The £50 Billion British Bank Bailout

What has the government done? How much extra cash will banks get? At £2,000 per household, will it steady the banking ship?

Last night, the government agreed a rescue package for British banks, revealing the details in a London Stock Exchange announcement at 7:30 today.

What do we get for our money?

The £50 billion bailout consists of:

1. An immediate loan of £25 billion for eight lenders, in order to boost their regulatory capital. 

2. An extra £25 billion, in return for preference shares in these lenders (these shares pay a high, fixed rate of interest and rank ahead of ordinary shares).

3. The Bank of England's Special Liquidity scheme will be increased from £100 billion to £200 billion. This allows lenders to borrow short term from the Bank by pledging high-quality assets (usually packages of mortgages or other loans).

4. In order to persuade banks to `unfreeze' the inter-bank lending market, up to £250 billion in loan guarantees will be available at commercial rates of interest and for a fee.

This is really important as banks haven't been lending to each other. Now Bank A might now be willing to lend to Bank B as the government will pay back the loan to Bank A if Bank B went bust.

However, bank bosses have to pay a price for these concessions: to join the bailout, they need to agree to a new charter on executive pay and ordinary share dividends. Also, future returns to bank shareholders will be lower, thanks to dividend cuts and the dilution of their stakes. The following lenders have signed up to the scheme:

• Abbey (owned by Spanish bank Santander)
• Barclays
• HBOS (set to be taken over by Lloyds TSB)
• HSBC
• Lloyds TSB
• Nationwide BS
• Royal Bank of Scotland
• Standard Chartered

HM Treasury confirmed that other banks and building societies can request to join this safety-net. Then again, global giant HSBC has no need to tap the government for extra capital. HSBC is bigger than all of its UK rivals combined, and is awash with cash, thanks to its strong presence in regions with strong savings traditions, such as the Middle East, Far East and Asia.

Darling does a Buffett

Of course, the government's new investment in the banks far from guaranteed -- it could make or lose money for taxpayers. If the impending recession is longer and harsher than expected, then banks will be hit hard by bad debts. Thus, we taxpayers could end up bearing substantial losses from our new semi-nationalised banks.

Then again, the government has done something smart: it receives preference shares in the banks. As these rank higher than ordinary shares, they are a safer bet. Indeed, ordinary dividends would have to cease and other shareholders be completely wiped out before taxpayers lose a penny, which is only fair. Thanks to their high, fixed rate of interest, I expect us to do well with these `prefs'.

Indeed, the world's greatest investor, Warren Buffett, recently bailed out two iconic American firms in similar fashion. His cash-rich firm Berkshire Hathaway handed over $5 billion to investment bank Goldman Sachs, plus a further $3 billion to industrial giant GE. However, these cash infusions came at a price: Buffett gets preference shares which, if these firms' shares recover, could make him 17%+ a year!

But will it be enough?

Who can say? 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?

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

Finally, with around 25 million UK households, this £50 billion rescue works out at £2,000 per dwelling added to our national debt. Thus, in effect, this partial 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 steep rates of interest. That really would take the biscuit!

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). That will be a huge relief to 350,000 Icesavers!

PPS: The Bank of England has cut its base rate from 5% to 4.5%.

More: Start saving hard today! | Darling Backs Icesave | Loan Rates Rocket