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Barclays existing shareholders are not universally overjoyed at the deal it has struck with the Abu Dhabi and Qatar.

Apart from anything else, if Barclays had raised the capital from HM Treasury - from all of us as taxpayers - it would have sold the new shares at just above 189p per share (assuming that it could have had the capital on the same terms as Lloyds TSB).

Now that price of 189p is almost a quarter higher than the price which Qatar and Abu Dhabi is in effect paying for 1.8bn new Barclays shares (which they'll receive when the mandatorily convertible notes are converted into shares before June 30 next year).

For the avoidance of doubt, Qatar and Abu Dhabi are paying much less than what was on offer to Barclays from the Treasury, from taxpayers, just over a fortnight ago.

So the wealth of Barclays' existing shareholders has been eroded by the refusal of Barclays to take the money on offer from taxpayers.

And it's worth noting that the Treasury was not undermining the important pre-emption rights of existing shareholders in the way that the deal with Abu Dhabi and Qatar has done.

The Treasury was offering to underwrite the issue of new shares at 189p, but taxpayers would have had the ability to buy the lot at that price.

That's very different from what Barclays has announced today.

Its existing shareholders have only been given the right to buy a fraction of the new equity on offer.

Barclays' big investors (and only the big ones) can today purchase up to £1.5bn of the mandatorily convertible notes, which is the equivalent of buying new shares at 153.3p each. They have no ability to claw back the £2.8bn of these notes that have been sold to Qatar and Abu Dhabi at that low price.

And, as I said in my earlier note ("Why Barclays prefers Abu Dhabi to GB"), existing shareholders don't get even a crumb of the attractive warrants sold to Abu Dhabi and Qatar with the £3bn of reserve capital instruments (these warrants can be converted into 1.5bn new Barclays shares at any time in the next five years, at a conversion price of 197.8p).

What's more Barclays is paying a whacking coupon, loads of income, to Abu Dhabi and Qatar. They get 9.75% on the convertible notes, and 14% (oh so loverly, a time of falling interest rates) on the reserve capital instruments.

And the 14% coupon is tax deductible (and, before you ask, the coupon on the prefs being sold by HBOS, Lloyds TSB and RBS to the Treasury is not tax deductible).

That means we as British taxpayers are subsidising the payment to these oil-rich states to the tune of £120m per annum - which presumably won't please Alistair Darling at a time when tax revenues are too tight to mention.

Oh, and by the way, while Qatar and Abu Dhabi are receiving this fat income stream, Barclays' existing shareholders have been told they can't have a dividend for the second half of this year (bye bye to £2bn).

So, to re-state the bloomin' obvious, Barclays is paying an arm and a couple of legs for this money from Abu Dhabi and Qatar (with a little bit of a contribution from British taxpayers), when it could probably have paid just one arm and one leg for the money from the Treasury, from taxpayers.

Why has it been so desperate to avoid taking taxpayers' cash?

Well, it wants to avoid making itself vulnerable to being bossed around by the chancellor and prime minister - which it fears would have happened it had taken taxpayers' moolah.

But what's really at stake?

Is this about protecting its right and ability to pay many millions of pounds, even tens of millions, to its superstar bankers?

After all, Barclays - following its takeover of the US bits of bombed-out Lehman - is in some ways more investment bank, more Wall Street, than retail bank these days.

And, famously, Bob Diamond, the head of Barclays Capital - its investment banking arm - has received double figure millions in annual remuneration for some years now.

I've already been rung this morning by sore investors and bankers who allege that Barclays has tapped Abu Dhabi and Qatar because it doesn't want Gordon Brown and Darling putting a ceiling on what it can pay its top execs.

Barclays tells me that it is motivated by a desire to protect its commercial freedom, which is about more than how it rewards its stars, but also includes that cherished freedom.

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• - What's this?

Some may think it's a funny old world in which would rather raise £5.8bn of from the state investment funds and royal families of Qatar and Abu Dhabi than take cash from the .

And the money being raised by Barclays isn't cheap, to put it mildly.

The £3bn of so-called reserve capital instruments it's selling to Abu Dhabi and Qatar pay an interest rate of 14% before tax and 10% after tax - only a bit cheaper, after tax, than the preference shares being bought by the British Treasury from other British banks.

But when you include the warrants attached to these reserve capital instruments, it's not obvious that this money is better value than what was on offer from the Treasury.

In some ways it looks pricier - because Abu Dhabi and Qatar have been given the right to buy 18.1% of Barclays shares at any time in the next five years at the current bombed-out share price or £3bn in total.

And £2.8bn of mandatorily convertible notes give the two buyers a dividend of 9.75%, and the ability to buy a further 33.5% stake in Barclays next June at a discount of a fifth to Barclays' share price over the past couple of days.

So Qatar and Abu Dhabi could together control just under a third of the entire bank.

That's astonishing.

That Barclays can raise the money at all is a testament to its relative strength compared to the other British banks - and in the course of today it hopes to raise another £1bn to £1.5bn from other investors.

But many jaws will drop at the disclosure that Barclays prefers what some may see as de facto nationalisation by oil-rich Middle Eastern states to nationalisation by Her Majesty's Treasury.

So why was Barclays so keen to pay a fat return to Abu Dhabi and Qatar rather than to the British taxpayer?

Well, unsurprisingly, it puts a high value on its commercial independence.

At almost any cost, it wanted to avoid taking money from the Treasury - because that would have imposed restrictions on how and what it could pay senior executives and when it could resume paying dividends to holders of its ordinary shares.

And taking British taxpayers' wonga would have made it more vulnerable to ministerial nannying that it should lend to those seen by the authorities as deserving.

Barclays has also disclosed that its profits in the first nine months of the year are higher than last year - which puts and , where profits have collapsed, to shame.

And so far Barclays takeover of the US bits of the collapsed Wall Street investment bank, Lehman, seems to be paying off.

Barclays' announcement will be the last bit of relatively good news from a British bank for some time.

Next week we'll have trading updates from HBOS, Royal Bank of Scotland and - and more detail on the capital being raised from UK taxpayers by Lloyds and RBS.

There'll also be more on the takeover of HBOS by Lloyds.

But what may attract most attention will be ghastly results from HBOS and Royal Bank - where the horror story will take a new and scary turn.

We'll see the beginning of the end of the sorry tale of writedowns on subprime and other toxic credit investments, and the start of a long saga of losses (what are known as impairment charges) on conventional lending to businesses and homeowners.

Or to put it another way, the new problem for our banks is that we are careering into a recession that's making it harder for companies and households to pay their debts.

Even Barclays cannot be immune to those looming losses - though, as of now, it can probably allow itself just a small smile of self-congratulation, having avoided putting out the begging bowl to British taxpayers.

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The Chancellor has said that he needs the flexibility in the looming recession to spend and borrow more than would be possible if he adhered to the fiscal rules.

These are the strictures on how much the Government can borrow that were introduced in 1997 by Alistair Darling's predecessor as Chancellor, Gordon Brown.

The positive gloss Mr Darling put on this admission that those rules would be breached is that - with recession looming - only spending by government can compensate for a slump in spending and investment by businesses and households.

And more government spending would mean more borrowing and an increase in the national debt.

But Mr Darling also conceded in an interview with me - to coincide with his Mais lecture on "maintaining stability in a global economy" - that there's a negative side to the inevitability that the ratio of the national debt to our economic output is set to explode through the 40 per cent ceiling.

The current contraction in our economy means companies and households are paying less tax.

Stamp duty receipts have all but evaporated with the collapse in house sales.

And the appalling plight of banks and other financial firms is endangering 25% of all revenue from corporation tax.

So there's less revenue coming into the Exchequer just as it has to find extra money to pay benefits to those losing their jobs.

The criticism of the government therefore from the opposition is that it allowed the national debt to grow far too much in the boom years.

And it is a serious criticism, because when Gordon Brown introduced the fiscal rules all those years ago there no suggestion that they were only to be applied when the going was good.

Nor is this an academic criticism.

If investment institutions controlling billions of dollars aren't to shun sterling and the debt being sold by the Treasury - with the horrid consequence for the Government of a sharp rise in the cost of servicing that debt - the Chancellor has to explain how the fiscal rules would be changed to remain credible and how the national debt can be reduced to some kind of tolerable level after it rises significantly.

So what slightly surprised me when I interviewed Mr Darling is that he wouldn't even confirm that the fiscal rules will be reformed, rather than simply being conveniently ignored for a while.

There can be no doubt that he will have to reform the fiscal rules in a matter of weeks, and come up with a convincing plan to reduce the national debt as and when economic growth resumes - because in this economic age of anxiety, failure to do so would bring the risk of a dangerous run on the pound.

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• - What's this?

If ever there were a country and a people that signalled their distaste for hedge funds, private equity and the self-defined alternative investment industry, that country and people were Germany and the Germans.

It was this famous quote of April 2005 to the German popular newspaper, Bild, by the then Deputy Chancellor of Germany, Franz Munterfering, that didn't exactly represent a "come-in-and-make-yourself-comfortable" message to the rocket scientists of financial services:

"Some financial investors spare no thought for the people whose jobs they destroy. They remain anonymous, have no face, fall like a plague of locusts over our companies, devour everything, then fly on to the next one."

There will be some pathologists of the economic mess we're in who'll argue that Munterfering was spot on. But we can have that debate tomorrow or the next day.

Today let's ponder the marvel of the €22bn (£18bn) loss incurred over just two days by hedge funds and other short-sellers of .

We know there is a loss of that magnitude, because the aggregated short positions in VW - or the sum of all those bets on a fall in VW's share price - have been equivalent to 11% of the business at a time when the shares have been soaring.

In fact on Monday and Tuesday, VW shares rose an extraordinary 348% - which is enough to burn to a frazzle anyone wagering that the stock would decline - after Porsche disclosed it had taken out financial contracts that would give it a controlling stake in VW.

Shares in a company tend to rise, when a corporate bidder arrives on the scene. But in this case the increment was way beyond normal human experience: at one point yesterday VW became the most valuable company in the world, worth more even than Exxon.

You may ask why VW's shares have risen quite so much in so short a time. And the explanation is that there are very few of its shares available to trade, as the German state of Lower Saxony controls more than 20% of VW stock with voting rights.

When the share price started to rise, those who had bet on it falling had to scramble to buy, to cover their short positions and limit their losses (they had borrowed shares, and had to buy them so as to be able to repay these loans).

Which hedge funds have been wounded, possibly mortally?

Not, in spite of widespread press reports to the contrary, Marshall Wace of the UK.

It has incurred a tiny loss on VW, of just €5m, and the value of its core fund is up a tiny bit on the month.

So the hunt is on.

Those in the somewhat stressed hedge fund world say those most likely to have been seriously burnt are the so-called quant funds that try to replicate the performance of stock-market indices by buying and selling a few representative shares - because they are more likely than others to have taken out short positions in a mechanistic way, unmitigated by human judgement ("computer says yes").

Inevitably some traders and investors are calling foul.

They're furious with Porsche - because the astonishing surge in VW's share price was precipitated after the maker of the City traders' favourite vroom-vroom disclosed on Sunday that it had acquired financial contracts (cash-settled options) to buy more than 30% of VW.

If it exercises those options, it would have almost 75% of VW.

What annoys the hedgies is that they feel Porsche has been less than clear about its intentions towards VW - since in March Porsche said that the probability it would take its stake in VW to 75% was "very small indeed".

Some of the hedgies are therefore complaining to the German regulator, BaFin.

Which, in view of German attitudes to hedge funds, may represent the supreme triumph of hope over experience - and a slightly surreal postscript to the years of super-boom for debt-fuelled investment.

UPDATE, 09:38AM: More mayhem in the shares of German car makers this morning. VW's price fell as much as 56% at one stage, while Porsche's rose by more than a third. And Daimler's climbed by a fifth.

Why the rollercoaster?

Well Porsche said it would be helping out the squeezed hedge funds by settling "hedge transactions in the amount of up to 5% of the Volkswagen ordinary shares" - which has the effect of releasing 5% of VW's stock on to the market for trading.

But it added that it was still "committed" to raising its stake in VW to 75% - and would buy VW shares at prices that were "economically justifiable".

Does Porsche's decision to offer respite to the hedgies amount to an admission that it had somehow behaved improperly in the way it released information about its intentions towards VW?

No hint of that.

Porsche said allegations of price manipulation by it were "without any foundation" and that it denied "all responsibility for these market distortions and for the resulting risks to which the short sellers have exposed themselves."

And, with that, it pressed down on the accelerator and vroomed off.

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• - What's this?

If I were you, I wouldn't get too worked up by the 's estimate that credit-crunch losses now total £1,800bn on an , such as mortgage-backed securities and corporate bonds.

Of course it's a big number - rather bigger than the annual economic output of the UK.

But it's peanuts compared with the losses suffered over just the past month by pension funds, insurance companies, banks and all of us from the slump of more than 25% in the average value of shares listed on global stock markets (just this morning , our biggest insurer, announced that its capital surplus has fallen by £600m or 32% in less than a month).

Which is to say that the collapse in price of collateralised debt obligations - and all the investment doo-doo created by brilliant bankers that put us in our current hairy predicament - is yesterday's story.

Today's tale is that we're careering into what looks like a pretty nasty global recession, which is causing capital to be withdrawn from all but the least risky economies, markets and business - and is mullering our wealth.

The number that stood out for me in the Bank of England's latest , which I would not recommend to those of a nervous disposition, is its estimate that £5,000bn has implicitly or explicitly been made available by central banks and governments since April 2008 to support wholesale funding by banks.

That is a genuinely big number. It's equivalent to about a sixth of the total annual economic output of the whole world.

So to put it another way, we as the taxpayers of the world are funding our banks to the tune of one-sixth of everything we produce.

Blimey, if I may be so bold.

It's the measure of the extent to which the private-sector banking industry has rather let us all down.

It also tells us something about the scale of the economic downturn we're facing.

Unless we're moving into a world - heaven forefend - of semi-permanent nationalisation of our banks, the banks have to be weaned off all that taxpayer support.

That will take years, of course.

But right now, when money's tight, the best way the banks can think of reducing their dependence on taxpayers and the state is to lend less to all of us.

The less they lend to us, the less they need to borrow from elsewhere - either from taxpayers or from more conventional depositors and lenders.

Here's the catch: the less the banks lend, the less money will be available to fund companies' investment and working capital and to finance consumers' purchases of goods and houses.

Which means that the economic downturn will be all the steeper.

What does this mean for the UK?

Well forecasting the path of bank lending is more craft than science.

But the Bank of England provides some useful charts and statistics, which point in an unpleasant direction.

The one bit of good news is that the Bank of England thinks - quite rightly - that bank lending would have fallen off a cliff without the government's recently announced £400bn rescue package for British banks.

Here's the less good news. Credit from the banks is still going to be much harder to obtain for two or three years.

Why?

Well, our banks were dependent on flighty wholesale funding to the tune of £740bn at the end of June 2008, up from zero in 2001.

Most of these creditors want their money back now or in the coming two or three years - which is why the Treasury and the Bank of England on behalf of all us as taxpayers is promising to lend more than £500bn to replace the lost funds.

However, to repeat the point I've been banging on about for months, all of this will have to be repaid at some point.

Which, as I've said, puts pressure on our banks to lend less, or at least to massively reduce the rate of growth of lending.

And there's another way of looking at this very powerful force which is shrinking how much banks lend.

From the late 1990's to today, our banks increased the multiple of what they lend compared to their capital resources from 23ish to 33ish.

Or to put it another way, they thought the world was becoming a less risky place and increased by more than 40% their lending relative to the capital they hold to cover potential losses on such lending.

