Leading Article: The Government is caught in a terrible trap of its own making

Northern Rock's problems have now ballooned into a financial disaster of truly horrendous magnitude. Its borrowings from the Government have gone up steadily week by week to a staggering £20bn or more, all at penal rates. It has no new deposits. Some 60 per cent of the loans that make up its formal assets have been passed on in loan instruments. And there is still no end in sight.

Not that the Government is yet admitting this. Having intervened belatedly to stop the queues of panicking depositors by guaranteeing their money, the Treasury has ducked behind the parapet in the hope that somehow, somewhere a white knight will ride to the rescue and take the whole catastrophe off its hands.

Two potential bidders appeared yesterday in the form of Virgin and Olivant and a couple more may come forward over the weekend. But it would be a singular optimist indeed – and there are not many of those left in today's jumpy markets – who would think about launching a takeover bid unless the Government came forward with some sweetener, if only in the form of government loans for the foreseeable future.

For the sorry fact is that Northern Rock is a basket case, kept alive only by unprecedented government guarantees to its depositors and ever-rising loans from the UK taxpayer. Of the £20bn loaned so far, £13bn has been made by the Bank of England directly secured against Northern Rock's loan book. A further £7bn has since been added by the Treasury, apparently unsecured. On top of this is some £13bn of deposit guarantees. To put this in perspective, the total sum of taxpayers' money now committed to a failing bank could add about 8 per cent to the country's total debt.

The trouble is that the crisis is far from over. The Government's hasty and belated actions to guarantee deposits and extend loans have worked to stem (although not entirely to stop) the run on the bank that produced the shaming pictures that were beamed around the world. But they have not produced a solution to the underlying problems of a bank that lent too much, borrowed too readily and found itself flat on its face once the financial markets turned.

The scale of the misjudgements of those involved, including the Chancellor and the Governor of the Bank of England, and the weakness of the regulatory framework established by the then chancellor, Gordon Brown, when he first gave the Bank its independence, are only just beginning to emerge. But, astonishingly, the very people who helped get us into this mess, including the management of Northern Rock, are the very people we now seem to be relying on to get us out of it. Yesterday, Northern Rock finally agreed to drop its chief executive, Adam Applegarth, but only from January – far too late for a man who brought the bank to such straits.

The Government is in a bind of its own making. It can still hope to find someone willing to take over all Northern Rock's debts and repay its loans to the Bank of England. But this is unlikely, considering the sheer size and cost of the government loans. The alternatives, though, are, if anything, worse.

To nationalise the bank and liquidate it in an orderly way – a course it has followed before – would be politically embarrassing and fraught with legal problems. Yet to force Northern Rock into bankruptcy – the preferred option of those most critical of its present manoeuvring – would expose the Government to huge losses. So the Chancellor and his Governor will continue their present course, searching for a discreet compromise and praying for a miracle, while all the time playing with the state funds.