Leading article: This is no way to run the nation's railways

The privatisation of profits and socialisation of losses is unacceptable

Does the return of the East Coast Main Line to public ownership prove that the privatisation of the railways was a mistake and ought to be reversed? No, but it does demonstrate that the system of awarding franchises to private train operators needs to be comprehensively overhauled.

At the moment, we have the worst of both worlds. Shareholders and managements of private franchise holders have a licence to reap the profits of running services in the good times, but when economic conditions deteriorate, the costs fall in the lap of taxpayers – moral hazard on rails. And those costs look set to be substantial. The public purse will pay for the running of the line over the coming months, and the rent the Government raises when it re-auctions the franchise is unlikely to match what National Express was paying.

The primary blame for this debacle lies with National Express. The company bid more than it could afford for the franchise in 2007, using unrealistic projections of passenger growth and profit margins. Now it proposes to walk away from its liabilities, which it is able to do since it was running the line through a standalone subsidiary. A company which has broken its contract in such a fashion should be barred from bidding for future franchises. The Government also has a strong case for taking over National Express's other profitable franchises, the Stansted Express and CC. A firm which fails to honour its liabilities in one corner of the network should not be allowed to continue doing business in another.

The new Transport Secretary, Lord Adonis, has played a bad hand as well as he could. He was right to refuse to renegotiate the terms of the East Coast franchise, even though this might have been cheaper than putting the contract up for auction again. This would have been an invitation to other franchise holders, who are also experiencing financial pressure in the downturn, to demand similar renegotiations. Allowing National Express to buy out its contract would have set an equally undesirable precedent.

Despite the yearnings of the rail workers' unions and some backbench Labour MPs, there is no case for resurrecting the inefficient British Rail. There are some patches of bad service and incompetent management, but the railways have generally improved in private hands over the past 15 years. Passenger numbers are at their highest levels since the Second World War and the quality of rolling stock is much higher.

But while public ownership is a dead end, a franchising system which privatises profits and socialises losses is plainly unsatisfactory. So, as well as dealing with the particular problem of running the Edinburgh to London route, Lord Adonis needs to set his mind to reforming the terms on which these contracts are awarded and policed.

First, it is essential that lines should not be run by subsidiaries of larger companies that can be easily cut loose if managers get their sums wrong. This ability to walk away with minimal costs is an incentive for firms to overbid for contracts. The penalties for default must be considerable. The contracts should also be drawn up to prevent managers from taking colossal bonuses for meeting paltry performance targets.

What this bailout confirms is that railway franchises are not normal private businesses, but public utilities like water and electricity. Ministers must be prepared to regulate those who run them in a similarly robust fashion.