To state the bloomin' obvious, our banks now see the world as a pretty risky place, so they're prepared to lend much less relative to their capital.

The Bank of England thinks this could force them to reduce their assets - by cutting back on lending and dumping investments - by a sixth.

Which may seem a lot, but the Bank of England is doing its best, in trying circumstances, to look on the bright side.

It is projecting a massively reduced rate of growth for UK bank lending to customers, but it is forecasting growth (albeit of the anaemic variety).

How confident is the Bank that there'll be such growth?

Hmmm.

It highlights a chart showing what happened to bank lending in Sweden, Norway, and Japan after comparable shocks.

In each case, the rate of bank lending didn't just slow - the overall stock of loans or credit in the system actually shank for two or three years.

If that were to happen here or globally - and it's not what the Bank of England is forecasting - we'd be coping with a very serious recession.

UPDATE, 11:58AM: It turns out I have identified an error in the Bank's Financial Stability Report. It said, on page 38, that as much as £5,000bn had been made available by governments and central banks since April to support wholesale funding of the world's banks. However the Bank now tells me it meant to say $5,000bn (dollars not pounds) - which is quite a chunky difference (as of today's exchange rate, about a third less).

That said, total taxpayer support for the global banking system isn't far off £5,000bn (yes we're back in sterling), if capital injections and toxic-asset purchases are included, together with guarantees provided in Asia and Australasia (ignored by the Bank for reasons that elude me).

So I think we can stick with £5,000bn as the total value to date of the global banking rescue, though I'm going to brand this as my estimate rather than the Bank of England's.

PS. The Bank of England is, as we speak, modifying the electronic version of its report.

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• - What's this?

Today's fall in stock markets across the world puts us on track to set new records for monthly declines in share prices.

So far this month, share prices in the US and Europe have fallen on average by more than a quarter, those in Asia by a bit more.

Unless there's a sudden bounce, the cumulative monthly falls in October for most major markets will be as big as has been by anyone alive.

In the case of the US, the monthly drop is likely to be the biggest for 70 years. For other markets, where serious measurement of stock-market movements is a younger pursuit, the drops are as bad as any seen since records began some 40 years go.

Why the rout?

Well three things are going on.

First, we're seeing the end of the carry trade, the investment of cheap, low-interest loans raised in yen and dollars for investment in higher yielding financial markets, such as those of the emerging economies, Iceland and - to an extent - the UK.

Investors are liquidating assets everywhere from South Korea, to Argentina, to Hungary, and holding the proceeds in the Japanese and US currencies.

And since so much of the carry trade came out of Japan, the yen has surged to an astonishing extent.

Sterling has been punished, in part because when the carry trade was booming, the UK received a disproportionate amount of this hot money, because our interest rates were always a bit higher than the developed economy norm.

A second phenomenon is the one I described in my note of earlier this morning ("Hungary, Goldman and Regulators"), namely that the conversion of Morgan Stanley and Goldman Sachs into banks is sucking the juice out of hedge funds.

That's forcing those hedge funds to dump assets such as shares, corporate bonds and commodities - which in turn is precipitating further asset sales , as the fall in their prices causes lenders to demand that those who've invested on credit (such as hedge funds) put up more collateral.

Finally, the global economic slowdown has prompted a re-evaluation and re-pricing of risk, in the jargon.

Or, to translate, investors have in the course of 14 months gone from the mad conviction that busts had been abolished to the fear that everything's going bust.

Neither view was rational. But reason doesn't hold much sway at market peaks, when the prevailing emotion is greed, and troughs - when it's sauve qui peut.

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• - What's this?

The , the ambulance service for the global economy, announced late last night that Hungary would be receiving an "exceptional level" of - without specifying how many billions of dollars in loans that would be.

Earlier it had said that it had agreed to provide $16.5bn in standby loans for Ukraine.

It's a fair bet Hungary will be receiving rather more than that, because its dependence on loans from overseas banks and financial institutions is greater than Ukraine's.

Official figures that are out of date and are therefore an understatement show that Hungary has borrowed well over $100bn from abroad, equivalent to more than its entire annual economic output.

Ukraine's foreign debt is about half that.

So Ukraine is less exposed than Hungary to the global trend of capital being withdrawn from economies perceived - rightly or wrongly - as weak.

Although Ukraine has a special problem of its own, namely its dependence on steel manufacture: there has been a serious worsening in Ukraine's trade balance caused by the slump in steel prices, which in turn has been caused by the worldwide economic slowdown.

Ukraine and Hungary are trapped in the vice of the last phase of deleveraging, or the reduction in credit being provided by banks and other investors, and the decline in the real economy.

As for this most recent phase of the withdrawal of credit, which has caused financial crises for a series of emerging economies in eastern Europe, Asia and South America (see "Now there are runs on countries") and also global falls in share prices, it was in a way wholly foreseeable.

It was caused, to a large extent, by an exceptional and unprecedented shrinkage in the prime brokerage industry, which in turn led to a serious reduction in the volume of credit extended to hedge funds, which in turn forced hedge funds to sell assets, especially those perceived as higher risk.

This contraction in loans provide through prime brokers was the inevitable consequence of the collapse of Lehman, but also - far more importantly - of the recent conversion into banks of Morgan Stanley and Goldman Sachs.

Morgan Stanley and Goldman are - by far - the biggest prime brokers, with Morgan Stanley the number one.

But as banks, they're prevented by regulators from lending as much relative to their capital resources as they had been as securities firms.

So the US authorities should have known - and presumably did know - that by allowing Morgan Stanley and Goldman to become banks they were in effect forcing a serious contraction in the hedge-fund industry, which in turn would lead to sales of all manner of assets held by hedge funds and precipitate turmoil throughout the financial economy.

Which, as if you needed telling, only goes to show that regulatory intervention carried out with the best of intentions can have consequences that - in the short term at least - can be very painful.

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• - What's this?

I've been desperately scrambling around for something positive to say today - and the best I can come up with is that the remarkable fall we've seen in the value of sterling today (again) shouldn't make the Bank of England so anxious about importing inflation that it postpones the widely anticipated further cuts in interest rates.

The Scarborough Evening News is responsible for this insight (if such it proves to be), because it contains some striking remarks by the Deputy Governor of the Bank of England, Charlie Bean:

"This is a once-in-a-lifetime crisis and possibly the largest financial crisis of its kind in human history" said Bean. "In terms of the impact on the real economy we are still in early days."

Those do not seem to me to be the views of an economist whose main anxiety is the outlook for inflation. They're the words of a central banker worried about the possibility of a deep dark slump.

If the Bank of England doesn't cut a further ½% off the policy rate - either at its next meeting or in another round of global cuts in co-ordination with other central banks - I'll be somewhat surprised.

Also, some of sterling's weakness can be seen as the corollary of dollar strength, rather than a wholesale decision by international investors to shun sterling assets.

The dollar and the yen have both risen today as the last vestiges of the years of the carry trade - in which investors borrowed cheaply in yen and dollars to invest in emerging economies - is unwound.

Hedge funds and other institutional investors are liquidating any assets they perceive as even mildly risky, especially in eastern Europe, Russia and South America (see my note on this yesterday, "Now there are runs on countries").

And such liquidation inevitably leads to purchases of the US and Japanese currencies.

But just because part of sterling's weakness reflects a flight to the safety of the dollar and yen, there's no real comfort there for us.

Sterling today hit a record low against the euro and is at a 12-year low on a trade-weighted basis.

Why don't international investors love our currency any more?

You know where the smell is coming from:

1) our huge and tumbling housing and property markets;

2) a banking sector massively dependent on flighty wholesale funding from overseas;

3) a fast-growing budget deficit that has to be funded by massive sales of sterling government bonds, at a time when central banks, sovereign wealth funds and institutional investors are suffering a squeeze on cash available for such investment (Michael Saunders of Citigroup estimates that the Treasury will have to flog around £100bn net of gilts every year for the next three years - which, as a percentage of GDP, takes us back to the horrible deficit years of the early 1990s);

4) oh yes, and we appear to be in recession.

Now the capital flight out of the UK is mild compared with the currency crisis hitting Eastern Europe and Russia, which may well be translated into severe economic difficulties.

But all that means is that we shouldn't expect vast numbers of the recent émigrés from those countries to return home when the job market tightens here.

If Poles have a choice between being unemployed here or in their homeland, it's not obvious they'll all decide to repatriate.

But while we are on the subject of the vulnerability of Eastern European, Russian and South American economies, here's something positive to say about our banks: their loans to these regions are limited.

If there are big loans losses to be suffered by banks exposed to emerging economies, disproportionate pain will be suffered by continental banks.

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• - What's this?

The noted British investor, Anthony Bolton, recently announced that he had started buying shares again, on the basis that we probably weren't too far from the bottom of the market.

Part of his logic was that the average ratio of share prices to corporate earnings - what's known as the Price-Earnings Multiple - never reached particularly high and stretched levels in the bull market that immediately preceded the .

Unlike the late 1990s, when those price-earnings multiples went into the stratosphere because of mad expectations of the future profits to be generated by dotcom and tech businesses, the rise in stock markets from 2002 to 2007 was driven primarily by sharp rises in corporate profits, rather than a massive and unsustainable rise in investors' optimism about prospective growth rates for those profits.

On Bolton's logic, stock markets ought not to fall too much from where we are now, because average price-earnings multiples shouldn't need to be squeezed too much as an adjustment to the more challenging economic circumstances that companies (and all of us) face.

That's the logic.

But it only works if the earnings bit of the Price Earnings Ratios doesn't collapse.

And that's been worrying me for some time.

Because arguably the debt binge - the credit bubble that was pricked in August 2007 - was artificially inflating the sales, profits and per-share earnings of companies.

How so?

Well consumers and businesses famously bought and invested on credit that seemed cheap.

And companies also reconstructed their balance sheets to take on more debt, again because debt seemed much cheaper than equity, so by borrowing more in this way - what's known as gearing up - there was an automatic enhancement of earnings per share.

To recap, in the upturn the boom in corporate sales, profits and earnings per share were all magnified by the borrowing binge.

So here's why there may be no comfort to be had from the apparent reasonableness of bull-market corporate valuations, the relative narrowness of price-earnings multiples.

The earnings bit of that ratio may have been significantly and unsustainably inflated by the borrowing binge: the debt bubble may have precipitated an earnings bubble.

Now, as you all know, banks and other creditors want their money back, in a vicious process known as "deleveraging".

Companies that borrowed a great deal are now ruing the day - because the cost of their credit, if they're perceived to be vulnerable to the economic downturn, has soared.

And few consumers or business want to borrow to spend any more.

Profits are now being mullered in the vice of high and rising interest costs and falling sales.

In just the past few hours - as we've had official confirmation that the British economy contracted by a bigger-than-expected 0.5% in the three months to 30 September - we've had profits warning after profits warning from huge manufacturers coping with horrible trading conditions.

At the world's second largest motor manufacturer, Toyota, there's been a drop in quarterly sales for the first time in seven years.

Sony has cut its earnings forecast.

The number two car maker in Europe, Peugeot, has reduced its targets for full-years sales and profits. And Volvo AB reduced its forecast for growth in the heavy truck industry this year.

What we're experiencing is a global economic downturn caused by a massive contraction of the availability of credit.

It may shortly be confirmed as a global recession, and - because it's global and because it's origins are in the withdrawal of credit - it's unlike anything we've experienced since the 1930s.

Unlike the 1930s, our governments have both the tools and the knowledge to stave off depression, so it's fair to assume we're in for years of poor economic performance but not serious impoverishment.

That said, I'm not sure many quoted companies can be confident they know quite how far their profits will fall before the inevitable bounce.

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• - What's this?

The sickness afflicting the global financial economy has entered a new and worrying phase.

It started last summer with the closing down of big chunks of the wholesale money and securities markets.

Then we saw a succession of crises at individual banks, as institutional providers of funds withdrew their cash from banks they perceived as weak (culminating here in the and , and the rescue takeover of HBOS).

In September the entire banking system was on the brink of total meltdown, because of semi-rational fears that almost no bank was safe from collapse.

And now we're seeing a massive flight of capital out of economies perceived to have been living beyond their means - either because they have a substantial reliance on foreign borrowings, or because they are net importers of good and services, or both.

Commercial lenders to these economies - banks, hedge funds, mutual funds and so on - want their money back now. That's driving down their currencies, pushing up the cost of borrowing for their respective governments and undermining the strength of their respective banking systems.

So they need financial help to tide them over - and with the global economy slowing down, those economies perceived as lacking the resources to cope on their own may need support for months and years.

Queuing up for the intensive care ward are Iceland, Hungary, Pakistan, Ukraine and Belarus, all of which are in discussions about accessing special loans from the International Monetary Fund, the emergency medical service for the global economy.

But there has also been a substantial withdrawal of capital from South Africa, Argentina and - most worrying of all - South Korea.

Let's put this into some kind of context.

The annual economic output of Pakistan, Hungary and Ukraine is something over $100bn each - which is not trivial but does not put them near the top of the rankings in terms of the size of their GDP.

However, the output of Argentina is well over $200bn and that of South Korea is around $900bn. In fact, South Korea is the 13th biggest economy in the world.

If you add together the GDPs of all the economies currently diagnosed with toxic BO by international investors you arrive at a sum that's not far off the economic output of the UK.

And the sums of debt involved are also fairly substantial. Hungary has external debt of more than $100bn, Ukraine has foreign borrowings of $50bn, while Pakistan's dependence on overseas funding is nudging $40bn.

As for South Korea, which hasn't requested formal help from the IMF, its foreign debt is nearer $200bn.

Now you may think this is all about remote countries, with no relevance to you. Well, that would be wrong. We're all connected.

It's been very fashionable for pension funds to invest in developing economies in recent years. If you're saving for a pension, you may own a chunk of South Korea or Argentina.

If you're very unlucky, your pension fund may have belatedly put some of your cash into one of the many hedge funds being royally mullered by the way they borrowed vast sums to invest in some of these emerging economies.

And of course the woes of these economies reduce their ability to purchase from abroad, which acts as a further serious drag on global economic growth.

Also the UK is being buffeted directly by international investors' re-awakened distaste for economies perceived to be too dependent on foreign capital or credit from institutions and companies.

What's happening to South Korea - where its currency, the won, has fallen 29% in the past three months, and shares have fallen well over 20% in a week - is particularly worrying for us.

South Korea is a great manufacturing and exporting nation. Its balance of trade is vastly healthier than the UK's.

But like the UK, South Korea's banks are dependent on wholesale funds that are being withdrawn because of fears that those banks face losses on imprudent deals (not lending to homeowners, as is the case in the UK, but currency hedges with local companies - see my note "Crisis is business as normal").

Of course, our banks - and South Korea's - are being shored up by massive financial support from taxpayers.

But if investors no longer think the UK's banks are at risk of collapse, they then look at our other vulnerabilities - such as public sector borrowing which is rising very sharply because of the costs of the bank rescues, dwindling tax revenues and the need to spend our way through the economic downturn.

They also look at our structural trade deficit and our huge reliance on financial flows generated by a City of London and a financial services industry that's shrinking fast.

As I've pointed out in a tediously repetitive way, the sum of all we've borrowed - the aggregate of corporate, personal and public sector debt - is equivalent to three times our annual economic output.

That's a vast amount of debt to repay - and it's all the harder to do so at a time when our most successful industry, financial services, is in some difficulty and the global economy is slowing down.

If international investors fear our credit isn't what it was and are selling pounds, we should hardly be surprised.

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• - What's this?

