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.

Today I learn that the Chancellor has become a mortgage salesman again. He is lecturing us to take long term mortgages at fixed rates. Has no-one reminded him that his government has made mortgage selling a regulated activity? I doubt if the Chancellor has bothered to fix himself up with the necessary regulatory approvals to start selling the fixed rate proposition so actively.

Is he aware that mortgage salesmen need to know their client? Does he grasp at all that long term fixed rate mortgages may work out dearer for some people? They do not make much sense if you plan to move on and repay the mortgage in a relatively short time period. The relative cost of floating rate and fixed rate mortgages can vary sharply as interest rates change. In a period of falling interest rates – which many think we are now in – locking yourself into a fixed rate mortgage may not be a good idea.

I hasten to add I am not a regulated mortgage salesman either, so anyone needing a new or different mortgage should go to a professional to seek advice geared to their own circumstances. This site general views and comments, but avoids individual advice on savings, borrowings and investments as these do require professional (and regulated) advice based on knowledge of the individual’s circumstances.

I find it extraordinary that our Chancellor is making this further foray into the world of lending and borrowing, after his last disastrous one just before the run on Northern Rock. Regular readers of this site will recall that I was very critical of his famous speech about how lending institutions had behaved irresponsibly, and would not in the UK be bailed out. His resolution to avoid helping the banks lasted but a few hectic days, before he bowed to the need to guarantee all deposits in all banks under pressure in UK jurisdiction!

He should also remember that as the taxpayer’s representative and principal bank manager to Northern Rock he is no longer above the fray on mortgage bank products. I just hope he has remembered to ask the management of Northern Rock to make sure they have plenty of the types of mortgages he favours available for their customers, before journalists come asking difficult questions about that.

On second thoughts, isn’t the government’s close involvement with a mortgage bank another very good reason why the Chancellor should have said nothing about mortgages to avoid any conflict of interest?

The main reason he seems to be offering us his thoughts is fear. He is afraid there will be a sharp fall in house prices. He does not seem to understand that it is in a way government policy to try to bring house prices down, as they are constantly telling us housing is not affordable and needs to become more affordable. He hopes that if more people take out fixed rate mortgages, more people will be able to pay the mortgage through difficult times. The only thing to be said about that is, at least he realises he is presiding over tricky times. Maybe spending a bit more time thinking about how to unstick them would be a better way to proceed. Lower interest rates will help. Lower interest rates make fixed rates a worse deal!

I was asked to write a piece on what the government should do next in the Northern Rock refinancing saga. Those most closely involved - the company, shareholders, the Bank of England and the government - will need to take professional advice on the legal, tax and investment complexities they have dug themselves into. The general position however, remains much simpler than those who clamour for nationalisation suppose. The government as main lender has all the power it needs to protect taxpayers, whcih should be its prime aim. I sent the following to the Guardian:

The government seems to have been mesmerised by shareholder power. I don’t know why. The truth of the position is simple. Northern Rock needs access to large sums of public money to keep its business going. There is no other source for this money in the short term. The government can therefore set out its terms.

It is wise to seek agreement with shareholders and the mortgage Bank, but foolish to underestimate the power in the government’s position. The taxpayer wants the government and the Bank of England to do a good deal, which saves the bank and ensures the taxpayer will get early repayment of the large sums with interest. The taxpayer should also be rewarded with stock warrants or options to give the taxpayer some share in success, if the rescue works well and the shares recover.

The rumoured decision to demand the end of the guarantee in three years rather than the originally floated five years changes the nature of the task any owner of Northern Rock faces. It means they need to generate more cash more quickly, or to be sure they can raise private finance more quickly. Assuming the government changed the terms on offer like this, it should ensure all potential bidders know, and each bidder has to be given a chance to change their bid in the light of the new circumstances. Presumably the government realises if they press for a shorter repayment period it will increase the pressure on management to cut costs, and may result in a smaller business. This does not mean it is wrong, as the taxpayer does want to know the money will be repaid sooner rather than later.

In order to decide between the competing bids, the shareholder representatives have to satisfy themselves they are recommending the best bid in the circumstances to improve shareholder value and give the business the best chance of future prosperity. It is not for the government to decide which bidder, but it is for the government to make its terms as Bank manager clear to all bidders. Given the scale of lending to the company the government has an effective veto on any bidder, as the government could decide (only if there were good reason) that a particular bidder did not satisfy the government that it was likely to be able to repay the loans in good time.

From the beginning the government has failed to tell us how much it has lent, what interest rate it will charge, when it will b e repaid and how much security it has taken for the loans. These are all elementary parts of good banking. Let us hope these necessary arrangements were made to protect the taxpayers’ interests. Now there is the chance of shareholders putting more money in, or a of a new plan by management to develop and finance the bank, the company needs to make a decision. To do so it needs to be sure how much money it can borrow for how long on what terms from the government. That will then help determine how quickly the business will have to be reduced in size to repay borrowings, and how much scope there is to try and trade their way out of cash shortage.

The Fed duly cut interest rates by another 50 basis points, taking them down to just 3%. We see recession fighting in full cry in the USA, where the Central Bank and the administration are uniting to pull the US economy out of its sharp slowdown.

Lower interest rates will ease some of the tensions in the housing market, allowing some people to carry on servicing mortgages which might have been too dear for them at higher rates. It makes it easier for all those businesses operating on borrowed money. It will also encourage a lower dollar, pricing US exporters back into world markets, and curbing the US appetite for imported products.

Meanwhile, on this side of the Atlantic, the authorities remain hesitant and divided over whether to carry on fighting inflation, or to see the Credit Crunch as the new enemy. UK rates are too high for comfort. Inflation will remain unpleasant this winter but will start to correct later in the year.

Yesterday the government published its review of the regulatory arrangements for banks in the wake of the Northern Rock crisis. They made suggestions and proposals in five areas:

1.” Strengthening the financial system” by introducing better risk management of banks and better supervision and rating of securitisation of loans.
2. “Reducing the likelihood of banks failing” by asking for more information and changing the arrangements for providing liquidity to banks.
3. “Reducing the impact of failing banks” by introducing a “Special resolution regime” by allowing the authorities to take action with a failing bank to achieve a rescue or orderly run off
4.”Effective compensation arrangements” including faster and bigger payments.
5. “Strengthening the Bank of England and improving coordination between authorities”.

The proposals combine the sensible with the foolish, mixing some important lessons learned with the sound of stable doors banging shut after the horse has gone.

I would suggest the government listens carefully to informed opinion before implementing these changes.

