The decision, the first nationalisation of a British company since the 1970s, ends months of efforts to find a private sector rescuer for the stricken mortgage lender, which ran into trouble as a result of the international credit squeeze.
It means that neither of the two bids for the bank, from Sir Richard Branson’s Virgin consortium and Northern Rock’s management team, have been successful.
Both bidders tendered revised offers on Friday after the government threatened that the bank would be nationalised unless their proposals were improved.
The government believes nationalisation is now the best option, even though it is likely to spark a political storm, an angry reaction from some shareholders and big job losses in the north-east of England.
Alistair Darling, chancellor of the exchequer, said that Goldman Sachs, which is advising the government on the bank’s future, had concluded that a “period of temporary ownership” better met the interests of taxpayers.
Deposits and savings would “remain safe and secure”, he said.
But George Osborne, shadow chancellor, accused the government of “dithering” over the bank’s future.
He told Sky News: “We have had months of dithering and delays and ended up in the catastrophic position, on a Sunday afternoon, of the chancellor announcing this decision to nationalise Northern Rock.’
“They have dithered for months and months trying to create a private sale that was never really there.’’
Mr Osborne said nationalisation would damage the UK’s reputation for financial services.
The chancellor confirmed that Ron Sandler, former chief executive of the Lloyd’s of London insurance market, would run Northern Rock.
Mr Sandler will receive a flat fee of £90,000 a month. Ann Godbehere, a former Swiss Re executive who becomes the lender’s chief financial officer, will be paid £75,000 a month.
The government would introduce legislation for the move on Monday. UK listing authorities will suspend the company’s shares prior to opening of the London stock market.
The shares, which closed on Friday at 90p, have lost some 90 per cent of their value over the past six months.
Taxpayers are subsidising the bank in loans and guarantees to other lenders totalling £55bn. Mr Darling said he expected these to be repaid.
“It is our expectation that the company can be moved back into the private sector at the earliest and most opportune opportunity,” he said.
Sir Richard Branson said that nationalisation was “not the right answer”. He said in a statement: “We were very clear the business plan we put forward was robust, conservative but ultimately capable of rescuing the interests of all stakeholders. However we must accept the decision with good grace and hope that the Rock will somehow find better fortune in the future.
“We put all the resources of Virgin’s senior management team on this for five months and we believe had a very strong proposal, an experienced team and one of Britain’s best brands.”
RAB Capital, the hedge fund which together with Jon Wood’s SRM Group holds a near-20 per cent stake in the lender, declined to comment until it had studied the government’s proposal.
In a statement, the British Bankers Association said: “It is important for the confidence of customers and in the UK’s financial services sector that the Northern Rock episode is finally brought to a close. For the bank’s savers and borrowers it is business as usual.
“We now need to work together to put in place a considered framework to prevent such a situation happening again and to ensure the regulation system spots trouble in time and has the skills and powers to take fast effective action in the interests of customers and the UK economy alike.”