s fianancial standing, given the high level of new borrowing being undertaken.