The slightly odd thing about is that it didn't address the issue of what the central bank, the , could do better next time.

King's analysis of what went wrong is spot on, as always.

In a nutshell our banks and other financial institutions lent too much against the security of over-valued assets, largely residential housing and commercial property.

And to obtain the funds they lent to households and business, those same banks were too dependent on credit from wholesale and overseas sources (net wholesale funding of our banks went from zero in 2001 to £625bn by the end of 2007).

So when the penny dropped that the value of houses and property was falling fast, two terrible things happened at the same time: the overseas and institutional providers of all that incremental funding wanted their money back from our banks, because the formal or informal collateral underpinning that funding was shrinking; and the capital foundations of the banks were eroded by actual and prospective losses on loans that had been made into those frighteningly pumped-up housing and real estate markets.

Banks have been living with this devastating combination of a liquidity crisis and a solvency crisis since the summer of 2007. At times, the symptoms of the disease have been relatively mild. Since the beginning of September, after the collapse of Lehman, the entire banking system was almost in its death throes.

And it's not just been a British disease. This near-deadly combination of banks that lent too much to finance the purchase of inflated assets while being dependent on capricious, unreliable wholesale funding has afflicted the US, other Western economies and - as the extreme case, the sickness in its purest form - Iceland.

Which is why governments and central banks all across the world have adopted similar remedies for their banks: injections of new capital; guarantees from taxpayers to providers of wholesale funds to persuade them to keep their money in the banks; and massive taxpayer-backed loans from central banks.

Few, I think, would dispute that these are the right remedies, although there is a question about striking the right balance between capital injections and the provision of liquidity or cash.

But although the patient, the banking system, is no longer close to death, it's not out of bed and handing out squillions to anyone able to utter those fateful words, "can I have a loan please?"

Nor, with any luck, will there be a return to the lending mania of the few years before the Crunch, or at least not for a long long time.

But there can be no growth in the economy while banks contract the credit they provide to companies and households.

And the reluctance of banks to lend will continue until they're confident they can see the bottom of the fall in asset prices - and we're not there yet.

Also, all that extra money that we as taxpayers have lent to the banks and invested in them (some £600bn and rising) will have to be repaid: that too acts as a serious constraint on how much our banks can lend to businesses and individuals.

Which brings me back to where I started, which is what the Bank of England and other central banks could do better next time.

What was important for me about Mervyn King's speech was that he conceded that our woes stem from a borrowing binge that both fed and fed off the over-valuation of our housing and property markets.

But shouldn't the Bank of England and other central banks have curbed that binge before it became near-lethal?

When in the spring I put this point to King's deputy, Charlie Bean, and also to Jean-Claude Trichet, the president of the European Central Bank, they both said - in essence - that they don't have the tools, that raising interest rates to put a brake on house-price rises or on the growth of credit would have had unfortunate consequences for the wider economy.

And, in the case of the UK, to have hiked interest rates to stem the bull-market in houses and property would have led to the Bank of England undershooting its inflation target in a way that would have been deemed a failure under the mandate it's been given by the Treasury.

Which perhaps means that central banks need new tools and new targets.

The Tories have talked about giving the Bank of England the power to vary the capital ratios of banks depending on credit conditions, which is a fancy way of saying that the Bank of England would be able to force banks to lend less in a period of economic euphoria.

Many will say that's by no means bonkers - although there are immense practical difficulties in devising a credible framework for the Bank of England to exercise such new powers.

Perhaps the important point is that the ultimate strength of any economic recovery will depend in part on all of us regaining confidence not only in the robustness of our banks but also that our central banks have regained the ability to deliver a stable economic environment of low inflation and steady growth - and the important word here is "stable".

It would be impertinent to suggest the theme for Mervyn King's next speech. But he would, I think, attract a large audience for his thoughts on how and whether the Bank of England can prevent the next credit binge and asset bubble.

UPDATE, 11:21AM: Crikey. At a time when some have questioned whether central banks have lost their power, Mervyn King still moves markets.

Sterling has plunged overnight and this morning - especially against the dollar, where it fell from $1.67 to $1.62 at one stage.

That's going to hurt a few traders and speculators, and may nudge inflation up a bit.

Which, in the typical mad fashion of financial markets, reduces the likelihood of the very prospect that has bashed sterling in the first place - namely the expectation, based on King's speech and this morning's minutes of the , that the Bank of England will cut interest rates again in the coming weeks.

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• - What's this?

I have learned that Nat Rothschild is not going to back down in respect of the allegations he has made that Mr Osborne was interested in receiving a donation for the Tory Party from the Russian billionaire Oleg Deripaska.

He would be prepared to defend his claims in court - and I understand that one of his close friends would also provide testimony apparently supporting his claims.

Mr Rothschild feels that Osborne has abused his friendship, by allegedly encouraging newspaper reports that embarrassed two of his other friends, Oleg Deripaska and Peter Mandelson.

The hedge-fund partner feels that friends who accept his hospitality should be entitled to feel that what they say and do in his home is private, and won't appear in the press.

Fairly or not, Mr Rothschild holds Mr Osborne partly responsible for media insinuations that have embarrassed Mr Mandelson and Mr Deripaska - such as that Mr Mandelson, who at the time was the European Union's Trade Commissioner, was guilty of a conflict of interest in accepting hospitality from Mr Deripaska on the aluminium magnate's superyacht

George Osborne was - until the past few days - a close friend of Mr Rothschild.

The relationship dates back to their days at Oxford University, where both were members of the raucous, public-school Bullingdon Club.

This summer George Osborne was Nat Rothschild's guest at his lavish property in Corfu for a fortnight. Mr Osborne's wife, Frances, stayed on at Mr Rothschild's house after Mr Osborne left.

During their stay, Mr Osborne was allegedly keen for Andrew Feldman, a Tory fundraiser, to visit them at Mr Rothschild's house.

When Mr Feldman was on his way, a decision was taken that they'd all go across and meet Mr Deripaska on his yacht.

Before they went on to the yacht, Mr Osborne and Mr Rothschild discussed the possibility of Mr Deripaska making a donation to the Conservative Party, according to someone present at the time.

This was a detailed conversation, which involved discussion of whether it would be against the rules for Mr Deripaska to make a financial contribution since he is not a British national.

The idea was mooted that Mr Deripaska could make the donation through a UK company he controls, LDV, which is based in the Midlands and makes commercial vehicles.

After Mr Feldman arrived, they all went out to Mr Deripaska's yacht on Mr Rothschild's dinghy.

According to one of those present, there was only a brief discussion then of whether Mr Deripaska would make a donation. This person added that they all stayed on the yacht for at least a couple of hours (this is disputed by Mr Osborne, who has said that his two meetings with Mr Deripaska have never last more than an hour).

After they returned to shore, Mr Feldman left to return to his family. But Mr Osborne then had dinner with Mr Rothschild. At this dinner, Mr Osborne allegedly talked more about the possibility of Mr Deripaska making a donation.

One of Mr Rothschild's friends is alleged to have witnessed most of these events and is prepared to testify to that effect, should the issue ever come to court.

Mr Rothschild has normally avoided the spotlight in his spectacularly successful moneymaking career.

As co-chairman of a hedge fund called Atticus, Nat Rothschild has accumulated a fortune of several hundred million pounds. He is a descendant of the world's most famous banking dynasty, and his father, Jacob, is a noted financier and patron of the arts.

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• - What's this?

The first thing to say about Nat Rothschild, whom I've met a couple of times, is that he is a tenacious, steely individual - who does not make allegations lightly.

He's also extremely well-heeled, having made hundreds of millions of dollars as a partner of the New York hedge fund, Atticus.

Also I would not have described him as a Labour supporter.

are not going to vanish into thin air as quickly as they've come.

I'd be amazed if Nat Rothschild were to retract what he's said.

Now, Rothschild's great friends include Oleg Deripaska, the Russian billionaire, Peter Mandelson and George Osborne, the shadow chancellor.

Osborne stayed with him over the summer in his house in Corfu, when there was quite a gathering of the powerful and well-heeled: Rupert Murdoch's yacht was moored by the house, along with Oleg Deripaska's

Now, the allegation is that during that time Mr Osborne discussed a possible donation by Mr Deripaska to the Conservative Party.

The sum in question was £50,000.

The Tories have said they did not solicit such a donation. I suspect that much will hinge on that word, "solicit" - whether the donation was sought or simply offered.

What I have learned is that there were witnesses to these conversations.

And that if push came to shove, this won't be a case of the word of one man, Nat Rothschild, against that of another, George Osborne.

At least one of these witnesses would be prepared to support Nat Rothschild's version of events, were it ever to come to court.

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• - What's this?

There was a hope that a global economic slowdown, which has led to a fall in oil prices, would also lead to a fall in the gas and electricity prices we all pay.

Well, don't hold your breath - for all the pressure that the prime minister, no less, put on the energy companies this weekend to cut their energy tariffs.

I've been talking to those who run our big power companies. And this is what they say:

1) gas prices are still 70% higher than where they were last winter, in spite of a fall in the past few weeks;
2) electricity prices are double where they were last winter;
3) there is very little spare capacity in the electricity generation market, because of the age and fragility of our generators, so there's a risk that - if another generator were to fall over - electricity prices could rise further;
4) over the summer, energy companies bought power on the forward market at prices that are higher than where they are today;
5) it's currently very difficult to hedge power prices at the slightly lower prices now prevailing, because the credit crunch has reduced the capacity of financial firms to take the other side of bets on the future path of energy prices (which is why certain power companies are no longer providing big fixed-price contracts to huge industrial consumers);
6) all the power companies are generating much reduced profits from their retail energy businesses, such that if they suffer a further margin squeeze they may well find it harder and more expensive to raise credit (another painful impact of the credit crunch);
7) power companies have no idea whether this winter will be cold, and therefore whether there will be a surge in demand for gas and electricity, which will lead to a spike in wholesale prices.

Put it altogether and what you've got is the near-certainty that those increased prices we saw in the summer - with British Gas increase the gas tariff by 35% and electricity by 9% - will prevail for many more weeks to come, and possibly all through the winter.

All the power companies will do what they can for those on lowest incomes. And they are conscious that for small businesses, the high cost of energy can prove fatal.

But the vast majority of us would probably be foolish to factor into our budgets any significant fall in what we pay for energy.

UPDATE, 10:40AM: If you are looking for gloom, today's public sector net borrowing figures are simply dreadful: £37.6bn for April to September, up from £21.5bn a year earlier.

And this horrible increment has come before we've seen any significant impact of the economic slowdown on personal and corporate tax receipts.

Public sector net borrowing in the current fiscal year may well turn out to be at least 50% greater than the £43bn forecast by the chancellor in March.

And, as I've been pointing out (see "Spend, Spend, Spend?") all the pressures on the government are to spend more in the short term, to lessen the downturn in the economy - which will lead to even greater public-sector borrowing.

Which is why many economists would argue that the priority for the Treasury is not to raise taxes or slash public spending now, but to map out a credible path for reducing public sector debt from 2010 onwards.

If the chancellor fails to do this, sterling and UK government bonds will come under very heavy selling pressure - and the cost for the government of servicing all that debt could rise quite sharply.

UPDATE, 12:36PM: I have looked again at where we are on wholesale gas and electricity prices - and they don't imply we are close to serious reductions in what we're charged.

Wholesale gas prices for delivery in the first quarter of 2009 are 62% above last winter's price. And electricity prices for the same period are 67% up, year on year.

As for wholesale electricity prices for November and December, they are even higher.

What's galling is that wholesale gas was supposedly priced off the oil price on the way up - but now that the oil price has more than halved, the gas price seems to have de-coupled (to use the awful jargon).

There's a bit of a smell around all of this. Few would probably argue that the gas market is either rational or efficient.

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• - What's this?

Well it's been the quietest weekend since the beginning of September.

What's happened over the past couple of days?

1) Chinese growth in the third quarter of the year slowed to its slowest rate in five years and grew at a lower pace than most analysts expected. The growth rate was 9%.

Please don't laugh. I know we'd love a bit of that in the UK.

But by the standards of the world's great manufacturing machine, this was significant. And it was the industrial production figures where the brakes (sort of) were on. Industrial production rose 11.4% in September, the smallest increase in more than six years, due to weaker export orders and the closure of factories for the Olympics.

As you know, I've been boring on about how we can't rely on Chinese growth to keep the global economy out of a serious slowdown.

But here's an encouraging statistic: retail sales rose 23.2% (oh yes) in September, not far off a nine-year record. Chinese consumers are trying to do their bit for the rest of us, for which we should be thankful.

2) The South Korean government guaranteed $100bn of its banks' foreign-currency debt and provided $30bn in US dollars to them.

This proved, if there were a doubt, that the economies most exposed to the credit crunch are those where the banks have greatest net exposure to overseas sources of funds - which would be Iceland, at the extreme, and the UK as a battered median case.

South Korea is unusual in an Asian context in having a banking sector that's not wholly funded by domestic retail deposits.

And that banking sector lost the confidence of providers of wholesale funds in part because its banks sold many billions of dollars of hedges again the US dollar to more than 500 local companies.

International investors fear that these companies would collapse, because they've suffered huge losses on contracts - known as KIKO or "knock-in, knock-out" contracts" - following a plunge in the value of the Korean won.

The won has lost a third of its value this year, and dropped almost 10% on Thursday alone.

So South Korea has had to join the US, much of Europe, Australia and Hong Kong as a member of the Great Global Banking Bail-out Club.

3) Talking of the Club of Global Banking Shame, ING - the pride of Dutch banking - is receiving a €10bn injection of new capital from the Dutch government.

Why? Well at the end of last week it suffered its first ever quarterly loss and its share price slumped 27% on Friday.

That's a mere trifle compared with the gyrations of the shares in our banks on a daily basis.

But this is not a moment to allow even a scintilla of doubt that any big bank anywhere in the world won't be 100% supported by taxpayers.

Inevitably I've been e-mailed overnight by viewers and readers questioning why the British authorities allowed ING to take over £3bn of British depositors' money from a pair of battered Icelandic banks less than a fortnight ago.

Perhaps that is a little bit embarrassing for the Financial Service Authority, the City watchdog, and for our Treasury.

But only a bit. Their analysis that ING is far too big to be allowed to fail - rather bigger than the entire Iceland economy, for example - is correct.

4) Wrap all this together and what do you have? A fall in interbank lending rates in Australia, Singapore and Hong Kong (a sign that banks are hoarding just a bit less) and rising share prices all over Asia.

In other words, global economic slowdown and banking crises are the new norm. Markets have perhaps become a bit more resilient to all but humungously horrible events.

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• - What's this?

One of the most striking trends of the past three decades - which became particularly pronounced again in the last few years - has been a widening in the gap between the poor and the rich, with the gap between the very poor and the super-rich expanding at an almost exponential rate since 2003 or so.

Well, in this grim year of serious economic slowdown and rising inflation, our society is becoming more equal again, on most measures of income and wealth gaps.

Part of the reason is that the super-rich have been battered by the turmoil in financial markets and by falls in the prices of shares, commodities, properties and other assets, just like the rest of us.

So investment bankers are lucky if they're still in a job - and bonuses this Christmas will be shrivelled and rare.

There'll be fewer humungous payouts to partners of hedge funds and private equity firms. In fact, with debt so difficult to raise, many of these firms will be lucky to be alive in a year or so.

Also the oligarchs and plutocrats of the newer, faster-growing economies are nursing losses on their exposure to markets, such as the Russian stock exchange, which are melting down.

