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From The Sunday Times

August 24, 2008

Taxpayers face £1bn Northern Rock loss

Taxpayers stand to lose at least £450m on the nationalisation of Northern Rock, according to warnings from the government’s own advisers. Goldman Sachs told the Treasury in February that losses to the public purse could stretch to £1.28 billion even in benign market conditions, leaked court documents have revealed.

The explosive revelations will add to concerns over the level of public subsidy for Northern Rock, which still owed the Bank of England £17.5 billion at the end of June.

Alistair Darling, the chancellor, has defended the nationalisation by arguing that the taxpayer’s exposure to Northern Rock is secured against a high-quality mortgage book. The new documents, however, offer the first indication that the government believes it could lose money on the deal.

The figures have been revealed by John Kingman, the senior Treasury official in charge of Northern Rock, in written evidence submitted to a judicial review into the decision to nationalise the lender.

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Kingman’s evidence, seen by The Sunday Times, states that “under none of the scenarios was it contemplated that the government would, taking this subsidy into account, make a net profit from taking Northern Rock into the public sector”.

Advisers from Goldman Sachs, who shared in a £45m pot of fees for their work on Northern Rock, told the Treasury that in a “base case scenario” the Treasury would be left with a “net subsidy” to the bank of some £1.28 billion.

Even on the “optimistic scenario” there was estimated to be a shortfall to the public purse of £450m, Kingman’s evidence claims.

The documents do not disclose an exact figure for the taxpayer’s liabilities should Britain go into recession, which some economists now believe is a real danger.

Kingman’s testimony suggests that Treasury officials did not consider it likely that house prices would fall by 15%-25% – a level that begins to put Northern Rock’s mortgage book into danger.

The ratings agency Standard & Poor’s has since predicted that a fall on this scale will be witnessed by next April. HBOS and Lloyds TSB have made similar predictions.

The evidence comes in response to claims made by SRM Global and RAB Capital, the two hedge funds that were Northern Rock’s biggest shareholders at the time of its collapse. They have alleged that part of the reason the government nationalised Northern Rock was that ministers knew they could profit by selling it back to the private sector at a later date.

Kingman also said that both the Virgin takeover and a separate proposal put forward by the bank’s previous management team, led at the time by former chairman Bryan Sanderson, claimed they could have reaped profits for the taxpayer of up to £230m, through a profit-sharing scheme.

The private-sector bidders, however, would have made ten times as much money under these circumstances.

“Ministers considered that this share of the returns was disproportionate to the share of risk borne by the taxpayer – or in other words the private provider would receive an excessive return relative to the risk taken,” the documents claim.

Northern Rock’s recent results showed that it lost £584.5m in the first six months of the year.

The level of arrears in its mortgage book had more than doubled over this period.

The Treasury also converted £3 billion of its loans to Northern Rock into equity, to provide an additional cushion of capital for the bank to see it through the credit crisis.

In a letter sent this month to John McFall, chairman of the Treasury committee, the chancellor said “the value of the additional equity will be reflected in the sale price for Northern Rock on return to the private sector”.

However, the advice from Goldman Sachs ahead of nationalisation assumed that the government would achieve a sale price of only about £1.24 billion for the bank, according to Kingman.