No one likes going into a negotiation naked, relying on the other side’s good will for an acceptable outcome. Far better to arrive armed with a nuclear weapon and your finger poised over the button. You must be willing to press it, but should never have to use your threat – so long as the other side believes it is credible.

In the Northern Rock saga, the tripartite authorities – HM Treasury, the FSA and the Bank of England – hold two giant H-bombs. They could nationalise the bank or, by withdrawing their financing, send it straight into insolvency.

The trouble is, for all the Treasury’s insistence that it is keeping all its options open, these threats currently lack credibility.

Nationalisation would leave the government open to years of litigation, unless the price the taxpayer paid for the equity was high. A messy insolvency is thought to be an even worse option, because an independent administrator would freeze depositors’ accounts for months before the Treasury’s guarantee could be paid out.

Shareholders have exploited the authorities’ weak position and are threatening to block any acquisition unless the terms are favourable. Some officials within the tripartite authorities think this is a monstrous stance, given the tiny value of shareholder equity relative to the assets or the money that taxpayers are risking.

Mervyn King, the Bank of England governor, has made clear what he believes is the long-term solution. Speaking in October, he said a special insolvency law for banks was “the single most important necessary reform”.

In future he wants retail deposits to be transferred to another bank within a day or two, so the authorities could let a medium-sized bank such as Northern Rock fail without a bank run or huge loans from the Bank of England. At the same time, shareholders would not be able to hold the taxpayer to ransom, rejecting takeover deals that do not involve a sizeable subsidy.

It has now emerged that the tripartite authorities think they are close to recreating such an insolvency regime with the tools they currently have. No one favours administration or nationalisation, but they want to be sure that in the negotiations with potential bidders they have a credible alternative.

In either case, the idea would be for the Bank of England to take over Northern Rock’s deposits and pay off savers very quickly.

In the case of insolvency, the authorities would need the agreement of an independent administrator to buy the bank’s deposit book, but that should be forthcoming, as the Bank would replace the depositors’ funds with the equivalent of freshly minted £50 notes.

The key is that the administrative systems must be in place to repay depositors extremely quickly, leaving shareholders at the bottom of the queue of creditors.

Officials are confident they are just days away from having a credible alternative to an acquisition of Northern Rock. They do not want to press the button, but are beginning to feel the nukes they have always held are armed and ready should negotiations on a sale get bogged down.


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