Further and final extension of the guarantee arrangements proved necessary

1.21  On 11 December 2007 Moody's, a rating agency, informed the Tripartite Authorities that it was considering a downgrade of Northern Rock's credit rating. Such a downgrade would have had an adverse effect on the company's financial situation. By this point, third parties that had expressed an initial interest in acquiring Northern Rock had done so on the assumption that there would be no adverse changes to the Granite securitisation programme, which would have happened if the company's credit rating had been downgraded.  As a consequence, on 18 December 2007, the Treasury announced further guarantee arrangements to cover additional wholesale borrowing by the company.

1.22  As a result of this emergency support, the taxpayer was now guarantor for a significant proportion of Northern Rock's business. Figure 6 illustrates how the guarantee arrangements provided by the Treasury to cover the company's retail and wholesale funding and loans from the Bank increased over time. Emergency support on such a scale had never been provided before to a financial institution in difficulty.

1.23  It was clear to the Treasury that continued indefinite emergency support would not be acceptable:

■  A contingent liability would have been created in a private company over which the Government had limited control;

■  It was not the role of the Bank, as lender of last resort, to engage in long term lending to a commercial bank. The support provided was intended to safeguard the financial system and prevent damage to the wider economy, and not to subsidise a particular financial institution;

■  The emergency support amounted to assistance from state resources and had to be notified to the European Commission. The Commission had accepted that the liquidity provided by the Bank on 14 September 2007 was not state aid, but concluded that subsequent guarantee arrangements and lending facilities provided by the Treasury and the Bank in October 2007 were, albeit that they were permissible as rescue aid. Rescue aid could not, however, be approved for more than six months from the date of the first measure, unless the Government submitted a restructuring or liquidation plan for the company by March 2008. Even then the rescue aid approval would only continue until the Commission reached a decision on the restructuring plan, specifically whether the support to the company continued to be restructuring aid and, if not, whether it needed to be amended or withdrawn. These requirements placed a key time limit on the Treasury's, and Northern Rock's, search for a solution.

1.24 The Treasury therefore sought to work with other members of the Tripartite and the company to enable it to pursue a range of strategic options which would resolve the liquidity problem. This report considers:

■  The search for a longer term solution (Part 2);

■  Oversight of the company in public ownership (Part 3);

■  The Treasury's capacity to respond to and manage events (Part 4).