Why all the fuss about Northern Rock today?
The Government is stuck with a £25 billion outstanding loan to an unstable bank. European Commission rules on state aid will allow the Government to continue to prop up the Rock for a limited time only. Alistair Darling needs to find a solution, and fast. The Chancellor is reluctant to take the bank into public ownership because that would be embarrassing for the Government. But would-be buyers are struggling to raise enough money both to pay back the Government and run the bank because of the turmoil in global financial markets.

What is the Chancellor’s solution?
Northern Rock would sell bonds to investors and use the proceeds to pay back the Government. This would remove one of the big stumbling blocks because any bidder for the bank would only have to raise enough money to keep it in business, not to pay off its huge loans.

Bonds are often used by companies as a way of raising cash. In return for buying a bond, investors receive an income, known as a coupon. Bonds are given a set lifespan of anything from six months to 50 years. When the bond matures, the company must repay investors their original capital. Northern Rock’s bonds are likely to have a five-year maturity.

These new bonds would be guaranteed by the Government. With global stockmarkets plunging at the moment, this kind of investment is even more attractive than usual to investors such as pension funds who prefer stable assets. There should be a big market for Northern Rock bonds.

Does this mean that taxpayers are off the hook?
Taxpayers would still be exposed to some risk for at least the five-year life of the bonds. If the bank failed to pay the coupons, the Government would have to use taxpayers’ money to cover the cost as well as returning the original capital to investors. But taxpayers might benefit if the bank is a success because the Treasury will hold a share. The Government will also receive a payment from Northern Rock’s new owners in return for the guarantee on the bonds.

The Treasury will retain control over a number of the Rock’s activities, so the bank’s new owners cannot do anything outlandish, such as paying huge dividends to shareholders, that would put the Government’s guarantee in danger.

What happens now?
Bidders must have their offers in by February 4. The Virgin Group is certain to bid, as is a private equity group led by Luqman Arnold, the former chief executive of Abbey, the high street bank. Rock’s existing board is also putting together a proposal that would keep the bank as an independent company. Other bidders, such as the American private equity firms that dropped out of the takeover battle last year, might return now that the funding issue is sorted but, if so, they would have to act quickly. Northern Rock’s future should be decided in less than a month.

How did Northern Rock get itself into this mess?
Until June last year, the Rock was Britain’s fifth-biggest mortgage lender. Most banks fund their mortgage lending by using savers’ deposits. Because the Rock has only 76 branches, it funded its lending by packaging its loans and selling them to investors. But the collapse of the sub-prime mortgage market in America meant that many investors — mainly other banks, fund managers and hedge funds — became scared of buying any type of mortgage-related asset.

Northern Rock was unable to borrow the money it needed to stay in business. It was forced to ask the Bank of England for an emergency loan to tide it over.

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