NIESR warns Rock could end hope of balanced Budget

The Bank of England and the Treasury's support for Northern Rock could "drive a coach and horses" through the public finances, according to Martin Weale, director of the respected National Institute for Economic and Social Research.

Mr Weale warned yesterday that the public sector's exposure to Northern Rock has the potential to break the Treasury's golden rules for the public finances. "It depends on how big the losses are: £2bn is the sort of sum that bounces around when the data are finalised, but if it were £20bn that would put a coach and horses through the idea of balancing the Budget over the economic cycle."

That would happen if the stricken mortgage lender were to be broken up and the losses accrued as that process went on found their way on to the public sector current deficit, which is supposed to balance over a per-iod covering good years and bad.

The Chancellor has forecast a deficit of £8.3bn on the current budget for 2007/08 and forecast the total public sector net borrowing requirement will stand at £38bn for this financial year. The public finances are already in an enfeebled state due to the slowdown in the economy and they currently show the highest outturn for borrowing seen since Labour took power in 1997.

A failure at Northern Rock would also have disastrous effects on the total national debt, the low size of which has been one of the Government's proudest boasts. "Should the Rock go bust with unpaid debts of £20bn, the Government's aim to keep the nat-ional debt at 40 per cent of the national income would be broken quite easily," Mr Weale said.

He added that in all events there is an immediate question, so far unanswered by the Government, as to how the taxpayer's contingent liabilities to Northern Rock will be treated in the national accounts. The closest parallel is the state aid provided to the rail industry after the private Railtrack company went bust with losses of £3.5bn in 2001. The not-for-profit Network Rail company was constituted in such a way as to keep the taxpayer's exposure "off balance sheet" in the public accounts.

The extent of the public sector's exposure to Northern Rock has been the subject of much controversy.

About £24bn has been lent by the Bank of England, with a further £14bn that has been guaranteed to depositors: a potential loss of £38bn. Against that is the Rock's loan book, worth £100bn. Half of that has been "securitised" – and the remainder might yield about £25bn on liquidation. That leaves the public finances with a £13bn hit if the Rock were broken up – and possibly more by next February when the deadline for buyers expires.