First the Government bailed out Northern Rock, then it was Bradford and Bingley.

Now, with nearly every other bank looking as nervous as a turkey on Christmas Eve, the Government has announced a £50 billion rescue package. However it could end up costing us taxpayers up to £500 billion!

The key points of the plan are:

• Banks will have to increase their capital by at least £25 billion and can borrow from the government to do so.
• An additional £25 billion in extra capital will be available in exchange for preference shares.
• £200 billion will be available in short-term loans from the Bank of England, up from £100 billion.
• Up to £250 billion in loan guarantees will be available at commercial rates to encourage the banks to lend to each other.
• To take part in the scheme, banks will have to sign up to an FSA agreement on executive pay and dividends.

Which banks are included?

It seems likely that five of the eight institutions listed in the announcement will participate in the equity raising; Royal Bank of Scotland, Barclays, HBOS, Lloyds TSB and Nationwide - while HSBC, Standard Chartered and Abbey will be more likely to take advantage of the money market operations. Other banks and building societies would be able to apply for inclusion in the plan.

In return for all our taxpayers money, the government insists it has extracted a price from the banks; no more big bonuses, no dividends to shareholders and a pledge to keep lending money to small businesses and would-be homeowners. But, whether this is adhered to, remains to be seen.  

How on earth did we get here?

In a nutshell, banks got careless and loaned too much money to people who just couldn't pay it back. If a lender makes too many bad loans, they go bust. But because these lenders are so vital to the economy, the government has decided we can't let them go bust; hence the bailout. 

How do banks borrow money?

They borrow it from you and me (through savings deposits), or from commercial lenders (through the wholesale money markets), or through issuing bonds. So say the bank has £1 in shareholder equity. It then borrows £9 on top of this. It then writes £10-worth of loans based on this.

There are two serious flaws to this. Firstly, you have to make sure the people you lend to will repay you and secondly, if everyone you've borrowed from wants their money back at the same time, you're in trouble, because you've loaned most of it out. So you have to keep an eye on when your payments are falling due.

Most bank lending is done over the long-term (like a 25-year mortgage) and banks charge more for this, as it's taking a bigger risk. Most bank borrowing, however, is done short-term, via instant access deposit accounts and 30 or 90-day loans from the money markets. This borrowing is cheap, because it's only short-term.

What went wrong?

All this is fine as when a short-term loan comes to an end, the bank just rolls it over, which the lender is usually happy to do.

Notice the word ‘usually’…

When the US sub-prime mortgages started going wrong, it was clear that the loans that banks had been writing were worthless. Would you be keen to fund a bank giving out bad loans? If it doesn't get its money back, maybe you won't either. More to the point, many of the people doing the lending are banks themselves. So they realise they're going to need that 'spare' money, and hang on to it.

So the money markets dry up as institutions hoard their cash and that is what the central banks have been trying to deal with. This is the liquidity problem, which is what scuppered Northern Rock. It relied too much on wholesale markets, couldn't repay its debts when they fell due and couldn't be rolled over, so it went to the wall.

Northern Rock; more of your money down the drain

What does all of this mean?

It means we've acknowledged that UK banks are broke. But by offering extra capital and vast liquidity to the banks, this may unblock the money markets, reduce inter-bank interest rates, and encourage banks to lend to each other again.

In this scenario, credit for businesses and individuals should become cheaper and more widely available. For now, this should stop the immediate panic about the security of British banks, but how will things be in a year’s time? What about 5 year’s time?

The Government can play a very long game, holding these assets for years, or even decades, until they recover in value.

For instance, Sweden bailed out its banks in this way in 1992, and made a profit for Swedish taxpayers. So, while this plan may be a short-term lemon, it could prove to be a long-term cherry.

How much will it cost all of us?

With about 25 million UK households, the £50 billion rescue plan works out at £2,000 per household added to our national debt.

What it also means that the part  nationalisation gives us all a stake in these lenders; hence we mustn’t allow them to take our money and then lend it back to us at high rates of interest! 

Though they may be recapitalised, banks can't return to rampant lending. None of this will be over until the property crash ends, because as long as property markets continue to tumble, the asset side of banks' balance sheets remains under question.