1. It is important to take action to improve the deposit protection regime, without requiring a large up front cash payment from existing banks at a time when they are struggling to re-establish strong balance sheets after the losses made on securitised loans.
2. The government should make the Bank more independent and stronger to deal with failing banks in the future. This requires transferring day by day banking supervision to the Bank of England, and transferring the necessary staff or recruiting the necessary staff with banking expertise to be able to do the job.
3. The “Special resolution regime” could give near nationalisation powers to the authorities without the need to compensate existing shareholders. These powers were not needed in previous rescues, as the Bank of England has a powerful position as only lender to a bank in trouble. It is difficult to see why they need all these extra powers. The one thing that does need clearing up is the legal power of the UK authorities to arrange rescues quickly and in private under current EU market regulation.
4. It is a moot point whether the Bank of England needs new legislation to clarify its powers and role, when it always used to be able to undertake these matters before many of its powers were taken away in the 1997-8 reorganisation. The availability of skilled and experienced staff in a banking and bank rescue is a more relevant consideration, given the removal of banking supervision from the Bank ten years ago.

As always, there is a danger of the authorities fighting the last war. There is no immediate prospect of another run on a bank. The current difficulties are those of a range of banks strapped for enough capital and cash, and a new aversion to risk as banks reveal losses on some of the paper they hold in the securitised and syndicated loans area. A sensible supervisor would be asking how can the regulatory burden be eased prudently at a time when banks have to recapitalise themselves. There is a danger that further capital adequacy and regulatory tightening, coupled with demands for up front levies for a compensation fund, will make it even more difficult to get the banks and the markets bank to balanced conditions, allowing a reasonable amount of credit to be advanced at sensible prices.

I will respond in more detail to the many individual consultation questions in the government document when I have had more time to consider all the detailed queries.

The Chancellor has promised a statement next week to try to sort out the regulatory mess that characterised the Northern Rock debacle.

What he needs to do is the following:

1. Ensure the Bank of England is more than just a monthly tea party for a group of academic economists sitting round talking about interest rates. The Bank needs to be given the power to direct and deal in government debt (currently with the Treasury).

2.The Bank needs to be a hands on operator in the money markets, so it does not allow in future the markets to become as illiquid as they were in August and September 2007, nor as loose as they were a year or more earlier. The Monetary Policy Committee became entirely academic last year when market rates diverged from MPS rates by up to 100 basis points. If the Bank is to set interest rates, it has to have all the powers and knowledge to operate successfully in money markets, to enforce the rates the MPC recommends.

2. Transfer banking supervision from the FSA to the Bank to allow the bank to operate properly in markets.This would ensure the Bank saw the main positions of the big banks daily, and understood the minute by minute pressures in money markets better.

3. Press for amendment of the EU MAD Directive to allow the Bank to organise rescues for ailing financial institutions in private and rapidly if needed.

4. Renegotiate Basel II to strike a better balance between off balance sheet and on balance sheet items, and to avoid Basel II becoming a further tightening of the capital rules at a time when banks are already finding it difficult to lend through balance sheet pressures.

5. Announce that the UK will not support any more EU regulations of financial services - there are too many new ones that have not yet bedded down, and we need a period of reflection and implementation to see how they will work.Some will need amendment or repeal, as they are too proscriptive and will drive busienss offshore from the EU.

6. Review the operation of the Rating agencies with other overseas jurisdictions, to see if they can operate more cautiously in future.

The sub prime crisis, a run on a UK mortgage bank, and now the loss of $7 billion dollars through rogue trades at Soc Gen: and still they say regulation works!

I accept that financial services businesses can be different. Where they take money from people, on the promise they will repay it at some date in the future, people need reassurance that the promise will be kept. In most other businesses the business takes the risk and supplies the good and service before the customer pays.

It makes sense to have deposit protection, and it should make sense to have some additional checks and requirements to reduce the risk that a business will steal people’s money, or will fail to keep enough capital to pay for losses and mistakes and still be able to give people their money back when they want it or are entitled to it.

This proposition has led to a vast regulatory industry, where clever regulators try to interfere in ever more details of the banks’ lives in the belief that this will prevent mistakes being made. As the last few months have shown, it does not work.

We need to ask how did the world regulators get it all so wrong, and what changes do we need to reduce risks in the future?

The biggest problem is the so-called sub prime crisis, which is in practise a world crisis, not just a US one, and is not confined to mortgages alone. It is a securitisation and off balance sheet crisis – too many banks packaged up too many loans born of the easy money conditions the authorities encouraged, and spread them around the system. The Regulators through their Basel I requirements positively encouraged this, asking for less capital if you securitised your lending and pushed it off your own balance sheet. This crisis should be called the Basel regulatory crisis, rather than the sub prime crisis.

The solution is for monetary authorities to be more careful about making money too easy – not that this is an immediate problem in the middle of the Credit crunch! They also need to revise rules over capital requirements, without lurching to a position where too much banking capital is required, intensifying the Credit Crunch. The whole thing is complicated by the move to Basel II, which needs urgent review in the light of current circumstances.

The run on Northern Rock was an unfortunate event for London. I do not agree with the MPs who say the FSA got it all wrong. As I understand it, the FSA was warning about the problems of Northern Rock well before the run on the bank began. The failure was a system failure, which owed a lot to the failure of the monetary authorities to keep money markets liquid, and to the dithering of the Chancellor who was meant to hold the ring and make the decisions in areas of overlap between the Bank and the FSA.

The UK government should decide that in future the Bank of England will get back its old powers to regulate banks and to run the government’s debt financing programme, so it once again sees the whole range of business going through the money markets. The Bank should have prime responsibility for banking the commercial banks, ensuring adequate liquidity in markets and avoiding any future run on a bank. They always used to be able to do this before Brown’s botched reforms.

The Soc Gen debacle is difficult to believe. Most banks make dealers deal in open dealing rooms where colleagues can hear what they are up to. I thought most require two signatures on larger deals, most have real time reporting through a common system, and anyone needing cash to pay margin or settle transactions would need someone else to certify or check the requirement. As the trader apparently acted without other authority he must have found ways to circumvent the checks in the system. The regulator presumably was completely unaware that such a thing was happening.

I do not think Regulators can stop a Soc Gen event. Only better internal controls and procedures in a bank can do that. The fact that Regulators cannot should make more people suspicious of the cry that what we need is more regulation. In this case what we needed was better bank management.

Three cheers for the Fed. One cheer for each 25 basis point cuts in interest rates announced as an emergency measure yesterday. It did the trick, limiting the savage market decline, and turning round the Asian markets which had been in freefall the previous day.

The US authorities have made it clear to the markets that they are going to stop a recession if it is in their power to do so. They have made aggressive moves in reducing interest rates. This will help a great deal. It means that many mortgage holders and companies in debt will now be able to afford their interest payments and repayments, improving the quality of the loan assets on the balance sheets of the banks and those held in securitised form. It means that all those financial companies that have borrowed so much to sustain the easy credit of earlier years will also have some relief on the amounts they have to pay in interest. The whole financial structure in the US is a little less unstable as a result of this development.

