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It's official. We the taxpayer own one of the world's biggest banks, Royal Bank of Scotland, or 58% of it.

Only a tiny number of RBS's shareholders chose to buy any of the new shares in Royal Bank that were being sold in order to strengthen its balance sheet - which was inevitable, since the new shares were more expensive than the price of the existing shares on the stock market.

So the Treasury, on behalf of taxpayers, bought up the remaining 23bn shares at 65.5p each.

And, with last night's market price at 55p, we as taxpayers are already sitting on a loss of £2.4bn on this stake.

But the share price may rise.

What's more important is that this huge bank - which has just under £2,000bn of assets - is now majority controlled by the state.

Its shares will be in the hands of a special new company, UK Financial Investments Limited, owned by the Treasury, but described as being at arms length from it (see my earlier note, "a new taxpayer-owned mega-bank").

This is intended to demonstrate that ministers will not meddle in Royal Bank's day to day operations.

That said, it is utterly implausible that ministers and officials will be able to stand by idly as and when Royal Bank takes actions that affect millions of voters.

The commercial judgements of Royal Bank's management will inevitably be conditioned by the inescapable fact that we the taxpayers now own the bank.

That's about a great deal more than whether it pays bonuses to senior executives or how much it lends to small business and homeowners (which is where the government has already exerted explicit pressure).

It's about fundamental questions of culture and about how much risk the bank is prepared to take or is allowed to take by the new proprietor.

Those who run banks such as Royal Bank have for years seen themselves as creators and manufacturers of financial products, companies that can generate incremental wealth and can grow faster than the underlying rate of the economy.

They didn't want to see themselves as the infrastructure of the economy, that couldn't and shouldn't attempt to push up their profits at an accelerating rate. Somehow it was a bit too humiliating to be no more than the pipework for the real generators of wealth, companies with genuinely new services, real products and real technology.

So bankers created and exploited new "financial technology" that enriched themselves (for a while, at least) and was supposedly benefiting all of us by providing unlimited quantities of credit at astonishingly cheap rates.

Much of that technology - the collateralised debt obligations, the collateralised loan obligations, the credit default swaps, the structured investment vehicles - generated colossal losses, hobbled the global banking system, and is part of the reason why taxpayers all over the world are now propping up wounded banks on a mindboggling scale.

So whether they like it or not, most banks and bankers are destined to lead a quieter, duller life for many years.

Which, many taxpayers would say, isn't such a terrible thing.

If our banks simply concentrated on the very basics - taking deposits, providing simple loans to customers they actually know, moving our money to where we want it to go - would that be so disastrous?

Throughout the entire history of banking there's always been a tension between their core function as public-service utilities and the desire of the bankers themselves to earn super-normal returns by speculating with their depositors' cash.

Whether they like it or not, all our banks will for the next few years look a lot more like building societies and a lot less like Goldman Sachs.

UPDATE, 09:45AM: Sorry. I forgot the elephant in the room, Royal Bank of Scotland's £1900bn of borrowings, deposits and other liabilities.

I'm sure these will be kept off the formal public sector balance sheet. The public finances really wouldn't look pretty if another 140% of GDP was added to the national debt.

But now that taxpayers own 58% of Royal Bank, we are explicitly and formally standing behind its entire, gargantuan balance sheet, its assets and its liabilities.

That was always true in an implicit sense, because Royal Bank was too big to be allowed by the government to fail.

But we shouldn't pretend that the liability isn't real. The assessment of Royal Bank's credit-worthiness is now closely linked to an assessment of the credit-worthiness of the UK state.

That cuts both ways. Royal Bank is benefitting from having the financial support of the state (which is why it really does have to behave itself).

But the fact that Royal Bank has this conspicuous support also shines quite a bright light on the huge and growing liabilities of the state, which will have an impact on the perceived credit-worthiness of Britain - and not in a nice way.

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• - What's this?

The manner of Woolworth's demise as a going concern was almost as shocking as the fact of its collapse into administration.

Although Woolworth had been one of the UK's weaker retailers for years - propped up by a decade of benign, debt-fuelled trading conditions which we now know to have been unsustainable - it was done in by a sudden deterioration both in the real economy and in financial markets that took hold four weeks ago.

And it's the suddenness of how everything turned bad that shocks - and means Woolies will not be the last casualty.

Up till then, Woolies sales had been broadly flat. Then, on an underlying or like-for-like basis, sales dropped off a cliff, falling by double-digit amounts in percentage terms.

Around the same time, many of its suppliers found they could no longer insure against the risk that Woolies would no be able to pay its bills. So Woolies was forced to pay suppliers in cash for all that important Christmas stock.

In the process Woolies maxed out its borrowing facility: its debt rose to the £385m limit imposed by its lenders, led by GMAC and Burdale (part of Bank of Ireland).

Perhaps unsurprisingly, GMAC and Burdale - each of which is owed around £70m - yesterday decided enough was enough, and pulled the plug. Other financial creditors include Bank of America, Barclays, GE, Wachovia and KBC, with GE owed the most of this bunch, or £50m.

Now what's significant is that Woolies is far from being the only retailer pummelled by the sharp contraction in Britain's economy and also by a sharp and painful rationing of credit insurance.

Many thousands of British businesses have had their insurance cover withdrawn for supplies to companies perceived by insurers as poor risks - and that's causing havoc on the high street.

Unless something can be done to persuade the big providers of credit insurance to reinstate cover - and that would probably require taxpayers to provide some kind of guarantee - Woolies will not be the last substantial victim.

Also, just because Woolies has been something of a lame duck for years, that does not mean its demise is somehow a self-contained episode, with little consequence for the broader economy.

The inevitable loss of jobs, perhaps 20,000 of them, will cause misery and hardship in itself.

There's a hole in the pension fund of £100m, so the Pension Protection Fund will have to pick up the bill for some of the group's pension liabilities - which drains the resources provided to the official protection scheme by other pension funds.

And then there's the knock-on to companies that supply Woolies stores with more than £1.5bn of goods every year. At a time when the UK economy is shrinking fast, the loss of these orders will be painful for hundreds of businesses.

Also Woolies owns a substantial wholesaler of books, music, games and DVDs, , whose turnover is well over £1bn. Entertainment UK has also gone into administration, which has raised the alarming prospect for some big supermarkets and high street stores that they won't be able to get hold of vital stock during the all-important Christmas selling period.

The corollary is that publishers and music businesses are anxious they won't be able to get their stock on the supermarkets' shelves.

What's more, as (and on Tuesday night he made the correct call that neither Woolies or MFI could avoid administration), Woolies' collapse will probably spark a price war - since the administrators will probably keep the stores open for the next few weeks, and slash prices to shift all the stock.

That would be good news for shoppers, very bad news for weak competitors.

So perhaps we should all weep for poor, lost Woolies. As it happens, I love its eclectic mix of light bulbs, pic'n'mix and gadgets you never knew you wanted. And for many kids, it's a treasure chest.

But even if you wrote it off years ago as an anachronism, you can't be wholly insulated from the indirect damage inflicted by the manner of its end.

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• - What's this?

I have learned that Woolworth, one of the UK's best known and oldest store groups, will under UK insolvency procedures.

The board will meet at 6pm to take the formal decision.

Deloitte will be appointed as administrators to the store chain and also to Entertainment UK, which supplies books and DVDs to supermarket groups.

However Woolworth's joint venture with the ³ÉÈËÂÛ̳ will not go into administration. It is owned by Woolworth's top company, which will not go into administration.

The collapse of Woolworth is likely to lead to the closure of hundreds of stores across the UK.

And it is also likely to lead to many thousands of redundancies.

Woolworth has 815 stores. The store chain employs 25,000 and Entertainment UK employs 5,000.

The company has struggled under the weight of £385m of debt. Its problems were compounded over the past couple of months when it was forced to pay cash when buying goods from suppliers, because trade credit insurers were no longer prepared to insure supplies to Woolworths.

UPDATE, 05:29 PM: For the millions of us who have grown up on Woolworth pic'n'mix and bought Power Ranger toys from them for our kids, the collapse of the store chain will bring great sadness.

And of course the pain and anxiety is much greater for the 25,000 employed in its stores.