PS: One piece of good news: the government has guaranteed all £4.5 billion of savings in failed Icelandic bank Icesave (and plans to sue the Icelandic government for withdrawing its savings safety-net).

What do you think of the Government’s decision?

Should they be bailing out the organisations who should have known better or are they not left with much choice?

Why not let us know what you think in the comments below?

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The Bank of England cut the interest rate by 0.5% to 4.50% even though inflation remains above target. The decision was due tomorrow.

At the exact same time, the Federal Reserve, European Central Bank and Swiss, Canadian, Swedish and Chinese central banks all announced similar cuts.

In this shock move, central bankers around the world took emergency action to end the market meltdown and hope the co-ordinated interest rate cuts will ease the credit crunch and lift the global economy.

It’s some encouraging news but the question is, will it work?

Growing food, petrol and utility prices have made it hard for many of us in the last few months, and things don’t appear to be getting much easier as winter sets in.

It’s not surprising that growing numbers of us are thinking about our finances as Christmas approaches. And its clear that for some of us, we aren’t worried about what we might spend on presents, but whether we can simply afford to eat or keep warm.

Debt calls on the rise

Debt, concerns most of us and the National Debtline is one of the many debt advice organizations on the front line of the credit crunch.

The scale of the problem facing them is shown by the fact that they estimate their debt advisers will take 200,000 calls this year.

The helpline, which gets one third of its funding from government and the rest from the finance industry, doesn't advertise its services but is listed in telephone directories.

In the three-month period to August, 16% of callers were in arrears on their mortgage, compared with 12% in the same period last year.

The National Debtline offers what advisers call 'assisted self-help'. Advice is free, impartial and not time-limited. Case notes are taken by trained staff and you can ring back. More often than not people do, some as many as 20 times.

Information is vital

Some debt advisers believe that if you present people with suitable debt information, the majority of them can deal with it themselves.  That appears to be borne out by a new survey of clients who have contacted the National Debtline since 2003. 90% who have made new payment arrangements with their lenders have been able to stick to them.

The average level of debt for those of you ringing in with mortgage arrears is between £20,000 and £30,000. Some people owe even more though, as it was revealed that one man owed £255,000 on credit cards. 

So,far most lenders are reticent about coming down heavily on their customers in debt, but debt advisers say that that have begun to see more aggressive behaviour towards those of you heavily in debt. 

Free debt advice

Money Hospital also provides a free debt enquiry service. We have partnered with a number of trustworthy debt specialists, so you should speak free of charge to an independent debt adviser who can provide you with advice and solutions to help you resolve your debt and credit problems.

What you can do

• Complete a budget sheet and prioritise your debts. Reduce payments on credit card debts so you can afford your mortgage payments.
• If your budget sheet shows that you can afford the contractual monthly payments plus a little extra towards your arrears, your mortgage lender should not be able to repossess your property.
• If your budget sheet shows you are still unable to afford contractual monthly payments, try to negotiate with your mortgage lender.
• Are you able to extend the term of your mortgage?
• Are you able to refinance to a cheaper mortgage? Although there are not as many products available on the market, if you have a large amount of equity and an excellent credit rating you may still be able to remortgage.

Other sources of free debt advice:

• Citizens Advice: The Citizens Advice service is a network of independent charities that helps people resolve their money, legal and other problems by providing information and advice and by influencing policymakers.
• Consumer Credit Counselling Service (CCCS): the impartial finance charity
• Payplan: Debt management and free confidential debt advice on resolving debt problems.
• Shelter:  If you are struggling with the cost of your mortgage or with any other housing problem, call Shelter's free housing advice line on 0808 800 4444. 
• The Financial Services Authority: The industry regulator has a series of practical guides on managing your money. 
• Speak free of charge to an independent debt adviser who can provide you with advice and solutions to help you resolve your debt and credit problems.

We’ve let the good times roll for the past ten years and now, according to debt counselling agencies, we’re now paying the price for a decade-long binge fuelled by cheap credit!