As I argued yesterday, two conditions need to be fulfilled for recovery to get underway. The first is lower interest rates. The second is the recapitalisation of the banks, so they have the stronger balance sheets they are going to need to lend people and companies more money again. This process can happen by the passage of time, as they trade profitably. It can be speeded up by cutting or cancelling dividend payments, or by raising new money from shareholders.

The gyrations of world markets in the last few days shows that the Indian, Chinese and Japanese markets are still very influenced by perceptions of the state of the US economy. All three are important exporters to the USA and are influenced to some extent by US conditions. The internal strength of the Indian and Chinese economies is becoming more obvious, but it is not thought sufficient to offset the full blown US recession which some market participants feared.

The Governor of the Bank of Englands remarks showed how far behind the plot the UK now is. The worse circumstances of the UK economy as a result of recent policy are now dragging it down relative to the US and the Asian giants. As the Governor pointed out, we have a bad inflation problem this winter. The governments own borrowing requirement was far too large before Northern Rock hit, only to be made far worse by the Northern Rock debacle. The big build up in UK public spending and borrowing, and the poor productivity of the enlarged public sector, all limit the UKs room for manoeuvre, at a time when the UK too needs lower interest rates to relive pressure on its financial system. The government is trying to control public spending at last by clumsy interventions on public sector pay, but still lacks a grip on large projects and staff numbers.

A recession can be averted in the US. The UK will experience a sharp slowdown, which will be made worse if the Chancellor presses on with plans to increase capital gains tax on entrepreneurs and with damaging plans to tax non doms too much.

The collapse of Stock markets around the world should come as no surprise. As readers of this blog will know, the years of easy credit were decisively ended last August when the financial community woke up to the reality of the securitised loans crisis, aided by the Central Banks at last in tighten mode after years of sloppy credit.

A credit crunch means there is little new credit available at a time when too many people and companies are desperate to sell assets to raise the cash they need. Investors with cash suddenly decide they want to hold more cash. Investors who have been investing on borrowed money have to rein back their activities and pay down debt. Banks that were able to lend people money and then package the loan up as security to sell to someone else suddenly find there are no buyers for these packages. As a result asset prices crash.

A credit crunch ends when two conditions are met. The Authorities have to signal they want easier credit by lowering interest rates, so high borrowings become affordable again. Banks have to sort their balance sheets out so they have the capacity to lend more. It is this latter condition which may take some time to get right this time round, because so many banks have been involved in syndicated credits and in trying to put their loans off balance sheet in structured vehicles. The sooner the banks sort out what all these investments are worth, write them down, and raise the new capital they are going to need to be able to carry on their business, the better.

The weakness of banks is not solely a US phenomenon, and the so called sub prime crisis is not just a US or a property related difficulty. This is a crisis in the global banking system, where there are worries about the Bank of China as well as about the European and US commercial banks. They have to contract their balance sheets as they value their loans more realistically, and then many of them will need new capital ??whether by cutting dividend payments and keeping more of their profits, or raising new money directly by selling new shares to shareholders. Doubtless the worlds regulators, led no doubt by the UK authorities, will make it even more difficult to by tightening the rules on capital adequacy at exactly the wrong point of the cycle.

The worlds economies are in different conditions to meet this sudden lurch from easy money to tight money. The Italian and Spanish economies are going to be made to suffer for their membership of the Euro, with interest rates and money growth dictated from Frankfort leading to painful adjustments in their domestic economies. The US economy is so far mainly suffering in the real estate and banking sectors, with some signs of a good export led recovery emerging in other sectors from the lower dollar. The UK economy is badly placed, thanks to the very high public deficit and poor productivity performance of the much bloated public sector. The bungled approach to money markets and banking which uniquely gave London the only run on a bank does not help either. If the Chancellor follows this up by taxing the rich out of London then we will have a major residential property price collapse to add to the current woes. The Indian and Chinese economies may find exporting to the US and the West more difficult, but they have the cushion of rapidly growing domestic demand and China has the huge foreign exchange reserves its successful exporting has built up in recent years.

We have seen a sharp contraction in real estate in the US, in Spain, and in commercial property in the UK. We are now seeing a sharp fall in share prices, as investors adjust to the new reality that banks and property companies will find it difficult to maintain earnings, and as the growth rate of the worlds main economies slows.

There remains plenty to worry about. Some are still worrying about the price rises that are coming through this winter as a result of the years of easy money. Others are worried looking forward, fearing a recession in the US and elsewhere. I still think a full blown US recession unlikely, and do not see an inflation problem looking out a year, but recognise that these fears will remain real to many unless and until my two conditions are met for a recovery.

There will be growing pressure on the US, UK and European authorities to lower interest rates, and lower rates will help. There also needs to be a concerted drive to clean up banksbalance sheets and establish some kind of a market in all of these securitised loans that characterised the years of easy money. Once we can know what is left on banks balance sheets, markets can get on with the necessary task of recapitalising the banks so more normal credit conditions can be recreated.

PS: The Fed’s move today to cut interest rates by 75 basis points, taking them down in one go from 4.25% to 3.5% is a good start.

I am glad to have won the battle against Vince Cable to avoid nationalisation of Northern Rock. I am grateful to the Jeremy Vine programme and the Week In Westminster for giving airtime to the case against nationalisation. Their commonsense and fairness shows up the lamentable performance of the Today programme, the World at One and Pm who gave ample platforms to the pro nationalisation case but refused me the opportunity to explain why it was a bad idea, and to offer a more positive alternative.

In the arguments with editors I was told that my proposals were unlikely to be taken up, whereas nationalisation was the likely outcome. I explained that the government had to come up with something better than nationalisation because nationalisation would have wrecked the borrowing and spending figures. The BBCs flagship programmes as always remained wedded to an old fashioned state solution and to the Lib Dems, so their listeners were not made aware that there was a better way, and were in ignorance that the governments advisers were working on it.

I am pleased this morning that the government has decided to

1. Avoid nationalisation
2. Get some cash back more quickly by selling bonds to replace the loans
3. Seek a new private sector owner
4. Take an equity stake via warrants to give the taxpayer some profit if it recovers well.

What I want to see in addition is

1. Proper banking disciplines enforced to repay the borrowings. Northern Rock still needs an injection of tough banking controls to make it work.
2. A phased withdrawal of the guarantees ?? we dont just want the cash back, we also want to get the taxpayer off risk
3. A fair competition allowing in new bidders ?? as the basis for bidding is now very different from before Christmas. Otherwise there could be legal challenges.

