BY nationalising Bradford & Bingley, the Government has effectively written a blank cheque to failing banks, with taxpayers picking up the bill. This demonstrates the full gravity of the Northern Rock decision. The Government now feels duty bound to stop banks from collapsing, no matter what the cost.
The economic consequences could be dire. The Treasury unwisely entered the current slowdown with a large budget deficit. Taking on extra billions of bad debt will send public finances further into the red.
Taxes are therefore likely to rise. There may also be upward pressure on interest rates as the Government borrows more on the money markets. These developments are likely to prolong the economic slowdown and delay the recovery of the banks. They could make further collapses more likely, heaping even larger burdens on taxpayers.
Then there are the problems that come with nationalisation. The 1960s and 1970s showed that government-owned enterprises become bloated and inefficient. Propped up by subsidies, they also damage private sector rivals through unfair competition. Such an outcome would be disastrous for the banking sector. If loan books are not well managed, then bad debts will multiply.
The free-market system is successful because it is highly effective at adjusting to changing economic circumstances. Firms that make bad decisions go under while those that make good decisions prosper. This process is essential if good practice is to proliferate.
Government interventions, such as bailouts and nationalisations, interfere with the market's self-correcting process. This laissez-faire lesson was learnt with manufacturing in the 1980s. The 1981 recession was painful but it ended decades of stagnation and led to strong growth in the years that followed.
Proposals from all three major political parties to make it more difficult for banks to repossess properties are particularly pernicious in this regard. If financial institutions find it harder to collect their debts, then even more of them will end up receiving state support.
Fortunately, in the case of Bradford & Bingley the Government appears to have avoided wholesale nationalisation. Some of the negative consequences of state ownership may therefore be avoided. It seems likely that Abbey, part of giant Spanish group Banco Santander, will buy Bradford & Bingley's savings business. Undoubtedly, the Government would have preferred an HBOS-style takeover of the entire company.
Although it would probably have done little to protect jobs, a full takeover might at least have offered some value to shareholders, many of whom received shares when the building society became a bank in 2000. These former members, who will be lucky to receive any recompense from nationalisation, may now be regretting their decision to demutualise.
The institution's conversion to a bank enabled it to engage in the lending practices that ultimately brought about its downfall. In the context of loose monetary policy and low interest rates, the conservative practices of the building society were replaced by strategies that promised high rewards but failed spectacularly. Shareholders voluntarily accepted the additional risks (and potential returns) attached to bank status and will have to accept their losses.
Indeed, the absence of a suitable bidder suggests that Bradford & Bingley's financial position is far weaker than that of HBOS. In particular, its mortgage business is heavily exposed to the buy-to-let and self-certification markets.
Buy-to-let investors often underestimated the costs of letting property and the length of rental "voids" periods with no tenants and no income. Moreover, encouraged by Government regeneration policie