A duo of oligarchs, who only recently were giants of global capitalism, Oleg Deripaska and Alisher Usmanov, have faced demands from bank creditors to hand over substantial assets (the odds of an Usmanov bid for the Arsenal are now presumably rather longer than they were).

The king of steel, Lakshmi Mittal, is less flush than he was.

And with the oil price having more than halved in just a few short months, there's less wonga bulging in the pockets of the potentates of the Middle East.

So the crunch is coming, later than for most of the rest of us, to the very very top end of income and wealth spectrum (though don't weep too much for them, because most stashed away enough cash in the boom years to weather the storm in some style).

But what about the very bottom?

Well for those in low paid, insecure jobs, the outlook consists of below-inflation pay rises and possible redundancy.

However, if you are living on benefits or you depend on a state pension, there's strikingly good news.

Your state-funding income will rise in line with September's retail prices index or an adapted measure called the Rossi index. And both inflation measures have been rising at a faster rate than we've seen since the early 1990s.

So the RPI, which determines increases in child benefit, incapacity benefit, disability allowance and state pensions, is up 5 per cent.

And income-related benefits (such as housing benefit, income support and jobseeker's allowance) should be increased by the 6.3 per cent increment in the Rossi index.

What that means is that after many years of receiving a smaller and smaller share of the national cake, those who depend on the state for their income will actually receive bigger pay rises than almost anyone else - and their share of national income will rise.

It may seem rather odd that those on benefits tend to do best when the economy is in the pits - but actually that's not unusual (it happened in the early 1990s too). But this time they'll do disproportionately better, because of the inflation we've imported from rising energy and food prices.

So what we're seeing is something of an uplift for those who are poorest, and some of the froth blown off for those with fabulous wealth.

In the middle, however, which is where most of us live and work, it'll be a year of squeezed incomes and fears of redundancy.

So most won't see this narrowing in the gap between rich and poor as a sign that our society is becoming fairer.

PS These increases in benefits and pensions will probably lead to further increase in public sector borrowing. But many economists would see that as a good thing, since the recipients of increased benefits and state pensions usually have to spend the lot just to have a dignified existence - and that additional spending would be good for all of us if it were to inject a bit of extra oomph into a weak economy.

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• - What's this?

Has the Bank of England lost its power, to re-work Scotty's famous line from Star Trek?

Last week it cut interest rates by 0.5%, in a coordinated attempt with other central banks to re-stimulate the global economy.

Since then, the LIBOR interest rate charged by banks for lending to each other over three months has barely moved.

And that matters, because banks set their prices for credit provided to households and businesses off that so-called interbank rate.

Or to put it another way, banks aren't passing on to us the full cut in the interest rate which the Bank of England thinks is necessary to prevent a deflationary recession.

This may be particularly frustrating for the Bank of England and the Treasury because they've been doing a sterling job, to coin a phrase, of providing loans and financial support to banks, to make up for the credit that's been withdrawn because of the seizing up of wholesale money markets.

As of yesterday, the authorities had committed - since the start of the credit crunch last August - to provide an incremental £600bn of taxpayer loans and support to our banks.

Which is just a little bit less than the net dependence of our banks on the defunct wholesale markets.

And our banks are likely to get even more financial help from the Bank of England, thanks to imminent reforms announced today of the way it provides them with loans and liquid assets.

Will this do the trick? Will banks start lending more to us and at reduced interest rates?

That's doubtful - and the Bank of England may well be seen as implicated in the way that banks are reducing how much they lend.

How so?

Well, the Bank of England stressed today that all its additional lending to banks is intended only to see them through this time of stress - and that this financial support should not be seen as a source of longer term funding to the banking system.

So if our poor battered banks don't expect a recovery in wholesale markets any time soon - and it would be foolishly Micawberish of them to count on such a recovery - then they have no option but to reduce what they lend to businesses and to individuals.

Which is why it will be very difficult to turn our super-tanker of an economy away from recession.

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• - What's this?

It's like an avalanche.

A snowball of tumbling share prices began in Europe yesterday afternoon, picked up momentum on Wall Street - where the important S&P 500 index suffered its biggest loss in 21 years - and has been battering Asia overnight.

And that in spite of the £2 trillion pounds of taxpayers' precious money committed by governments to bank rescue plans all over the world.

What's more - and probably more worrying for the authorities - is that interest rates charged by banks for lending to each other for three months remain at disturbingly high levels (see my note from earlier this morning for detail on this).

It means that last week's dramatic and co-ordinated cut in interest rates by central banks is having an only limited impact on the cost of credit for businesses and individuals.

What we're witnessing is the limits of what these banking bail-outs can achieve in the face of what increasingly looks like the onset of a global economic recession.

Governments have been able to prevent individual banks from falling over. There's another example of that this morning with the announcement that to a special new company set up to extract poisonous assets from the huge bank, UBS.

But they've been powerless to prevent the banks contracting the amount of credit they're providing, which has reduced the ability of companies and individuals to invest and spend, and risks turning an economic slowdown into something rather worse.

That's why the British government is being forced to think about something new: a substantial and sustained increase in public spending to offset the contraction of spending by the private sector (there may be little point in cutting taxes, since nervous consumers and businesses would probably hoard any extra cash that went into their pockets).

A rise in public spending would increase the burden of public-sector debt, which is already - on one measure - above the government's self-imposed limit.

And paying off the increased debt would limit the growth of the economy as and when the economy turns.

There's also a risk of downward pressure on sterling and upward pressure on the cost of borrowing for the government, if the UK's balance sheet were perceived to be weak by international standards.

But ministers increasingly believe that may be a price worth paying, if an old-fashioned Keynesian stimulus to the economy meant that the UK suffered a shallow recession rather than a deep and dark one.

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• - What's this?

Something very strange and worrying is going on in money markets.

First the good news.

The two trillion pounds of taxpayers' money that governments all over the world have put behind the banking system, both in the form of capital injections and guarantees for lending between banks, has reduced the perceived risk of banks going bust.

This reduction in the probability of banking failure is measurable, in that the price for insuring bank debt in the credit-default-swaps market has roughly halved over the past few days.

Here's what you've been expecting: the less good news.

Banks are still not lending to each other at anything like a normal rate of interest relative to official rates.

The statistics (kindly updated for me by Barclays Capital) are extraordinary.

Back in the first half of 2007, before the onset of the credit crunch, the gap between what banks charge each for three-month loans, the three-month sterling LIBOR rate, and the average of expectations of the overnight interest rate for the following three months (the OIS rate), was 0.09 percentage points.

In other words, the three-month lending rate was closely aligned to expectations of what the Bank of England would charge for overnight money.

And that's where the gap stayed for months - until the onset of the credit crunch in August of that year, when the gap widened to 0.23 percentage point, or 23 basis points in bankers' lingo.

Which was wider than normal, but not devastatingly so.

Since then this interest-rate gap, known as the three-month sterling LIBOR-SONIA spread, has risen and fallen as the money-markets have become more or less stressed.

The more stress, the wider the gap or spread.

But the spread never got much above 1 percentage point, or 100 basis points.

Or at least not till September of this year.

Since when the gap has been widening and widening.

Last Friday, the spread reached what was probably an all-time record, of 219 basis points. That was a staggering 2.19 percentage points.

And it's only narrowed a very little since then, to 202 basis points, or 2.02 percentage points.

You may think "so what?"

Well the "what" is big.

It means that banks are only prepared to lend to each other for three months at an interest rate that is a full two percentage points above the rate at which they expect to be able to borrow funds from the Bank of England over those three months.

Which means they just don't want to lend to each other.

And, of course, if they're not prepared to lend to each other for less than 2 percentage points above the expected policy rate, what chance that they'll lend at a keener rate to consumers, households or businesses?

Slim to none, seems a fair bet.

A glance at the chart of the LIBOR-SONIA spread shows that last week's half percentage point cut in the Bank of England's policy rate has been more-or-less totally absorbed: almost none of that interest-rate cut has been passed on in the form of lower interest rates charged by banks when lending to each other.

Which is why only a relatively small number of mortgage rates and business lending rates have been reduced by the full half percentage point.

That's distressing, because it seems to indicate that monetary policy has become toothless, ineffective.

At a time when we're in a recession, it's particularly worrying if cuts in interest rates by the Bank of England aren't leading to reductions in the cost of credit for real people and real businesses.

And don't forget that in the last few weeks, central banks - including the Bank of England - have literally been spewing loans of short-term and medium-term maturity into the banking system. And these central banks have been providing these loans in return for more and more eccentric and eclectic collateral.

Yet although there's a ton of cash or liquidity sloshing through the system, banks want to hoard it rather than lend it.

What's going on?

Well the widening in the interest-rate spread may in part reflect the margin demanded for the new interbank lending guarantees demanded by the Treasury.

But that would seem to me to be a relatively minor factor.

It may simply be the case that banks are so badly shaken by the 14 months of crisis in their industry that they have lost almost any appetite to lend.

They've made a decision to lend less, to deleverage, and no amount of cajoling or even bullying by the authorities is going to persuade them to do otherwise.

Which is highly undesirable, to put it mildly, when the real economy is showing every symptom of having caught a very bad cold from the sickness in the financial economy.

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• - What's this?

There may have been a bit of a misunderstanding between the banks and the Treasury about the nature of the prohibition on dividend payments pending repayment of the preference stock they are selling to the state.

Apparently, according to well-placed sources, a sensible interpretation of the complex documentation drawn up for the banks' capital-raising would say the following:

1) there is a strict ban on dividend payments for a year;

2) thereafter there would be discretion for the Treasury to permit dividend payments to start again at Royal Bank of Scotland and Lloyds (as enlarged by the planned takeover of HBOS), irrespective of whether all the prefs had been repaid.

So what would determine whether the Treasury gives permission for dividend payments to be resumed?

Well it would depend on whether the balance sheets of the banks had been strengthened by their having disposed of many of their riskier assets and on whether the ratio of their capital to risk-adjusted assets (what's known as their capital adequacy) is back at world-class levels.

As it happens, the prefs are expensive, paying a 12% coupon. So it might well be in the banks' interests to repay them before allocating whatever spare cash is available to the distribution of dvidends on the ordinary shares.

But what should reaasure shareholders in Lloyds and RBS in particular is that there is no blanket prohibition from the Treasury on the resumption of dvidend payments (well except for the coming year - which is sensible in a climate of capital scarcity; and it's relevant that Barclays is not paying a dividend for the second half of this year, even though it is not taking capital from the Treasury).

I expect ministers to confirm all this before too long.

Which would be highly significant: it would rescue the takeover of HBOS by Lloyds TSB from possible collapse (see my note on this from yesterday); and it would make the new shares being sold by Lloyds TSB and RBS much more attractive to private-sector investors, reducing the risk that most of them will be dumped on the taxpayer.

Some will doubtless see all this as a u-turn under pressure by the Treasury. But the banks will probably simply breathe a sigh of relief.

That said, the scale of the misunderstanding between them and the Treasury was quite something, in that on Monday morning the assorted official announcements of the capital injection by taxpayers all stipulated that dividends would be ceased till the prefs were repaid.

The negotiations were, of course, carried on all through Sunday night till the sun rose on Monday morning - so perhaps important nuances were lost as exhaustion gripped the ministers, officials and bankers.

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• - What's this?

It may be a case of shutting the stable door after the thundering herd has bolted, but law and order is being brought to the wild wild west of global financial markets.

G Brown will, for example, in the coming days put on his Wyatt Earp costume, and will ask the financial gunslingers to hand over their weapons.

A huge and totemic encapsulation of the imminent arrival in town of a new breed of marshals and sheriffs is buried away in an article in today's Wall Street Journal.

It's an excerpt from an e-mail sent on April 12 2008 by Richard Fuld, the somewhat tarnished former chairman of Lehman, the investment bank whose collapse last month brought the global financial system to the brink of meltdown (the e-mail was uncovered by Congressional investigators who've been examining Lehman's demise).

In an message to Lehman's General Counsel, Thomas Russo, Fuld summarised a conversation he had over dinner with the US Treasury Secretary Henry Paulson.

According to Fuld, Mr Paulson said he wanted to "kill the bad HFnds + heavily regulate the rest."

Crikey.

No wonder "HFnds," or hedge funds as most of us know them, are a teeny bit anxious at the moment.

After years of stellar performance, many of them (but not all) have suffered serious losses in the past few months of extraordinarily volatile markets.

Their increasingly risk-averse backers are asking for their money back.

And the likes of Paulson - who you might think would be on their side, as a former chairman of Goldman Sachs - apparently wants to slaughter the cowboys among their ilk and put the rest in shackles.

Of course, we only have Fuld's word for this.

But my own conversations with politicians and regulators are indicative that the tide has turned massively against this trillion dollar industry.

The authorities on both sides of the Atlantic have belatedly noticed that hedge funds' speculation in unregulated markets - such as the mind-boggingly huge credit-default-swaps market - has exacerbated the instability in regulated markets, notably stock markets.

They've belatedly noticed that hedge funds have vast amounts of power to decide the fate of banks and other financial institutions of central importance to the functioning of the global financial system - and yet there's almost no formal system for holding them to account for the use of that power.

And the authorities have abandoned their staggeringly naïve view that hedge funds are the girl guides of the financial community (I kid you not), because of the near-truism that when hedge funds fall over, they tend to hurt mainly their well-heeled backers in a direct sense, rather than millions of ordinary savers or taxpayers (I say near-truism, because the notoriously precipitated a financial markets tsunami).

The point about hedge funds is not what happens when they make big booboos.

What matters is whether their activities make the financial system more or less adept at allocating capital in an efficient way, to the long-term benefit of our economies, and whether they enhance or undermine the robustness of the financial system.

As economic boom turns to bust, because of a systemic malfunctioning in the financial system, that's moot.

A few far-sighted hedge funds can argue that they were the good guys, that they shouted from the rooftops (through their profitable trading strategies) about what was going wrong before it went wrong (and more fool politicians and regulators for ignoring them).

But the industry as a whole hasn't even begun to address the central charges against it: namely, that it helped to stoke up the credit bubble by providing a market for toxic investments; and that it has brought disorder to the puncturing of that bubble, through the poisonous combination of deliberate strategies to destroy the credibility of weaker financial firms, and through massive automatic sales of assets in a falling market.

Proving that they've enhanced the general good, such that they protect themselves from being regulated into a dull and lifeless industry, may turn out to be somewhat more challenging than the trials of Hercules.

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• - What's this?

As I said this morning, there's a chance the state won't end up owning a whacking 60 per cent of Royal Bank of Scotland and 40 per cent of the superbank formed by the merger of Lloyds TSB and HBOS.

But if the Treasury wants to minimise the probability that it will own the maximum number of shares in these two banks, it may have to make a fairly important change to its banks rescue scheme.

In the case of Royal Bank, for example, its market price has been hovering around the subscription price for the new shares.

If the market price were to settle higher in six weeks, when its make-your-mind-up time for investors, lots of those new shares might end up being bought by those investors, leaving taxpayers with a relatively modest stake.

But to woo private-sector shareholders, the Treasury may have to concede that the banks were right in their last minute negotiations that there is a flaw in the rescue scheme - and it's rarely easy for Government to put its hands up and say "we were wrong".

The Treasury may have to abandon its stipulation that no dividends can be paid to shareholders in RBS, HBOS and Lloyds until these banks have repaid preference shares which they are selling to the state.

The prohibition on dividend payments has spooked our big investing institutions.

It's wreaking havoc in particular on Lloyds TSB's share price, because its takeover of HBOS would give it a vast burden of preference shares to pay off.

Which may sound technical and dull, but a good deal is at stake.