So since the government has recently made such a great fuss about keeping small businesses alive, why didn't ministers try to keep such a substantial retailer afloat?

As it happens I understand that Peter Mandelson, the business secretary, had contact with the company today - to ensure that if it went into administration, it would minimise the anxiety to its employees, it would do what it could to protect its pension fund and it would keep its stores open if possible during the vital Christmas period.

But Woolies has been something of a lame duck retailer for years. It has been losing market share against intense competition.

And government policy is not to prop up lame ducks.

Which is why the board of Woolies, in the end, had no choice but to call in the administrator.

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• - What's this?

As I said boringly and monotonously on Monday, before during and after the pre-Budget report, the overhang of excessive debt accumulated in the boom years remains the biggest problem for the UK economy and for the world.

The past, current and future write-offs of trillions of dollars of imprudent loans is - as you know - the main reason why there is so little new credit being made available.

Which doesn't mean to say that Alistair Darling's attempt to stimulate economic activity is irrelevant.

But as , in a classic case of creating news by stating the bloomin' obvious, it's the massive retrenchment of lending by banks and other private-sector financial institutions that's doing us the most damage.

In response to this failure of the credit-creation system, what we're seeing - particularly in the US and the UK but also in other parts of the world - is a transfer of the risk of lending on a colossal scale from the private sector to the public sector, from commercial investors to the taxpayer.

That's happening because, after the collapse of Lehman, there's been a massive increase in the perception of the dangers of lending to the private sector and to emerging economies perceived to have borrowed too much.

So pension funds, money managers and sovereign wealth funds are demanding punitive returns for investing in pure private-sector entities. Their preference is to lend to countries like the US perceived as too impossibly large to fail.

And because the US state is still perceived to be a good credit risk, the US authorities can borrow to fill the lending gap created by the disappearance of private-sector funding.

Only hours ago, we saw the - in effect from taxpayers - to breathe life into the markets for residential mortgages, credit card finance, small-business loans, car loans and student finance.

That brings to more than $8000bn the aggregate amount of loans, guarantees and investments committed by US taxpayers in the past few months - whether they like it or not - to bailing out failing banks and insurers and also unfreezing credit markets.

It's a mindboggling sum, equivalent to around half of the annual economic output of the US.

Some analysts see this as the start of the money printing-presses being turned on with a vengeance, a deliberate attempt to stoke up inflation to reduce the real value of all those excess debts.

I'm not sure we are there yet - though it's probably only a matter of time.

The biggest chunk of the Federal Reserve's recent financial support has been allocated to the commercial paper market - which in effect means that US taxpayers are providing short term loans to the biggest US companies.

There's no reason to assume that we've seen the end of this process of the nationalisation of credit.

The head of one of our largest banks has told me there'll probably have to be sovereign guarantees provided at some point to the corporate bond market, because big companies are increasingly finding it both expensive and difficult to raise longer-term loans in the form of bonds sold to investors.

Here in the UK, the chancellor has signalled that British taxpayers will be called on to underwrite a revival of lending to small businesses and to home buyers - probably to the tune of well over £100bn.

And remember that taxpayers in Britain have already provided £600bn of loans, guarantees and capital for battered British banks.

To reiterate, the credit-creation process has already been nationalised to a great extent - and this process of taxpayers standing in for commercial lenders isn't over.

How far will it go?

Funnily enough, to a large extent that depends not on what happens to credit markets but on what happens to share prices.

As George Magnus of UBS points out, part of the problem for most banks is that they are not perceived to have enough capital, even after the recent injections they've received from governments all over the world.

With recession taking hold in most of the developed world, and with financial crises gripping many emerging markets, investors fear that we've only seen the tip of an iceberg of losses to be incurred by banks from their ill-advised lending splurge of the previous few years.

The big simple point is that banks can only lend what they can borrow. And when money managers provide funds to banks and financial institutions, and when banks lend to each other, they look at how strong the borrowers are: they assess whether the borrowing banks have sufficient capital to weather the storms ahead.

Right now, providers of funds to banks want them to have far more capital than they could ever possibly erode through the write-offs of the loans provided when the banks were infected by an epidemic of blindness about the risks of lending.

For some reason, the Treasury doesn't seem to understand this simple point. It yesterday issued a statement telling banks that they had more capital than they need for the long term - in the hope that this will provide our banks to lend more and take on greater risks.

However, it's almost irrelevant whether the Treasury thinks our banks have enough capital. It's the private-sector holders of trillions of pounds of potential funding for banks who'll determine whether the banks are appropriately capitalised. And at the moment, they'd like the banks to have more capital.

With stock markets on their knees, there only one source of new capital for most banks: us, taxpayers.

So here's the Catch-22 to end all Catch-22s. If we want our banks to lend more, they're going to have to be able to borrow more. And to do that, they're going to need to raise more capital.

Raising more capital, for many banks, means huge further cash injections from taxpayers.

That's why, as the governor of the Bank of England implied yesterday, we may yet see most of the banking system formally nationalised, so that it can do what it's supposed to do - which is to provide the credit that's absolutely vital if we're to avoid a prolonged and very painful slump.

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• - What's this?

Net new mortgage lending is likely to fall to less than zero next year, commissioned by the Treasury from Sir James Crosby, the former chief executive of HBOS, owner of the Halifax.

Sir James is warning that as homeowners are paying off mortgages, banks are putting less money back into the housing market than they are taking out.

This represents a wholly unprecedented collapse in funding for the British housing market and Sir James says it's likely to lead to further declines in house prices, falls in consumer spending and a rise in unemployment.

It comes after net new mortgage lending has already fallen from £108bn in 2007 to a forecast £40bn this year.

Net new mortgage lending has never been negative, since records began.

Sir James is particularly worried about the impact of the collapse in housing finance on Britain's battered housebuilders. He says that they are dependent on mortgages worth 85% of the value of homes being sold, and that the provision of these has tumbled.

Part of the cause of this drying up of finance is that banks are having to redeem £160bn of bonds backed by mortgages over the coming three years, when it expects to receive just £150bn in deposits from ordinary savers.

That's why Sir James is recommending that the Treasury auction £100bn of insurance to wholesale providers of funds, which banks would then lend in the form of mortgages.

The chancellor said yesterday that he'll provide the support, if he's allowed to do so by the European Commission.

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• - What's this?

There were three big numbers in the .

The biggest and most startling is that more than £500bn is being added to the national debt between now and 2015.

And the amounts that the government will be borrowing over the next two to three years will be unprecedented for peacetime.

But here's the thing.

If it weren't for substantial rises in National Insurance from 2011 onwards, those debt figures would be even greater.

Increases in employees' and employers' national insurance raise about £5bn every year.

And, funnily enough, £5bn a year is also what the Treasury hopes to save every year from 2010 in so-called "value for money savings" in National Insurance.

There was also a small number that caught the eye, which was that the Treasury expects the recession to be less severe than many independent forecasters.

And the Treasury also expects a sharpish economic recovery from the end of 2009.

Again, there are economists who fear the Treasury is guilty of optimism.

But investors apparently liked what they heard: the rise in the FTSE100 today is the biggest ever (though some of that is due to the bailout of Citigroup, which has very little to do with G Brown and A Darling).

Here's the big simple point.

This pre-Budget report symbolises a massive structural change in the British economy.

Quite apart from the massive rise in public-sector debt, there is also a big change in the structure of tax incentives.

These are the first seriously redistributive tax changes since the 1970s.

Or to put it another way, from 2011/12 the top 2% of earners will pay more tax.

In a way, this Labour government has ditched the cornerstone of Thatcherism, which is that those on highest earnings will create wealth for the benefit of all of us if they're allowed to keep as much as possible of their respective incomes.

More than a decade after the 1997 landslide, some will say that Labour has gone back to its socialist roots.

Tonight, the British economy has taken on a Scandinavian, left-wing tinge.

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• - What's this?

The overnight bailout by the is big and fairly complicated, but then it had to be: until recently Citi was the biggest bank in the world and even today its assets are not far off the size of Britain's economic output.

has been undermined by its hugeness and global reach, which made it difficult to manage.

And it has near-fatal exposure to the shattered US housing and commercial property markets.

