Branson is winning Northern Rock battle

Treasury mandarin John Kingman, leading the negotiations for ministers, told Virgin and the in-house rival bidder made up of Northern Rock's current management team that Virgin is the front-runner to take control of the bank.

But he warned both bidders that their offers were not good enough. The threat of nationalisation - which sent the shares crashing 8p, or 8%, to 97p - was seen as a blatant attempt by Gordon Brown and Alistair Darling to get more money out of Virgin and secure a better deal for taxpayers.

A Treasury source said: "It was a reasonably strong message. There are a number of areas in which we believe the Virgin bid can be improved."

Virgin refused to comment but will continue negotiations with the Treasury this week. It is thought that Paul Thompson, the non-executive director of Northern Rock heading the in-house bid, was given an even stronger warning that its offer did not come close to meeting the Government's aims.

"The message has been given that the board needs to go back and think again," said the Treasury source. "Their bid isn't as good as Virgin's."

The decision to highlight Virgin's superiority could weaken the Government's hand in trying to persuade Sir Richard to come up with a better offer.

The Prime Minister and Chancellor want Virgin to raise the amount of money its is offering to pay the Government to guarantee the bond issue of £30 billion. The bonds cover the £25 billion Northern Rock was forced to borrow from the Bank of England and other taxpayer guarantees.

Brown and Darling also want a bigger potential stake in Northern Rock for the taxpayer, via a warrant over the bank's shares.

But Liberal Democrat deputy leader Vince Cable said he feared the Government "may just be talking tough in order to extract some last-minute concessions".

He said the Virgin deal was "a bad deal in which the Virgin consortium takes the profits and the taxpayer is left with most of the risks".

Nationalisation would be a blow to the Government but it is now clear that it is back on the agenda as an option.

It is also a disappointment to shareholders including SRM Global and RAB Capital, which together own about 18% of Northern Rock.

They first favoured the now-defunct Olivant bid before backing the current management team. A successful Virgin bid and nationalisation leave them with virtually nothing.

Analysts said the threat of nationalisation was a "shot across the bows" for the shareholders - a warning to accept the Government's decision or end up with nothing.