Lloyds TSB's shareholders could refuse to approve Lloyds' takeover of HBOS, because of their annoyance that the deal would make them wait much longer for dividends to be resumed than would happen if Lloyds were to stay independent.

So if the Government doesn't show flexibility on dividend payments, it'll probably end up owning much more of the banks than is necessary and the takeover of HBOS by Lloyds could implode.

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• - What's this?

Whisper it softly, but there's just a chance that Royal Bank of Scotland won't be nationalised after all.

Its shares have been lifted this morning on the wave of global stock-market euphoria to around 70p, a margin above the 65.5p price being paid by the government.

At that level, it would be rational for RBS's existing shareholders to exercise their right to buy the new shares and "deprive" taxpayers of this investment.

After all, if apples - or RBS shares - can be bought from the orchard at 65.5p when the market price is 70p, you'd be a fool not to buy in the orchard, even if you plan to dump them almost immediately in the market rather than hold them.

Which means that if RBS's share price were to stay at this level or rise, the state's stake in RBS might turn out to be far less than the 60% that taxpayers would own if we bought all the new stock.

The big imponderable is how much spare cash is available to our battered pension funds and whether some cash-rich overseas investors might be tempted to buy - because the £15bn that RBS needs is a lot of wonga.

But the important point is that, for all its hideous booboos, RBS is a fearsome moneymaking machine. And its new chief executive, Stephen Hester, has a formidable record of sorting out complex financial problems (which he demonstrated from his time at Abbey).

So private-sector investors might just conclude that this is too attractive an opportunity to leave for taxpayers.

Whatever happens, RBS will still be lumbered with paying off £5bn of preference shares which we as taxpayers are buying willy nilly.

Hester didn't want these but he's lumbered with paying the 12% coupon and ceasing dividend payments on all ordinary shares till the £5bn has been repaid.

That said, it's all looking a lot less bleak than Hester might have feared yesterday.

Hester may find himself running a bank that can claim with conviction that it's still largely in the private sector.

And that's all the more humiliating for HBOS, whose shares have also risen this morning but remain firmly below the subscription price being paid by HM Treasury.

What is it about HBOS, owner of the Halifax, that makes it less attractive to investors than RBS?

It's our viciously deflating residential housing market, to which the fortunes of this market-leading mortgage lender are inextricably linked.

Probably almost nothing can prevent us as taxpayers becoming the full or partial owners of the three mortgage lenders most closely associated with the bubble years in UK residential housing.

Soon we'll have the full set of Northern Rock, Bradford & Bingley and HBOS - which will be seen by many as confirmation that the near-catastrophic failure of macro-economic management by Bank of England and Treasury over the past few years was to allow house prices to rise and rise and rise and rise and rise.

UPDATE, 04:00 PM: The wobble in Lloyds TSB's share price, down again today in a rising market, will be giving the jitters to the bank's board.

Its shareholders don't seem to like the Treasury's insistence that no dividends can be paid till all the prefs sold to the state are paid off.

The merged Lloyds/HBOS would have to pay off some £4bn of the prefs before it's dividends as usual for the group's ordinary shareholders. And that could perhaps take a couple of years.

But if Lloyds weren't to buy HBOS, it would have only £1bn of prefs to pay off.

So some shareholders may well be wondering whether Lloyds should press ahead with the takeover.

If the prime minister wants the takeover to go ahead - and he seems very keen on it - he may well have to instruct the Treasury to waive the requirement to cease all dividend payments to holders of the ordinary shares.

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• - What's this?

Argument will rage for weeks and months about the extent to which Gordon Brown was responsible for the economic mess we're in.

But it would be churlish to fail to note that the bank rescue plans announced by eurozone governments yesterday and expected to be announced in the US later today are variations on the template launched a week ago by the British government.

HM Treasury has led. Other governments have initially expressed severe reservations about the UK's prescription of injecting new capital into banks and guaranteeing lending between banks. But, finally, those governments have followed the British lead.

If HM Treasury were the corporate finance department of one of those battered investment banks that are now being rescued, it would be collecting a very fat fee.

And if you believe in the trickle-down effect on public opinion, what's striking is that business leaders, who only a fortnight ago had more-or-less given up on G Brown as the political equivalent of an over-leveraged business with the bailiffs at the door, are now buying shares in him again.

But in the scale of what's gone wrong with the global economy, that's all relatively trivial.

Far more important is that bankers and investors have become a bit more confident that the governments of the major Western economies are back in control of events, rather than running around putting out small peripheral fires while the main inferno raged.

Yesterday France, Germany, Spain, the Netherlands and Austria committed around £1,000bn to guaranteeing loans between banks and injecting new capital into them.

Today, the US Treasury Secretary, Hank Paulson, is expected to confirm that he's investing $250bn in US banks, including $25bn each in the three biggest and proudest, Citigroup, JP Morgan and the merged Bank of America/Merrill Lynch.

Even Goldman Sachs - once the bank which defined swaggering self-confidence - is being obliged, it seems, to take $10bn of US taxpayers' money.

And, apparently, all this money comes with the obligation to restrict executive compensation - though there's scant detail as yet about quite how much more than minimum wage the bankers will be earning.

One important wrinkle is that the capital injection in the US will be in the form of preferred stock with attached warrants to buy ordinary shares (common stock). It's similar to how the world's greatest investor, Warren Buffett, took his recent stake in Goldman.

The point of doing it this way is that existing shareholders will be diluted far less than will be the case at RBS and HBOS after the UK government completes its acquisition of controlling stakes in them.

But there's a risk for US banks and their shareholders in the Paulson plan - which is that recipients of Paulson's capital injection will be under greater financial pressure, to pay back the dividends on the preferred stock and possibly also redeem it, before a penny goes to existing shareholders.

What's happening in the US is less obviously nationalisation than what has happened in the UK.

But it still gives the US government vastly more influence over the behaviour of US banks than it's had for decades.

And the overall scale of the plan is, like that of the UK and the eurozone, without any meaningful precedent.

The US package includes the extension of deposit protection to businesses, to deter them from pulling out their funds to the detriment of individual banks perceived to be weak.

And the US authorities will provide a taxpayer guarantee to issues of new debt by banks, which is very much like what the British Treasury has done.

For me, the greatest hope that we're back from the brink of a financial-markets meltdown that could turn recession into depression comes from this new global action by governments to establish taxpayers as the formal guarantors of all lending between banks and big financial institutions.

But we should be under no illusion that these ambitious rescue plans are cost-free.

They heap on to the public sectors of the US, the eurozone and the UK undreamed-of levels of debt and contingent liabilities.

That will probably dampen growth for years in the whole of the developed West, as governments may feel financially constrained from spending and investing on other services and projects, and the banks themselves are likely to devote all their spare resources to repaying their debts to taxpayers, rather than financing proper wealth creators.

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• - What's this?

Today investors on the stock market gave something of thumbs down to shares in Royal Bank of Scotland and HBOS - which means that we as taxpayers will almost certainly end up owning around 60 per cent of Royal Bank of Scotland and about 40 per cent of a new super-bank created by Lloyds TSB's rescue takeover of HBOS.

Think about that for a second - because it is one of the great events in the history of the British economy.

Both of these giant banks are central to how we create wealth in this country.

They look after the savings of countless millions.

They lend to countless millions.

They grease the wheels of capitalism.

But the incompetence of RBS and of HBOS means that we as taxpayers have had to bail them out to the tune of £31.5bn.

Chances are that this is the moment when future historians will say that the tide turned decisively against almost-anything-goes, laisser-faire financial capitalism (what I described yesterday as an important strand of Thatcherism) - which has been the prevailing ideology for almost 30 years.

It'll end because some bankers themselves have been chastened and will choose to mend their ways - and others will be hectored into doing so by the City watchdog, the Financial Services Authority, and the Treasury.

Till just a few weeks ago, the City and our banks - the financial services industry - swaggered that they were the great British success in a country with few other world-beating industries.

But as boom year followed boom year, and fat bonus followed fat bonus, many banks and bankers became over-confident, arrogant.

They forgot the essence of good banking, which is to know your customer, to measure the risks when lending or investing, and to never lend more than the customer can afford.

A great and enduring bank is almost invisible, a dull and self-deprecating provider of basic services - not the puffed up, too-clever-by-half firms that many big banks became over the past few years.

The humiliation of RBS and HBOS will probably cut all our hubristic banks down to size - it should return us to a world of simpler, safer banking.

Which would probably be a good thing - although it means the City of London will probably shrink over several years.

And that'll be a drag on the economy as a whole - unless and until they achieve what many would like them to do, which is to provide finance and nourishment for wealth-creating industries that are less prone than is the City to boom and bust.

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• - What's this?

Let's add up the .

1) Taxpayers are injecting £37bn of capital into just three banks, RBS, HBOS and Lloyds - with RBS and HBOS taking £31.5bn of that (this is nationalisation Jim, though perhaps not precisely as we know it);

2) RBS and Lloyds TSB/HBOS have promised to the government that they'll maintain mortgage lending and small-business lending at 2007 levels - which is massively more than they are currently lending (this is hugely significant - given that a shortage of credit is to a large extent behind the economy's deceleration into recession levels);

3) Lloyds TSB is paying less to buy HBOS than it originally announced, to reflect the disclosure that HBOS's problems are rather worse than it thought just a couple of weeks ago;

4) Barclays is raising £10bn from selling new shares and securities to private-sector investors, abandoning its dividend for the second half of this year, and taking other actions;

5) So total capital raising today, including fairly modest amounts being raised from private sources by the UK businesses of HSBC and Santander, is nudging £50bn (wow);

6) The Bank of England and other central banks have announced they are lending as many dollars as are needed by banks (phew);

7) Eurozone governments are today fleshing out their plans to inject capital into their own banks and to guarantee lending between banks (double phew);

8) Stock markets and money markets are in slightly better shape this morning - which is something of a relief, because if they can't be buoyed by so much taxpayers' money being chucked at the banks, then we would be in rather more serious trouble than I feared.

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• - What's this?

Who would have thought, only a few weeks ago, that taxpayers would end up owning around 60% of Royal Bank of Scotland and about 40% of a super retail bank formed by Lloyds TSB buying HBOS.

But that's what has been announced today by the Treasury, in what will count as perhaps the most extraordinary day in British banking history.

Those three banks alone are raising £37bn from the state, with Royal Bank of Scotland taking £20bn of that.

It will lead to changes in their behaviour.

The government has insisted, for example, that senior directors should receive no cash bonuses this year and will receive future bonuses in the form of shares - in the hope that this forces them to take a long-term approach to the way they manage what are now our banks.

The three banks have also agreed to maintain lending to homeowners and small businesses at the levels of 2007.

As for Barclays, it is proudly standing to one side.

It has agreed with the authorities to raise £6.5bn of new capital, but is confident it can do this by tapping its shareholders and other private-sector investors, rather than going cap in hand to taxpayers.

But it's not all good news for its shareholders - because it will abandon the dividend for the second half of this year, to save £2bn of cash.

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• - What's this?

The City of London has never seen anything like it in its long and illustrious history.

A quartet of our biggest banks have been negotiating all day today - and will continue to do so all through the night - with the Treasury, the Bank of England and the Financial Services Authority about how much capital we as taxpayers need to invest in them.

Right now it looks as though first thing tomorrow Royal Bank of Scotland, HBOS, Lloyds TSB and Barclays will announce they're raising up to £40bn in total.

In the case of Royal Bank of Scotland, the sum of capital it's being forced to raise is mindboggling - at least £15bn (and rising).

Which is the kind of disaster that no chief executive can survive - which is why Sir Fred Goodwin's resignation will be announced tomorrow, to be replaced by British Land's Stephen Hester (as I mentioned in yesterday's note).

Meanwhile HBOS will come second in the list of capital-raising shame: it's being obliged to raise around £10bn.

Taxpayers will underwrite or provide all of what the Banks are raising - although the banks will give their shareholders and other investors the option of reducing the taxpayer investment by taking some of the new shares on offer themselves.

It's the biggest fund-raising exercise that's ever taken place in the UK.

What it demonstrates is the weakness of Britain's banks.

And the banks that feel most humiliated by the debacle are - of course - Royal Bank of Scotland and HBOS.

But its embarrassing even for Barclays. It didn't want to raise more than £3bn but it has has been pressurised by the Treasury, Bank of England and FSA to raise nearer £7bn.

This is history in the making.

At the end of it, the state will own a very substantial proportion of our biggest and proudest banks.

What a sorry end to Britain's longest ever period of unbroken economic growth.

But with any luck, it will be clear - when the money's been raised and taxpayers are standing firmly behind them - that they're safe from collapse.

UPDATE: 19:01

I have one additional fact and one thought.

First, the City watchdog - the Financial Services Authority - has done its sums about how much capital the banks need on the basis that an economic tsunami is coming.

It's not forecasting such a tsunami, but it has sensibly concluded that the banks' foundations need to be reinforced so that they could withstand such an unprecedented battering.

Which we should probably see as reassuring.

I've also been musing on the historic significance of tonight's events, and I think it can perhaps be seen as the death of Thatcherism, or at least of an important strand of the dominant ideology of the 1980s and 1990s.

It was Margaret Thatcher who in a series of bold reforms from 1979 onwards gave the City the freedom to trade in everything and anything.

She removed restrictive practices, she encouraged the free flow of capital to and from anywhere in the world, she created the notion of the City as the Great British Success.

For the liberalisation of the City to end with a quartet of our biggest and proudest banks being forced to put out the begging bowl to Government, well that is a moment in ecnomic history - which may well, ultimately, be as significant as the nationalisations of the 1940s and the privatisations of the 1980s.

UPDATE 20:46

The amounts the banks are being forced to raise are increasing by the hour. Right now, it looks as thought the authorities will force RBS to raise up to £20bn and HBOS around £12bn.

And the total for all four may well hit £50bn.

Also, with HBOS being forced to raise so much, Lloyds is demanding that the terms of its takeover of HBOS should be changed - so that Lloyds doesn't have to pay so much.

The revised terms of the takeover may well be announced in the morning.

PS By the way, there's also been something of a breakthrough in Paris, at the meeting of the eurozone heads of government hastily arranged by President Sarkozy. If financial institutions aren't reassured by their pledge to guarantee interbank lending for five years, well then we're in the kind of mess that's simply not amenable to government solutions.

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• - What's this?

As I said on the Ten O'Clock news last night, the UK's big banks are racing to raise capital, most of which will either come directly from taxpayers or will be underwritten by taxpayers.

The reason is that the Government has said that without the injection of new capital, banks won't be able to take advantage of a £250bn state guarantee for what they borrow from other banks and financial institutions.

And without this taxpayer guarantee, banks will continue to find it immensely difficult to raise vital wholesale money from other banks and financial institutions.

So it's a no-brainer for most of them to attempt to solve their capital and liquidity problems simultaneously.

What's more, the Treasury has made it easy for them to obtain the capital: the Treasury has offered to provide up to £50bn in aggregate directly; or if a bank wants to try to raise the capital from shareholders through a conventional sale of new shares, the Treasury will underwrite the shares, thus providing certainty that that the bank will get its money.

Which bank will be first to tap taxpayers?

Well I would expect Royal Bank to raise the capital it needs over the weekend. On paper its balance sheet looks okay. But its board has concluded it needs a further cushion of capital, perhaps as much as £10bn.

This need not spook any depositor or saver with RBS. In fact the contrary is true. RBS will be all the stronger for strenthening its balance sheet and accessing the Treasury's interbank guarantee.

But it's a terrible humiliation for RBS's chief executive, Sir Fred Goodwin - who broke all British records by raising £12bn in a rights issue less than six months ago.