So to reassure those who provide vital credit to Citi, its lenders and depositors, the and the have said they will absorb a proportion of future losses on $306bn of dodgy mortgages and mortgage-backed securities.

And the US central bank, the , is providing a "backstop" borrowing facility, just in case other creditors lose confidence and pull out their funds.

Also the US Treasury will inject $20bn of new capital into the bank in exchange for preferred stock.

In this complicated deal, the US authorities receive a further $7bn of preferred stock by way of a fee and warrants to buy ordinary shares.

The other "quid" for this very substantial taxpayer-funded "quo" includes prohibitions on all but token dividend payments on the ordinary shares and controls on executive compensation.

So this is the end of Citigroup's cherished commercial freedom, its long swaggering history of bestriding the globe as a banking giant.

This proudest of US banks has been humbled: the rescue is about as close to nationalisation as it's possible to get without the state taking 100% ownership.

And the deal is likely to presage a massive shrinking of its international operations, so that it eventually becomes a smaller, simpler operation, more suited to our newly sober age.

Over the weekend, there have been plenty of other manifestations of why so many of our heads are sore after the borrowing binge turned to bust.

Woolworth has been negotiating with its bank creditors and with a buyout firm, in an attempt to avoid being put into administration under UK bankruptcy procedures.

According to those close to the negotiations, even on a best case outcome up to 20,000 jobs could be lost at the iconic and battered retailer and more than 500 stores could be closed and sold.

Then there's the plight of all those overseas businesses that manufacture cars in the UK.

They're being mullered by a massive contraction of available credit and a collapse in sales.

So Jaguar and others want to borrow from taxpayers, since they can't borrow easily from banks or on wholesale markets.

Part of what they've requested is access to the Bank of England's special liquidity scheme which allows banks to swap mortgage-backed securities for Treasury bills (which can be turned into cash).

The motor makers want to exchange bonds or securities backed by car loans for Treasury bills - which would help them provide finance to those who might still want to buy a car, in spite of the inclement economic weather.

If you're shocked by the thought that we as taxpayers may soon be financing car purchases, don't be. You may recall that on 11 November I pointed out that VW said it was trying to exchange securitised car loans for £2.2bn from the European Central Bank (see my note, "The Rising Taxpayer Burden").

And in the US, the Federal Reserve is providing short term loans to all manner of big companies, including motor manufacturers, by buying up their commercial paper.

Governments and central banks all over the world are standing in for dysfunctional financial markets and providing financial support to large but humbled private-sector businesses.

Oh, and then there's the small matter of the UK's national debt, which is rising at a dizzying speed.

With public-sector borrowing in 2010 and 2011 expected to be equivalent to well over 8% of our economic output in each of those years, there's a serious risk that sterling will be shunned by international investors - which could lead to a painful increase in borrowing costs for our government, and perhaps even difficulties in financing the deficit.

So, in a way, the most important bit of today's pre-Budget report won't be the eye-catching tax cuts - which will be implemented more-or-less immediately.

More significant will be what the chancellor says about how he intends to reduce borrowing from 2010 on onwards, how he intends to restore the credit-worthiness of the UK (see Friday's note "Taxes to fall and then rise").

To fill a structural hole in the government's revenue account, Alistair Darling will announce deferred tax increases and public spending cuts.

These rises in tax rates and reductions in public expenditure would need to be both credible and substantial, to minimise the risk of a run on sterling and of a crisis in the public finances.

So what do you have when you put together all the new information to be digested this morning on the ailing patient, the global economy? Just another manic Monday.

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• - What's this?

On Monday, the chancellor will admit, by implication, that the government's industrial policy of the past decade has been something of a disaster.

Actually to call it an industrial policy is a bit misleading - but what I mean is the Treasury's celebration over many years of the UK's growing economic dependence on the City of London and financial services.

The City contributed around a third of our economic growth in the recent past and about 10% of total output.

It also generated a huge slug, directly and indirectly, of the tax revenues that flowed into the Exchequer.

So here's part of the horrible news we'll get on Monday in the pre-Budget report.

The slump in the City has knocked around £40bn - yes £40bn! - from annual tax revenues.

That's made up of lower corporation tax (our banks and other financial services provided about £10bn of this), lower income tax (those controversial fat City bonuses, now gone, yielded a fair chunk of tax), and lower stamp duty (on share trading and property deals).

And much of that tax revenue has probably gone forever, or at least for as long as the time horizon of most sensible forecasts (viz, up to five years).

How so?

Well, quite apart from the mess our banks are in, which has sent them tumbling into losses (no good for the tax man), the City in general is being forced by regulators to become a place where fewer risks are taken.

Such was the unambiguous message of last weekend's statement by the leaders of the G20 leading and most dynamic economies.

You may think it's a good thing that there'll be fewer risky deals by banks, hedge funds, private equity firms and so on.

But fewer risky deals, less risky lending, also means much smaller banks and City firms, much less employment, much smaller revenues, and much diminished tax payments.

So part of the hole in the government's revenues to be unveiled after the weekend should be seen as permanent.

Which is why the chancellor will have to announce that taxes are going to rise at a specified date in the future, to fill the structural hole in the public finances.

To be clear, I am not talking about immediate tax rises.

Quite the reverse.

I am certain that on Monday the chancellor will also announce a significant package of measures to stimulate the economy.

These will include tax cuts and spending increases funded by extra borrowing, equivalent perhaps to as much as 2% of GDP.

And the bulk of the tax cuts will be directed at those on lowest incomes, partly because they have the highest propensity to spend - for the good of the economy - and also for reasons of social justice.

Alistair Darling will describe such a giveaway as vital to lessen the sharp and painful economic contraction we're experiencing.

But he will also announce deferred tax rises and deferred cuts in public spending - to kick in when the economy has recovered a bit.

When would that be? Maybe 2010, maybe 2011.
If he fails to announce such debt-reduction measures, there could be very strong downward pressure on sterling and a corresponding damaging rise in the cost for the government of borrowing.

And, to be clear, the incremental sums he'll announce he has to borrow over the next couple of years will be colossal - equivalent to at least 8% of GDP, possibly more, or well over £110bn per annum.

You have to go back to at least the 1970's for a time when public borrowing was spiralling up at such an alarming rate.

Such a rise in public borrowing would be unsustainable.

Which is why, to repeat, there will have to be deferred tax rises and deferred public spending reductions inked into the public accounts and announced by the chancellor.

All of that is inevitable.

So which taxes will rise?

Well my prediction is VAT.

For the sake of transparency I should say that I don't know that there will be a VAT rise.

But a deferred increase from 17.5% to 22.5% in the VAT rate would raise around £20bn.

And it's one of the few future tax rises which might actually stimulate a bit of increased economic activity ahead of its implementation, rather than encouraging us to save

To use the economic cliche of the moment, it would give us all quite a "nudge" to spend now, before the swingeing increase in VAT would kick in.

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• - What's this?

In saying that there's a case for , John McFall - the chairman of Commons Treasury select committee - has shone a light on the paradox of the recent global rescue of the world's biggest banks ().

McFall and many others are exasperated that our banks remain deeply reluctant to lend to businesses and to individuals, even after so much taxpayers' money has been pumped into the banking system.

"What are the banks playing at?" many of you ask.

Well, funnily enough, part of the reason our banks are restricting the supply of credit actually stems from the official description of the bailout as "temporary".

Governments and central banks are saying that they want their (our) money back from banks within about five years.

That may seem a long time. But it's no time at all in the context of all the money that we've pumped into the banks.

The capital element of taxpayer support is only a small part of the problem.

Take the UK. Taxpayers are providing £37bn of capital to Royal Bank of Scotland, HBOS and Lloyds TSB.

Redeeming that will be enough of a headache in the coming few years, given the parlous state of capital markets.

But it's the tip of an enormous iceberg.

Special, additional taxpayer loans and guarantees to British banks are a further £600bn in total, or just under half the UK's total annual economic output.

All of that has to be paid back too. And since it can't be refinanced on wholesale markets (which are closed till who-knows-when), paying it back automatically requires our banks to lend less to all of us.

There's nothing the banks or we can do about this - unless we tell them that we don't want our money back. And I'll return to what that would mean in a moment.

