Banks must take off the blinkers to save system

Much more intriguing than playing the blame game is working out how the rescuers are going to get out of the quicksand. Increasingly, it looks as if bailing out Northern Rock so that it did not suddenly collapse was the easy part. Finding a long-term solution to its problems is a much tougher challenge.

The Government, the Bank of England and the Treasury have got into this difficulty, with £15 billion of the Bank's money committed so far to the rescue operation. But how do they get out? How does the Bank get its money back?

Essentially there are only two solutions to the Northern Rock crisis. One is that the mortgage bank is put into run-off. In this scenario it is bought for next to nothing, no more loans are made but existing mortgages are allowed to run their course or are parcelled up and sold on. This can be profitable and it is what New York-based investment group JC Flowers reportedly wants to do.

As it is surely impossible for Northern Rock to survive on its own, the only other outcome is that someone with very deep pockets buys it.

The pockets have to be deep - not to buy Northern Rock equity in the market, because it is probably worth relatively little and is well within the means of a lot of financial players, but if the business wants to continue to operate, by this time next year its financial needs could be as much as £35 billion.

This is not new money for new business but what will be needed to pay back the Bank of England and re-finance other short-term financial instruments that will mature before then and which are supporting its current lending.

There you have the problem in a nutshell. Until the credit crunch, that money was easily available in the interbank market and was rolled over into new finance whenever a tranche matured. That is where the short-term money Northern Rock used to grant its long-term mortgages came from. But with the collapse of confidence, other banks are not willing to re-finance and no one else, apart from the Government, has that kind of money or can take that kind of risk. So everything is stalled.

At present, there has been only one public bid approach - from a consortium of financial players led by Virgin and advised by Greenhill. There has been a tendency to dismiss this as just another publicity stunt by Sir Richard Branson. But if that was all it was he would surely not have won the backing of AIG, the world's biggest insurance company, or one of the most respected figures in British banking, Sir George Matthewson, who since his retirement from the chair at Royal Bank of Scotland has found a home at an investment house Tosca.

So it deserves to be taken seriously. But that said, it looks as if the only way the consortium can hope to succeed is by securing agreement in advance from the major High Street banks that they will start lending to Northern Rock again on reasonable terms in the interbank market. Then the £35 billion would no longer be a barrier and negotiations for the takeover could proceed.

Unfortunately, this is a major stumbling block. In the old days the Bank of England could have called the bank bosses in, locked them in a room and not let them out until they agreed to cough up the money for a lifeboat. But those days have gone.

Today one hears that the big banks show no inclination to help - partly because they are quite pleased to see a competitor get its comeuppance, partly because they worry about the risk of loss if they did lend money, partly because they want to hoard the cash in case they they need it for themselves.

While these are understandable sentiments, they are also dangerously blinkered. They remind me of the joke about the person in the rowing boat who refused to help bale because the hole was at the other end.

The banks should realise that, whether they like it or not, Northern Rock is part of the British banking system and the longer it is allowed to fester unresolved, the greater the risk of a further collapse of confidence elsewhere in the system. That, in turn, would greatly increase the likelihood that the credit crunch would spread to the real economy and precipitate a serious economic slowdown.

This is why the clearing banks have got it so wrong. There may indeed be a risk that they will lose money by beginning to lend again to Northern Rock. But there is surely a much greater risk that they will lose vastly greater sums of money if they do nothing and the whole economy takes a dive.