Immoral hazard

18 September 2007 By Hugo Dixon

The guarantee should stop the run on the stricken mortgage bank and a domino effect on other institutions. But foolish behaviour hasn t been adequately punished. In exchange for the guarantee, the state should have nationalised it.

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The UK government has guaranteed all cash deposited at Northern Rock. The guarantee, announced by Alistair Darling, the chancellor of the exchequer, came after an earlier support operation – under which the Bank of England offered to supply funds to the stricken lender in return for collateral – triggered a run on the bank. The government became alarmed after other mortgage bank shares, especially Alliance & Leicester, fell sharply on Monday.

Darling said: "I want to put the matter beyond doubt. In the current market circumstances, and because of the importance I place on maintaining a stable banking system and public confidence in it, I can announce today that following discussions with the Governor and the Chairman of the FSA, should it be necessary, we, with the Bank of England, would put in place arrangements that would guarantee all the existing deposits in Northern Rock during the current instability in the financial markets."

The government also made clear that it would provide similar support to similar institutions in a similar situation.

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