Nor is this simply a UK problem.

As I've pointed out in earlier notes (see "The £5000bn bailout"), taxpayer support for banks across the world - from South Korea, to Australia, Germany, the US and so on - is around £5000bn in total.

Which is equivalent to a sixth of the entire output of the global economy.

And, again, the imperative of paying this back is a massive drag on banks' ability to lend and is therefore also a ball-and-chain on economic growth.

This, of course, is just one of the deadening weights on banks' ability and desire to lend.

The other severe constraints are:

1) regulators' very belated stipulation that banks and other financial institutions should hold much more capital and cash in their balance sheets relative to the value of their loans - which in a world where capital and cash is scarce and expensive is a massive disincentive to lend;
2) the devastating effect on credit creation of falling asset prices;
3) the relative dependence of British banks on funding from overseas institutions which are progressively calling in their loans;
4) the considerably increased risks of lending to individuals and companies when the economy shrinks.

Against that backdrop, the question is whether it is remotely sensible to put a deadline - implicitly or explicitly - on the repayment of all that taxpayer funding for banks.

But if we don't demand our money back, we'd be formalising that there's been a semi-permanent nationalisation of the entire banking system.

And that would massively encroach on the ability of our banks to operate as independent commercial entities.

There would be massive political pressure on them to become quasi-social utilities, providing loans at the behest of ministers and officials rather than on the basis of commercial criteria.

So here's what may turn out to be the choice: less lending for years or public ownership of the banks for the foreseeable future. It's not an easy choice, is it?

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• - What's this?

It's very rare indeed for a bastion of Britain's corporate establishment to say sorry about anything - let alone say it in a public meeting.

So Sir Tom Mckillop's big sorry to shareholders, customers and employees is a proper event.

Royal Bank has much to be sorry for.

The bank expects to make losses this year. There's a £20bn hole in its balance sheet, which is being filled by capital provided by taxpayers.

It doesn't get much worse - although there's evidence today that for Britain's banks, we're a long way from the end of the bad news.

A part of Northern Rock, called Granite - which packages up mortgages and sells them to investors as bonds - has disclosed that mortgage customers are 90 days or more behind with the payments on more than 2% of £35.5bn of mortgages.

That compares with less than 0.5 per cent of mortgages that were 90 days in arrears in mid 2007.

To translate, it means borrowers are in some difficulty on more than £700m of mortgages.

The Rock disclosed this serious worsening in mortgage arrears when also announcing that in effect it will be winding down Granite - which was the vehicle which financed the Rock's rapid growth over many years.

The demise of Granite is a setback for any recovery in the mortgage-backed securities market.

Such a recovery was always something of an elusive hope.

But if banks can't find any way to raise money for mortgages from wholesale markets, it means Britain's housebuyers will remain starved of loans for some time yet.

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• - What's this?

It's clear from comments posted on my blog that there's a widespread misunderstanding about what the massive taxpayer bailout of our banks was designed to achieve or could achieve.

The primary motive of the £400bn of additional taxpayer support provided last month by the Treasury was to prevent the collapse of the banking system (and really it wasn't such a bad thing to prevent a meltdown of most of our banks).

Or to put it more bluntly, the transfer to our banks of so much of our cash wasn't designed to kickstart lending by our banks - although it's unsurprising that many of you think that's what it was all about, because ministers created that impression.

The chancellor stipulated that recipients of the capital element of the bailout funds - of which £37bn has been drawn down so far - should maintain "over the next three years the availability and active marketing of competitively priced lending to homeowners and to small businesses at 2007 levels."

Which sounded very macho. And was politically necessary, because of a public sense of outrage that the banks should be propped up and yet give little back in return.

But what does "the availability and active marketing of competitively priced lending to homeowners and to small businesses at 2007 levels" actually mean?

It certainly doesn't mean lending at the same margin over the Bank of England's policy rate or Bank Rate, because for both mortgages and small-business loans that margin has soared - to reflect the increased risks of lending when the economy is shrinking and when many more businesses and individuals are financially stretched.

Obviously I can bore for hours about how mortgage providers are earning considerably more from providing scarce homeloans than they were only a few months ago.

But the only fact that you need to know about mortgages is that well over 50% of lending capacity in the mortgage market has been taken out by the problems at HBOS, the collapse of Bradford & Bingley and Northern Rock, and a freeze on new lending by small building societies.

The Treasury can shout all it wants to the recipients of capital from taxpayers that they must provide more loans to homeowners, but these recipients simply don't have the resources to fill the gap.

Which is why the pre-Budget Report on Monday is certain to contain measures designed to increase the flow of funds to our banks for transmission to homebuyers and homeowners in the form of mortgages.

Whether we like it or not, yet more taxpayers' money is bound to be thrown at reviving the mortgage market.

As for what's going on in lending to companies, the Bank of England's summary of business conditions, as prepared by its network of agents, blew the whistle on that yesterday. It said:

"Contacts reported a tightening in their own credit conditions since September. The all-in cost of finance had increased as set-up and management fees were raised and loans were increasingly priced relative to Libor rather than Bank Rate. Some contacts expected future cutbacks in facilities".

Or to put it another way, credit for business has become harder to obtain and more expensive.

Against that backdrop, the chancellor is considering giving increased taxpayer support to small business lending. As this morning's FT says, this is likely to involve an extension of a scheme that currently provides public-sector insurance (in effect) for 75% of the principal on some kinds of small-business loans.

The current scheme is tiny: it represents just 6% of all small-business lending of just under £6bn. So it would have to be massively expanded to yield serious benefits.

But this obsession with supporting small business may be a distraction from where the real weakness lies in corporate UK.

It's plainly important that as many small businesses as possible survive the current downturn, since they represent the future of the British economy.

However, they are not particularly indebted.

Many of them, very sensibly, have accumulated very substantial cash deposits.

On a net aggregated basis, small British businesses have zero debt. They are, to a great extent, well placed to survive our current economic woes.

Which cannot be said, I'm afraid, of all our bigger companies.

Our non-financial companies' gross debt is equivalent to 120% of our annual economic output. And much of that debt is concentrated in big companies in the sectors most damaged by the shrinkage of the economy.

From housebuilders, to national estate-agency chains, to construction groups, to property investors, to retailers, to restaurant and pub chains, indebtedness is at worryingly high levels.

The possibility that Woolworth could sell its entire chain of 800 stores for £1 and the collapse yesterday in the share price of the electrical retailer DSG are symptoms of a wider problem.

To repeat, the credit crisis is most acute for big British companies, not for small ones.

In the US, the Federal Reserve has thrown a $1800bn lifeline to substantial American companies, by agreeing to buy up their commercial paper. In effect, the US central bank is lending to them for up to nine months.

Our economy has huge structural similarities with that of the US. Draw your own conclusions.

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• - What's this?

In the next day or two, Sir Peter Burt and Sir George Mathewson will pull up their tent pegs and relocate themselves away from the furore over HBOS's future.

The duo of veteran Scottish bankers will announce that the barriers to keeping HBOS independent are insurmountable.

And they'll say it's the Chancellor, Alistair Darling, who has erected those insurmountable barriers.

As my note pointed out yesterday, the chancellor has raised strong doubts about whether the Treasury would provide vital new capital to an independent HBOS and he has also made it clear that the cost to HBOS of such capital (were it to be provided) would be almost prohibitively expensive.

So Burt and Mathewson - both of whom have other commercial activities to occupy themselves - can't escape the painful reality that their campaign to keep HBOS independent has become futile.

They recognise that most HBOS shareholders would take the view that voting to block the takeover against the revealed wishes of the Treasury would be an instance of turkeys clamouring for an early Xmas.

There is evidence that many (perhaps most) investment institutions support the deal. That can be deduced from the overwhelming support for the takeover shown today in a .

The reason it's possible to extrapolate from that vote is that there is an overlap of more than 50% between the institutions owning HBOS and Lloyds TSB.

So I think it is reasonable to predict that this takeover will now take place.

And it's also reasonable to predict that as and when Lloyds TSB reduces the headcount of the combined banks by 20,000 or more - as it must do because of the overlap between the operations of these two large organisations - some members of the government will not feel totally euphoric in getting what they wished for.