The government needs to:

1. Get a grip on its lending to Northern Rock and set out how and when it will be getting money back from this bank.
2. Remove wasteful and unpopular public spending, like ID cards, regional government, extra contributions to the EU, too many spin doctors and consultancy contracts.
3. Start applying pressure to raise public sector productivity in those areas where we do need spending. Impose a staff freeze on the civil service.
4. Cancel the increase in CGT from 10% to 18%, and leave the new 18% rate in place of 40%.
5. Issue more index linked bonds to finance the remaining deficit, as inflation will come down after this winter’s fuel and food rises.
6.Create an employee ownership scheme for the Post Office and press ahead with its privatisation involving employees.
7. Open the water industry up to competition, to bring prices down and open up new supplies and new investment.
8. Get on with commissioning private sector investment in energy capacity by granting the necessary licenses and planning permission.
9. Introduce more private capital into railways, reuniting track and train in regional private companies.
10. Call a halt to the overregulation of financial services from Brussels, and put through deregulatory legislation which starts to lift the burdens on business.

This programme would at one and the same time

1.Lower prices by using competition to cut monopoly prices
2.Increase investment in infrastructure where we are short of capacity by harnessing private capital
3.Reduce public sepnding
4.Allow lower interest rates as a result of 1 and 3 above.

<p> The idea that Northern Rock loans will be packaged and sold to the private sector is not a solution to the crisis, especially as there will be a government guarantee on them. Instead, this represents a decision by the government to lengthen the period over which it is prepared to lend to Northern Rock.</p>
<p> It means that all interested bidders wanting to buy a share of the action in Northern should; be invited to rebid, as the terms on which they are bidding are now so much better than they were. It appears that a bidder now has the government as its bank manager, guaranteeing substantial lending, for a long time period. This is a much better proposition than the one they sought bids for before Christmas.</p>
<p> No-one writing up the story seems to grasp the importance of adopting the recommendations that readers of this blog know well, recommendations to the government and Bank of England to get a grip as Northerns most important bank managers.</p>
<p> Whether Northern is to be nationalised, sold to a private bidder or remain independent, the need is the same. It is high time the authorities toughened up the terms of their lending to Northern Rock, and set out a timetable for repayment that is demanding but realistic. It should be up to the management to decide if they can repay from trading profits and cash, or if they need to sell assets to meet the demands for money back by the taxpayers.</p>
<p> I find it almost unbelievable that Mr Darling and the Bank should make maybe £55 billion of loans and guarantees available to Northern Rock with no public statement of how long they can have the money for, how the asset cover has been secured, and when the money has to be repaid. All these things should be public because they have such a big impact on public spending, and so bidders can form a proper view of the value and the liquidity of the business. More worrying is the likelihood that there is no private agreement about how and when the loans will be repaid. What private sector banker would ever lend large sums to a distressed company without first asking and answering the questions How and When do I get my money back?</p>
<p> The governments decision to back the "solution" of selling bonds to the private sector to release cash to the government that it has lent to Northern would work well if there were no government guarantee, but the existence of the guarantee keeps the taxpayer on risk. At the very least if they wish to go this route they should look at time limiting the guarantee, or phasing it out.</p>
<p> This could prove to a dear way of avoiding the ruin of nationalisation. Maybe one day the Treasury will wake up and understand that they have a banking problem. The way out is by applying proper banking disciplines to this business, and making the shareholders and directors of Northern Rock confront the simple truth either they trade their way out of the borrowings, or they sell assets to repay the borrowings. Nationalisation, or lengthening the terms of the loans and guaranteeing them take the pressure off the management. A sensible bank manager with that much money at risk with a single client would want to hold their feet to the fire, not let them off in the way the latest proposal does.</p>

Things are bad enough without talking ourselves into recession.
Some banks and commentators have already called a recession in the USA, when the figures for the last quarter of 2007 show the US economy was still growing well. Here in the UK the retailers have added to the sense of gloom by concentrating on their sales figures on a ??like for like?? basis, leaving out all the sales in new shops.

The current position is both better than the pundits admit, and worse than the government will let on. The bad news is that the banking systems in both the USA and the UK are damaged by discovering that some of the lending they carried out in the heady days of low interest rates and easy money has been in their balance sheets at values that can no longer be sustained. We are living through a difficult time as banks adjust for the losses they have made, and rein in their lending as they are short of cash. In the UK commercial property values are falling fast, undermining the security for some of the loans. Residential property values are under attack from the UK government, who want housing to be more ??affordable??, but are being held up in part by the high Stamp duties and the imposition of Home Information Packs which is deterring people from selling their homes and buying a different one. There are too few homes coming onto the market at the moment to cause a crash in prices. The UK authorities have made the problem worse by their ham fisted approach to Northern Rock and by their failure to keep markets liquid enough during the last four months of 2007.

The good news is that many companies are still trading well. Profit margins are good in many cases, and on both sides of the Atlantic activity is higher overall today than it was when the Credit crunch first hit. Both the US and the UK have experienced a falling currency. As both economies need to divert much more activity into exports, or into import substitution, that will help. Both economies can export so much more to the rich parts of the world ?? China, India, Russia and the Middle East. Both economies now have to seek inward investment from these new giants that have built up huge cash surpluses at the same time as we have built up huge deficits by buying their oil and their manufactures. It is repayment time.

Few forecasters expect a downturn in the UK this year ?? just a sharp slowdown. Some commentators expect the US to get away with a slowdown rather than a recession. The US Fed is very keen to stop a slump, and is taking the right action by making cash available to banks and by cutting interest rates. Now the US President is also promising tax cuts, would boost activity as well. The US authorities recognised earlier than the UK that they had to shift from inflation fighting to recession fighting, and they have been bolder in their actions. They will probably succeed in avoiding recession.

The UKs position is weaker because the UK has increased public spending by too much, wasting too much of the money. At a time when other countries were reining in their public deficits and controlling their spending, the UK government went on a spending binge. This limits the UK governments scope to cut taxes and relieve the pressure on consumers. As consumption is the largest part of activity, this means we are going to experience a slowdown which consumers will feel badly. If the government really wanted to help us out of this change of fortune, it would get a better grip on its spending immediately, cancelling the needless parts like ID cards, computerisation schemes, regional government, and larger EU contributions as well as keeping wages down. Then it could follow the US example and cut taxes to help the hard pressed private sector.

Instead the UK is only going to tackle one of the twin deficits, the balance of payments one, through the mechanism of a cheap pound. Our best hope this year is that the strategy works and the private sector does shift a lot of activity into exports. That could be helped if the government would relent on its planned increases in small business tax and CGT. They need the goodwill of entrepreneurs to right the imbalances in this economy. Its a dangerous time for the government to be sandbagging the very people on whom they rely to recreate their much quoted ??economic stability??. Our economy at the moment is as stable as a row boat in a storm.

There is no need to talk ourselves into recession ?? we can get through with a period of slow growth. To do so, the government needs to curb its own appetite for waste and be realistic about how much it can squeeze out of us in tax.