After the eyewatering fall in RBS's share price at the end of last week, RBS's entire market value is now less than the cash it raised just a few months ago. And in terms of what can damage the credibility of a chief executive, it doesn't get much worse than that

Goodwin has told colleagues that his priority is to raise the desirable new capital, and that he wouldn't stay in his job after that if shareholders wanted him to go.

That's his coded way of saying he's off, possibly as soon as Monday - and he'll be replaced by the former Abbey finance director, Stephen Hester, who is currently chief executive of British Land.

But, to be clear, RBS won't be the only bank raising capital in the next few days.

I expect HBOS, Lloyds TSB and Barclays to disclose that they're raising up to £25bn between them - all of it underwritten by us as taxpayers or simply given to them by us (aren't we generous?).

It won't be long before we know how much of the banking system belongs to us. Which means we'd better start thinking about what we want in return.

Some might say a return to old-fashioned, prudent, know-your-customer banking mightn't be such a terrible thing to ask for.

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• - What's this?

In the past 50 years, there haven't been many - if any - meetings of the world's seven richest developed nations as important as .

Markets are in meltdown. Investors are dumping almost any asset that can be sold for cash - and never mind the price.

It's a vicious downward spiral.

When the prices of assets fall sharply, that triggers margin calls for other investors, a hideous, insidious form of feedback that triggers another round of asset liquidations.

Which in turn undermines the capital of banks - which forces them to dump yet more assets and call in more loans.

It's a terrifying process, the precursor to a "Minsky Moment" - called such after the economist who described a breakdown of the entire financial system caused by a panicked mass liquidation of assets.

To ward off the Minsky Moment - which would have devastating economic consequences - a circuit breaker has to be found. And only taxpayers can provide that circuit breaker, by - inter alia - underwriting the banking system so that lenders to banks regain confidence that they'll get their money back

I don't mean just British taxpayers. We've been doing our bit. I mean the taxpayers of the developed world (because this is the developed world's mess, our mess, whether we like it or not).

The problem is global so the solution has to be global.

National initiatives - such as the UK's £400bn bank rescue plan and the US Treasury's scheme of equivalent size to remove toxins from banks - are useful.

But they can't be a complete cure, because they treat only parts of the ailing body, not the entire sick global corpus.

What would an effective medicine look like? Well it might be a global version of the British Treasury's recently announced £250bn guarantee for lending between banks - which is designed to demonstrate to institutional lenders that they are safe when lending to banks.

This could restore the flow of money between the banks and financial institutions; it could unblock the pipes that underpin our very way of life.

But for reasons that aren't at all clear, the US and French governments have dismissed that kind of initiative.

Maybe there's another cunning plan available to ward off the Minsky Moment.

If the leaders of rich Europe, Japan and North Amierica fail to find such a plan today or over the weekend, the painful consequences could scar a generation.

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• - What's this?

The sharp and nerve-straining falls in share price on and in are damaging to the wealth of many, especially those saving for a pension.

But it's as well to remember that they are the symptom of the disease, not the disease itself.

The underlying illness remains in the financial system, as manifested in the record amounts banks were charging each other yesterday for lending to each other for three months.

One serious anxiety concerns the auction today to settle liabilities on insurance - or credit default swaps - on debt of the collapsed investment bank, Lehman Brothers.

As I noted a couple of weeks ago, there are estimates that claims under insurance contracts will total $400bn. Sandy Chen of Panmure was one of the first to highlight the scale of this looming problem.

If demands for payment are as big as $400bn, there will be pain for banks, insurers, hedge funds and other financial institutions.

Here's why.

For every winner in a claim, there is a loser, the underwriter who has to divvy up. And if the underwriter lacks the resources to pay - which may turn out to be the case in this under-regulated market - that creates two losers: viz the bust underwriter and the claimant which doesn't get the money on which it was counting.

And if that claimant had been calculating its own financial strength on the basis that it had insurance against its Lehman debt, well then failure to receive payment could shatter the integrity of its balance sheet. Which in turn would create potential losers among its creditors.

So this day of reckoning on Lehman credit default swaps is momentous - and it could not come at a worse time for fragile bank shares.

The fall in Morgan Stanley's share price yesterday was a remarkable 26%, on the back of various nebulous rumours and as Moody's said it was reviewing Morgan Stanley's credit rating for possible downgrade.

There was also a doubling in the credit-default-swap price for insuring Morgan Stanley's debt: there was contagion from this opaque market to the more transparent stock market.

As soon as regulators have time for breath, they surely must as a matter of urgency bring some light, order and proper regulatory oversight into the credit-default-swaps market

But probably more urgent is for the US Treasury Secretary to decide how and whether he will inject US taxpayers' money into banks to recapitalise and strengthen them, along the lines of what the British Treasury is proposing to do.

But he "only" has $700bn to play with, which no longer looks that enormous in the context of the $400bn claims that may be enforced in just the next, anxiety-inducing few hours.

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• - What's this?

Shipping rates for transporting raw materials to the great manufacturing economies of the world, as measured by the , have halved over the past month - and have fallen 75% since mid-May.

This index is normally seen as a leading indicator of global economic activity.

In recent years it's been buoyed by China's voracious appetite for the world's natural resources, especially iron ore.

There may be one or two exceptional factors depressing shipping rates, such as a decision by China (which may turn out to be temporary) to consume from its vast stockpile of iron ore rather than bring in more.

But the fall in rates is redolent of a global economy on the turn, in a pretty sharp negative direction.

It's the backdrop to that the world's economy will grow at 3% in 2009 - which is on the cusp of what it regards as a global recession.

And it's the context for the , from China, to Europe to North America - which extended overnight to rate cuts by South Korea, Taiwan and Hong Kong.

The emergency action by the authorities to reverse the direction of the global economic supertanker away from a seriously impoverishing economic downturn also includes the lending of taxpayer's money to banks on a mindboggling scale.

This is absolutely essential, if banks aren't going to dramatically reduce what they lend to households and businesses and to ensure that at least some of the reduction in official rates is passed on to customers.

But the world's banks are becoming seriously dependent on incremental funding from central banks, and special additional liquidity provided by finance ministries, to make up for the seizing up of money markets - which in turn stems from the fear that grips managers of vast pools of cash (typically our pensions and long-term savings) and makes them wary of lending money to any bank where there's even the faintest smell of trouble ahead.

The money managers are switching their investments into government bonds and official national debt in its various forms, on the assumption that we as taxpayers are always good for our debts - although the recent behaviour of the Icelandic government in apparently failing to honour its deposit insurance guarantee to Icesave customers makes that a slightly more courageous assumption than it was.

What's happening, therefore, is that money managers are lending to governments like ours, and those governments are then recycling that money to the banks.

The perfect illustration of this is the £250bn guarantee announced yesterday by HM Treasury for short and medium-turn debt issued by our banks - that should allow them (phew!) to refinance their debts as they fall due in the next two or three years.

There's quite a big question - for later - about how on earth we wean the so-called commercial banks off their addiction to borrowing from the state.

And if the addiction can't be broken, there'll surely be big implications for how banks are permitted to behave (should a taxpayer-supported institution be paying any of its employees 800 times average earnings, which a few that are now utterly dependent on taxpayer support have been doing?).

But for now the pressing issue is how we can pull the global economy out of the deleveraging vortex, how we can crush the devastating phenomenon of banks collectively atoning for their past sin of lending too much by lending too little.

No single government, not even that of the US - as - can contain the destructive power of deleveraging, of the de-facto lending strike, on its own.

It may require global collective action by governments on a scale we've never seen before.

You only have to look at the implosion of Iceland's ludicrously oversized financial economy to recognise that even the British government's £400bn package of support for UK banks is a drop in vast and stormy global ocean.

Today the Icelandic Financial Supervisory Authority is .

It's not as big as Lehman, but it's connected to lots of other international financial institutions and businesses, and it has $73bn of assets.

Some of its overseas assets were dumped on the market yesterday. If there's a fire sale of the rest, the pain would spread way beyond this small and storm-battered nation.

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• - What's this?

The symbolism couldn't be worse.

- equivalent to about a third of our entire economic output - to rescuing the banking system.

And .

In other words, there's been a co-ordinated global attempt to prop up the financial system and save individual economies from a deep dark recession.

Yet the FTSE 100 plumbs new depths.

What on earth's going on?

Are we all doomed?

Well, the symbolism is a bit misleading, because the FTSE 100 is massively unrepresentative of the British economy.

The main reason it's fallen is because of sharp falls in the prices of giant mining companies that are listed on the London exchange.

So does that mean the FTSE 100 drop doesn't matter?

No, for two reasons.

First, one of the untold horror stories of the credit crunch is that it's wreaking havoc with the investments that underpin the value of millions of people's pensions.

Also, the reason for the fall in those mining companies is that there's been a further sharp drop in the price of commodity and energy prices.

Good news in a way, if it leads to lower household bills.

But the cause of those drops is a slowdown in economic activity throughout the world and the onset of recessions in several developed economies.

So what Gordon Brown and central banks have done today should stave off economic Armageddon - but it's probably too late to save us from months, or even years, of sluggish growth.

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• - What's this?

The government massive, unprecedented financial support for our banks, and their share prices fall - well all of them but that of HBOS.

Shome mishtake shurely.

Well no, that's completely predictable on the basis of a decision by the and the - as part of the rescue package - to pressurise eight banks into agreeing to raise at least £25bn in new capital.

This capital can come from commercial sources. But even if, for example, Barclays was able to raise new capital from regular private sector investors, that capital would be expensive - which is why its share price has fallen (by 15%, as I write).

And since the Treasury is actually making available at least £50bn of new capital to recapitalise the banks, it's pretty clear that the FSA - the City watchdog - thinks they'll need that much.

So it may be good news that the Treasury is prepared to shore up their balance sheets, but it's pretty bad news that there's such a big hole to fill.

Also the £50bn from government comes with expensive strings attached - such as reductions in dividends payable to other shareholders, and commitments to start lending again to small business and home buyers.

In other words, shareholders in the banks are being punished for the sins of executives who will need to go cap in hand to taxpayers.

Why has HBOS's share price risen?

Well, the big danger for HBOS was that it wouldn't be able to refinance its medium-term borrowings from the money markets as they fall due in the coming couple of years.

It faced possible insolvency due to the drying-up of these wholesale sources of finance.

HBOS has in effect been taken back from the brink by the Treasury's decision to provide a guarantee for new short-term and medium-term issues of debt securities by banks.

This may sound like gobbledegook. But what it means is that when banks raise money from other financial institutions, those loans will be guaranteed by the state.

Which means that when a bank or money manager lends to HBOS from now on, it is in effect lending to the Treasury or to all of us as taxpayers - and we're a pretty good credit.

So HBOS - and other banks that take advantage of the guarantee - should be able to start raising funds again from commercial sources.

Now here's the resonant conclusion.

If HBOS is no longer in imminent danger of going bust, there's no longer quite the same imperative for it to be rescued and taken over by Lloyds TSB.

That deal now looks like a fantastic one for Lloyds TSB, because it's a once-in-a-lifetime opportunity to create a retail super-bank.

But HBOS shareholders might wonder whether they're selling out too cheaply.

And the competition authorities may bristle too. They may nag the government about whether ministers were right to rule that the deal should go through, irrespective of whether consumers could be hurt by the birth of this monster bank.

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• - What's this?

The is substantial, as big an economic initiative as it has probably ever taken.

But then the problem it's trying to fix is huge.

First, the government will make available at least £50bn of taxpayers' money to invest in banks.

The cash will be there if banks need it, if they are being damaged by a perception that their balance sheets are too weak.

If any bank didn't need the additional capital - which will be classified as Tier One under the rules that determine the strength of banks, and will probably be in the form of preference shares - it would not have to take our money.

But if a bank does want it, there will be strings attached - such as restrictions on executive pay and limitations on what it pays out in dividends to other shareholders.

Taking taxpayers' money will not be a licence to trade as normal.

Second, the government will try to fill the almost lethal funding gap created by the collapse of wholesale money markets.

For a fee, it will guarantee the money they borrow from other banks and financial institutions for periods of up to three years.

This is crucial. Because one of the great fears at the moment is that they will be unable to refinance their asset-backed bonds and other wholesale borrowings as they mature over the coming two or three years.

This will be seen as particularly helpful to HBOS - and should facilitate its takeover by Lloyds TSB - since there has been uncertainty about how it was going to pay back holders of its mortgage-backed bonds,

Third, there will be a doubling from £100bn to £200bn in the Bank of England's Special Liquidity Scheme - which allows banks to swap their mortgages for Treasury bills, which are the equivalent of cash. It's a way of providing them with greater certainty about their funding for the next two and a bit years.

Pulling this together, what the government is doing, on behalf of taxpayers is providing hundreds of billions of loans and risk capital to fix banks and a banking system that's perilously close to the brink.

At a time when financial markets across the world have seized up, only taxpayers have the resources to fix this problem.

But three questions follow.

Will it be enough?

Well, unless the economy spirals into total freefall, it should be sufficient to keep our banks functioning in these challenging times.

Can it prevent the economy sliding into recession?

Most economists think we're already there. But the package should help to prevent the downturn becoming vicious.

Will taxpayers be poorer for the rescue?

There are a number of ways of looking at this.

Plainly it would be better for most of us if a deep recession - which would create misery for perhaps millions thrown out of work - can be avoided.

But there is no guarantee that we'll make a profit on the £50bn that's being invested on our behalf (although we might).

And given the sheer scale of how much we're lending to banks, many many hundreds of billions of pounds, there has to be a question mark over whether we'll get every single penny back.

This represents the semi-nationalisation of the banking system.

And what can't be predicted with any scientific precision is how many years it will take for the system to be privatised again, for there to be a reversion to almost business-as-normal for our banks.

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• - What's this?

The Government is poised to announce details of a comprehensive rescue package for the banking system.

It will include a proposal to inject capital into banks and to provide a standby facility to ensure our big banks have enough cash to fund their day-to-day operations.

In a UK context, this is a very big moment.

It is the government's attempt to stabilise our banking system.

I'll file more as and when I have more detail.

UPDATE: 20:03

As I said this morning, the amount of capital to be invested in our banks by the Government on behalf of taxpayers will be up to £50bn - which is what most analysts estimate is needed by the British banking system.

And there will also be a promise that if any bank has difficulty raising funds from wholesale markets - which remain chronically seized up - the authorities will fill the gap.

I presume that will require the Treasury to provide additional financial help to the Bank of England (that's more taxpayers' wonga), since the Bank of England's balance sheet is probably not big enough to fill our banks' wholesale funding gap on its own.

These are big sums of our money being put at risk to stabilise the financial system. It matters to all of us that the ambitious works - not least because the reluctance of our banks to lend to companies and households is sending the economy into recession.

For what it's worth, one banker - who runs one of our biggest banks - tells me that he is optimistic that it will bring a bit of calm to the extroardinarily turbulent banking market.

It's also a big moment for the Prime Minister, Gordon Brown. This is the first genuine, full-scale economic crisis he has had to face since he entered government, as chancellor of the exchequer, in 1997.

His place in history will depend on whether taxpayers' cash is being used to slow or stem the downward spiral in the economy or whether this is good money disappearing down a deep black hole.

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• - What's this?

A shortage of capital is a big issue for banks, as I've been blathering on about for days (and see my note of this morning on our banks' meeting with the chancellor and request for a capital injection from taxpayers).

But the really urgent issue is the breakdown of wholesale markets, and the increasing difficulty that almost all banks are having in funding themselves on a day-to-day basis.