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• - What's this?

Barclays has sold the £500m of Reserve Capital Instruments that it clawed back from the royals and state investment funds of Abu Dhabi and Qatar.

Bored with what you've read so far?

Well it may be worth reading on, because in a way it's shocking that Barclays found buyers for this stuff - because it raises questions about why the bank gave away around £300m in commissions and warrants to Gulf investors who aren't exactly short of a bob or two.

Here's what you need to know.

When Barclays only 19 days ago sold £3bn of these Reserve Capital Instruments (RCIs) to Qatar and Abu Dhabi, it threw in warrants to purchase 1.5bn new Barclays shares at any time in the next five years at a price of 197.775p each.

According to Sandy Chen of Panmure Gordon, each of these warrants is worth around 16p, which would value the lot at just under £250m (and, by the way, some analysts have argued that the warrants are worth a good deal more than this).

They were apparently an important sweetener to persuade Qatar and Abu Dhabi to buy the RCIs. What's more, Qatar and Abu Dhabi were also paid a £60m commission in cash for taking the RCIs.

In other words, Qatar and Abu Dhabi were paid a bit more than £300m for buying £3bn of securities - and these securities pay a stonking 14% rate of interest until June 2019 (many of us would love a bank to pay us that kind of interest).

Here's the thing.

Other investors yesterday bought £500m of the RCIs without the inducement of the warrants or the cash commission.

Perhaps unsurprisingly, although Qatar and Abu Dhabi were prepared to release £500m of the warrants for sale to other investors - following complaints from British investors that they should have been offered these in the first place - the Gulf investors didn't give back any of the commission or warrants.

Qatar and Abu Dhabi therefore ended up being paid over £300m for taking even less risk on their investment in Barclays.

It's worked out very nicely for them indeed. Now there's a proven appetite for these RCIs, they could presumably sell the rest on the open market, should that be appealing to them. In which case, the £300m would become pure profit attached to zero investment risk.

So why on earth did Barclays less than three weeks ago feel it had to pay so much money to Qatar and Abu Dhabi, to persuade them to buy these securities?

Well, it points out that market conditions were fraught at the time.

But there was no urgent rush to raise the money. As Barclays told me back then, the had given it till early next year to raise the capital it needed.

Arguably therefore Barclays has needlessly given away £300m.

And don't think this is about losses suffered by funny, remote people in the City with no connection to you.

It represents an erosion of wealth for millions of us saving for a pension, since most of our pension funds and life companies have an interest in Barclays.

You should be concerned.

Could the board make amends? Well Barclays' four executive directors have volunteered to forego their bonuses.

But they would probably have to do without bonuses for around 10 years to compensate for the shareholder wealth given away in this transaction.

Which means that the decision by the board to offer itself up for re-election may turn out to be more than a symbolic gesture.

In particular, there is likely to be pressure on the chairman, Marcus Agius, to explain why he and the non-executives permitted the deal with Qatar and Abu Dhabi to be transacted on such generous terms.

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• - What's this?

The chancellor has this morning delivered a swingeing kick to Sir George Mathewson, Sir Peter Burt and any HBOS shareholders who may think the battered mortgage bank has an exciting future as a state-supported independent bank.

The context is the proposed takeover of HBOS by Lloyds TSB, which has the blessing of the government, but which the veteran Scottish bankers, Burt and Mathewson, wish to blow up - as does the Scottish National Party.

Alistair Darling makes a number of pertinent points which will make many HBOS shareholders curse, but may persuade them that they have no alternative but to vote for the takeover.

First, he says that "there is no automatic right of access to the recapitalisation scheme" - which is not what Burt and Mathewson have believed to be the case.

Darling says that any institution applying for an injection of capital from taxpayers "must have a sustainable business model and delivery plan" and its "funding profile, sources and mix must be clear, broad-based and sustainable."

HBOS's own board determined that it flunked those tests, that the probable alternative to being taken over by Lloyds was full-scale nationalisation - hence its decision to agree to be taken over by Lloyds TSB.

The onus is therefore on Burt and Mathewson to prove that the HBOS board is wrong, that HBOS has a sustainable future as an independent organisation - in spite of its exposure to the tumbling British housing and commercial property markets, and in spite of its reliance on funding from the collapsed asset-backed securities market.

Mathewson and Burt may be right, and the HBOS board may be wrong.

But it's courageous of them to battle on in the teeth of the conspicuous doubts of HM Treasury.

Even if Mathewson and Burt were right, Darling has given HBOS shareholders a second reason for holding their noses and backing the takeover by Lloyds.

The chancellor has consistently made it clear that the terms of the capital injection for HBOS were agreed by him on the basis of the business plan presented by Lloyds and HBOS as a single, merged entity.

If that takeover were no longer to take place, he would wish to re-open the negotiation.

What does that mean?

Today's statement from the chancellor says that even if he were to agree to inject capital into an independent HBOS, that capital would be hugely more expensive.

All the new ordinary shares required by HBOS would be priced at an 8.5% discount to the prevailing market price. As of today, that would mean that the new capital would be priced at 61p, compared with 113.6p under the current recapitalisation plan (the plan that would collapse if the deal with Lloyds collapsed).

The implication is that taxpayers could end up with a stake of more than 70% in HBOS, on the conservative assumption that the FSA, the City watchdog, determined that HBOS only required £500m of additional capital (which HBOS's own board fears may be unrealistically low).

Many would see a 70% taxpayer shareholding as de facto nationalisation.

What's more, the Treasury has also said that the coupon or interest rate on the preference shares which HBOS is selling to taxpayers, along with the ordinary shares, would be re-set.

The new interest rate would be based on "the rate at which eligible institutions have announced the issue of such instruments recently" - which is a pointed reference to Barclays paying 14% on the "instruments" sold to the state funds and royals of Qatar and Abu Dhabi (see this morning's earlier note).

In other words, an independent HBOS - if it were allowed to remain in the private sector at all by the Treasury - would be paying a stonking 14% interest on the prefs, not the 12% negotiated as a bank being taken over by Lloyds.

So what do you get when you crunch the chancellor's technocratic statement into a single sentiment?

Hmmm.

It looks like a pretty blunt warning to HBOS's beleaguered shareholders that they would vote down the takeover by Lloyds at their severe potential peril.

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• - What's this?

There's a slightly odd statement from .

It says that "in recognition of the extraordinary circumstances" of the way it raised £5.8bn from a Qatar state investment fund and an Abu Dhabi royal, its executive directors are foregoing all bonuses for 2008 and all board members will offer themselves up for re-election at the annual meeting in April.

And Barclays is offering £500m of reserve capital instruments - which pay a fat 14% interest rate - to (mainly) British shareholders.

But gallingly for UK Investment institutions, they're not being offered any highly valuable and desirable warrants to buy Barclays shares: no warrants are being released by Qatar or Abu Dhabi.

Some will argue therefore that the claw back for British pension funds and other investors of the £500m represents Abu Dhabi and Qatar getting an even better return for taking even less risk.

So Barclays British shareholders will still be feeling miffed.

The background is that many Barclays shareholders are concerned that their bank has given away far too much to Abu Dhabi and Qatar when raising the essential billions from them (and see my previous notes on this saga).

Their complaint is that if Barclays had taken underwriting from British taxpayers, which was offered by the Treasury, the capital could probably have been raised more cheaply and British shareholders could have subscribed for most of it.

The charge against the Barclays board is that for emotional rather than rational reasons it preferred partial nationalisation by a couple of Gulf states to partial nationalisation by HM Treasury.

While not formally admitting they bogged it up, a quartet of Barclays executives have volunteered to do penance by surrendering any entitlement to this year's bonus and living on gruel rations - by their standards - for a year.

For Bob Diamond, the head of Barclays Capitals - the bank's investment bank - this means getting by on basic pay of £250,000 (more or less what the prime minister is paid, including his salary as an MP, allowances and benefits), compared with £21m last year

And then there's the "back us, or sack us" gesture, with Barclays taking the unprecedented step (I think) for a British bank of putting every board member up for re-election.

This is slightly redolent of John Major's decision in the mid 1990's to offer himself up for re-election as leader of the Tory Party, in an attempt to put paid to the rebels who were trying to oust him as premier.

