Wednesday, September 17, 2008

What Happens When A Bank Goes Bankrupt?

It is an extraordinary time for the world's Banking system.

First, the US subprime mortgage companies, then Northern Rock, Bear Sterns, Freddie Mac, Fannie Mae, Lehman Brothers, AIG and others (it's hard to keep track), have either been rescued or allowed to go under.

Now HBOS (owners of Halifax) and investment banks such as Morgan Stanley are facing serious question marks about whether they can survive.

The government will not want to let a commercial bank like Halifax go bankrupt. The disruption to the financial system and economy would be too great. They will risk taxpayers money, rather than risk a financial meltdown.

Nevertheless, as many have been asking, if the unthinkable happened and a Bank like Halifax did collapse what would happen?

Mortgage. - You would still have to pay your mortgage. The liability would be bought by another organisation. (The administrator of the bank will try to collect as much as it can). Not much would change, you would simply pay your mortgage to another company. However, at the end of your mortgage deal, you may face a much higher interest rate.

Savers. In the UK, the first £35,000 of your savings are guaranteed. But, after that you could lose everything.

Mortgage Market. It would get even more difficult to get a mortgage, as their would be fewer banks to lend money. It would be bad news for a stagnant housing market and house prices would fall even further.

Unemployment. A bank like Halifax employs thousands of staff across the country. Even a merger between Halifax and Lloyds TSB could lead to upto 5,000 job losses.

Confidence. If a bank like Halifax went bankrupt and savers were left out of pocket. It could lead to a classic run on the bank, savers at other banks would worry that there bank could be next. If people did go to take their savings out, the banks would simply be unable to honour the demands. The deposits are tied up in long term loans like mortgages which they can't get back. It is this confidence in the banking system the government will feel almost obliged to protect.

Recession. With the economy already entering into recession, a banking collapse, would cause further unemployment, falls in spending and lower economic growth


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