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 SIPDIS NOFORN 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 �00A;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 -------------- -------------- LONDON 00000634 002 OF 003 ¶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 LONDON 00000634 003 OF 003 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. Visit London's Classified Website: http://www.state.sgov.gov/p/eur/london/index. cfm TUTTLE