Debt advice agencies are being flooded with calls from many of us worried about how we will cope with our debts, while The Insolvency Service reports that more than 25,000 of us went bankrupt or took out an individual voluntary arrangement (IVA) in the first three months of 2008.

Back in 2002, only an average of 6,000 of us a quarter went bankrupt, which suggests that bankruptcy no longer carries a stigma.

Some of us may even see insolvency as the easy way out of our debts, especially since a change in the law in 2004 that means bankrupts can be discharged after just a year.

But that doesn’t mean that the slate has been wiped clean!

Information about a bankruptcy or Individual Voluntary Arrangement (an option that allows you to pay off an agreed proportion of your debts over a fixed period) remains on your credit report for six years and could damage your future chances of getting a loan, mortgage or credit card.

Lenders will usually see it, along with other data such as your repayment history and the number of loans or credit cards you have or have had, whenever you apply for credit. As a result, they may consider that there is a risk that you will not repay what you owe and either turn you down or set stringent conditions and high interest rates.

• It is worth looking through your credit report carefully, to ensure that all the information it contains is up to date and accurately reflects your circumstances. If there are special circumstances surrounding an entry , you can contact the credit reference agency and explain what happened.

For example, you might have missed a few repayments because you had an accident, but have never had problems before or since. You can even give the background to a bankruptcy, if you believe it will help lenders to make decisions in the future. They can add a note about this to your credit report, which will be seen by any future lenders.

• Regular monitoring of your credit report will also help you to keep control of your finances, allowing you to see credit accounts in a single, simple document. That makes it less easy to ignore or even forget outstanding loans or the status of your repayments and can help to keep you out of trouble.

To check the information that lenders could see about you, see your Experian credit report for free with a free trial of Credit Expert, the UK’s leading online credit monitoring and identity fraud protection service.

Source: © Credit Expert/Experian 2008

Sources of free debt advice you can use:

• Citizens Advice: http://www.adviceguide.org.uk/ The Citizens Advice service is a network of independent charities that helps people resolve their money, legal and other problems by providing information and advice and by influencing policymakers.
• Consumer Credit Counselling Service (CCCS): http://www.cccs.co.uk/
• National Debtline: http://www.nationaldebtline.co.uk/
• Payplan: http://www.payplan.com/
• Shelter:  If you are struggling with the cost of your mortgage or with any other housing problem should go to http://www.shelter.org.uk/ or call Shelter's free housing advice line on 0808 800 4444. 
• The Financial Services Authority: The industry regulator has a series of practical guides on managing your money at http://www.moneymadeclear.fsa.gov.uk/
• Speak free of charge to an independent debt adviser who can provide you with advice and solutions to help you resolve your debt and credit problems

It was nearly bye bye to Bradford & Bingley…

With all the world’s banks looking a bit nervous, the UK's biggest buy-to-let mortgage lender has become the latest victim of the deepening financial crisis.

Banco Santander (owners of Abbey) agreed to pay £400 million in order to take control of £21 billion of deposits and 200 branches. B&B’s savers will be transferred to Abbey and B&B’s £50 billion of mortgages and loans will then be taken over by the Government, using the same powers employed to seize control of Northern Rock. Shares in the firm have also been suspended.

The Government decided it was no longer a viable bank, after the recent collapse in its share price, and a developing run on its funds by savers.

So, with all the upheaval in the banking world over the last few days, we examine how affects you.

• Is the B&B insolvent? 

Actually no!

Which is odd when you consider all the fuss about the bank's future, and now its nationalisation. 

Its assets still appear to be higher than its debts. But the lack of confidence in the B&B's ability to keep going was on the verge of becoming reality.

Banks rely absolutely on public and investor confidence to operate, because if all of us asked for our money back all at once, they would all be up the river without a paddle!

Then a bank would not have enough money to meet the demand as they lend a lot of it out and cannot recall it instantly.

• Why did B&B get into trouble?

It has been hit hard because it was badly exposed to the plummeting buy to let mortgage market. Its shares have plunged more than 93% over the past year amid fears that its buy-to-let and self-certified mortgages sector will generate huge losses in the midst of falling house prices and the credit crunch.

