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Q&A
Hugo Duncan23.09.08
Q. What happens if the US government's $700 billion bail-out fails?
A. Banks could be plunged back into the kind of crisis which saw Lehman Brothers collapse last week. Lehman, like other banks, relied on the money markets for funding but no one would lend it or anyone else any money. Lehman collapsed, Merrill Lynch was taken over in an emergency deal by Bank of America, and shares in Wall Street giants Goldman Sachs and Morgan Stanley plunged. The crisis inevitably swept across the Atlantic to Britain where Halifax owner HBOS was forced into a merger with Lloyds TSB.
Q. Why does this matter?
A. The collapse of Lehman and takeover of HBOS means tens of thousands of job losses. If other banks go to the wall, thousands more will lose their jobs. And the banking crisis is fast spreading to the wider economy. If the plan fails, banking stocks are likely to drag shares around the world into the mire sparking further panic over the financial system and state of the economy. It would make recession in America and Britain ever more likely, with house prices and standards of living falling and repossessions and unemployment rising.
Q. What would this mean in the markets?
A. The pound and the dollar would both come under severe pressure, falling sharply against a host of other currencies as investors bail out of Britain and America. With a falling dollar usually comes a surge in oil prices which would send petrol prices and gas and electricity bills soaring. This would push inflation higher, making it difficult for the Bank of England to bring much needed relief through interest rate cuts.
Q. And what about Hank Paulson?
A. The $700 billion bailout was the brainchild of Mr Paulson, the US Treasury Secretary and former head of Goldman Sachs. If it fails, he is likely join those on the unemployed list.
Q. Why is the bailout needed?
A. Banks and other financial firms have been crippled by spiralling levels of poisonous assets on their books after the meltdown of the mortgage market in America. It has led to hundreds of billions of dollars of losses, collapsing confidence and the worst financial crisis for 80 years. Banks are so nervous they have all but stopped lending to each other, starving the markets of much needed liquidity. The US government hopes that by spending as much as $700 billion to buy up these toxic loans, confidence will return and banks will start lending again.
Q. Why might it fail?
A. Democrats and Republicans are worried about the US taxpayer effectively paying for the mistakes of greedy bankers. Some want pay restrictions imposed on these bankers while others are demanding help for homeowners at risk of losing their homes. Both Presidential candidates, John McCain and Barack Obama, have raised doubts about the size of the bailout.
