How Lehman's Collapse Could Affect You

You may not own shares in any company - let alone Lehman Brothers - but the financial turmoil could affect you nonetheless. Here's how.

The news is full of stories about the collapse of Lehman Brothers, but does the bankruptcy of an American investment bank really affect you? 

Sadly, the answer is almost certainly yes. Here's a look at some of the ways you may be affected.

The economy

Unlucky employees of Lehman Brothers have already lost their jobs. Confidence in the City has been seriously damaged, so more job losses in the financial sector are inevitable. The newly unemployed will have less money to spend and that will affect businesses across the UK.

As I wrote yesterday, the scariest economic danger is deflation. In other words, prices in the shops could start falling. This sounds like a good thing, but it's not. Deflation normally leads to lower company profits, increased unemployment and rising debt levels.

I'm not saying that this is a likely scenario, but it's possible. 

Central bankers are aware of this risk and will probably cut interest rates over the next few weeks. That should boost the economy and is good news for borrowers. But it's bad news for savers.

And the trouble is, the bankers could go too far and end up boosting inflation. So the likes of Mervyn King -- the Bank of England's governor -- face some very tough decisions.

Mortgages

We had seen some signs of recovery in the mortgage market in recent weeks. However, the Lehman collapse may mean that the `mortgage famine' becomes as bad as it was a couple of months ago. That's because lenders may find it harder to raise the cash to lend to homebuyers.

On the other hand, if the Bank of England does cut its base rate, homeowners on variable rate mortgages - such as discounts and trackers - should see their mortgage rates reduced.

I also think house prices will carry on falling. This is because the mortgage market will stay slow, unemployment will be rising, and consumer confidence will be damaged. Many people will be reluctant to buy property when there's so much uncertainty.

Savings

If the base rate is cut by, say, 0.25%, savings rates on many accounts will fall by the same amount. That said, some banks may not cut the rates on their accounts. That's because they desperately need to raise cash to lend out, and money from ordinary savers is the best route open to them.

If you're a saver, your best bet may be to go for a fixed rate bond now, so you can lock in a high savings rate for the next year.

Pensions

If you have a salary-related pension, you probably won't be affected. That's because the size of your pension is linked to your salary, not the health of the stock market. Of course, the pension fund that will pay your pension may have been damaged by the recent crisis. But your employer is obliged to top up your fund if that's the case - assuming it has the cash.

If you have a money-purchase pension, then the risk is higher. Your employer -- and possibly you as well -- has paid money into a fund which has then been invested in the stock market and other assets. That fund is then used to buy an annuity when you retire.

Luckily, I'm 40 years old, so I can be relaxed on this issue. I'm confident that the stock market will have recovered by the time I reach 60. All that matters to me is the size of my pension fund when I retire, not what it's worth now.

However, if I was 55 or older, I would be more concerned. I'd want to know what percentage of my fund is invested in shares, and how much in less risky assets. Hopefully a decent chunk of the fund has already been put into bonds.

If you're worried, it may be worth seeing an independent financial adviser. He/she can advise you on your circumstances and see if there's anything you can do to improve things.

Will my bank go bust?

Probably not. Even if one of the UK banks was in deep, deep trouble, I don't think the UK government could afford to let one of the 'Big Five' go to the wall. But these are extraordinary times, so it's impossible to say for sure that everything will be fine. 

If you're worried, make sure that you don't have more than £35,000 saved with one banking group. That's because the Financial Services Compensation Scheme will pay up to £35,000 if your bank goes bust.

And finally..

We live in uncertain times. Nothing like this has happened since the 1930s. This article gives my best estimate on how you may be affected. But, in truth, no one knows for sure. So my final piece of advice is: try and be as careful as you can with your cash... and expect the unexpected!

More: Five Ways To Beat The Credit Crunch | Letting Lehman Collapse Was Right Move