Northern Rock Nationalization: The Best of Bad Options

With conventional wisdom holding that private sector solutions are better than public stewardship, to have the government winding up owning a financial institution looks bad. It revives the memories of the regulatory failures that led the bank to be bailed out in the first place.

Oddly, though, Northern Rock could have been allowed to collapse were it not for shortcomings in the UK’s deposit insurance scheme. Not only were accounts less than fully guaranteed, but getting one’s money back was a time consuming process (by contrast, the FDIC disburses cash fast). So a run on the Rock was rational, and at a time when the credit markets were in turmoil and worries were at a fever pitch, it seemed to make sense to bail out Northern Rock and fix deposit guarantees (although one could argue that the latter alone would have been sufficient, you don’t want to take the chance of encouraging more bank runs by doing too little).

So why the nationalization? The government had been trying to find private sector rescuers, but deemed the deals on offer (one from Richard Branson, the other a group put together by Northern Rock’s management) too stingy to taxpayers.

The Financial Times, in its editorial today “Chained to a Rock,” concurs with the government’s decision:

Ever since the British government lent tens of billions of pounds to Northern Rock, and guaranteed its deposits, nationalising the bank has looked the best way to protect taxpayers’ money. There has been five months of delay during a search for a private sector buyer, but the right choice has now been announced by Alistair Darling, the chancellor.

Nationalisation was never an attractive option; it was the least bad of the limited options available. A private rescue that needed no public money would have been ideal, but Northern Rock was in too much trouble for that. Insolvency, the normal solution for a troubled company, would have been fine if it did not mean chaos for retail depositors under Britain’s current laws.

The government’s preference was to find a private buyer to inject new capital and so provide greater protection for the taxpayers’ loans. But there were always two problems with that. First, existing shareholders kept voting control of the company, and could hold the process to ransom. Second, it was likely to mean handing over most of the potential returns to the private investors, while the taxpayer kept most of the risks.

Whether nationalisation is a good deal for taxpayers will depend on what they have to pay shareholders in compensation. That amount should be nominal. Northern Rock’s theoretical book value may still be substantial, but the equity only has any value because of government loans, and because of speculation about a private sector solution. The independent valuer who determines the compensation should not force taxpayers to pay for the value of their own support to the bank.

Once the bank is in public ownership it will be possible to look to the future. Northern Rock has a future. It may even be a bright future. The inflated £100bn-plus size of its loan book will have to be scaled back to reflect its deposit base, but Northern Rock has efficient operations and some well-located branches.

The differences between this nationalisation and failed nationalisations of the past are clear. Northern Rock’s spell in public ownership will be temporary. It will be managed at arm’s length. Most of all, nobody claims that Northern Rock will perform better under government control, only that it is necessary because of the straits it is in.

Therefore anybody who suggests that the Labour government has gone back to 1970s socialism deserves ridicule. It has made a sensible, hard-headed, non-ideological choice. But there remain legitimate questions about why it took five months to get there.

Floyd Norris heaps scorn on the Rock rescue moves. Although Norris is a smart fellow, we Americans are treading on thin ice when we criticize others’ salvage operations. Countrywide, like Northern Rock, was also not too big to fail, yet it has received a massive and largely unpublicized bailout via the Federal Home Loan Banks. The Fed’s interest rate cuts are more about shoring up asset values rather than fostering growth, as are the moves to saddle already undercapitalized Freddie and Fannie with what Tanta calls, Loans Formerly Known as Jumbos.

If you are going to have a bailout, I much prefer the British version, where it’s done in the open and the cost are explicit.