Expect the new Railtrack to cut costs and corners even more, because it will have to keep the bankers happy

Most of you, I imagine, are cavorting around the clapped-out shell of Railtrack, now that the most ill-starred of privatised companies is being taken out of service. And who can blame you? After all, Railtrack is the defective engine of an industry whose structure was botched at privatisation.

But do not be fooled into thinking its final journey to the corporate scrapyard will be some delightful idyll. As we leave the station, you will notice a big blot on the landscape called "Recession".

With so many big businesses enfeebled by substantial debts - Marconi, Telewest, NTL, British Airways, Invensys, Corus, the list goes on - it does not do wonders for economic confidence that the government should undermine a household name so conspicuously, however much that name may be loathed.

To be fair, placing Railtrack into administration was not quite as crass as the big job cuts announced recently by the state-controlled Post Office. It is slightly odd that this government should not wish to use its clout to temper a lurch in the economy rather than exacerbate it.

As someone with a GCSE in new Labour economics, I would concede that old-fashioned demand management has had its day, that governments should not second-guess markets and should never even think about picking industrial winners. However, for ministers to choose to announce the worst kind of corporate news precisely when we are all at our lowest ebb shows a slightly unhinged attachment to free-market disciplines.

And there is also the pour encourager les autres factor. In the coming months, ministers will expect banks to behave responsibly when companies run into difficulties. They would prefer that creditors should not act precipitately to seize assets by calling in the receivers or administrators. Indeed, there is a code, with the resonant name of the London Rules and overseen by the Bank of England, which is supposed to ensure that banks show patience and understanding when the going gets tough for a big corporate borrower. The Bank of England's authority in these matters has not been enhanced by the actions of Steve "the Undertaker" Byers.

Anyway, this brings us to another ugly landmark, which is this government's distaste for share ownership ('fraid so, Tony Blair). It spiels a good spiel about shareholder capitalism, with an interminable stream of reforms to capital gains tax and savings schemes. But real sympathy and understanding for the plight of investors would have prompted ministers to make sure that the gravity of Railtrack's condition was more widely appreciated.

Something is badly awry when a share price goes from 280p to zero over a weekend, so that a company valued at £1.4bn on a Friday night is priced at zilch on a Monday morning. In efficient markets, where shareholders are kept abreast of relevant information, these things simply do not happen.

Blame is being heaped on Railtrack directors and ministers in equal measure, and there has been lots of argy-bargy about who knew what about the company's parlous state and when they knew it. Only two things are clear: the shareholders were not told enough and they are minded to sue anyone with deep pockets.

Even in the absence of litigation against Byers and Brown, there will be a financial cost to the government. The perceived risk of doing business with it has gone up. So the equity risk premium - or the return that investors demand - for railway businesses and privatised utilities has risen. Investors want to be remunerated more for the possibility that ministers will choose to wipe out a business. And that, in turn, means the government's beloved public/private partnerships may have to pay more when they seek funds from banks or investors.

Meanwhile, you should not be misled into thinking that Blair has had a Damascene conversion to the joys of state ownership. He does not want Railtrack renationalised. The Prime Minister loathes the public sector and reveres the private sector as much as he ever did. But, in a Wilsonian corporatist tradition, what he loves are the giant multinational companies and big banks, not the battalions of Tory-voting shareholders.

So the plan is for Railtrack to be reconstructed as a not-for-profit trust financed exclusively by borrowings from banks and bond markets. The model is Glas Cymru, the Welsh water business taken off the stock market by the former Treasury permanent secretary Lord Burns.

But debt-financed companies, of the sort Railtrack is set to become, face egregious pressures to cut costs and cut corners in order to keep bankers happy. I am not sure this is quite what the doctor ordered for the rail industry. The great advantage of being financed by equity - in the way Railtrack was - is that if you cut dividends, the worst thing to happen will be that the share price will fall. However, if you stop paying interest to bankers, the wheels fall off.

I also fear that the government's hopes of keeping Railtrack off the public sector balance sheet are naive. Given the impossibility of quantifying the future liabilities and investment needs of the rail industry, it is implausible that new credit will be extended without guarantees from Gordon Brown to cover the risk of future financial collapse.

You know what that means. Whether the Prime Minister likes it or not, however much he shouts that it will not happen while he is the Fatless Controller, the rail industry is coming back into state ownership.

Robert Peston is editorial director of Quest(TM); www.csquest.com; e-mail rpeston@csquest.com

This article first appeared in the 15 October 2001 issue of the New Statesman, A nation in panic