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Northern Rock is Nationalised - What does this mean ?

The nationalisation of Northern Rock is the culmination of a series of blunders by the Bank of England, the Financial Services Authority and the UK Treasury. The calamities of these three agencies dwarf the risky and flawed business strategy of the Northern Rock management.

The much heralded economic success of New Labour, and its Chancellor of the Exchequer during the Blair years, Mr Gordon Brown, has been reversed and the nationalisation of a bank provides echoes of Old Labour and a stagnant economy.

Gordon Brown prefers the euphemism of temporary public ownership, but most commentators believe that it will take years before Northern Rock is ready to be returned to the private sector.


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1 March 2008

Northern Rock plc was nationalised by the UK government and the shares suspended on 18 February 2008. The government then rushed legislation through the House of Commons without allocating adequate time for debate and scrutiny.

There are several groups of interested parties in Northern Rock. They are the shareholders, depositors and mortgage holders. The fate of employees is not considered, but labour savings will be sought as part of the downsizing agenda.

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Nationalisation is devastating news for shareholders. There were several options for a rescue plan, and the City considered the Virgin bid, by Sir Richard Branson, to be the front runner. Sir Richard unashamedly lobbied Gordon Brown during his visit to China in January, and many financial reporters thought a deal was in the bag.

When shares were suspended, they were trading at 90 pence. Around 420 million shares are in issue, so this values the company at £378 million. The price of 90 pence is a dramatic reduction from the price in January 2007, which was £12. At that time the company was valued at £5 billion.

Due to the way that the Government intends to work out the compensation for shareholders, it is quite possible that they will receive very little indeed for their shares. This is because the government has directed that the valuation takes account of the fact that the company would be unable to continue as a going concern without government funds, and is effectively bankrupt.

These terms of reference dictate that any valuation will determine that the shares are worthless. However, on the contrary, it is clear that the company remains a going concern as it continues to accept deposits and is offering mortgages to borrowers.

Shareholders are very likely to mount a legal challenge, although they will may await the official valuation before commencing action. There may well be several legal challenges, from shareholder groups such as the UK Shareholders Association, and also from the hedge funds RAB Capital and SRB Global.


Savers with Northern Rock enjoy the best security of any UK Bank or Building Society. Savers with other institutions are only given a guarantee for the first £35,000 of any holding, yet Northern Rock savers can invest unlimited funds and have the assurance of UK government backing. This is the benefit of a nationalised bank.

At the same time, the rates of interest enjoyed by depositors are among the highest available. There is a Tracker Online account which pays 6.49% plus a 1.24% bonus. This is just one of the attractive products being offered by Northern Rock.

The problem is that other financial institutions in the UK have already started complaining to the government about unfair competition. The package of high interest rates for savers, backed by the government, is an unbeatable package which no other bank or building society can match.

The Governor of the Bank of England has met with senior bankers on several occasions in order to assuage fears and complaints about unfair competition.

Mortgage Holders

As with savers, it is business as usual. However, in order to reduce taxpayers' funding of the nationalised Northern Rock, the book value of mortgages will have to shrink dramatically. It is estimated that the UK government have advanced some £35 billion to Northern Rock since it encountered funding difficulties.

The total value of mortgages outstanding is some £115 billion. This means that the mortgage book needs to be reduced by around 30%.

Northern Rock Mortgage Holder and Family

The clear implication is that existing borrowers will face sharp increases in the costs of borrowing. These increased costs will take effect as soon as possible, and there will be no extension on ‘sweetners' enjoyed by new mortgage customers. Mortgage holders will be charged interest rates of up to 7.9% in the near future.

Northern Rock have already suggested that mortgage holders seek alternative mortgage products and have indicated that independent financial advice may be appropriate.

This policy is bound to cause distress to mortgage holders. Northern Rock had a scheme whereby some 125% of the value of a property could be used for the purpose of a mortgage advance. In other words, the value of the mortgage greatly exceeded that of the property. New mortgage holders would immediately be in a negative equity situation.

Many Northern Rock mortgage holders will have great difficulty finding alternative lenders. This is due to the current market conditions in which lenders are reigning in on attractive mortgage offers, and are expecting customers to increase their own level of deposit. Some customers who currently enjoy 125% mortgages from Northern Rock may be horrified to learn that other mortgage lenders may only offer around 90% of a property valuation.

In addition, property valuations are moving downwards in line with the depressed state of the UK housing market. This means that many Northern Rock customers will be penalised by increased lending costs from the company and will also be unable to find an alternative mortgage lender.

In the aftermath of nationalisation, we will soon see Northern Rock mortgage holders defaulting on their repayments and risking re-possession. What will make this different from foreclosures in the US subprime mortgage market is that the mortgage lender is the UK government, and moreover, a Labour government committed to helping families on low incomes and those experiencing financial hardship.

The prospect of repossessions must be a nightmare for the Labour government. Not only would it antagonise traditional Labour Party supporters, but it would remove any vestige of economic competence from Gordon Brown.

Mr Brown has consistently sought to take credit for the economic prosperity enjoyed by the UK during the Blair years. He has been put to the test by Northern Rock. By any yardstick, he has failed. Government incompetence has also damaged the international reputation of the City of London. Further bad news is expected.

Copyright - Leslie Hardy, 1 March 2008

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