What price an ethical foreign policy?

Today sees Mr Brown in China trying to act as a super salesman for British business. It is a relatively harmless use of his time, forced upon him by the dire straits of the UK economy under his policies.

Mr Brown has debauched the strong economy he inherited. His first couple of years wisely continued Conservative spending plans and repaid public debt, but elsewhere the long march of this government to a malfunctioning socialist economy had begun. The undermining of the Bank of England proved to be a long fuse to the explosive Northern Rock crisis. The taxation of pension funds began the route march to most people no longer having the benefit of a final salary scheme, whilst burdening too many companies with large deficits to repay.

Worse followed after 2001 when Mr Brown embarked on an irresponsible twin track ?? easy money, and massive spending increases on public services. Because he wrongly saw all public spending as ??investment?? and felt large sums were proof of better service, he failed to ask the obvious question ??What am I buying for all this cash??? The answer turns out to be a whole load of extra civil servants, spin doctors, consultancy contracts, pay awards, quangos and regulators.

Ten years on the UK is one of the world leaders for twin deficits ?? a record balance of payments deficit, and a large government borrowing requirement. Alarmed by the record deficits on the balance of trade figures which he used to pour over to harry the Conservatives when in government, he decided on a trip to China. It is a sign of his desperation that he feels the need to act as pied piper to the British business community to sell more there, and to see the need to ask the Chinese government for more Chinese funds to be invested in the UK. He is right we require the money, to pay for our double deficits.

When the Labour government first came into office its then Foreign Secretary Robin Cook claimed they would run an ethical foreign policy. The phrase was chosen to imply that all previous UK foreign policies had been other than ethical. The Labour knight was to wear the purest white, and would charge into world Councils with morality as the billowing pennant on the lance.

Today that seems a very long time ago. We look back on the invasion of Iraq, the continuing fighting in Afghanistan, the lack of any action over Zimbabwe, the skirting round North Korea, the inconsistent approach to other countries gaining nuclear weapons and the erratic response to human rights abuses and have to ask what ethical or moral stance now lies behind these actions? Arent they all driven by media, by events, by US pressure, by EU argument, by a growing sense in the present Foreign Office that there are many obvious limits to British power?

Worse still, when many want Mr Brown to raise Chinas human rights record as the central issue whilst there is still a window of opportunity before the Olympics, many of us are embarrassed to say this when we look at the deteriorating record of human rights in our own country. Now the UK wants to have the western record for detention without trial or charge, seeks to stifle public opinion by ratting on the promise of a referendum, spends a fortune on clumsy physical ??security?? at so many places and events, treats travellers like suspects or criminals and intensifies the range of thought crimes that preoccupy the elite, we are no longer in a good position to lecture China even if we wanted to.

Mr Browns visit recognises the reality of the new world order. China is emerging as a superpower, with a fast growing economy, a large population, and a wish to project its power. When a country has more than $1 trillion in the bank it is difficult to argue with it, especially when our country has been newly impoverished by Mr Browns policies. He sold our gold holdings for a fraction of its current market value, ransacked our long term savings, failed to stop a run on a British bank and now needs to go cap in hand to China to seek inward investment to the UK. These are sorry times for our country. They have been brought on by incompetent stewardship of our money. It is humiliating to see our Prime Minister ask for sovereign wealth fund money from China to keep us afloat. If he really wanted to improve the UK economy he should have stayed at home, working on how to get more value from his public spending, and how he could curb spending so we do not need to borrow so much.

The debate about Northern Rock on Newsnight yesterday failed to produce a thought through alternative to nationalisation, to protect the taxpayers interest and avoid more damage to markets.

As readers of this blog will know, there is such an alternative. Maybe I have to spell it out again.

The government and the Bank should set Northern Rock targets to

1. repay debt
2. generate cash and profit
3. sell assets

These targets should be tough but achievable. The rate of asset sales should be geared to what the mortgage market can absorb, so the assets can be sold for a reasonable price, leaving the taxpayer with sufficient cover to get our money back.

Putting Northern Rock into administration could lead to a fire sale of assets, and might result in taxpayers not getting all our money back.

Nationalising Northern Rock could lead to huge losses for taxpayers, as taxpayers became responsible for all the rest of Northern Rocks assets and liabilities, including paying the staff, any redundancies, and the pensions shortfall.

Northern Rock has started to follow this managed run off strategy, selling ?2 billion of mortgages recently and using this to repay some of the taxpayer debt.

The meeting today at Northern Rock has been called to try to limit the managements scope to make decisions. This could be used to limit the Companys ability to reduce its debt to taxpayers, so it is not a helpful development from the governments or managements point of view.

The meeting is also a reminder to those who think nationalisation is an easy option, that it could be bitterly fought by existing shareholders. Taxpayers would not take kindly to existing shareholders being offered a good price for their shares, whilst existing shareholders are likely to contest nationalisation for a nominal or low price. I cant understand how anyone sensible can think this would be a good route to follow.

It appears that the government is flirting with nationalisation because it is having trouble persuading the shareholders of Northern Rock to see things its way. It is a very cumbersome and potentially very expensive device to try to get shareholders to do as the government wishes, when the government has a much easier way of doing it.

The government still does seem to have grasped how powerful its position is as Northern Rocks bank manager. It stepped into this role, and is now committed massively to it. As of today it is clearly the only bank manager Northern Rock has that is prepared to extend the huge sums needed for the bank to be able to carry on trading.

As bank manager the government needs to assert itself in the following ways:

1. Set out how much asset cover it wants for any additional lending ?? and make sure it has taken enough asset cover for the loans so far.
2. Set out how much money it expects Northern Rock to repay on specified repayment days.
3. Establish targets for cash generation and profit in the underlying business with management, and make them report variances with explanations of action to be taken to get back on target.
4. Establish the usual banking covenants that Northern Rock has to hit to keep its facility

I read that the shareholders are not happy about selling assets. There should be no argument about this. The government/Bank of England should tell them what repayments they expect. Northern Rock then has four ways of making those repayments:

1. Sale of whole business to an owner that can meet the repayments
2. Refinancing of Northern Rock in the private market to repay the state borrowings
3. Cash generation from the business
4. Sale of assets

The government should just insist on the repayments. It is up to the shareholders and management of Northern Rock to do the hard work and decide how they can meet the need for such repayments. If selling assets is the only option ?? as it appears to be at the moment ?? then they must do that. The government does not need to dictate how Northern Rock refinances itself ?? just has to insist on the taxpayers getting their money back in sensible tranches over a realistic time scale.