• Are any other banks in similar trouble?

Unless you have been living as a hermit in the Nullabor Plain, you probably know that the entire banking system is still in trouble!

But it appears, so far, that there are no other UK banks quite in the position that the Bradford & Bingley, and the Northern Rock, found themselves.

Even so, we can’t be sure what may be lurking in the financial undergrowth…probably something creepy and crawly.

• Quite a few banks have disappeared, haven't they?

Yes indeedy!

The past year has seen the Northern Rock, B&B, Alliance & Leicester and Halifax Bank Of Scotland lose their independence.

So what? Well, if you add in the smaller mortgage lenders who specialised in lending via mortgage brokers only, more than 40% of the mortgage lending capacity of the UK financial services industry that existed in 2007 has either evaporated or been swallowed up by rivals.

That is a big reduction in competition and means less choice and more expensive deals for most of us.

• Will my savings be safe?

If you are one of B&B’s 2.5 million savers, you might feel happier that the bank stressed that your cash is secure as deposits of up to £35,000 are covered by the Financial Services Compensation Scheme.

Any savings above this amount are not protected. However, if the government takes over the bank, it is most likely to guarantee deposits as it did with Northern Rock.

• What is the Financial Services Compensation Scheme?

FSCS is the UK's statutory fund of last resort if you are a customer of a financial services firms. This means that FSCS can pay compensation to you if a financial services firm is unable, or likely to be unable, to pay claims against it. This scheme used to cover just 80% of the first £35,000 but it was changed to 100% after the collapse of Northern Rock.

• What should I do if I have more than £35,000 in savings at B&B?

Many financial experts believe it is wise to spread your savings with a number of different firms in order to ensure that you are fully protected by the FSCS guarantee. This would mean spreading your savings around so you have no more than £35,000 in any one bank or building society.

Some experts now believe Northern Rock is the safest place to keep your money as it cannot go bust because it is backed by the Treasury.

• What happens if I have a joint account?

Each individual is entitled to the benefit of the £35,000 so for example, two people holding a joint account will have the first £70,000 of their savings protected.

However, if one of the account holders has a separate current account with B&B then it gets tricky.

Let's say Mr Smith has £20,000 in his current account, and also has a joint savings account with Mrs Smith with £40,000 in it. In the event of a failure, the FSCS will split the £40,000, giving £20,000 compensation to each partner. But it will only then compensate £15,000 of the £20,000 in Mr Smith's current account, as he has already enjoyed £20,000 of his £35,000 compensation limit.

• What will happen to my B&B mortgage?

Sadly, this is not a once in a lifetime opportunity for you to escape your debts!

If you have a mortgage or loan with the B&B you still owe the money and you must continue to make your regular repayments.  But you are now paying to a bank owned by the government, not a bank owned by shareholders.

Several experts believe that if the government takes over B&B, interest rates are likely to rise. Chris Cummings at the Association of Mortgage Intermediaries said:

“The Treasury will be under a lot of pressure to shrink the mortgage books as soon as possible. Therefore, B&B will push up mortgage rates in order to encourage people to remortgage with other lenders but other lenders have no appetite for lending so people will have nowhere to go and will end up having to pay higher interest rates."

Fool.co.uk responded to the takeover of Bradford & Bingley by saying that the Chancellor Alistair Darling must reassure savers at building societies and foreign-owned banks too.

David Kuo, Head of Personal Finance at money website Fool.co.uk, says:

“It is encouraging that the UK government has learnt from past mistakes. Its timely intervention at Bradford & Bingley has averted another potentially embarrassing run on a British bank.

However, questions have to asked as to whether correspondingly swift actions would be possible if a troubled financial institution was neither British nor a bank.

We therefore urge the UK Government to give similar assurances to customers at foreign-owned deposit-taking companies and also to savers at any one of the UK’s 59 building societies.

In these difficult times, consumers need to be confident that their investments are safe, regardless of whether their money is deposited in a UK bank, a foreign-owned bank or a building society”.

So are you a Bradford & Bingley customer? How has the nationalisation left you feeling?

Are you worried about what will happen to your money?

Let us know in the comments below.