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Armageddon avoided

• Robert Peston
• 8 Oct 08, 04:42 PM

The symbolism couldn't be worse.

- equivalent to about a third of our entire economic output - to rescuing the banking system.

And .

In other words, there's been a co-ordinated global attempt to prop up the financial system and save individual economies from a deep dark recession.

Yet the FTSE 100 plumbs new depths.

What on earth's going on?

Are we all doomed?

Well, the symbolism is a bit misleading, because the FTSE 100 is massively unrepresentative of the British economy.

The main reason it's fallen is because of sharp falls in the prices of giant mining companies that are listed on the London exchange.

So does that mean the FTSE 100 drop doesn't matter?

No, for two reasons.

First, one of the untold horror stories of the credit crunch is that it's wreaking havoc with the investments that underpin the value of millions of people's pensions.

Also, the reason for the fall in those mining companies is that there's been a further sharp drop in the price of commodity and energy prices.

Good news in a way, if it leads to lower household bills.

But the cause of those drops is a slowdown in economic activity throughout the world and the onset of recessions in several developed economies.

So what Gordon Brown and central banks have done today should stave off economic Armageddon - but it's probably too late to save us from months, or even years, of sluggish growth.

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Why bank shares are falling

• Robert Peston
• 8 Oct 08, 10:23 AM

The government massive, unprecedented financial support for our banks, and their share prices fall - well all of them but that of HBOS.

Shome mishtake shurely.

Well no, that's completely predictable on the basis of a decision by the and the - as part of the rescue package - to pressurise eight banks into agreeing to raise at least 拢25bn in new capital.

This capital can come from commercial sources. But even if, for example, Barclays was able to raise new capital from regular private sector investors, that capital would be expensive - which is why its share price has fallen (by 15%, as I write).

And since the Treasury is actually making available at least 拢50bn of new capital to recapitalise the banks, it's pretty clear that the FSA - the City watchdog - thinks they'll need that much.

So it may be good news that the Treasury is prepared to shore up their balance sheets, but it's pretty bad news that there's such a big hole to fill.

Also the 拢50bn from government comes with expensive strings attached - such as reductions in dividends payable to other shareholders, and commitments to start lending again to small business and home buyers.

In other words, shareholders in the banks are being punished for the sins of executives who will need to go cap in hand to taxpayers.

Why has HBOS's share price risen?

Well, the big danger for HBOS was that it wouldn't be able to refinance its medium-term borrowings from the money markets as they fall due in the coming couple of years.

It faced possible insolvency due to the drying-up of these wholesale sources of finance.

HBOS has in effect been taken back from the brink by the Treasury's decision to provide a guarantee for new short-term and medium-term issues of debt securities by banks.

This may sound like gobbledegook. But what it means is that when banks raise money from other financial institutions, those loans will be guaranteed by the state.

Which means that when a bank or money manager lends to HBOS from now on, it is in effect lending to the Treasury or to all of us as taxpayers - and we're a pretty good credit.

So HBOS - and other banks that take advantage of the guarantee - should be able to start raising funds again from commercial sources.

Now here's the resonant conclusion.

If HBOS is no longer in imminent danger of going bust, there's no longer quite the same imperative for it to be rescued and taken over by Lloyds TSB.

That deal now looks like a fantastic one for Lloyds TSB, because it's a once-in-a-lifetime opportunity to create a retail super-bank.

But HBOS shareholders might wonder whether they're selling out too cheaply.

And the competition authorities may bristle too. They may nag the government about whether ministers were right to rule that the deal should go through, irrespective of whether consumers could be hurt by the birth of this monster bank.

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A very big rescue

• Robert Peston
• 8 Oct 08, 07:30 AM

The is substantial, as big an economic initiative as it has probably ever taken.

But then the problem it's trying to fix is huge.

First, the government will make available at least 拢50bn of taxpayers' money to invest in banks.

The cash will be there if banks need it, if they are being damaged by a perception that their balance sheets are too weak.

If any bank didn't need the additional capital - which will be classified as Tier One under the rules that determine the strength of banks, and will probably be in the form of preference shares - it would not have to take our money.

But if a bank does want it, there will be strings attached - such as restrictions on executive pay and limitations on what it pays out in dividends to other shareholders.

Taking taxpayers' money will not be a licence to trade as normal.

Second, the government will try to fill the almost lethal funding gap created by the collapse of wholesale money markets.

For a fee, it will guarantee the money they borrow from other banks and financial institutions for periods of up to three years.

This is crucial. Because one of the great fears at the moment is that they will be unable to refinance their asset-backed bonds and other wholesale borrowings as they mature over the coming two or three years.

This will be seen as particularly helpful to HBOS - and should facilitate its takeover by Lloyds TSB - since there has been uncertainty about how it was going to pay back holders of its mortgage-backed bonds,

Third, there will be a doubling from 拢100bn to 拢200bn in the Bank of England's Special Liquidity Scheme - which allows banks to swap their mortgages for Treasury bills, which are the equivalent of cash. It's a way of providing them with greater certainty about their funding for the next two and a bit years.

Pulling this together, what the government is doing, on behalf of taxpayers is providing hundreds of billions of loans and risk capital to fix banks and a banking system that's perilously close to the brink.

At a time when financial markets across the world have seized up, only taxpayers have the resources to fix this problem.

But three questions follow.

Will it be enough?

Well, unless the economy spirals into total freefall, it should be sufficient to keep our banks functioning in these challenging times.

Can it prevent the economy sliding into recession?

Most economists think we're already there. But the package should help to prevent the downturn becoming vicious.

Will taxpayers be poorer for the rescue?

There are a number of ways of looking at this.

Plainly it would be better for most of us if a deep recession - which would create misery for perhaps millions thrown out of work - can be avoided.

But there is no guarantee that we'll make a profit on the 拢50bn that's being invested on our behalf (although we might).

And given the sheer scale of how much we're lending to banks, many many hundreds of billions of pounds, there has to be a question mark over whether we'll get every single penny back.

This represents the semi-nationalisation of the banking system.

And what can't be predicted with any scientific precision is how many years it will take for the system to be privatised again, for there to be a reversion to almost business-as-normal for our banks.

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