What The Government Bail-Out Means For You

How will the Government's decision to hand billions of pounds over to banks affect you? Will it make you richer or poorer?

Even weeks – never mind years – ago, few would have believed it possible. The thought that Gordon Brown’s New Labour Government would gamble with £300bn of tax-payers’ money in order to part-nationalise eight banks… well, it was unthinkable.

But it’s happened. So what does the £50 Billion British Bank Bailout mean for you?

It’s a gamble

The Government isn’t just handing over money for nothing. It's getting something back: some of the banks’ profits. To get access to the £50bn on offer, the banks have to give the Government preference shares. The exact terms of the deal aren't known, but preference shares typically pay a fixed dividend to their owners. 

The Government will be paid this fixed dividend before other shareholders receive anything.  So, should the shares go up significantly in value and banks start to make decent profits again, the taxpayer will benefit.

But it is difficult to say whether this will happen. This is not a risk-free investment, and it could backfire. If it does, we could all pay the price for many years to come. This is because the Government  is borrowing the money it plans to invest in the banks. (This has a sort of terrible irony – the Government is effectively leveraging - rather like banks and borrowers did when they got us into this mess! So the cure is a bit like the disease….)

If the Government’s plan doesn’t work out – if it loses the money it is investing in and lending to the banks – how will this affect you? Well, we could see higher taxes, to pay off what the Government has borrowed, or higher inflation, as the Government may print money to get itself out of debt. Or both.

The good news

If it does work, the chaos that has been reigning over the financial markets should start to calm down.

This is because the Government has promised to guarantee loans to banks, like a parent guaranteeing a mortgage. I call it the Big Daddy approach. Basically, if the Bank A defaults on the money they borrowed from Bank B, then Big Daddy Gordon (and Big Daddy Alistair) will step in and pay Bank B the money that is owed.

Why is the Government prepared to take this risk and guarantee a bank’s debts? In order to get banks lending to each other again. At the moment, banks are so scared that other banks are going to collapse, they are refusing to lend anyone any money. 

This measure should hopefully eradicate all the risk from such a decision, allowing them to lend freely with total peace of mind. It’s the taxpayer and Big Daddy who will be having the sleepless nights…

But why should you care if it all calms down? Apart from the fact that you won’t have to worry about your bank going bust, this measure to encourage inter-bank lending should – in theory – ease lending conditions for you and me too. 

In other words, it should filter through the system from “Wall St.” to “Main St.” – as they would say in the US.

This is good news because, if banks have the confidence that they can borrow money when they need to, they should start offering more competitively priced loans and ease up on borrowing restrictions, just as they did in those (sigh) happy pre-credit crunch days.

That’s the theory, at least.

But - and it's a big, big, big BUT - it might not work.

Fingers crossed, everyone….

More: The £50 Billion British Bank Bailout | Interest Rates Cut