Which may not be a complete coincidence, since Major's main political adviser then was Howell James - who just happens to be Barclays' newish director of comms.

Major of course won that contest, but many would say that he never really regained his authority as prime minister.

Does the same fate await Barclays directors, and its chairman, Marcus Agius, in particular?

That rather depends on how the bank performs between now and the April vote. And also on whether our government starts to meddle in a way perceived as irksome by the City in the affairs of those banks such as Royal Bank of Scotland that are taking capital from taxpayers.

It is inconceivable that the entire Barclays' board will be sacked, but the judgement of executives and non-executives has been called into question.

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• - What's this?

Barack Obama said last night that he would do "whatever it takes" to "avoid a deepening recession" and that "we shouldn't worry about the deficit next year or even the year after."

This commitment to pull out all the fiscal stops to avoid a slump, in a recorded interview for CBS News's "60 Minutes", was probably music to the ears of Gordon Brown.

After all, if the US cuts taxes, increases public spending and borrows as if there's no tomorrow, surely that provides cover for the UK to do something similar next Monday in the Pre Budget Report.

But does it? It probably provides political cover. "What's good for America is surely good for us," will be a natural conclusion for many to draw. And in the sense that the whole world would benefit if America's downturn could be a short and relatively shallow one, that would be correct.

It would, however, be potentially dangerous to assume that America's economic policy can simply be replicated in the UK - because, and this is perhaps deeply unfair, international investors condone apparently reckless fiscal behaviour by the US, while punishing similar behaviour by other economies (such as ours).

For all the damage over the past eight years to America's reputation for sound economic stewardship, the dollar is still the world's reserve currency.

Its public sector debt is well over $10,000bn, equivalent to around 80% of US economic output - which is double the share of GDP take by UK government debt (albeit on official figures that many would say understate the true level of British public-sector liabilities).

What's more, even before the advent of Obama, the US national debt has been on a strongly rising trend.

And yet given a choice between buying dollars and pounds, international investors have been opting for the greenback - and how. The value of sterling against the dollar has fallen by a quarter in just the past four months.

Or to put it another way, the US - still the world's biggest and most powerful economy - plays by its own rules. Rightly or wrongly, it is perceived to be fundamentally more robust than our economy. Which means that the US can live beyond its means to a greater extent and for longer than the UK, and yet be spanked less by international investors.

So some will feel it's a little unfair that so much opprobrium has been heaped on the head of George Osborne, the shadow chancellor, for warning that there's a risk of a damaging run on the pound, in the event that our national debt was perceived to have escalated to worryingly high levels.

Maybe, locked in the bowels of the Treasury, there is a secret book of fiscal and monetary etiquette that defines what chancellor and shadow chancellor may say at times of economic crisis. Maybe Osborne has committed a terrible breach of the Treasury's club rules, the equivalent of passing the port in the wrong direction.

That said, perhaps it was the furious reaction of ministers to Osborne's remarks that was more telling, in what it implied about their fears for sterling's vulnerability.

In that context, what mattered more for Brown than Obama's "I-heart-debt" vow was the on Saturday night that they would "use fiscal measures to stimulate domestic demand to rapid effect."

What would suit the UK would be a massive increase in borrowing by all our competitor economies. Because if all economies were perceived to be shackled by mad levels of public-sector debt, then there would be no reason to single out the UK as being unusually burdened by the expense of service its borrowings.

But even then, the competitive position of the UK in an international beauty contest for investors' cash isn't brilliant.

Right now, our economy appears to be contracting more than that of any other major economy (a view reinforced by the that the UK's GDP will shrink 1.7% in 2009).

And although there are concerns about whether the eurozone economies will cohere at a time of such global stress, money managers right now prefer the apparent safety of investing in a currency, the euro, that pertains to a huge economy, rather than in sterling and the smaller British economy.

Which is why on the Ten O'Clock News last Thursday I highlighted sterling's weakness against the euro as a particular concern.

As for the other part of the G20's statement, on making financial markets safer and improving the regulation of financial institutions, Gordon Brown can take some satisfaction that the blueprint is similar to what the UK wanted.

Even so, he may regret getting what he wants. There will be significant costs to the UK over the next three to five years - and perhaps longer - of putting the financial economy on a sounder, more stable footing.

The G20's insistence that all financial institutions - from banks, to insurers, to hedge funds and private equity - should hold more capital and more cash means they will conduct less business and will generate significantly reduced profits.

The City of London will shrink. And what was for many years the engine of the British economy, generating a third of economic growth and a significant proportion of tax revenues, will be running at 30mph, not 90mph.

There is a cost to making the world a safer place. And much of the bill is being picked up by the UK.

UPDATE: Thanks to UltraTon for pointing out typo in paragraph three, now corrected.

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• - What's this?

HBOS's board has this afternoon explained why it sees the independence of the bank as a highly unattractive option.

In a document sent to shareholders about its plan to raise £11.5bn of new capital and to be taken over by Lloyds TSB, it says that it would need to raise more capital were the deal with Lloyds to collapse, by order of the City watchdog, the Financial Services Authority.

What HBOS calls a "preliminary indication" from the FSA - given a few weeks ago - was it would need to raise £12bn as an independent bank, a 4.3% increase on the amount HBOS is currently raising.

But HBOS fears it may have to raise rather more and on worse terms, were it to go back to the Treasury at this later stage and reopen negotiations on the fund raising. It tells shareholders there is no certainty about quite how much additional capital it would need to raise.

The letter to shareholders from HBOS's chairman, Lord Stevenson, is pretty alarming, It warns that independence could lead to "the loss of private sector status", or de facto nationalisation.

HBOS fears that all the increased capital would probably have to come from taxpayers - and that would give the state a large majority shareholding in the bank, perhaps of 70% or more.

Which explains why HBOS has rejected calls from the prominent Scottish bankers, Sir George Matthewson and Sir Peter Burt, for HBOS to remain independent.

UPDATE 06:00 PM

Some, such as Burt and Matthewson, will say that HBOS doth protest too much about the risk of the business losing its private sector status and becoming a nationalised bank.

After all, HBOS has confirmed what Burt and Matthewson contended, that the FSA had originally said that an independent HBOS would need only a few hundred million extra pounds of capital.

So for HBOS's case to be taken over by Lloyds to remain totally and utterly compelling, its chairman Lord Stevenson needs to demonstrate that he is right to fear that the FSA would now demand that the bank raise more capital and also that the Treasury would provide this capital on worse terms.

Shareholders may insist that he prove that he is not being alarmist.

Which in turn probably requires that the Treasury and the FSA both come out of purdah and state precisely how much capital they would want an independent Lloyds to raise and also the price of that capital.

PS This is the important part of the HBOS document:

7. Importance of voting

The HBOS Board unanimously recommends that shareholders vote in favour of the resolutions required to implement the Recommended Transaction.

It is important that all of the Resolutions are passed by the requisite majorities. This is because the Capital Raising and the Acquisition are interconditional and, together, they form the Recommended Transaction proposed and unanimously recommended by the HBOS Board.

If the Resolutions are not passed, none of the Acquisition, the Placing, the Open Offer or the HM Treasury Preference Share Subscription will proceed, and HBOS will be required to find alternative methods of increasing its capital base, and funding its business. On 11 October 2008 the FSA gave a preliminary indication to HBOS that if the Acquisition were not to occur, it would require HBOS to raise £12 billion of additional capital, made up of £9 billion of HBOS Shares and £3 billion of HBOS Preference Shares.

However, whilst HBOS would seek to raise additional new capital in those circumstances, there can be no certainty that the amount required would not be more than £12 billion or that HBOS would be able to successfully raise capital or as to the terms on which capital could be raised, including the terms of any participation by HM Treasury in any capital raising, or as to whether such fundraising would be on a pre-emptive basis. There can also be no assurance that HBOS would be successful in increasing its capital to the levels required to qualify for access to the Proposed Government Funding arrangements or to satisfy the requirements of the FSA on an ongoing basis.

This could result in an increase in funding costs arising from any credit rating downgrades or increased reliance on Government supported liquidity schemes; contraction of HBOS's balance sheet; and a longer time horizon than the one contemplated by the Recommended Transaction for the resumption of any dividend payments on HBOS Shares. Any capital raising might also be more dilutive and is unlikely to be available within the same time period as the Recommended Transaction.

