UK NATIONALIZATION OF NORTHERN ROCK: ANOTHER BLOW

C O N F I D E N T I A L SECTION 01 OF 03 LONDON 000634

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SIPDIS

E.O. 12958: DECL: 02/28/2018
TAGS: PGOV PREL ECON EFIN EU UK
SUBJECT: UK NATIONALIZATION OF NORTHERN ROCK: ANOTHER BLOW
TO GORDON BROWN, BUT NOT A KNOCK-OUT PUNCH

REF: A. LONDON 476


B. LONDON 432

Classified By: Ambassador Robert H. Tuttle, reasons 1.4 b, d


1. (C/NF) Summary. The nationalization of British bank
Northern Rock adds to the list of woes besetting Gordon
Brown's government, but it is not the political catastrophe
that the opposition Conservative Party has painted -- and
hoped -- it to be. Sixty percent of respondents in a recent
poll blame the bank's management for the current
difficulties, while only five percent blame the Brown
government. The Tories gained little political traction from
the issue because they failed to offer an alternative to
nationalization and instead could only attack Brown for
"dithering" in reaching a decision. Our financial sector
contacts tell us nationalization was not a surprise and that,
provided Brown's government fixes the regulatory problems
that allowed the crisis to occur in the first place, London
will emerge unscathed as an international financial center.
The Northern Rock issue plays out against the back drop of an
uncertain economic forecast, combined with a steady stream of
other bad-news stories that have kept Brown on the defensive,
while striking at the heart of his reputation: his capable
management of the economy. The next test of the Brown
government's economic leadership comes March 12 with the
Government's announcement of its budget. End summary.

Not "Black Wednesday"...
--------------


2. (SBU) HMG's decision to nationalize Northern Rock, which
Chancellor of the Exchequer Alistair Darling announced
February 17, and which Parliament enacted on February 22 (Ref
A),ended a six-month saga during which the Brown government
tried, and failed, to find a private sector buyer for the
bank, after Northern Rock's aggressive mortgage-lending
tactics provoked an unprecedented bank run in August 2007
that ended with a GBP 55 billion (USD 110 billion) government
bail-out. If Northern Rock fails to repay, this bail-out
could cost each individual taxpayer in Britain GBP 3,500 (USD
7,000),according to some estimates, but that is highly
unlikely.


3. (SBU) The Conservative Party's immediate response to the
nationalization announcement was to dub it "Labour's Black
Wednesday," a reference to the day in September 1992 when
sterling crashed out of the European exchange-rate mechanism,
humiliating then-PM John Major and ruining the Tories'
reputation for economic competence. At a bruising session of
Prime Minister's Questions February 20, Tory leader David
Cameron accused Brown of having "something to hide" by
exempting Northern Rock from Freedom of Information requests,
refusing to reveal the total cost to the taxpayer, and
separating out the more profitable mortgages. For his part,
Liberal Democrat leader Nick Clegg accused Brown of
"frittering away" tens of millions of tax payer pounds in
consultants' fees during the time it took to determine the
bank's fate, and causing "untold damage" to the UK's
reputation as a world financial center. Political and
business opponents have also tried with varying success to
link Northern Rock's problems to other financial headaches
largely of the government's own doing, such as their
much-criticized tax proposals on capital gains and
non-domiciled expatriates (Ref A).


4. (SBU) The "Black Wednesday" moniker hasn't caught on. An
Economist/YouGov poll conducted February 18-20 found that 60
percent of respondents believe the management of Northern
Rock is most responsible for the bank's difficulties, while
only five percent blame the government. Fifty-nine percent
said the Tories are "playing politics" and would probably do
much the same as the government is doing now if they were in
office, and 63 percent said the Tories would have handled the
crisis the same as or worse than the government.
Interestingly, in the same poll 40 percent of respondents
said they would vote Tory, as opposed to 34 percent for
Labour.


5. (C/NF) Part of the reason for the lack of public anger at
Brown is the failure of the Tory opposition to outline a
convincing alternative to nationalization. Their narrative
has been to accuse the process and delay in reaching a
decision - a critique that, while relevant, does not resonate
with the public. The real political winner appears to be the
LibDem Party, which from the start of the crisis had called
for nationalization as the only viable solution.

