The Treasury has broken one of its jealously guarded borrowing rules after the National Statistician ordered Alistair Darling, the Chancellor, to put the stricken bank's liabilities on the Government's books.
The ONS said it was classifying Northern Rock as a public corporation
The total amount of public money involved in rescuing Northern Rock is the equivalent of saddling every family in Britain with £3,000 of debt.
It means the national debt will rise as high as 45 per cent of gross domestic product, well above the limit set by Mr Brown in his sustainable investment rule when he was Chancellor.
The Conservatives said Labour's claim to economic competence had been "blown to pieces".
George Osborne, the shadow chancellor, said: "Gordon Brown has staked his reputation for competence on meeting his own fiscal rules. Those rules have been blown to pieces as a result of his economic incompetence. Gordon Brown has effectively saddled every taxpayer with a second mortgage as a result of his mishandling of the Northern Rock crisis."
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FMM Comment: The following comment is also made in the article:
"However, when historians look back at the Northern Rock saga the broader question of how the Government allowed this to happen will be more important than whether one borrowing rule was broken."
How the British Government allowed this to happen is an easy answer. Any country with a Central Bank allows this to happen. It's called fractional reserve banking or the money-multiplier effect.
If you have never heard of these terms, read part 1 and 2 of how this system works.
The following is an excerpt from an article, written in MARCH 1991, by the late Murray Rothbard.
"A fascinating phenomenon appeared in these modern as well as the older bank runs: when one unsound" bank was subjected to a fatal run, this had a domino effect on all the other banks in the area, so that they were brought low and annihilated by bank runs. As a befuddled Paul Samuelson, Mr. Establisment Economics, admitted to the Wall Street Journal after this recent bout, "I didn't think I'd live to see again the day when there are actually bank runs. And when good banks have runs on them because some unlucky and bad banks fail . . . . we're back in a time warp."
A time warp indeed: just as the fall of Communism in Eastern Europe has put us back to 1945 or even 1914, banks are once again at risk.
What is the reason for this crisis? We all know that the real estate collapse is bringing down the value of bank assets. But there is no "run" on real estate. Values simply fall, which is hardly the same thing as everyone failing and going insolvent. Even if bank loans are faulty and asset values come down, there is no need on that ground for all banks in a region to fail.
Put more pointedly, why does this domino process affect only banks, and not real estate, publishing, oil, or any other industry that may get into trouble? Why are what Samuelson and other economists call "good" banks so all-fired vulnerable, and then in what sense are they really "good"?
The answer is that the "bad" banks are vulnerable to the familiar charges: they made reckless loans, or they overinvested in Brazilian bonds, or their managers were crooks. In any case, their poor loans put their assets into shaky shape or made them actually insolvent. The "good" banks committed none of these sins; their loans were sensible. And yet, they too, can fall to a run almost as readily as the bad banks. Clearly, the "good" banks are in reality only slightly less unsound than the bad ones.
There therefore must be something about all banks--commercial, savings, S&L, and credit union--which make them inherently unsound. And that something is very simple although almost never mentioned: fractional-reserve banking. All these forms of banks issue deposits that are contractually redeemable at par upon the demand of the depositor. Only if all the deposits were backed 100% by cash at all times (or, what is the equivalent nowadays, by a demand deposit of the bank at the Fed which is redeemable in cash on demand) can the banks fulfill these contractual obligations.
Instead of this sound, noninflationary policy of 100% reserves, all of these banks are both allowed and encouraged by government policy to keep reserves that are only a fraction of their deposits, ranging from 10% for commercial banks to only a couple of percent for the other banking forms. This means that commercial banks inflate the money supply tenfold over their reserves a policy that results in our system of permanent inflation, periodic boom-bust cycles, and bank runs when the public begins to realize the inherent insolvency of the entire banking system.
That is why, unlike any other industry, the continued existence of the banking system rests so heavily on "public confidence," and why the Establishment feels it has to issue statements that it would have to admit privately were bald lies. It is also why economists and financial writers from all parts of the ideological spectrum rushed to say that the FDIC "had to" bail out all the depositors of the Bank of New England, not just those who were "insured" up to $100,000 per deposit account. The FDIC had to perform this bailout, everyone said, because "otherwise the financial system would collapse." That is, everyone would find out that the entire fractional-reserve system is held together by lies and smoke and mirrors, that is, by an Establishment con."
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