Brown blinks again

20 January 2008 By Hugo Dixon Follow @hugodixon

What was supposed to be temporary government life support is now to become a mediumterm crutch. No wonder the shares have rebounded sharply. Elements of the package provide some protection for taxpayers. But it far from clear that they are sufficient.

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The UK government has proposed a new financing plan for Northern Rock, designed to aid a private sector solution for the stricken bank.

The scheme involves the conversion of the government's £28bn of loans to the bank into bonds guaranteed by the state. The plan, devised by Goldman Sachs, would involve the establishment of a special purpose vehicle (SPV). The government would receive a oneoff £28bn payment but would guarantee bonds issued by the SPV.

In return for providing the guarantee, the government would receive a fee from Northern Rock. The SPV would also be overcollateralised meaning the first of any losses would be borne by Rock.

The government has asked for privatesector proposals by February 4. It says it expects such proposals to involve injecting additional capital and to give the government an appropriate share in the potential equity upside. The government would need to be satisfied that any proposed business plan was robust. Any scheme would also need to be approved by the European Commission.

In the event that a privatesector solution cannot be found, the government says it will take the Rock into temporary public ownership by acquiring its ordinary and preference shares. Compensation would be determined by an independent valuer. The principle in determining valuation would be that the government would not compensate shareholders for value that was dependent on taxpayers' support and the fact that public sector ownership would be an alternative to administration.

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