...But Still, Yet Another Problem To Add To Brown's List
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6. (C/NF) In the short term, the Brown government has taken
two hits from the announcement. According to the
Economist/YouGov poll, 58 percent of respondents agree with
the statement that "government ministers have taken far too
much time to make up their minds and dithered over Northern
Rock." The "dithering" description resonates with the
stammering, uncomfortable image Brown often portrays in
public. Brown justified the six-month lag time to the
Commons by saying that that the government needed to examine
all possible options before coming to a decision, and claimed
that HMG would have been subject to legal claims if it had
not done so. Pundits have argued that although Brown took
his time, he systematically examined every possible option
before deciding on nationalization - a testament to the
diligence and fortitude that are arguably his strongest
assets.


7. (C/NF) Second, Chancellor Alistair Darling has been
severely weakened during the process, with 52 percent of
those polled believing that he is doing a bad job as
Chancellor. Tory Shadow Chancellor George Osborne described
Darling to the Commons February 18 as a "dead man walking,"
and media speculation of his possible resignation has been
rampant. For now, there is no apparent successor to Darling
at Treasury with his reputation or clout, but the move
earlier this year of Yvette Cooper to Treasury does line her
up to succeed him if Brown goes that route. We assess
Darling will survive this crisis, but the deterioration in
the reputation of one of Brown's most trusted advisors will
impair the government's overall ability to manage the economy
in the face of an uncertain economic outlook and a growing
budget deficit.

Financial Market Reaction -- Yesterday's News
--------------


8. (SBU) As the Northern Rock crisis unfolded and conditions
in the financial markets deteriorated last fall, it became
clear to the financial community that nationalization was
inevitable. Our contacts in the banking sector tell us they
soon realized that no private-sector "white knight" was going
to emerge, and that when nationalization finally happened,
the City viewed it as "yesterday's news," a non-event.


9. (SBU) The crisis did expose gaps and vulnerabilities in
the Tri-partite System of financial market regulation of
which Gordon Brown was the architect when he was Chancellor.
Our financial services contacts all agree, however, that the
crisis does suggest that the UK system of principles-based
regulation has short comings but is not fatally flawed.
Accordingly, if the government is able to fix the problems
highlighted by the bank's nationalization, London's
reputation as a financial center may emerge unscathed.


10. (SBU) HMTreasury issued a consultation document with
proposals to enhance financial stability and depositor
protection. The Financial Services Authority (FSA) will
release its review of the Northern Rock crisis in March, and
the FSA's CEO, Hector Sants, has already acknowledged that
Northern Rock highlighted FSA shortcomings. Much will depend
on the government's ability to implement the changes
recommended by these reviews and on its ability to improve
the effectiveness of the Tri-partite Authority in crisis
situations. Northern Rock was a stress test on the UK system
of financial regulation that could ultimately strengthen it.

Comment
--------------


11. (C/NF) In the broader perspective, the Northern Rock
crisis has undermined Brown's reputation for economic acumen.
Although he was initially praised for taking swift action to
stop the bank's hemorrhage in August, after the dust settled
the UK public began to question the efficacy of the financial
services regulatory system -- put in place during Brown's
tenure as Chancellor -- that had allowed the bank run to
occur in the first place. And Northern Rock is one more item
on the ever-increasing list of bad-news stories that have
kept Brown on the defensive since his short-lived honeymoon
period ended in September 2007 (Ref B). With economists
predicting that the bank won't be back on its feet until at
least 2010 - in other words, not until the next election -
Northern Rock will continue to provide fodder to the
opposition, especially if the government ends up paying out
on its loan guarantees.


12. (C/NF) Brown has asked to be judged based on Britain's
economic performance, and while the public hasn't given him a
failing grade on Northern Rock, the process leading up to

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nationalization has left the impression that he needs to
improve his score. Much will depend on the government's
ability to implement the recommended regulatory changes and
on its ability to improve the effectiveness of the
Tri-partite Financial Authority in crisis situations.
Northern Rock was a "stress test" of the UK system of
financial regulation, and could, ultimately, strengthen it.
The next indication of public views of Labour economic
management will be reaction to Chancellor Darling's March 12
budget presentation to Parliament.


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