There can be no certainty as to sources of capital if the Resolutions are not passed. The HBOS Directors would expect the UK Government to take appropriate action consistent with the policy objectives set out in HM Treasury's announcement of 8 October 2008 on Financial Support to the Banking Industry, which are to ensure stability of the financial system, and to protect ordinary savers, depositors, businesses and borrowers. Such action may include the issuance to HM Treasury of HBOS Shares on a basis which could be more dilutive to HBOS Shareholders than the Placing and Open Offer and the issuance to HM Treasury of other securities on terms less economically advantageous and more restrictive than the HMT Preference Shares or the loss of independent or private sector status for HBOS. The occurrence of any such action may cause the value of HBOS Shares to decline substantially with negative implications for HBOS Shareholders.

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• - What's this?

For reasons I explained a fortnight ago, Barclays shareholders don't like the way it's chosen to raise £5.8bn from the state funds and royals of Qatar and Abu Dhabi (see my note, "Barclays Protects its Bankers Pay").

Traditional British investment institutions don't like the substantial commissions paid to Qatar and Abu Dhabi to obtain the money (£172m in commissions and £66m in fees - and the commission would be payable even if the deal was blocked by revolting shareholders in Barclays).

Some existing Barclays shareholders think the interest rates on the novel securities being sold are too high. And they hate the way that the two Gulf states are receiving a generous dollop of warrants that convert into shares.

Put simply, they think Qatar and Abu Dhabi have been sold a stonkingly good deal, at the expense of long-suffering British pension funds and insurers.

Many of these investors simply can't understand why Barclays refused to raise the vital capital from British taxpayers, since the money being offered by HM Treasury to our battered banks looked considerably cheaper.

But although the deal with Qatar and Abu Dhabi leaves them feeling queasy, it's very dangerous for shareholders to reject the plan and deprive Barclays of the money.

Which is why, , RREV - the leading shareholder advisory service - is recommending that shareholders abstain when the fund-raising comes up for a vote on November 24 rather than vote it down.

That said, Barclays wouldn't be at risk of going bust if shareholders forced it to cancel the deal - because the Treasury has promised that all major British banks can raise the capital they need from taxpayers.

But my understanding is that HM Treasury would not provide the money as cheaply to Barclays as would have been the case only a few weeks ago - because it feels market conditions have changed (and it's also miffed with Barclays for implying that British taxpayers' money comes with horrendous strings attached - an insinuation that has embarrassed the banks that are taking shillings from the public purse).

So it probably wouldn't be rational for Barclays to go back to the chancellor with its cap out-stretched.

Is there nothing Barclays can do to placate recalcitrant British investors?

Well it could offer them an extra £1bn each of the two kinds of securities sold to Qatar and Abu Dhabi (they've already been sold £1.25bn of one class of the new securities on offer).

Barclays wouldn't have to underwrite this £2bn, because it would be nice-to-have money, rather than must-have money.

I suspect that pension funds would be ecstatic to be given the chance to buy some of Barclays' so-called Reserve Capital Instruments, which pay an annual coupon of 14% till June 2019 and have warrants attached to purchase shares at 197.775p.

Wouldn't you fancy being offered interest of 14%, with what's known as an "equity kicker" thrown in for nothing?

In fact, I've been contacted by Barclays' customers saying that they'd love it if the bank would pay them 14% interest.

If Barclays offered this investment to its millions of savers (which is not going to happen, so don't get your hopes up), there could well be a stampede to buy the stuff.

These Reserve Capital Instruments are, of course, riskier, than money held in a bank savings account.

But most of us are prepared to take a bit more risk for a bit more return - and that 14% rate, plus warrants, is a wonderfully healthy reward for risk.

UPDATE 11:49

I have just received a copy of the advice given by the Association of British Insurers to its members on how they should vote on Barclays' capital raising.

Unsurprisingly, it raises concerns about the cost of the money being raised, and signals discontent that the securities were not offered in a conventional way to existing shareholders.

The ABI's note is marked with an "amber" top, which means that it rates the deal as irksome rather than scandalous.

But, it also says that its assessment is "pending" - which implies that the "amber" may yet change.

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• - What's this?

So it's RIP to the First Septic Bank: the US Treasury will not, after all, be buying toxic assets from battered US banks and insurers.

Apparently there was simply too much residual poisonous poo in the system for the US Treasury Secretary, Hank Paulson, to mop up.

The proposal to buy all those collateralized debt obligations and other distressed securities would "take time to implement and would not be sufficient given the severity of the problem."

Little wonder Wall Street had the blues again last night - and, after the recent bounce, US shares are once again very close to hitting five-year lows. The downward trend extended to Asia in the ensuing gloomy hours.

So what's going to happen to the $700bn that Congress very reluctantly gave Paulson a few weeks ago? Well - as you'll recall - $290bn has already been allocated to strengthening balance sheets of leading banks and AIG, by injecting capital into them, as part of the global bailout of the banking system.

As for the rest, well more capital will be made available to financial firms, there will be attempts to stem the rising tide of foreclosures or repossessions of homes, and - which is the latest horrible phase of the credit crunch - Paulson will try to stem a threatened collapse in the provision of funds for car loans, credit cards and student loans.

The foreclosure numbers are horrible. In October alone, 280,000 US properties received a default notice, were warned of a pending auction, or were repossessed, according to RealtyTrac, which gathers such data. That's a rise of 25% year-on-year, and 5% worse than in September.

But as troubling for the US government is the drying up of consumer credit. In what we now have to refer to as the AL Era (that's the world after "After Lehman", or after Paulson allowed the Wall Street firm to collapse, thus shattering the confidence of lenders everywhere), the valve has been turned down on the provision of finance for credit cards, loans to buy a car and student loans.

What's happened is that the market for securitised credit-card receivables, car loans and students loans - those forms of debt packaged up into bonds or securities - seized up in October. Which is depriving the institutions that provide these loans of around 40% of their funding.

Which in turn means that US consumers are suddenly finding it pretty hard to get a loan of almost any sort.

So Paulson and the brainboxes at the US Treasury are working on a scheme that would involve taxpayers' money somehow supporting the provision of finance for consumer loans.

What appears to be under consideration is that the taxpayer would in effect guarantee to take the first five per cent of losses on securitised car loans, or student loans or credit-card loans - in the hope this would give investors the confidence to lend to financially-stretched US consumers.

We'll see.

In the meantime, the merciless onward march of the global economic downturn continues.

Germany is now officially in recession.

Chinese industrial output in October rose at its slowest rate for seven years - and the China has cut taxes on more than a quarter of exports, to stimulate trade.

Intel, the world's biggest chipmaker, says sales in the last three months of the year will be up to 15% lower than it expected (that's more than $1bn of lost revenue).

BT is slashing 10,000 jobs, principally among sub-contractors and agency workers (there may be slightly less to this than meets the eye, since apparently 4,000 have already gone).

GM is still teetering on the brink of collapse (see yesterday's note "Forced Convergence of China and US").

And so it goes on.

As I've remarked before, what's come to pass is what governments, central banks and regulators most feared: economies are shrinking while banks and financial institutions fear that their stinking Augean stables may never be clean.

UPDATE, 12:57 PM: I am indebted to "Queens-Subject", comment number seven, for pointing out a typographical howler that's now been amended. The amount already injected by Paulson into banks is of course $290bn, not $290m. Only wrong by a factor of a thousand.

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• - What's this?

The Bank of England's central projection for growth is that the economy will contract at an annualised rate of about two percent some time around March or April of next year, which is when it thinks we will be at the bottom of this particularly horrible cycle.

However, Mervyn King, the governor, thinks I shouldn't really refer to a precise number for the projected economic decline, because so much may change in the coming weeks: the government may cut taxes; the Bank of England may reduce interest rates again; credit conditions could tighten (a bad thing) or could ease; and so on.

He would rather I simply pointed you to the Bank of England's website where you can find its new - and on page 7 of that slim but characteristically elegant publication you'll see a fan chart of a range of probabilities for our economic prospects.

