The mismanagement of the Northern Rock crisis

Today there is a withering attack on the Government's management of the crisis at Northern Rock in the Times, by Anatole Kaletsky:

"The Northern Rock bailout will demolish or, at best, discredit the entire economic policy framework created in 1997. Since the creation of this framework was his one unquestionable achievement, it seems fair to say that Mr Brown's career as a serious  ended yesterday."

Here at the TaxPayers' Alliance we've been doing a lot of work fighting the taxpayers' corner on this issue in the media.  Politicians are going to be lobbied by shareholders who insist they shouldn't suffer when their company's risky business model, which paid fat profits when it was doing well, runs into trouble.  Companies bidding to take over the bank will try to exploit the Government's political trouble to extract more taxpayer support.  Someone needs to speak for taxpayers who stand to face such a big bill if Northern Rock gets into trouble - insist that their interests are the Government's top priority.

 

Taxpayers' should be outraged at the new rescue package announced by the chancellor.  It gives up on having the private sector pay back significant amounts of the taxpayers' money immediately and leaves us hoping to claw back our money over a number of years.  This exposes the taxpayer to significant risk.  It is likely to be expensive as we might not get a market rate for the kind of risk we will be running.  For more examination of this issue see this post on the Burning Our Money blog.

 

We don't know what kind of mechanisms will be in place to ensure that taxpayers get a share of the upside if things go well at Northern Rock, in return for the risk we are taking.  The deal which will set out these mechanisms is still to be decided but there seems little reason to expect the Government can be expected to get us a good deal.

 

Beyond that, the incentives being created by the new deal for any private sector rescuer are pretty poor.  They are being shielded from the downside risk - if things go wrong it is mostly taxpayer money at stake - and, in return, their share of the upside is being limited - we'll take a chunk of any profits.  That means we have dramatically reduced the incentive for them to make a success of Northern Rock in the years to come.

 

This issue has been examined ad nauseum but there is an important lesson to be learned about the ability of politicians to manage public services:  This was a big, obvious problem.  The politicians were focussed on it and had every incentive to get it right.  Despite that they've made a complete hash of their management of the crisis at Northern Rock.  Why do we expect them to effectively handle the detailed decisions required every day in order to run high quality public services?

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