Action & Reaction

I was not particularly enthusiastic about the Government's latest additional £350bn bail out and I was a few quid short of the predicted loss at RBS which hit £28bn but despite a drop in inflation today to 3.1%, it seems the markets are now turning their attention to Britain's economic health with great scepticism.

Blankety Blank

Despite Gordon Brown taking on the role of master blank cheque writer, it could not stop a fierce run on shares in banks yesterday as RBS plunged 67%, Lloyds TSB by 34%, Barclays by 10% and HSBC only 6.5%. Worse still, our currency also plummeted to below $1.40 after being $2 last Summer.

After such a massive second bail out, why are the markets reacting so badly? What is it that they know that the UK Government does not know?

Debt

The rumours alluded to on the front page of today's Telegraph talk of a leading agency is about to cut its rating on Britain's sovereign debt. Edmund Conway, Economics Editor at the Telegraph, explains that while this does not mean Britain is much worse off, what it does underline is a growing opinion that Britain is inching toward Insolvency.

I have to say it's all a bit scaremongering. Yes, there is a lot of gloom in Britain, High Street names are dropping like flies and major industries are cutting back in the face of a dramatic slowdown, but realistically we have been here before, have we not?

I guess the argument revolves around the massive borrowing Britain has embarked upon. From targets of 37% of GDP, pretty soon Britain will have upped its borrowing to 58% of GDP. And the money to service this debt is tax revenues which are set to fall sharply as unemployment goes up and the strain on the State grows. The outside concern is that Britain is borrowing more and becoming less able to pay back the money.

A Realistic View

58% of GDP is not that harsh and is more in line with the borrowing of Germany and France, so we cannot be that badly off, despite our own concerns. And there is always the prospect that things will get better when the recession ends - tax revenues will start to grow as business picks up and unemployment comes down. Also by actually not being too hemmed in by currency and not being part of the Euro and fixed interest rates, our depreciating pound may help us.

The fact is, even if Britain's rating is changed it does not affect our ability to repay the debts but it is a measure of external confidence in our ability to do so.

Confidence

The issue is confidence. While the British Public seem satisfied enough with our PM's performance in the crisis, the external markets are mildly terrified. For the second time in less than a few months, Britain has come up with a botched bail out, having reassured us that the first one was more than enough to save the world. This time around the cost is equally large and potentially more so as now we are proposing to underwrite to toxic debts that no one seems to be able to quantify but some optimistically put it at £200bn, yet RBS has liabilities of £1.3 trillion alone. The taxpayer is faced with a liability which is equal to 90% of the disastrous bank lending of the last 10 years.

The biggest question from yesterday's announcements that perhaps has spooked the markets the most is, now that the toxic debts are underwritten, how does the Government propose to sort them out?

The almost inevitable outcome of yesterday's announcements and market reaction is that the Government took a further lurch toward nationalisation of banks and in some ways their dalliance on the subject will only fuel further concern. Banks are now having a hard time raising funds and if their shares are scuppered much further they almost certainly will have no place to turn. If we nationalise the banks and our ratings go down, the banks will have further difficulty in raising money.

It's a vicious circle that needs to be broken as soon as possible.

'Forgotten Victims'

As we all look at our failing Pension Plans as the stock markets whirl madly, analysts pointed out that many Pension Funds are highly dependent on bank shares. There was a time in the past that 'Bricks & Mortar' and Banks were the safest investments but this year has proved a savage exception. Well over 10m people own shares directly and many more own them via Pension Schemes - and as bank shares constituted about 21% of the FTSE value 2 years ago, many Pension Schemes are highly exposed to these shares - now those same shares will be only 10% of the FTSE value and most of us don't know how exposed we are.

With the collapse of bank shares and the looming possibility of nationalisation, it means widespread losses for pension scheme participants. In many cases, not only will people not be aware of their exposure but they may not be able to do anything about it, as the only time they get a chance to gauge it or do something about it is when their annual statement arrives. With over 90% of bank shares by value being held by institutions, it's clear that the exposure is huge.

The UK Shareholders Association has warned that private shareholders will be the 'forgotten victims' if nationalisation occurs and compensation will be a long time coming and will not cover much of the losses, certainly if Northern Rock is anything to go by.

It may already be too late, but a call to your Independent Financial Adviser (IFA) may clarify what your options are. Try Haymarket Associates at www.haymarketifa.co.uk if you do not have one.