A government rocked

A government rocked

Little wonder the government was forced yesterday to guarantee deposits at the stricken Northern Rock. This was a problem that, while it may have affected one mortgage lender, threatened to engulf other high-street banks - and even endangered Labour's hard-won reputation for sound economic management. Before he made his announcement, chancellor Alistair Darling must have been given news from the markets. There was carnage among bank shares, with nearly a third knocked off the value of Alliance & Leicester. What had seemed a local problem on Thursday evening, confined to a Newcastle-based bank that had made outlandish business decisions, threatened by Monday night to become a banking crisis.

Yesterday's announcement represents a huge change in policy: it replaces a long-standing, but limited, compensation scheme for depositors, with a government commitment to ensure every saver gets every penny he or she wants out of the Rock. For the government it raises all sorts of troubling questions. Why did it not provide such a guarantee earlier, and quell customer panic? Will ministers extend such a guarantee to other bad banks? That last question may well be asked by Mervyn King, head of the Bank of England, for whom this decision is a giant rebuff. Dr King had vowed not to create "moral hazard" by bailing financial institutions out of their own foolhardy decisions. He had come in for a lot of flak for holding the line. Some financiers accused him of being unsympathetic; others argued such a stance was fine in theory but threatened the wider economy. The Bank head was decried as a mere academic, yet until last night it looked as if he had prevailed.

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In the end though, the queues won. The angry customers outside the Rock were on news bulletins and in newspapers all weekend long. They served as a constant reminder that whatever financial crises Labour has endured in the past decade - trouble in emerging markets, the dotcom bust, 9/11 and a long trough in the stock market - this was the first to burst on to the high street.

It had begun to threaten Mr Brown's own reputation as a steward of the economy. David Cameron had already tried to pin the blame for the Rock's strife on Labour, arguing: "Though the current crisis may have had its trigger in the US, over the past decade the gun has been loaded at home." Now the government's biggest critics will probably include other savers who feel cheated. What about members of Equitable Life? As for Dr King, and those worried about underwriting businesses' foolish behaviour, their arguments remain relevant. One way the Treasury can justify its action is by getting tougher on bank behaviour.

There is a link between the Rock and the government's economic record; it is to do with confidence. Confidence is what keeps a customer's life savings in a bank, and confidence in Labour's stewardship of the economy is largely what has won it elections. As chancellor, Mr Brown was proud of his light-touch financial regulation. That is what allowed Northern Rock to grow so quickly. Now it has ended up in a mess, and the markets are in turmoil. That may cast a shadow over Labour's popularity, and it certainly means the economy will be squeezed. After all, the City and finance accounts for just under a third of the UK's annual income.

After a "nice" economic decade, with relative calm and constant growth, the UK economy was already moving into choppy waters. Even after Mr Darling's hastily arranged guarantee Northern Rock's troubles will dent consumer confidence - making things even choppier. To stop things getting even worse for the economy and the government's standing, Mr Darling probably concluded that he had to give that assurance. The early success of his pledge will be judged as soon as this morning, by checking on trade at branches of Northern Rock.

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