The government’s bail-out of Northern Rock reminds me of the story when J.P. Morgan (the man not the bank) was a pproached by a young man who asked him if the banker would finance his business. “No”, replied the great financier, “but I will put my arm round your shoulder and walk you across the floor of the New York Stock Exchange”.
There is no risk and has never really been any risk to the depositors at Northern Rock. With most of the liabilities incurred through commercial paper, the demand depositors would always have been able to withdraw their deposits. The bank could always sell some of its prepackaged assets to make up the shortfall. So the government’s guarantee was always meaning less. The only reason to withdraw a deposit would have been to buy the shares after the 75% fall in three days.
The problem for the government is that they will now be obliged to underwrite all retail deposits. Apart from some Clinton-esque weasel words (“It depends what you mean by ‘deposit’”), it looks as though the government are exposing themselves to substantial liabilities, which can only be met by higher taxation which would cause more mortgage defaults, bad loans, bank problems etc.