From banks to bankruptcy, everything you need to know about the bailout

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The Independent Online

How big is the rescue package?

In total, very big. It amounts to £500bn, which is to say £500 thousand million, or £500,000,000,000. To put that in perspective, it is about a third of the total national income and a bit less than the total (£589bn) that the Government spent last year on education, health, defence, pensions, roads, policing, prisons and everything else in the public sector put together. Of course the Government will be getting something for that money – bank shares and the loans to banks should be repaid – so it isn't all gone for good; but we are talking about huge sums.

What is it beingspent on?

In due course some £50bn will be used to "inject capital", ie buy shares in the UK's leading banks; it's up to them whether they want it and up to negotiation as to how many shares the taxpayer will get and on what preferential terms, if any. Then there's a further £250bn going into loan guarantees for the cash banks lend to each other, and an extension to about £200bn in the Bank of England's Special Liquidity Scheme, which is going to allow banks to borrow from the Bank using their rather devalued mortgage-backed securities as collateral, the stuff no one else will lend against.

Why is it needed?

In the first place, to end the panic surrounding banks. Such is the febrile state of public and market sentiment that a run on even the biggest banks cannot be ruled out. As we have seen in the US no institution is safe in such circumstances.

Second, the loans are needed to ease the frozen credit markets. That banks won't lend to each other has been true for months; they've also been less keen on lending to first-time buyers. The great danger was that they would then stop lending cash to businesses, typically small ones, and the wider "real economy". Without bridging finance to pay wage bills and money for investment the recession would be much worse than already feared (the IMF now says the UK economy will shrink in 2009).

Third, the banks need new capital to repair their balance sheets. As these have been hit by bad debts on mortgage-backed finance and from the economic slowdown, they tend then to lend less. This is an attempt to break that vicious cycle, and on a grand scale.

If the plan is so clever, why do we need an interest rate cut?

You can have both, and both were probably necessary to reassure markets that the authorities will continue to throw whatever they can at the crisis.

How low could interest rates go?

Very low indeed, because changes in the official rate have tended to have had so little impact on the commercial money markets. Some analysts say the Bank of England will cut rates right down to 2.5 per cent by this time next year – their lowest since 1951. They may even fall to or below 2 per cent – their previous all-time historical low.

Will it work?

Short term, yes. The markets reacted fairly favourably to the news; shares rallied and conditions in some credit markets eased. However, in the long term it may prove futile. Witness the trillions of dollars, euros and pounds that have been spent so far. They work up to a point, but after a while the law of diminishing returns sets in and the markets demand even bigger cuts. It has been a consistent pattern over the years. Fear is never far from the surface.

Has this ever been done before?

It wasn't in the 1930s, and that is the lesson the world authorities are trying to show that they have learnt. Ben Bernanke, chairman of the Fed, is an economic historian and economic expert who gained the nickname "Helicopter Ben" from his reference a few years ago about using a "helicopter drop" of money into the economy to fight deflation. Looks like he's clambered into the cockpit and persuaded his central bank colleagues around the world to do the same.

What could go wrong?

The taxpayer could lose out, depending on how low the shares the state buys in the banks fall, and how many of the loans go bad. More widely, the uncomfortable feeling is that the world will go through what Japan went through after her stock market and property bubbles burst in 1990. At that point Japan's banks got into broadly the same mess as the rest of the world's are now, and for much the same reason; too much "leverage" (ie creation of debt) against the economic fundamentals. The authorities cut interest rates to close to zero, and spent huge sums on public works to get the economy moving, a legacy of which is a network of bridges and motorways in Japan that go nowhere and enjoy little use. Still the economy failed to grow. Fifteen years plus of stagnation is a horrid prospect, but it is precisely what the world's second largest economy has endured. Indeed the Bank of Japan couldn't join in yesterday's international half percentage point cut in interest rates because her bank rate is already down to 0.5 per cent.

What will it mean for the public finances?

Some of this will inevitably have to be reflected in the official figures and will shred any remaining credibility attaching to the Government's "fiscal rules". How much depends on the judgement of the national statisticians. Public sector net debt, more-or-less what we used to call the "National Debt", is about £600bn, about 40 per cent of GDP, and will rocket as a result of decisions already taken on nationalisations of Northern Rock and Bradford & Bingley, public spending and the economic slowdown. Even at its worst, though, public sector net debt is unlikely to climb as high as the 262 per cent of national income it peaked at in 1946, when the nation was paying for the Second World War. However it would still be way above where it was for most of the post-war era and far beyond the 40 per cent of GDP "sustainable investment rule".

What will it mean for...

You

As a bank customer, which most of us are nowadays, it ought to mean more reassurance that whatever happens to the share prices of these institutions our savings will be safe and that the authorities will see to it that cheques don't bounce and debit and credit card transactions don't fail to go through. Economic life can go on and we won't be reduced to a cash economy.

The Taxpayer

Bad news. At worst, the state could see its "investment" in bank shares shrivel to nothing and the loans it makes to the banks go sour. We could end up nationalising the lot and taking whatever meagre profits that come through. In all events, the taxpayer will have to shoulder the burden of paying the debt interest on all these new gilts. It could well be better than that. If the economy doesn't collapse, the taxpayer might even see a profit on the Government's investment, just as Warren Buffet expects a healthy return on the $5bn (£2.9bn) he put into Goldman Sachs. But is Alistair Darling as smart an investor as the Sage of Omaha?...

Depositors

All the words coming from ministers suggest that the Government will do anything – anything – to protect these. So your money should be safe, even though it could take time

to get it back.

Bank shareholders

Inevitably they will experience some pain, if only because when the Government takes a share – "preferred" or not – their holding in the bank is diluted, so it can be expected to offer a lower return for you. Not that there may be much in the way of profits for some years to come anyway...

Small businesses

These have been more vulnerable during the credit crunch because they tend to generate fewer of their own funds and have less access to capital markets than big transnational corporations, and they are newer and suffer lower credit ratings as a result. But they may feel the benefit of the banks returning to lending money and from lower interest rates, if those do feed through.

Bank executives

No bonuses this year, in all probability. the Prime Minister has said that the new state body to administer all this will be taking a look at executive rewards. It is not only the level of these that has been a problem, but the way they have encouraged short-term risk taking – the structure of remuneration as much as its level has been problematic. As it stands, the latest estimates from the analysts CEBR say City bonuses will be down 7 per cent this year in any case.

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