Gilts fall as City digests impact of bailout on public debt

The impact of the Government's latest banking bailout on already ballooning public debt may be worse on paper than in reality, but falling gilt prices suggest investors expect the package to be expensive.

Under the measures formally ann-ounced by the Chancellor of the Ex-chequer, Alistair Darling, yester-day, the Government is widening the scope of the Credit Guarantee Scheme (CGS) launched in October in an attempt to ease lending. Under the new scheme, the existing arr-angement is to be extended until December, and a new version is to be added. The facility will guarantee "eligible triple-A rated asset-backed securities" across the spectrum of mortgages, corporate and consumer debt, the Treasury says.

By expanding the Government's role as a guarantor, the package is exposing the taxpayer to ever greater potential losses. Public debt for 2008 is already expected to have reached an eye-watering £70bn, with further to rise in 2009. But the cost of the latest insurance package cannot be known until the loans expire. The market is nervous – the yield on gilts shot up by 14 basis points to 3.44 per cent, pushing down the price of the bonds as investors baulked at additional, unpredictable liabilities.

The Treasury says the effect on the public finances will be temporary because any investments will be held only as long as is necessary. And since the insurance only extends to highly rated asset-backed debts, even as total liabilities rise there will be a concomitant rise in the value of the Government's assets.

The Government cannot avoid listing the figure somewhere on its balance sheet, but the ultimate impact on the taxpayer may be not as bad as it looks. "By taking on greater risk, there will be a cost to the taxpayer, but the difficulty at this stage is knowing how big that will be," Robert Chote, the director of the Institute for Fiscal Studies, said. "Although the liabilities are matched by assets, the liabilities tend to count towards the measure of debt but the assets don't – which makes the net debt look conspicuously worse."

There is even a not unprecedented possibility of profit, as securities prices are already significantly depressed, and the Bank will be buying at market rates that already have the possibility of default priced in. Mr Chote said: "From the experience of the Nordic banking crisis in the early 1990s, the taxpayer can make a profit out of holding bank shares for a while."