As I stated on this blog before, the taxpayer should also be rewarded for making these huge loans that no commercial business would make in the event of Northern Rock recovering well. That can be done by the government taking options to buy shares at the current price at any time over, say, the next five years. This should also be a condition of continuing the lending to the company. Should it then do well the government can buy the taxpayer shares at a favourable price and sell them on to make a profit as a reward for carrying so much risk for so long. I read that this idea is now being taken seriously by the advisers.

There are at least ten good reasons why Northern Rock should not be nationalised:

1. It is bad enough for taxpayers to have ?57 billion at risk in Northern Rock. Nationalising the bank would put more than ?100 billion at risk, a very large sum even for the government and taxpayers.
2. Once nationalised, taxpayers become liable to pay all the wages and salaries. Ministers would have to sanction redundancies if these are needed to cut costs, and taxpayers would have to pay for them.
3. The taxpayer would become liable for the whole pension fund, which has a deficit.
4. The management of Northern Rock appointed by the government would doubtless expect substantial new funding from taxpayers to invest in and develop the business, adding to taxpayer woes.
5. There is nothing the nationalised management could do that cannot be done now to try to cut the liabilities and repay some borrowings.
6. Nationalising would make it more difficult to persuade the management of the bank that there is a crisis which requires exceptional efforts to increase business revenues, cut business costs and sell assets to repay borrowings. It would take the pressure off.
7. Politically it would become a long term reminder of the governments failure to handle the credit crunch well. The bank is unlikely to have been privatised again before the next election.
8. Given the growing pressure on public spending ?? difficulties in finding money for police pay, hospital improvements and the rest ?? it would be an embarrassment to see spending rising on a nationalised bank at the same time as cuts elsewhere.
9. The pay of people at the top of such a bank is likely to be high even by the standards of modern higher pay in the public sector, leading to further embarrassment, especially if they do not perform well.
10. All the spending on Northern Rock would then have to be accounted as public spending, whereas at the moment it is kept off the governments balance sheet to make the public accounts look better.

I was pleased to hear that Northern Rock is selling ?2 billion of mortgages with a view to repaying ?2billion of its debt to the taxpayer. We need to see more of such progress as markets permit - the skill is selling at the right pace so you receive a sufficiently good price to ensure taxpayers get all our money back.

I was pleased to learn today that Goldman Sachs are looking at the possibility of selling on the taxpayers loans to Northern Rock. It would be excellent news if taxpayers can get their money back. Then idea apparently is to turn the loans into bonds and seek some other institution or intermediary to grant a guarantee of repayment, then selling them on to the private sector.

There is also at last some movement away from the lunatic idea of nationalising the bank which would mean taxpayers moving from a position where we have ?57 billion at risk to a position where we would be responsible for all ?100 billion plus of Northerns liabilities. (see previous blog entries on why that would be bad news for taxpayers and shareholders alike). We learn this morning they are looking at the government acquiring a minority stake in the company, so taxpayers will get some upside from their shareholding if the rescue works well.

I would suggest there is no need for taxpayers to buy any shares at the moment in Northern Rock. Taxpayers should continue as bankers of last resort. What Ministers could demand to continue in this role is the grant of options to buy shares in the company at a future date. The taxpayers long term interest would be best protected by having the right to buy a substantial minority stake in the Northern Rock at around the current share price at any time over say the next five years. If all goes well and the companys share go up substantially, and taxpayer can then buy its shareholding, the company will get extra share capital, and taxpayer can sell on the shares in the market to make a profit. If the companys shares do not prosper the taxpayer has no share capital at risk and does not have to buy the shares. That would be less risky than buying a stake in the company today and would reward taxpayers if our lending to the company enables it to recover well..

The Chancellor today sounded like a old cracked record that no-one wants to hear any more. Listening to him on the Today programme, I was left wondering does he really believe what he is saying or does he think we are stupid?

He told us the UK had enjoyed economic stability for ten years, including a better record on inflation than many other countries. Has he checked the figures? If you look at the UKs record on the RPI it is worse than the EU or the USA, which is why his predecessor had to switch indices to make it look less bad. Does he think the credit boom followed by the credit bust and a run on Northern Rock is proof of stability?
Is he aware that UK interest rates have been higher than US and EU rates for most of the last decade?

Worse still was his incantation that all this stability had been created and guaranteed by an independent Bank of England. Is that the same Bank of England that Mr Brown reduced in stature so badly by amputating its control over government debt and clearing bank supervision? Is that the same Bank that has to work with the FSA under the chairmanship of the Chancellor when banking problems emerge in the markets? Is that the same Bank that gets briefed against when the Chancellors tripartite system makes a mistake? Is that the same Bank that had to keep interest rates lower than it would have liked and money looser, because the former Chancellor changed the target for inflation at a crucial time when rates would otherwise have gone up? Is that the Monetary Policy Committee whose members are appointed directly by the Chancellor, or by bank officials themselves appointed by the Chancellor? Is that the same Monetary Policy Committee where we are not allowed to know why some members were renewed by the government, and some were not?

The Chancellor should learn that he cannot spin himself out of the current economic difficulty. Some figures will pop up to reveal spin. Many clever and well informed people are watching his every action, and every movement of the economy. The Chancellor would do himself a favour if he dropped the tired old fashioned wrong headed highly spun rhetoric of the Brown years, and started to understand the true nature of the problems he faces. These include:

1. An overspending state which is not getting value for all the money it is tipping into the public sector. He should immediately impose a staff freeze on all public sector posts other than front line in essential services. He should take Conservative proposals to get people back to work seriously, and do something similar himself instead of just talking about them.
2. He should try to stop the flood of public money into Northern Rock, and impose some discipline to ensure repayments.
3. A broken regulatory regime where the Bank has been undermined. He should return government debt management and day to day banking supervision to the Bank.

The Chancellor is now ransacking the files of the 1970s as he seeks to curb an inflation his predecessor and the monetary authorities allowed to get a good hold through their easy money policies of a year or so ago.

He seems to believe that lectures to groups of people will work. This week he is applying his time to lecturing the energy companies to keep the price of electricity and gas down. Has he noticed the international price of oil has just surged to a new high? Will he, like King Canute, signal to the oil market that it must recede? If he managed to hit it just as the tide was turning, he could look quite clever to the uninitiated.

Meanwhile, his mentor next door is busy lecturing MPs to vote down the independent pay award recommendation (whatever that may be), so that MPs can show solidarity with the police, whose independent pay award has been docked by the government. The Prime Minister may at last have found a popular cause with the public, but it is difficult to believe the odd percent off MPs pay will transform the inflationary problem the government faces.

You might have thought Mr Darling would be fed up with lecturing people, after his disastrous lecture on the need for bank to become more prudent without government or Bank of England intervention and assistance, just before he offered the most comprehensive assistance to banks and markets during the Northern Rock crisis.
This latest round of arguing against the energy price and pay inflation is like arguing against the weather. This inflation was made some time ago. It is not going to persist in a year or sos time, given the dreadful credit crunch we are now living through in money markets. Timing is everything.