The basic problem is that the collapses of Lehman and Washington Mutual have made all financial institutions wary of lending to any bank where there is even a scintilla of risk.

It turns out, therefore, that and the were probably wrong in allowing them to fail.

But that's spilt milk.

The more important point is that, across the globe, there are very few banks that are finding it easy to raise money from wholesale sources.

In other words, all this fuss about insuring retail deposits is beside the point.

We all know that governments won't allow retail depositors to lose money - so that's not something to worry about.

A far bigger concern is that most banks are suffering a progressive erosion of the money they receive from other financial institutions.

To date, that's been replaced by colossal loans from the authorities.

In the case of the UK, the and the have collectively provided well over £200bn of incremental lending to our banks over the past year.

It's what I've described as nationalisation by stealth.

But all governments will probably need to do more.

What the Irish government did, in guaranteeing both retail and wholesale deposits in their banks, may turn out to be something of a model for Europe-wide action.

What we may need is a cast-iron pledge from all European governments that they will fill whatever funding gaps emerge at their respective banks from the seizing up of money markets.

It's probably the best outcome that can emerge from today's meeting of European finance ministers.

Bankers all across Europe are watching this meeting, and keeping their fingers and toes crossed, that the finance ministers understand how fragile they are - and that the finance ministers will pledge to keep them afloat, whatever the apparent strain on public-sector balance sheets.

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• - What's this?

When Treasury officials started working overtime last week on an emergency plan to inject new capital provided by taxpayers into our banks, the chancellor wasn't sure how our banks would react.

Would they proudly tell him to hop off?

Or would they put out the begging bowl?

Well last night a trio of the UK's biggest banks - Royal Bank of Scotland, Barclays, and Lloyds TSB - signalled to Alistair Darling that they'd like to see the colour of taxpayers' money rather quicker than he might have expected.

According to bankers, these three were disappointed that at a private meeting last night with Darling, held at his request, he didn't present to them a fully elaborated banking rescue plan.

One banker told me that what he called the Gang of Three of Barclays, RBS and Lloyds TSB told Darling to pull his finger out and finalise whatever it is he's eventually prepared to offer on taxpayers' behalf.

On paper, Lloyds TSB, RBS and Barclays don't have a pressing need for additional capital.

But they have become concerned that they are being weakened significantly by investors' perception that they are short of capital and their balance sheets need to be strengthened.

Also at the meeting were Mervyn King, Governor of the Bank of England, and Adair Turner, chairman of the Financial Services Authority.

And although the other big banks were represented, it was the chief executives of Lloyds TSB, Royal Bank of Scotland and Barclays - respectively , and - who formed a tightly-knit caucus and gave urgent focus to the discussion.

The three banks estimate that they may need around £15bn of new capital each, with £7.5bn paid up front and a further £7.5bn guaranteed by the Treasury that would be delivered if it became necessary.

Current rough estimates are that the capital injection could be as much as £50bn in total for all British banks.

As yet however, there has not been any detailed negotiation with the Treasury on the amount of taxpayers' money that may be invested in them.

There is no precedent in the UK for taxpayers to take such significant stakes in banks.

The Treasury has been working on a rescue plan along those lines, as I disclosed in my note on Saturday.

The three chief executives will talk again today, so that they can establish a common position, in advance of any further negotiations with the Treasury on a rescue package.

The Treasury's current thinking is that it would acquire preferred stock in the banks, that wouldn't carry voting rights. But it would also take warrants over the ordinary shares, which is a device for ensuring that taxpayers would benefit if the banks' share prices were to rise.

However, the chief executives also told Darling that a capital injection of this sort would not be enough to stabilise the banking system.

The steady withdrawal of funds by other financial institutions, the collapse of the wholesale funding market, remains a serious problem - which probably can't be solved by the Bank of England continuing to provide ever greater loans against an ever wider range of collateral.

In the next couple of years, many tens of billions of pounds of asset-backed securities have to be paid off or redeemed by British banks. So the banks want a commitment from the government that it will lend to them, whether or not they have collateral of the sort demanded by the Bank of England, to allow them to redeem these bonds.

The banks are not looking for a formal guarantee from the Treasury that it will protect wholesale depositors, which is what the Irish government gave to Irish banks, but they would like a formal pledge that it will fill any funding gap created by the steady ebbing away of wholesale funding

If such a commitment were not forthcoming, confidence in one or more British banks may continue to ebb away, to a potentially lethal extent - or so the banks fear.

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• - What's this?

Blimey it must be serious.

Every European Union leader has signed up to the following statement:

"All the leaders of the European Union make clear that each of them will take whatever measures are necessary to maintain the stability of the financial system - whether through liquidity support through central banks, action to deal with individual banks or enhanced depositor protection schemes.

"While no depositors in our countries' banks have lost any money, we will continue to take the necessary measures to protect both the system and individual depositors. In taking these measures, European leaders acknowledge the need for close coordination and cooperation."

So the mayhem of uncoordinated statements and actions over the past few days by the governments of Germany, Denmark, Sweden, Ireland and Greece was simply an accident.

They're all back on the same hymn-sheet today.

Investors seem underwhelmed: the FTSE 100 index is tumbling and shares are currently almost 8% lower.

If sustained this would make it the third worst fall in the history of the FTSE 100 index.

Does this mean we're close to that fabled moment in stock markets - the point of capitulation - when investors lose all hope and dump their stock at any price?

According to the theory, there can be no sustained recovery until the markets are in the clutches of utter despair.

Not everyone subscribes to the pseudo-economic psycho-babble.

But it certainly looks hairy out there.

UPDATE 17:35PM:

Today was when no one could be under any illusion that the global banking crisis is primarily a North American phenomenon.

There's a mess in Europe too, because European banks were also seduced over the preceding few years into lending too much to cheaply to consumers and businesses.

In the past 24 hours, we've seen bank rescues in Belgium, Luxembourg and Germany, and an attempted rescue of an entire economy, that of Iceland.

We've also had the worrying spectacle of apparent disunity among the governments of Europe, with Germany, Denmark, Sweden and Spain all taking unilateral steps to reassure their savers - which risked destabilising banks in other countries.

And when EU government heads then issued an emergency joint statement promising to collaborate more closely, curiously that served to spook investors even more - presumably because it underlined the fragility of the banking system.

What's also prompted high anxiety among investors and bankers is the mounting evidence that the crisis in financial markets is causing a severe economic slowdown.

And when there's a collision of a financial and economic downturn, well the consequence can be painful - because rising unemployment leads to more loans going bad which further weakens our banks.

So the chancellor's plan to strengthen our banks by injecting taxpayers money in the form of new capital is also an economic recovery plan.

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• - What's this?

It gets weirder.

My official sources tell me that the German government is not legislating to formally increase protection for savers.

What Angela Merkel did, they say, was give a "political" commitment that no German savers would lose a penny - which is more-or-less identical to the commitment given by our Chancellor of the Exchequer, Alistair Darling

But the horse has already bolted - in that this morning the Danes have given an unlimited guarantee to their savers and the Swedes have massively increased the level of protection they offer.

Whether the German or British governments like it, there does appear to be a clear trend towards almost total protection for European retail depositors.

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• - What's this?

Welcome to another anxious Monday morning.

Money markets are deeply stressed again, with the Asian rates for lending between banks for three months remaining at their highest level since last December.

Asian stock markets are falling, with Japan down 5%.

And it's the troubles of Europe's banks, and the messy response of the authorities, that's to blame.

First, let's accentuate the positive.

's Belgian and Luxembourg operations have been bought - and effectively rescued - by the mighty of France for just under £12bn in shares and cash.

The troubled German property lender, , has been rescued for the second time in a week, with a package of loans provided by the government in partnership with a consortium of banks and insurers.

And the UK seems to have moved a step closer to announcing the details of a contingency plan being worked on in the (which I described in my note on Saturday) to inject billions of precious new capital into British banks.

So far, so reassuring.

But.

We still don't know how and what the Icelandic government will do to restore confidence in its banking system.

There's talk of a great national effort, or the use of its citizens' £8bn of pension savings to provide financial support to banks that may need it.

But as of now, it's unclear what Iceland will attempt to do to stem the flight out of its currency and shore up banks that have borrowed £80bn in foreign currencies (and see my other Saturday note, "Markets call time on Iceland").

Finally, there's the residual uncertainty about the extent of Germany's guarantee to holders of private accounts.

It certainly looks as though it's providing 100% insurance to £450bn of deposits. Which seems fairly ambitious, and will put pressure on the UK government to do something similar.

But here's the thing: retail deposits in the UK are much greater than that, some £950bn, according to an analysis by the City watchdog, the .

In other words, we in the UK appear to hold more of our savings in authorised banks than seems to be the case in Germany.

So for the UK to offer 100% protection would put a proportionately great strain on the public sector's balance sheet.

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• - What's this?

I don't now expect an immediate decision by the Chancellor of the Exchequer to follow the example of the Germans and offer a full 100% guarantee to protect the savings of ordinary retail savers.

Why not?

Well Alistair Darling and the Treasury can't get any sense out of the German government about what it is precisely that they are doing.

So there's no point in responding to something that's still a touch ephemeral.

There are two possibilities.

The German Chancellor, Angela Merkel, may be saying that the full financial might of the German state is guaranteeing or underwiting the retail liabilities of German banks - and thus bringing hundreds of billions of additional debt on to the public sector balance sheet.

That's certainly what's implied in briefings by the German finance ministry. And if that's what's happening, it will reverberate all over Europe.

It is the kind of commitment that would at a stroke strengten German banks in the eyes of their creditors.

And if there weren't to be an ebbing away of deposits from British banks, our chancellor and prime minister would have to respond in kind - at the cost of a massive increment to our national debt.

But it is theoretically possible that Angela Merkel thinks she is simply saying what Alistair Darling said at the height of the Northern Rock crisis a year ago, and repeated last week - which is that she's prepared to do whatever it takes to protect the savings of German retail depositors.

That's a rather softer promise, which wouldn't lead to a swelling of the German national debt.

One thing, and one thing alone is crystal clear: European governments are as dazed and confused by the mayhem in the global banking system as most of the rest of us.

So they shouldn't be surprised if money markets open tomorrow even more stressed than they have been of late.

After all it's been another weekend of attempted rescues of banks from Iceland, to Germany, Luxembourg, Belgium and Italy.

Fingers crossed all the relevant battered banks - or in the case of Iceland, a battered economy - have had the salve and plasters attached by dawn.

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• - What's this?

The decision by the German federal government to guarantee all private savings in German banks is momentous.

In a globalised banking market, in which money can leak across borders like a sieve, it will be almost impossible for the UK not to follow Germany's lead.

I would be immensely surprised if Alistair Darling, the Chancellor of the Exchequer, didn't announce a similar commitment within the next 24 hours.

The formalisation of full protection for depositors throughout the European Union became almost inevitable after similar decisions were taken over the past few days by the Irish and Greek governments.

But Germany is the biggest economy in Europe, a global powerhouse, with a banking sector that for years prided itself on its conservativism.

That Germany is the first of the major European economies to provide 100 per cent insurance to private savers shows just how fragile its banks have become.

The trigger for the announcement seems to have been the desperate straits of Hypo Real Estate, the commercial property lender whose rescue in jeopardy.

But that's only the trigger.

The underlying cause is a near-total collapse of confidence by creditors to banks and by bankers themselves.

Update 19:16

What an unfortunate mess. Just hours after leaders of the UK, Germany, France and Italy promised to co-ordinate their responses to the global banking crisis, Germany seems to have struck out on its own - by offering 100 per cent state-backed insurance to the country's private savers.

The German initiative - which is long on resonance and worryingly short on detail - caught the British Government off guard. The UK Treasury wasn't expecting any such drastic attempt to shore up confidence in Germany's banks.

And although official statements from the German government are unambiguous that savers money will be fully protected by the state, there's a disturbing lack of detail about precisely how this guarantee would work.

For example, it's not clear whether this is a formal, unambiguous commitment to take the retail liabilities of the German banks on to the public sector's balance sheet - a commitment would add many hundreds of billions of euros to Germany's national debt.

Also, to add an almost comic element to Germany's evasive action, almost simultaneously there's been a statement by the EU Competition Commissioner Neelie Kroes that blanket guarantees on bank deposits by individual members states are "discriminatory".

Kroes added that she was hopeful that Ireland's controversial 100 per cent guarantee - launched last week - would be modifiedn in "a form for which we can together state that it is line with the treaty".

At a time when there's profound unease across Europe about the safety and security of our banks, the spectacle of governments seemingly at odds with each other and with the Commission is unsettling, to put it mildly.

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• - What's this?

It's into the dangerous land of hubris that I'm going to stray today.

I have a plan (perhaps better than a Baldrick-style cunning one) that might just ease the credit-crunch pressure in the UK and help to fill the UK's yawning pensions hole, the humungous gap between what we as a nation save for retirement and what we should be saving.

This first bit is not my plan, but part of the Treasury's contingency preparation for the moment we reach Defcon 1 in the financial crisis (if we reach Defcon 1).

What's being considered by Chancellor and Prime Minister is that the public sector would inject new capital into our battered banks, to strengthen their balance sheets, and provide them with the muscle to start lending in a sensible way again.

And I'm told that their officials and advisers have sensibly learned a thing or two from the world's greatest investor, Warren Buffett, who recently bailed out Goldman Sachs with an injection of $5bn.

For this succour, Buffett received preferred stock paying a fat dividend of 10 per cent and warrants to buy a further $5bn of common stock at below the prevailing Goldman share price.

In other words he was being handsomely rewarded for providing Goldman with the resources to weather the storm and rebuild.

Which is arguably what we as taxpayers should receive as our just deserts, if the Prime Minister were to issue the call to arms, in a financial sense, and decided to inject billions of our cash into banks.

We too could take the stakes in our banks in the form of preferred stock with a warrants' kicker - so that we as taxpayers received both a steady and generous stream of income, and a very generous share of any future capital gains.

And I think, as I say, that if the worst came to the worst, that's what the PM and Chancellor would do.

Now, here's my modification of the Treasury proposal, my twist on a conventional Government rescue.

It's about making the most of a new institution that the Government has already established, the Personal Accounts Delivery Authority (PADA), which is setting up a new national pensions savings scheme for launch in 2012.

This will be a semi-compulsory, contributory pensions scheme for those not already in an occupational pension scheme - who number many millions, including a disproportionate number on low incomes.

My suggestion is that the Government could lend, say, £50bn to the PADA, and it could then use that cash to buy cheap stakes in banks, to help them recapitalise, and also - perhaps - to pick up other distressed assets.

Why am I excited by this idea?

Well, for those with deep pockets - like Warren Buffett - now and over the next couple of years is the best possible moment to be investing.

The best time to invest, always, is when everything looks gloomiest. That's when the bargains are to be had.

But normally those bargains are only available to the super-wealthy. Those on low incomes almost never have the money to invest when asset prices are low.

However, if endowed with a jumbo loan from taxpayers, PADA could invest like Buffett on behalf of the low paid.

It would be important that as and when employees and employers start putting their money into the scheme, in 2012, they should buy in at the effective price at which the stakes were built in banks and any other assets were acquired.

What I mean by this is that contributors to the scheme at the off should receive any upside in the value of these investments that had already accrued - which would also be an incentive for them to invest, because savers would receive an automatic and instant uplift in the value of what they put in.

And if by bad luck there weren't any upside by then, well then those capital losses would revert to all taxpayers - but the risk of capital losses would, I think, be quite small.

