Yes, it looks bad, but it's not the end of the world

Financial doomsday is not around the corner, despite the recent bankruptcy traumas, says James Daley

(EPA)

The collapse of Lehman Brothers on Monday was an extraordinary event – up there with the likes of Enron and WorldCom amongst the world's largest ever bankruptcies. Unsurprisingly, the news sent shockwaves across the world as investors were again forced to reassess the safety of their "safest" investments. Stock markets inevitably plummeted.

In the UK, attention immediately turned to HBOS, the owner of Halifax – the weakest of the major British banks, and as their shares began to tumble, savers started to wonder whether their money was safe – even in the coffers of the UK's fifth-largest bank. By Wednesday, regardless of the true strength of HBOS, the regulators had no choice but to push through a takeover. If Lloyds, or another stronger bank, had not come to the rescue, HBOS would have faced a run that would have forced it into bankruptcy.

Don't panic

While last week's events have been unnerving, what they proved is that the largest banks and building societies will not be allowed to fail. The collapse of any of the major savings banks would create a financial and political disaster, leaving the remaining banks – as well as the Government – to replace billions of pounds in lost deposits.

Although the Financial Services Compensation Scheme guarantees to replace the first £35,000 of any lost deposits, it would have to raise £160bn if the likes of HBOS were to go bust. The other banks would not be able to come up with this at short notice, which would force the Government to step in – at a time when it has more than enough financial problems of its own. The Government can't afford for this to happen, which is why it has been lining up emergency takeover deals of the weakest financial institutions for much of the past year.

Only two weeks ago, Nationwide came to the rescue of the ailing Derbyshire and Cheshire Building Societies. While, back in July, a group of institutions were lined up to support Bradford & Bingley's fund raising initiative, at the first hint that Texas Pacific Group, a US private equity company, was considering pulling out of a deal to invest in the company. In short, the regulators are working overtime so another Northern Rock doesn't happen.

While US regulators let Lehman Brothers go to the wall, the difference is that its clients were institutions, not private individuals. Although many companies stand to lose millions of pounds on the back of its collapse, the US government is happy to let companies take some of the pain in a financial crisis. It simply could not take the same view if it came to a major savings bank.

Once the situation with HBOS has been stabilised, it's still possible the hedge funds (who have helped push banking shares down in recent months) may turn their attention to the next most-vulnerable bank – Bradford & Bingley or even the Royal Bank of Scotland. But once again, the regulators will do everything they can to ensure these companies do not fail.

Is my money safe?

The current depositors' protection scheme guarantees to refund 100 per cent of all deposits up to £35,000 if a bank goes bust. So even if you don't have faith that the Government and regulators can stop a Lehman Brothers happening on the UK high street, then you can take comfort that your money will be returned, whatever happens. When Yvette Cooper, the chief secretary to the Treasury, was asked what would happen if there was not enough money to fund the depositors' protection scheme, she gave assurances that the Government would provide the funds in the short-term to ensure that savers got their money back.

If you've got more than £35,000 on deposit with any individual bank or building society, however, then there is perhaps a case for thinking about spreading some of it around – especially if it's with a smaller organisation. If you want to keep all your money in one place – and you have more than £35,000 – then the only place you can be sure it's safe is, ironically, in Northern Rock, or in National Savings & Investments. Both of these are Government owned and have the full backing of the state.

Banks such as HSBC and Santander Central Hispano (the owner of Abbey), which have retained their capital strength throughout the credit crunch, are the next best thing. But the likes of Lloyds, Barclays and Nationwide are also very safe options, as they are simply too big to be allowed to fail.

Are my investments at risk?

AIG, the world's largest insurer, ran into its own capital difficulties this week, raising the important question about what would happen if a life insurer or asset manager went bust. As news of AIG's problems spread, the company was inundated with requests for redemptions from several of its UK funds – a move which eventually forced it to suspend withdrawals. However, the US government eventually came to the rescue.

If a life insurer or asset manager was to go bust, the amount of protection that customers would receive depends on the products they are holding. For example, investors in guaranteed income bonds, such as those offered by AIG, would receive 100 per cent of the first £2,000 and then 90 per cent of anything else. The same applies for any other kind of long-term insurance product – such as life insurance or pensions. In regular investment funds, such as unit trusts and Oeics, investors receive 100 per cent of the first £30,000, and then 90 per cent of the next £20,000. This puts the maximum compensation at £48,000 for these plans.

With non-compulsory insurance, such as for the home, the FSCS would only pay out 100 per cent of the first £2,000, and 90 per cent of the rest.

It's not all bad news

Although some of the news of the past week may have left you feeling like the world is approaching Armageddon, conditions are not as bad as you think for most borrowers and savers. Mortgage rates have come right back down over the past two months, with the most competitive fixed-rate deals now below base rate. But you do still need a much bigger deposit than you did a year ago if you're a first-time buyer. But with the housing market continuing to fall, it's probably not the best time to buy anyway.

If you do need a mortgage, make sure you take the advice of a mortgage broker, such as London & Country (www.lcplc.com), which doesn't charge you any fees, or Savills Private Finance (>www.spf.co.uk) – as their advisers are best placed to find the cheapest deal for you. However, it's also worth checking the websites of some of the larger lenders – as some of the best rates are being held back for direct customers.

Meanwhile, if you decide to hold off and put your deposit into a savings account, you'll find the best rates out there for a decade. Several instant access accounts are paying around 6.5 per cent, while the best fixed rate bonds are paying over 7 per cent.