The Shadow Chancellor warns that the UK economy is unprepared.

George Osborne MP

ANDREW MARR: Now then, Gordon Brown, Tony Blair and leaders and financiers and thinkers from all around the world have spent much of the past week in a remote ski resort in Switzerland.

But in terms of informal international powerbreaking Davos is every January the place to be.

And since George Osborne hopes and expects to be in charge of the sixth largest economy in the world it was natural that he too has taken to the slopes. Shadow Chancellor good morning, thanks for joining us.

It looks a little cold out there, if I may say so.

GEORGE OSBORNE: Good morning.

ANDREW MARR: I don't know if it is!

GEORGE OSBORNE: It's not too cold!

ANDREW MARR: We've had a lot of talk, obviously in today's papers, about Northern Rock and the MPs' criticisms of the way that the regulatory authorities have handled that.

But some people say we haven't yet heard from the Conservatives, people like yourself, what you would do given where we've got to?

GEORGE OSBORNE: Mmm. Well let me come on to that in a second, but let's be clear that the deal done by the government is a bad deal, it means that a second mortgage is being taken out really for every citizen in Britain.

And it's interesting here at the discussions I've been having in Davos with other finance ministers and international bank leaders and so on, they are actually pretty surprised about the way the government is really putting together the biggest rescue package we've ever seen in Britain, throwing more money at Northern Rock than they ever threw at British Leyland or British Steel back in the 1970s.

Now what is the Conservative answer? We believe that given the position we're in now, and there's plenty of arguments we could have about how on earth we ever reached this point. But given where we are now probably the best answer is a reconstruction led by the Bank of England.

A form of administration but not an administration that leads to a fire sale but rather one managed by the Bank of England where they can protect the depositors which of course is in the interests of everyone, and that's what the first priority of any government for the stability of a financial system. And then we can deal with the rest of the bank...

ANDREW MARR: Could I just jump in there to get some clarity on this. So this is a form of semi-closure of the bank, but with certain parts of the bank underwritten by the Bank of England? You would actually shut all those offices?

GEORGE OSBORNE: Well this is the Bank of England acting as an administrator in the public interests to make sure that depositors are protected, to make sure that we get as much of the taxpayers' money back as possible.

And this process, by the way, is something that the Chancellor of the Exchequer, Alastair Darling, is going to propose next week for future bank rescues. Now he happens to think that those powers should rest with the Financial Services Authority. I think they should rest with the Bank of England, indeed the Labour MPs on the Parliamentary Treasury Select Committee agree with me.

So, if we can get the Bank of England involved in this role of managing a reconstruction of Northern Rock I think that would give us the best chance of getting the maximum taxpayer money back and protect the depositors. And I think that is a much better way forward than the second mortgage on every home approach which Gordon Brown is using, really just to dig himself out of a political hole.

ANDREW MARR: And just to be clear, what you would envisage happening is that the Northern Rock offices, effectively the organisation would close, would shut down, would end. Presumably the employees would lose their jobs. But from your point of view that is better than either nationalisation or underwriting some private takeover?

GEORGE OSBORNE: It doesn't automatically follow that the banks would be closed or indeed that jobs would be lost although I'm afraid under any of the options at the moment, including the one the government is promoting, there may well be job losses and that's just a sad fact of what's happened and the poor management at Northern Rock.

But the Bank of England acting as an administrator would be able to make a decision about what is the best way forward both to protect the depositors and the taxpayers, but also if there is a going concern there that can be protected for the long term. This is something I've been speaking to some of the chief executives of the big retail banks in the UK, this is something they think is a sensible way forward. It is also, as I say, the very process that Alastair Darling is going to stand up next week and suggest for future bank rescues.

One of the things that strikes you when you're at meetings like this is how damaging Northern Rock has been to the UK's reputation, for financial stability, and for financial services. And we really need to make these reforms and give the powers to the Bank of England that they need in order to preserve a reputation that Britain is a good place for financial services to come and do business.

