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Keep at arms length, Darling

Adrian Coles, director general of the Building Societies Association, shares his thoughts and concerns about the strategic direction of Northern Rock under the Sandler regime

Now that the government has made the politically momentous decision to nationalise Northern Rock, the question arises as to how the bank will be run.

The chancellor has emphasised that Northern Rock’s new executive chairman Ron Sandler will be operating at “arms length” from the government. Nevertheless, it is clear that it will have significant representation on the board and will have a huge influence over the business plan that Sandler has promised to produce.

That business plan
The business plan now becomes a crucial document. Private sector competitors which ran themselves more prudently than Northern Rock and did not need taxpayers’ support to continue in business will be watching carefully to ensure that Northern Rock’s behaviour does not distort the savings or mortgage markets.

It may be that Sandler intends to run Northern Rock down to a fraction of its current size. This will be bad news for the employees of the bank in Newcastle but would minimise the distortionary effect of Northern Rock’s activities on the rest of the private sector.

On the other hand, it is possible that the government will put pressure on NR to repay the £25bn that it has borrowed from the Bank of England quickly, in which case NR might seek to raise significant retail deposits in order to make such payments. (Having said this, of course, the government would be guaranteeing these deposits so the economic impact of making the payment to the Bank will be less important than the political impact.)

The National Savings Landscape Review
Now that NR has been nationalised the government owns two savings institutions, the other being National Savings and Investments. There is already a framework in place governing the impact that NS&I should seek to have on the retail savings market.

The Landscape Review of NS&I: Stakeholder Summary published by HM Treasury in July 2007 (http://www. hm-treasury.gov.uk/media/D/9/land scapereview_190707.pdf) makes it clear that National Savings does not have as an overarching target a market share or fundraising objective. Rather, National Savings is asked to prioritise “value added” – that is the relative cheapness by which it raises funds compared with other methods available to the government (ie, through the wholesale market by issuing gilts).

Indeed, the Landscape Review says that the emphasis should be to “reduce the risk of NS&I having a negative impact on individual competitors and the competitiveness of the retail savings and investments market as a whole, by de-emphasising growth”.

This seems a suitable overall objective for NR – and may indeed be the actual objective once we have seen the Sandler business plan. The Landscape document also contains the economic secretary to the Treasury’s undertakings on the particular objectives. Kitty Ussher agrees, for example, that NS&I should maximise value added, as noted above in particular, however, and of relevance to the potential future behaviour of NR. The document states: “The Treasury should ensure that it is aware of the impact of NS&I on the wider retail financial savings market when setting financing targets. NS&I should ensure that it mitigates its impact through more transparent communication and reporting of overall aims and objectives, tax forgone, all key future targets, and a public quarterly business update.”

Admittedly, Northern Rock is a different business from NS&I. It has a mortgage book, for example. Nevertheless, while acknowledging this, it is difficult to argue that the recommendations agreed by the economic secretary in respect of NS&I should not also be applied to NR, which is now owned by the taxpayer. It has a different set of accountabilities from institutions owned by shareholders. Surely no one can argue with “more transparent communication” on the part of NR.

One hopes that Northern Rock will shortly report its “overall aims and objectives”. Taxpayers are surely entitled to know “all key future targets” in the bank that they own. Finally, in order to assess whether those targets are being met it does not seem unreasonable to require Northern Rock to prepare “a public quarterly business update”. How else are taxpayers to know how wisely their investment is being spent?

What would be a realistic outcome
It is entirely possible that the taxpayer will ultimately make a profit from Northern Rock. Suggestions that each taxpayer is being charged £3,500 to enable the government to buy Northern Rock are very wide of the mark.

This figure – equivalent to sharing out the £113bn balance sheet of Northern Rock between all taxpayers – would become true only if all NR borrowers stopped paying anything on their mortgages and the government found that when the lender possessed the properties these had zero value. This seems extremely unlikely.

While the potential losses are nowhere near the headline figures screaming from the tabloid newspapers, the taxpayer is, nevertheless, entitled to a fair deal. The adoption by NR of the business approach previously agreed by the government for NS&I would be a sensible step forward within the current controversy.

PS: There will also need to be a slight change at National Savings. No longer will it be able to make the statement in its latest annual report that “we offer a unique promise of 100% security backed by HM Treasury”. At the very least, now that government owns two savings institutions the word ‘unique’ will need to be deleted.

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