In the 1970s a previous Labour government used to lecture everyone on how much they could earn and what they could charge for things they sold. The pay and prices policies they developed of course failed to contain inflation, and became extremely unpopular. They overspent, overborrowed and wasted money as a government, and failed to keep proper control of the money supply.

There are some worrying similarities in outlook between Labour Chancellors then and Mr Darling now. The good news is the international background is much less inflationary today, and the credit crunch means inflation is not the true enemy looking beyond the next few months. The bad news is Mr Darling does think his lectures will make a difference, at a time when he should be concentrating on getting the credit and banking markets functioning properly again. His two tasks for this week should be

1. Find a solution for Northern Rock which stops the taxpayer funding increases
2. Start controlling public spending ?? he could place strong controls to prevent recruiting extra people to the public sector other than front line people like nurses and teachers, and back that up with a moratorium on management consultancies and IT projects without very thorough examination of why they were needed

Unfortunately we have a Chancellor who sees his role as being part of the media commentary on the situation, instead of the key player trying to lift a losing team.

There are two tired and overworked phrases in this governments repertoire which we are about to hear concerning Northern Rock.

The first is ??We have learned the lessons?? of whatever catastrophe they are talking about.

The second is: ??We will make sure this will never happen again??.

Ministers usually recite these phrases instead of providing proper analysis of what went wrong, and in place of ensuring the people in whatever regulatory system they have are up to the job and empowered to make the right decisions in good time.

I remember when I was the DTI Minister responsible for financial regulation, in the days when the DTI regulated insurance and financial services itself, having to handle the occasional problem. Each time the cry would go up to change the law and regulation. I usually pointed out that what had happened was a breach of the law or regulation anyway. We werent short of laws even then and there are many more now. It was intelligent enforcement that had failed. I was also pressed to guarantee it would never happen again. I was usually careful to make no such guarantee, and to point out that in any field of human endeavour there will always be some mistakes and some lawbreakers.

This government is foolish to say there will never be another loss of data by the public sector, because there will be. They should claim instead it is much less likely. They do have to be able to say there will never be another run on a bank, as we know we can have a period of more than a hundred years without one. Something uniquely wrong has happened on their watch.

My concern with Northern Rock is that the government does not appear to have learned the lessons. It is usually wise to manage a crisis to a conclusion before attempting to learn all the lessons. This crisis is far from over. Where there is a need for earlier action ?? as there may be on a deposit guarantee scheme ?? it needs to be carried out as an interim response, not foreclosing other action to mend the regulatory system once the crisis has been resolved or is stable.

What are the lessons of Northern Rock?

It is unwise for a Chancellor and Bank Governor to lecture the banking system about the need to deal with their own banking mistakes without assistance from the authorities, just a few days before offering massive assistance on a scale never before seen in the UK. If the authorities know of an institution in trouble ?? as they did a month before the run on the Rock ?? they should avoid inflammatory statements that they might have to rescind.

It is unwise to keep the banking system starved of cash until a major institution is in deep difficulties, and then to provide money to the system after a run on a bank has begun. If money is going to be provided, it should be provided early.

A tripartite structure for responding to a banking crisis is too inflexible, and keeps the Bank starved of important hour by hour information on the state of banking markets. There should be a unified command under the Bank of England. The Bank should have to keep the Chancellor informed, and submit to his judgement if things become out of hand. The Bank needs to get back the management of government debt, and day to day banking supervision, as it had before the Brown reforms.

The Basel I capital rules did not work as intended, and Basel II may now make matters worse. The government should enter discussions with the international community about a sensible capital adequacy regime, which gives enough attention to liquidity, and which deals differently with off balance sheet items.

The world authorities should avoid seeking to increase the capital requirements rapidly at a time of banking risk aversion. Any necessary increase in banking capital requirements should be phased in, as the system stabilises and starts to function more aggressively. IT will make matters worse if we hear the sound of regulators slamming the doors on capital adequacy after the horse has bolted, against a background of damaged balance sheets and a reluctance to lend.

The government should consider changes to allow take-overs of banks in trouble to take place rapidly, with the negotiations happening in private. This may well entail changing or clarifying EU law. This should be carried out urgently.

The government has asked the private sector to come up with a better deposit guarantee scheme. This should be put into effect promptly. More importantly,. The government should work out how to climb down from its blanket guarantee of all bank deposits in the UK of any bank in trouble without triggering a further run, seeking to do this in parallel with the changes to the overall guarantee system.

The news today that London Scottish Bank is being told by the FSA that it needs to raise additional capital is a grim reminder that the credit crunch of 2007 gives 2008 a grisly hangover. London Scottish itself is a small company, led by a new cautious CEO who wants to provide for difficult conditions in the lending markets and to meet the Regulator’s requirements for capital. Understandably he wishes to write off anything he has inherited which he does not like the look of, just to be sure. The provisions can always be put back at a later date into profits if conditions improve. The importance of this small case is that it setting a standard for how much write off and provision should be made against certain types of lending. The Regulators will use it as an example of how much capital a bank now needs in these straightened times. It could mean more write offs and more capital raising by the bigger banks.

There is always a danger that worldwide regulators will seek the lock the stable door after the horse called Prudence has well and truly bolted. If they do this on any scale, they are tackling last year’s problem of excess, not this year’s problem of too little lending and confidence which will delineate the opening months of 2008. Regulators will reason that they must learn the lessons of the period of too much credit, and now demand more cautious lending as well as insisting on banks having bigger reserves and more spare capital. This impulse will intensify the downturn in lending and keep money tight in banking markets. Inspired Regulators respond to the conditions that pertain today, looking ahead to tomorrow’s problems. Other Regulators look back to past problems and try to make sure they can never happen again. They will, of course, once the Regulators have been forced to respond to the next set of problems which are the opposite of those of the period of excess.

All this has been made much more difficult for the western economy by today’s adoption of Basel II, the new regulatory capital requirements. The natural temptation for the world’s regulators will be to use these new rules as an opportunity to revisit the money banks need, and to raise the standards, demanding more liquidity and more capital for any given volume of business. If this had been done a year or two ago it would have been a very good thing, and would have reduced the excess in lending and leverage which characterised the easy money era. Done too much today, and it will deepen the crisis, reducing the amount of money available for lending in the system still further, and pushing banks into more aggressive competition to raise the regulatory capital they need to sustain their current level of business.

Regulators are very important players in this credit crunch. As I argued yesterday, the regulatory requirement for Home Information packs is distorting the UK housing market, keeping homes off the market and delaying the price adjustment. Worldwide banking regulation could reinforce the boom bust lurch in credit markets if we are not careful. In the good times Central banks and other regulators turned a blind eye to the big build up of lending and the low levels of liquidity held by some institutions. Now they might go too far the other way, demanding standards of prudence that the damaged and constrained markets will struggle to provide at sensible levels of new lending.