Anyway, the big point here is that for the past few years, there's been a massive widening in the gap between the rich and poor, because it's only been the rich and the super-rich who've been able to take advantage of the fabulous investment opportunities that presented themselves in the decade or so before the Crunch.

But the boot is now on the other foot. Probably only governments, through the deployment of taxpayers' money, can solve a financial crisis that was created in large part by the foolish financial risks taken by bankers and financiers whose common sense was wiped out by greed.

If we as taxpayers are cleaning up the mess, there should perhaps be a dividend for those in low paid jobs and insecure employment, who are hurt most by the economic slowdown precipitated by this crisis.

If PADA bought into the market for them over the coming two or three years, their retirement prospects should be that much improved.

And if the PADA could become an institutionalised Buffett on their behalf - buying low and selling dear - well then a bit of natural justice might be restored to the financial system.

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• - What's this?

The best way of seeing Iceland is as a country that turned itself into a giant hedge fund.

For years it paid higher interest rates than in many parts of the world, so its financial institutions borrowed a ton of hot money from abroad, which they then re-cycled into investments all over northern Europe, including the UK.

The Icelandic banking boom was an economic phenomenon created by what's known as the carry trade - whereby colossal sums of money were borrowed in places like Japan, where interest rates were effectively zero, for lending to institutions in high-interest-paying economies, such as Iceland.

This, for years, seemed to be a no-lose arbitrage on differential interest rates in a globalised economy.

But it was just another manifestation of the pumping up of the credit bubble, which is now deflating and hurting us all.

Here are the lethal statistics about Iceland: the value of its economic output, its GDP, is about $20bn; but its big banks have borrowed some $120bn in foreign currencies.

Now that's what I call leverage - and remember that's just the overseas liabilities of its commercial banks.

If this were a business, and if it had no other borrowings (which of course Iceland does have), this would be a ratio of 6.

Or to put it another way, Iceland simply doesn't have the domestic earnings to service this kind of debt.

Which is why if the Icelandic government were to formally underwrite all these liabilities - which it might just have to do, given that other banks and financial institutions no longer want to touch Iceland with the longest barge-pole ever constructed - well its national-debt-to-GDP ratio would be at a level that make the UK in the 1970s look like a model of prudence.

And if Icelandic taxpayers actually had to service all that debt, well there wouldn't be a lot left over for even the basics of life.

It's a proper old mess.

Of course I'm being a tad unfair, in that the banks that have foolishly borrowed all this wonga have invested in tanker-loads of offshore assets.

Much of the British high street, a load of property and the Hammers have been financed or are owned by Icelandic banks and financiers.

And those that have borrowed from Icelandic banks have frequently borrowed too much. Which means they will have to start looking for alternative sources of working capital and debt at a time when over-leveraged outfits aren't flavour of the month with our banks. Ouch.

So Iceland's problems have a direct knock-on for the British economy - and goodness alone knows how exposed our banks are to Icelandic ones through the interbank market or derivatives market. One British bank with a reasonable name and a long history, Singer & Friedlander, is owned by the Icelandic bank, Kaupthing.

That'll be making the City watchdog, the Financial Services Authority, a tad uncomfortable, because Kaupthing - which is no minnow, with gross assets of $73bn - has the worst case of financial BO I've encountered in some time.

On Friday, had anyone wished to take out insurance in the credit default swaps market to guarantee repayment of debt issued by Kaupthing, he or she would have had to pay a premium of £625,000 to guarantee the return of £1m.

Which is simply to say that Kaupthing couldn't issue new debt, even if it wanted to.

And even the Icelandic government is classed by the markets as a lousy credit risk. On Friday, the cost of insuring $10m of Icelandic debt was $1.5m up front and $500,000 a year - a cripplingly large premium.

So what'll happen to poor indebted Iceland?

Well, although its central bank has fairly substantial reserves - enough according to the central bank governor to cover imports for eight to nine months - it's difficult to see how it can re-float without international help.

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• - What's this?

So Mervyn has buckled, in the face of the near lethal conditions banks were facing in raising money.

There were reports from dealing floors this morning that a big British bank was having difficulty renewing credit, which took it too close-for-comfort to the brink.

And the market for commercial paper - which are securities issued by companies to provide short term funds - has been contracting in an alarming way, putting further pressure on all banks' balance sheets.

So the Bank of England has announced important steps to make it easier for banks to borrow from it.

The background is as I set out in my note yesterday afternoon (Nationalisation by Stealth).

The Bank will now provide three-month loans to banks in exchange for securities manufactured out of corporate and consumer loans, and also for certain kinds of asset-backed commercial paper.

This may sound slightly technical. But it really matters, because it makes it much easier for banks to borrow from the Bank of England, to replace the funds they are finding it almost impossible to raise from commercial sources.

And Mervyn King is not underplaying the significance of what the Bank has announced.

He says: "In these extraordinary market conditions, the Bank of England will take all actions necessary to ensure that the banking system has access to sufficient liquidity".

And there is big money to go with King's mouth.

There'll be an auction of £40bn of three-month loans next Tuesday, and further weekly auctions - whose size is yet to be determined - till at least 18 November.

This represents a massive increase in the help provided to banks by the Bank of England - and, of course, it means in effect that we as taxpayers are replacing all those funds that banks can't raise from wholesale markets.

What King has done should ease some of the strains in the banking system, though it won't be business as usual for a long long time.

And the Bank of England's succour is particularly important for HBOS, which was identified by investors as having the greatest difficult raising vital finance.

HBOS can now be confident that it will be able to raise the cash it needs - which means that today's action by the Bank of England can perhaps be seen in part as a bridging loan to it, till its rescue takeover by Lloyds TSB is safely completed.

PS. On the Ten O'Clock News on Wednesday night I took the slightly eccentric step of quoting , who in the 1870's taught us more-or-less all we know about how to deal with banking panics.

Bagehot was not a fan of the way that the Bank of England had reacted to 19th century banking crises, arguing that it had responded "hesitatingly, reluctantly and with misgiving".

He also wrote: "To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies; but it is the policy now being pursued".

Some critics of the Bank of England would say that Bagehot's criticism could apply to the recent performance of the Bank of England.

However, today's statement by Mervyn King, that the Bank of England stands necessary to provide whatever liquidity is necessary to protect the integrity of the banking system, implies that he's been re-reading his Bagehot.

UPDATE 15:16 Although HBOS is perceived in the market to be particularly strapped for cash, and is therefore a significant beneficiary of the Bank's new-found largesse, it isn't the bank that was having difficulty renewing credit in the money markets this morning.

That was another of our big banks - which only goes to show that the liquidity drought (which was acute again this morning) is vicious and pervasive.

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• - What's this?

The big vulnerability of British banks does not come from the danger that retail depositors, the likes of you and I, might shift our money around.

In the end, it's not practical for most of us to move our funds abroad - although we can and do move our money from banks we deem to be weak to those we see as strong, which obviously undermines the weak banks.

No, the big flaw in the British banking system is the way it became massively dependent on the money markets and wholesale funds.

Bank of England figures show that at the end of last year, there was a £625bn gap between the money lent by our banks and what they took in from conventional deposits.

That gap shows their dependence on wholesale markets - which have seized up and are very difficult for our banks to tap.

And, to be clear, this dependence on wholesale markets was a problem of the banks' recent making, because as recently as the beginning of 2001 the funding gap was zero.

Over the past few months, much of that gap has been filled by loans from the Bank of England.

In fact figures published just this afternoon showed that the Bank of England's direct loans to our banks jumped £49bn in just one week - and, including the special scheme that allows the banks to swap their mortgages for Government bonds, the authorities' financial help for the banks has grown more than £200bn in the past couple of years.

It's a sort of nationalisation of our banks by stealth.

However the banks told the Governor, Mervyn King, on Tuesday evening that they need even more cash from him, to avoid falling over.

Part of the problem is that as these wholesale loans become due for repayment, they're not being rolled over - which makes the banks ever more desperate for help from the Bank of England.

But King's not keen to forgive the banks for their past sins and bail them out even more than he has been doing. He views them rather as a parent sees a mischievous child, as needing to be taught a lesson.

And rather like upset sulky children, an extraordinary number of bankers have said plaintively to me over the past couple of days that "Mervyn really doesn't get it" - which is as much as to say that the mess they've made is far too big for them to clean up without his help.

The Chancellor rather agrees with the bankers. He is increasingly taking the view that although there may be a time for spanking the banks, this is probably not it - because the priority is to restore them to some semblance of health.

So there's a spot of tension between Chancellor and Governor, which is probably a bit more than then normal rivalry between Treasury and Bank of England - although officials close to them say that King seems to be less inflexible than he was.

As I pointed out this morning, at issue is the range of collateral the banks can provide in return for loans from the Bank of England.

King only wants the best quality assets as collateral - which is understandable, since he wants to protect his balance sheet and the interests of taxpayers.

But the banks are running out of the good stuff, and now want to swap commercial property loans, loans to companies and car loans for readies from the Bank of England.

This may sound tedious and technical.

But it really matters to all of us.

Because if the banks were to run out of collateral they can swap for Bank of England loans, well in the current inclement weather, that would be lethal.

Unconvinced?

Well, one of the reasons why the board of the Financial Services Authority deemed last weekend that Bradford & Bingley was no longer viable and fit to take deposits - which was the precursor to it being nationalised - was that it had almost run out of good quality assets that it could swap for loans from the Bank of England.

It wasn't the only reason why the City watchdog decided that B&B had reached the end of the line.

But B&B's inability to get much more out of the Bank was like the valve being closed on an intravenous drip.

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• - What's this?

If the patient is the financial economy, here's a smattering of the latest worrying symptoms.

1) National Savings has been overwhelmed by calls from anxious savers wanting to lend their money to HM Treasury rather than keep it in a high street bank. And there's also been such a rush to place deposits in taxpayer-owned Northern Rock that .

2) There's been a flight by some British savers to the safety of Irish banks, where . And here's an odd thing. Yesterday Ulster Bank, a subsidiary of Royal Bank of Scotland, was given 100% deposit protection by the Irish government, on the same basis as the independent Irish banks. So it's now safer for both wholesale and retail depositors to put their money into Ulster Bank than into RBS's NatWest subsidiary in the UK.

3) Austrian, South African and US mints are working 24/7 but still unable to press enough gold coins to meet soaring demand.

4) As I disclosed on the Ten O'Clock News last night, British banks urged the chancellor and the governor of the Bank of England at a hastily arranged meeting on Tuesday to please please let them swap their car loans, their loans to companies, their commercial property loans for cash from the Bank of England - because of their deep concern that wholesale funds are draining from the system. The banks felt they received a sympathetic hearing from the chancellor and a relatively hostile one from the governor. The banks fear, perhaps guiltily, that Mervyn King's understandable desire to see them spanked for their past sins and deterred from repeating their errors could turn out to be a capital punishment (smack! - no more banks).

5) Those same banks told the chancellor that their real vulnerability isn't the instability of retail savings, or the fear that the likes of you and me will move our modest amounts of cash. What really worries them is that huge wholesale deposits made by professional money managers are harder and harder to retain. And what the banks warned is that the Treasury may find itself having to follow the example of the Irish by guaranteeing retail and wholesale deposits (though the Treasury is reluctant to do this, because of how it would automatically lead to a ballooning of the national debt).

And now for the complicated and scary stuff. Today is the beginning of "auction season", when the starts a series of auctions to settle who pays what to whom on a plethora of credit derivative contracts relating to businesses that have gone into default.

It's settlement time on those humungous insurance policies for corporate debt, called credit default swaps, which I've mentioned to you as being another potentially lethal flaw in the financial economy.

In the coming three weeks, payouts of hundreds of billions of dollars may be made - or at least demanded - to cover losses arising from the defaults on the debt of Fannie Mae, Freddie Mac, Lehman and Washington Mutual.

Sandy Chen, the analyst at Panmure who's been a smart predictor of credit-crunch accidents, estimates that payments on Lehman's battered bonds could be as much as $350bn.

Now the problem here is that for every beneficiary of these payments, there's an underwriter - those who provided the CDS insurance - which has to find the cash. And, as I've pointed out, this was a largely unregulated market, so the great fear in markets is that some underwriters have insufficient capital and will simply collapse when the claims are made.

That in turn would hurt financial institutions expecting to be paid out on their CDS contracts and damage others with separate exposure to the collapsed businesses. The shock to the system could be very severe.

To compound the current anxiety about all this, the CDS market is so opaque that it's impossible to know right now who is holding the radioactive baby.

This gigantic CDS mess has contributed to the seizing up of money markets in recent weeks, the tendency of all banks and financial institutions to hoard cash - because no-one knows who or what may be vulnerable during the CDS auction season.

That, as if you needed telling, is just one more reason why the US $700bn bank bail-out is no panacea, even if we should be relieved that it has passed its first Congressional hurdle.

The financial weather ahead remains stormy and unpredictable.

PS. The most significant British corporate announcement today was that , It was planning to spend up to £900m this year on improving stores, its supply chain and computer systems. That's being reduced to £700m - and next year it'll be slashed to £400m.

In other words, M&S will be placing far fewer orders than planned with other businesses - which will have a damaging impact on their profits and on the prospects for their employees.

That's a graphic illustration of how the horrors of the financial economy are infecting the real economy.

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• - What's this?

First things first: if Lloyds TSB's takeover of HBOS were to collapse, HBOS itself would collapse and we'd all be staring into the abyss.

So that's not going to happen.

The deal has been agreed by both boards.

It's being backed with legislative help by the government.

The prime minister has staked his career on this rescue takeover.

It's going to happen.

But the gap between the value of what Lloyds is offering in shares and the market price of HBOS shares is so wide as to be impossible to ignore.

As of last night, HBOS's share price was 122.4p, while the per-share value of Lloyds TSB's offer was 188p.

So if you believe that the terms of the deal won't and can't be changed, the current HBOS share price is an opportunity to buy £10 notes for £6.60.

That looks too good to be true. And the normal investing rule is that if it looks too good to be true, then don't touch it even if you're in a radiation-proof suit.

But normal rules don't apply right now.

There's a from an unnamed "major" investor, who said to that newspaper: "the market is suggesting that the deal is not going to happen. And the market is usually right."

The market is usually right? Where has he or she been for the past few years?

In that period, the market has been comprehensively, systematically wrong about almost everything. But don't get me started.

I feel a burning desire to find out whether this "major" investor is by chance looking after my pension, because if so I might as well top myself.

To be clear, however, I am not saying the terms of the deal won't be renegotiated.

That'll depend on one thing and one thing only - whether the two banks fear that the deal will be voted down by Lloyds TSB's shareholders.

Now, there's a 50% to 60% overlap between the shareholders of the two banks.

And if those shareholders were being rational, they would vote for it - because they are simply exchanging one load of paper, their HBOS shares, for another load, Lloyds TSB shares, and the terms of the exchange should be irrelevant to them.

For Lloyds TSB to do the deal, it needs a simple 50% majority of those voting in a poll of its own shareholders.

In spite of the noise from a few recalcitrant shareholders, it's not obvious that the majority won't be secured.

What's more, the date for the vote hasn't even been fixed yet. And markets are so volatile, there's a risk that any revision of the terms at this second would have to be unscrambled again in a few days.

For both boards, it's time to put on the tin hats and explain to their shareholders why the terms were set as they were only a few days ago.

Which implies that those investors betting that Lloyds will massively reduce the price may be burned.

Maybe there will be a downward tweak in the value of the offer. Maybe not.

Markets are exhibiting all the symptoms of madness, so it's conceivable that right now there is an opportunity to buy pound notes for rather less than their face value.

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• - What's this?