Calamity for pound after banks went bananas

There are echoes of those days in what is happening now. Only last summer, the pound was comfortably over $2. Yesterday, after the latest cut in the Bank of England base rate, it sagged to $1.46. A month or so ago when it was around $1.80, this column suggested it could drop to $1.30. Now that looks too cautious. It would be no surprise to see it slide down to parity - £1 worth $1 - in the next few months.

It is also losing ground against the euro, which is in effect the Deutschmark with some disreputable friends, and yesterday it hit another low of 86p against the single currency. Not so long ago, a euro was worth only 64p. Given the shorter distance down the slippery slope still left to travel, we might reach parity with the euro even before we get it with the dollar.

Clearly, something odd is happening. The global view of Britain's economic prospects is a lot more gloomy than it was a year ago, but that of itself hardly seems to justify this precipitous slide. It is also true that Americans are pulling their investments out of overseas markets, as they usually do at the first sign of trouble, and this repatriated money has given the dollar a boost.

Similarly, hedge funds - which in calmer times used to exploit the difference in interest rates between say Japan and New Zealand, what is known as the carry trade - have retreated back into dollars. These funds flowing home may explain part of sterling's weakness, but only part.

But what about the rest of it? One of the more perceptive suggestions is that sterling's weakness could once again be the bankers' fault. One thing that has become clear in recent months is the extent to which British banks were borrowing off foreign banks in the wholesale markets, and lending those funds on to UK retail customers.

This is how they financed the explosion of debt. There was no way the mortgage and credit-card booms and the huge increase in personal debt that took place in the 10 years after 1997 could possibly have been financed out of UK bank deposits, because we simply do not save enough.

So instead the banks borrowed off foreign banks, and used those funds to lend to people here to finance consumption at home. This is the economic model, also known as the Rake's Progress, pioneered by Argentina and banana republics down the ages. It has invariably ended in tears for them, just as it now is for us.

Of course, all this borrowing abroad will have contributed significantly to the strength of sterling as the money was converted into pounds. Hence the $2 exchange rate.

But now the interbank market is much reduced, and British banks are borrowing very much less or even repaying some of the funds, that prop under sterling has been removed. The calamitous slide is the result.

Lost opportunity at Equitable

The success this week of Clive Cowdery's Resolution in raising £600 million or so to go hunting for deals in the insurance and asset management industry contrasts rather bleakly with the decision a week ago by Equitable Life to abandon attempts to find a buyer for its remaining with-profits life fund.

Though this was generally dismissed as just another casualty of the credit crunch, the collapse of the Equitable deal is much more than that. It means the fund will go into run-off, gradually dwindling in size as policyholders are paid out on the maturity of their policies. If the job is done properly, all the expenses will have been paid up to the very last day, all the premises disposed of and the business wound down, leaving just the right amount of money in the fund to pay the last policyholder the correct sum on the day that final policy matures.

Put like that, you can see the impossibility of what is being attempted. No one has tried to run off a mutual with-profits fund before with the core requirement that everyone is treated fairly. But the volatility of markets and asset prices make it hugely complex.

The point of a deal with another firm is that it would have given Equitable wiggle room - it would have bulked up the business to allow everyone to be paid off fairly, and removed the risk that there might be nothing, or indeed excessive amounts, for the last few policyholders. It would have allowed the management to fudge it in the interests of fairness.

There was a brief window of opportunity where the actuarial mix of Equitable's customers would have allowed a deal to be done. Let us hope they do not come to regret not taking it.