Fannie & Freddie to be nationalised. Costing the US tax payer $500b now and heading for 1T in due course.

lets see how the dollar reacts on the news.

On the face of it there were three options open once NR ran out of money: (i) let it fold, (ii) lend it the money it was unable to raise on the markets in the hope it could trade its way out of trouble or (iii) buy the business (i.e. nationalise it).

The first option was decried as dangerous and impractical because it would cause a loss of confidence in British banking as an institution. But since a major mortgage lender was bust it is hard to see that confidence was anything other than overstated. On a political level the more important issue was not confidence in British banking but confidence in the British government. Savers with Northern Rock had placed their liquid assets with a company which was thriving on a bubble of the government's making. Had it folded they would not just have lost their attractive returns but their capital itself might have been in danger. There were votes to be lost by the bubble bursting all over sensible people with savings.

The second option was tried but by then the bubble had been exposed, at least to the satisfaction of the savers, hence the "run" on the bank. Other banks also took emergency loans from the Bank of England but Northern Rock was different from the other major mortgage lenders because its business was a bubble on a bubble.

There was the national bubble of feel-good synthetic wealth … "look darling, we have made an extra £20,000 on the value of the house this month let's have dinner at Granita". That bubble existed no matter who lent the money to buy the property. Northern Rock's supplementary bubble was caused by its appallingly risky business model. It engaged in far too much equity lending, giving little heed to the value of the borrower's personal covenant to repay. And it did so because the taps were open; money could be borrowed in seemingly endless amounts on the money markets, then lent at a narrow margin and presented as secure (on paper) because the equity in the property was rising and rising. There was risk at both ends – the raising of the money and the lending. Other banks could have followed this model but the others had learned from the 1989-92 crash and were much stricter about proof of income and loan-to-value ratios (still too lax on both counts, however) and their businesses were not so highly concentrated on domestic mortgage lending.

In the end the third option was inevitable. The government can be criticised for taking a little longer than necessary to get there, but that seems rather unfair to me because the run on the bank was halted by emergency lending – the very same system of emergency lending which was used by other banks with less risky business models – and government guarantees. The panic was over. Had the government given those interested in taking over Northern Rock 6 weeks rather than 3 or 4 months to formulate their bids it is a matter of conjecture whether the result would have been any different.

I see no difference in substance between the guarantees the government gave Northern Rock in October last year and the guarantees the US government has given the troublesome siblings, Fannie and Freddie. Both expose the taxpayer to huge risks and do little if anything to improve the business model of the equity lender.

By all means criticise the government for creating the initial bubble, a bubble which has been exposed more and more as the months have passed. By all means also criticise the government for not acting as fast as it could have done, but in making this latter criticism one must ask whether faster action would have improved the situation. If we are in exactly the same situation as if the government had been Linford Christie rather than Fatty Arbuckle, the criticism is empty.

To criticise the government for taking over Northern Rock and then restricting its ability to lend is, in my view, equally unfair. Quite apart from the need not to use the might of the public purse to gain unfair advantage (a need which is both political and legal), it was essential to cut back on much of the core business because they were lending too much to people who could not afford to repay them. That part of the market simply had to be reduced.

If I might say so Mr Redwood, I feel your article today exceeded legitimate criticism of the government. But don't worry, I'll agree with you, as usual, tomorrow and we can surely both enjoy a steady run of arrant knee-jerk nonsense from Mr Brown and his merry incompetents in the months ahead.

In other guise I have predicted what is to come under this government:

Reply: If you want to see my contemporary criticisms before the run on the Rock then look under the Rock tab on this site. I recommended a fourth way – keeping the markets more liquid in August/september 2007 so the Rock could borrow the money it needed.
http://thefatbigot.blogspot.com/2008/07/governmen…

I hope you've got a powerful telescope.