ANDREW MARR: When the committee of MPs suggested a radical overhaul of the regulatory system and said that, you know, more focus should be given to the FSA and so on, big debate here I suppose about what the future of the Financial Services Authority really is to be. What's your position on that now?

GEORGE OSBORNE: Well I think that the Financial Services Authority does a reasonable job as a one-stop regulator, i.e. if you're selling banking products, if you're selling insurance, you can go to one regulator and they adopt the so-called principles based regulation. But clearly it failed in monitoring the liquidity of Northern Rock. In other words it failed to see that Northern Rock was in a position where it could run out of money. And that's why I think we've got to have a long, hard look at the way that the FSA monitors liquidity, it clearly didn't do its job properly.

We need to look at the powers of the Bank of England, and also we need to look at the role of the Chancellor of the Exchequer. I mean his dithering and delaying over Northern Rock as with many other things, has done enormous damage to Britain's reputation and means that as we enter this period of economic turbulence around the world Britain is less well prepared than any other major economy. And that is a pretty shocking state of affairs.

ANDREW MARR: Mmm, well I mean that does imply diminishing the FSA. Can I also ask however, about the bigger picture which is, you know, you're there with the big players and the bankers and other world leaders and so on. We seem to be on the edge of a truly serious and dangerous financial situation. Britain and other countries too. What's your current reading of that?

GEORGE OSBORNE: Well obviously it is an extremely dangerous moment for the world economy and, you know, every country is exposed to financial turbulence which may have begun in the US sub prime market but is affecting different countries in different ways. I think the question for British policy-makers and the British public is "how well are we prepared for this turbulence"?

And, if you take just one example, take Britain's budget deficit, we are heavily in the red, we're more in the red than any other European country. And I was at a meeting here in Davos yesterday evening with two other finance ministers, and they were talking about how they had surpluses at the moment, and what they were going to do with their surpluses to help their countries weather a possible severe downturn. That debate can't even be had in Britain because we've got the biggest budget deficit in Europe, and indeed we're now spending �30 billion a year simply on interest payments.

So the debate that other countries are having about using their tax and spending systems to help with the downturn we can't have in Britain. And I'll give you one other example Andrew, very quickly, one of the questions I've been asked for example, several times, is is Mervyn King going to be reappointed? And it's extraordinary that only in Britain do we not know who's actually going to be running the central bank in a few month's time.

ANDREW MARR: Fair point.

GEORGE OSBORNE: There's something that Alastair Darling and Gordon Brown could do next week, they could simply announce that Mervyn King is going to be reappointed and end at least one bit of the uncertainty in what are uncertain times.

ANDREW MARR: Fair point, but my last point, if it's true that we're in such problems with over-borrowing and all of that, your own promises about matching government spending on health and education and spending more on the armed services, and giving that tax cut that had such an impact on politics in the autumn - you can't do all of that, you can't promise the tax cut too, can you?

GEORGE OSBORNE: Well the tax cut was fully funded and in the way that we explained at the Party Conference, that's one of the reasons I think it had the political impact that it did, in terms of the budget, that we are where we are and the options now for dealing with the budget deficit in the short term would to either be massive public spending cuts or big tax increases, and I don't think either of those are sensible given the economic downturn that the world is facing.

But what you do need to do as a government is plot a long-term course of stability in the public finances, so you don't get this boom and bust in public finances. And the way to do that in my view is to grow government more slowly than the economy grows. And if you do that in the long term then you wouldn't be in the mess that Britain is in at the moment and you'd be in the position that the other countries here in Davos are in which is able to use fiscal instruments to deal with an economic downturn.

ANDREW MARR: All right, George Osborne, I hope you come and join us in the warmth of the studio before too long, but from now to Davos thank you very much indeed.

INTERVIEW ENDS

Please note "The Andrew Marr Show" must be credited if any part of this transcript is used.

NB: This transcript was typed from a recording and not copied from an original script.

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