All this is relatively bad news for the UK economy, where government indebtedness and the huge balance of payments deficit add to the unfortunate inheritance for 2008. There is talk of further tax rises to tackle the excessive government borrowing. There should instead be talk of controlling public spending better, as the last thing the UK economy needs right now is a set of further stealth tax increases. The government could begin by showing it now understands the need to control its spending, by getting a grip on how much it will lend to Northern Rock and when it intends to receive some repayments. It could cancel the hated ID cards spending, on a day when it is revealed that the UK has come to rank in the lowest grade of countries with respect to protecting citizens’ privacy. The Privacy International Think Tank just tells us based on comparative study what many of us have known intuitively for some time - we have lost a lot of liberty, and the government is sending us the bill for all the suurveillance and form filling. There will be an economic price to pay for all this in 2008 as well as the loss of liberty.

The choices for handling Northern Rock have been narrowed to three by the spinners for the government and the Lib Dems.

The first is sale of the bank to a third party who could repay some of the government loans immediately, and take care of Northern’s financing needs thereafter. The best chance of doing this was the Lloyds expression of interest before the crisis became acute. The authorities failed to respond positively.

Since then we have not been told of any large organisation emerging as a bidder which has the balance sheet strength to take it on and solve the problem itself. The two preferred? bidders need access to substantial market funding, and one only wishes to buy a minority stake. Even Lloyds needed financial help from government and the markets, as Northern is big even for a bank the size of Lloyds. Anyone needing access to substantial market funding will face the same kind of difficulties that caused the problem in the first place the drying up of credit in markets.

Everyone agrees the sale to a third party who could solve the financing problem would be ideal, although there remains scope for disagreement about how to value the existing shareholder interest in such circumstances, and scope for disagreement about how much money taxpayers should expect to get back immediately, and for how long the remaining money could be lent to the new owners.

The second is nationalisation, the Lib Dem’s recommended solution?. The new Lib Dem leader showed his folly by rushing in to back this irresponsible proposal as one of his first acts, after appointing a pop star as an adviser! He clearly does not want to be taken seriously and does not think things through before issuing the press release.

Taking on over ??100 billion of risk in a single mortgage bank at a time of falling house prices and credit crunch is too big a bet for taxpayers. Many of us think taking on ??25 billion of risk is dangerous, but quadrupling that is absurd. The government itself has stupidly increased our risk by an amount the Chancellor told us on December 19th he could not quantify! It shows they are being far too cavalier with our money.

As the Lib Dems themselves admit, the government would not bring any especial expertise to running a mortgage bank and would need to seek professional management from the City. They say it would be temporary, leading to a sale at a later date. They forget that nationalising would mean the taxpayer had to pay for any one off losses or write downs that may be necessary on inspecting the books, and for any running losses the bank might incur under nationalised management.

If it turns out the bank cannot sustain its current level of employment, the taxpayer will have to pay for the redundancies. If the bank needs to expand its branch network or invest in new computers, the taxpayer will have to make a judgement about that use of public money as opposed to school and hospital spending. Given the scale of Northern Rock total liabilities bigger than the health budget any government would be mad to take on those risks. Just losing 1% of the assets costs more than ??1000 million.

The third is Administration. The government could demand repayment of its loans (subject to any legal promises it has made about their duration, which the government refuses to tell taxpayers and Parliament) which could trigger administration in current circumstances as there is no lender prepared to replace the taxpayer at the moment. That too would be a foolish policy. Shareholders would be aggrieved, as they have been told by the authorities that their bank is solvent and been led to believe taxpayer funding will see it over a difficult period. There is no good market in mortgages and the other principal assets Northern Rock owns, so any fire sale at these levels would guarantee the taxpayer lost money. The Administrator is no more likely to find a big buyer for the whole bank than the current auction team. There cannot be any potentially interested party in the world who is unaware of the sale process. If the government favoured this route it should have refused to lend the bank any money in the first place so no public money was at risk.

There is a fourth option which needs proper discussion. I call it the tough bank manager? approach.

The option starts from where the government has got us from the position where taxpayers have lent money and guaranteed loans but do not own the mortgage bank. It recognises that when you are in a hole you should stop digging. We have to accept that the Treasury/Bank of England combination are the principal bankers to Northern Rock. It is high time they started acting as a bank manager faced with an over borrowed client who cannot repay in a timely way.

They need to:

1. Explain the limits of their funding to Northern.
2. Set out the interest rate and interest payment dates for the loans.
3. Set out a schedule for capital repayments.
4. Take all the asset cover there is left in Northern to secure their huge loans.
5. Insist on daily cash and profit monitoring.
6. Place a cash sweep on the business that returns surplus cash to the taxpayer at regular intervals.
7. Insist on approving all increased spending of any kind on capital and revenue account.

The repayment schedule should not expect repayments currently, whilst the main banks are trying to arrange their own affairs to show strong balance sheets for the year end. It should start phased capital repayments later in 2008. It would be up to Northern’s management to decide whether these repayments could be met from trading profits and cash generated within the business, or from refinancing in commercial markets, or from selling assets. Where assets are sold, the government team needs to insist on a minimum price to protect its asset cover position.

The extraordinary thing is that apparently many of these basics of banking have not been observed by the nation’s top financial team. The Chancellor on December 19th in the news conference once again told us little. I hope they are doing more than they are saying, but there is no evidence that they done a good job on securing the taxpayers position, either by means of securing full specific asset cover or by means of repayment schedules that are tough but achievable. It’s high time they started. We are told they have asset cover for the loans, but specific questions have not been answered about how the protection works. There has been no hint of any repayment schedule.

It appears they hoped the Branson bid, and then the nationalisation idea, would reassure depositors, reducing the pressure for taxpayers to put up more money to replace lost deposits. The best way to secure the deposit base is to take strong and sensible action, so it looks as if the government as bank manager has a professional grip on its over borrowed customer, and will stand behind them until it is sorted out. If a buyer emerges who can raise the necessary money then all well and good the bank manager can agree to the sale if that is what shareholders want to do, having secured the taxpayers’ interests.

All this assumes Northern is a solvent business which we know it has to be as the regulators are letting it trade. Assuming they are right there is no need for taxpayers to lose a penny so why won’t the Prime Minister repeat his promise about that? His hesitation damages confidence. If they nationalise it the taxpayer is likely to end up with a huge bill given the past track record with nationalised businesses, as well as legal actions from unhappy shareholders assuming they offer little or no compensation to them.

I naturally wish those trying to sell Northern every success in finding a good answer, but I do want the government to protect the taxpayers’ money fully in those negotiations.