The unambiguous message of this chart is that there will be a fairly painful recession in 2009, with the economy declining by perhaps 1.5% over the course of the year.

But it also shows the economy recovering in 2010 and storming ahead in 2011.

On that basis, the loss of output in this downturn would be less than the 2.5% shrinkage in the recession of the early 1990s.

Which some economists, such as , regard as too optimistic (Capital Economics is forecasting an overall contraction of 3%, which would make this recession worse than the last one).

Anyway, even on the basis of what some will see as King's relatively sanguine prognostication, it's reasonable to expect measures to stimulate the economy from the chancellor - a combination of tax cuts and public spending increases - in his forthcoming Pre Budget Report.

And because various other fan charts in the Inflation Report show that there is a serious risk of deflation - of prices actually falling - it would be a bit odd if interest rates weren't cut again.

All of which should lessen our economic malaise a bit.

However there is a big leap of faith in the Bank of England's forecast that the recession will be short and sharp and that the recovery will be bouncy.

The Bank of England is assuming that at some point in the next few months the banks will stop the remorseless and devastating process of reducing the amount of credit they provide and will also cease increasing the cost of loans for those perceived as risky borrowers.

But a gradual recovery in the volume of lending may start rather later than it expects.

Given that the governor himself constantly refers to the recent crisis in the banking system as "the most severe episode of instability since the outbreak of World War I", few can doubt that the confidence of bankers has been shattered.

Bankers now have a perhaps exaggerated fears of making losses and are reluctant to lend to any business or household which they perceive to be a potential victim of recession - which, of course, is one of those examples of fears that, if acted upon, become self-fulfilling.

Also the recent bail-out of the world's banks made them financially dependent on taxpayers to the tune of £5,000bn.

Bankers detest their transmogrification into the welfare dependents of our post-bubble age, and they are desperate to pay taxpayers back - which would be much easier, in theory, if they lent less and therefore had a correspondingly smaller need to borrow.

You only have to think about the way that Northern Rock has massively reduced the number of new mortgages it provides to see how the kind of rescues we've seen of banks may stop them from falling over, but - in spite of the rhetoric of the chancellor and the governor - doesn't provide them with a serious incentive to lend more, to free up credit.

In a way, the government has come off the fence about the rescue of our banks.

If the chancellor wants them to lend more to all of us, he probably has to persuade them that a state of semi-permanent nationalisation is a good thing - and that they mustn't even think about paying taxpayers back for many many years.

But if he wants to wean them off state support as soon as possible, he can't expect them to grease the wheels of the economy effectively, to end the contraction of credit that's been doing us so much harm.

Or to put it another way, if the chancellor wants to be confident that we will eventually bounce back with a vengeance from this economy misery, he and the banks may have to accept that massive taxpayer funding of the banks is the new norm, the new status quo.

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• - What's this?

So how much of the US economy, the home of free enterprise, will end up being nationalised or bailed out by the state during the current economic crisis?

So far we've seen banks, mortgage companies, and a mighty insurer all being propped up and bossed around by the federal government.

And now it's the real economy, manufacturing, that US taxpayers are set to rescue.

Last night, for example, the Democrat Speaker of the House of Representatives, Nancy Pelosi, urged Congress to provide emergency financial help for the crippled US automotive industry.

What's being requested by General Motors, Ford and Chrysler is $50bn in loans, on top of the $25bn in low-interest borrowing approved by Congress in September for retooling plants.

As cash-strapped US consumers continue to feel this is not the best time to buy a car, and are purchasing fewer vehicles than at any time since the early 1990s, most at risk of collapse is General Motors, the largest US carmaker.

Pelosi made clear that she felt the big automakers had to be kept out of bankruptcy at all costs, because of the danger that its failure would lead to massive damage to suppliers and connected businesses, with the possible loss of millions of jobs. A recent study by the Center for Automotive Research concluded that the failure of just one carmaker would lead to 2.5m job losses.

The scale of what's at stake was captured chillingly in a quote from a bankruptcy lawyer at White & Case, Alan Gover, who is quoted on Bloomberg: "Trying to reorganise the auto industry in bankruptcy would be as close to reorganising the whole US economy as you could get," he said. "The vast supply chain involves thousands of businesses, millions of existing jobs and just as many retirees, as well as whole communities and states".

But here's what some may see as ironic, even - in a dark way - slightly amusing.

The fundamental cause of America's woes (and ours too) is that its consumers, businesses and government all borrowed too much in the good years, especially from China.

China's semi-nationalised, heavily state-controlled economy generated huge financial surpluses through its massive trade in manufactured goods with America. And those financial surpluses were recycled back to America in the form of loans, so that US consumers and businesses could buy even more from China's factories and workshops.

These massive trade and financial imbalances were unsustainable - and are now being brought closer to equilibrium in a painful way.

Because US financial institutions both borrowed and lent too much, and because many other mighty companies took on far too much debt, they have been facing collapse. And where they are perceived as too big too fail (where the collateral damage were they to fall over would be devastating), the US government is stepping in with financial succour from taxpayers.

For years the great trend in the world was the embracement of free enterprise in China.

But now, in America's darkest hour for generations, the US is embracing a form of state-control and intervention that looks remarkably Chinese.

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• - What's this?

For me, the most interesting story of the past 24 hours is that , the stressed German carmaker, is trying to raise €2.8bn (£2.2bn) from the .

It plans to raise cash from the ECB in exchange for €2.8bn of securities backed by car loans.

In effect, the ECB - and ultimately taxpayers in the eurozone - would be financing purchases of automobiles.

Crikey, is all that comes to mind.

What next?

Perhaps Marks & Spencer will be able to dump its unsold jumpers and knickers on the Bank of England, in exchange for a bit of useful short-term credit (the reported today by the is the first fall that the trade body has ever reported that wasn't caused by special factors, such as the timing of public holidays).

Or perhaps the Bank of England will allow Taylor Wimpey - which reported pretty dire results again today - to swap its unsold houses and land for some Treasury bills via a re-worked special liquidity scheme.

If only the Bank of England and taxpayers would refinance Taylor Wimpey's £1.9bn of net debt, the battered housebuilder wouldn't have to make veiled threats to its banks and bondholders that administration under insolvency procedures is an option, if the lenders don't agree to make the terms of their loans less onerous.

I don't expect the Bank to become so liberal in the provision of loans and liquidity, but I am not being wholly flippant - since a great deal of the dire economic straits we find ourselves in stems from the contraction of credit from normal commercial sources.

And, because of that, expectations are rising by the day about what we as taxpayers can provide in incremental loans to limit the pain.

As you'll recall, around the world taxpayers have provided a staggering £5,000bn of support for ailing banks. And I haven't included in that the astonishing funding provided by the US authorities, the US Treasury and the Federal Reserve, to AIG, Fannie Mae and Freddie Mac.

There's literally no point in sharing with you the losses announced yesterday by AIG, the radioactive insurer, and Fannie Mae, the mortgage provider. Those losses run to so many billions of dollars that they defy comprehension.

In a way, therefore, I see the UK's "whose-tax-cuts-will-be-biggest?" competition between the political parties as a bit of a sideshow.

Doling out a few extra pounds to most of us would probably be no bad thing, if we were to spend it (hoarding it would do the economy little immediate good - but there is quite a risk that we would hoard it).

But it's a bit like a blood transfusion for an ailing patient. It'll provide a bit of extra energy, but it doesn't deal with the underlying cause of the disease - which in this case is a global contraction of lending.

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• - What's this?

, the giant Chinese bank, is the mystery bank that Jim Spowart and hope will make an offer for to stymie the takeover bid from Lloyds TSB.

It would be quite an event were it to happen. If Bank of China swallowed our biggest mortgage bank, that would represent the most ambitious overseas acquisition ever by a Chinese institution.

Which many investors will see as reason to believe that - when it comes to "make-your-mind-up" time - an offer won't be forthcoming. Since Chinese businesses are not famous for their derring-do in the deals market.

Also, if Spowart and Bank of China were anywhere close to making a formal offer, they would by now have been forced to make a statement to that effect by the , under the code that governs these things.

So we can safely assume that Bank of China is not poised to swoop, that preparations are at a pretty early stage.

Which means, for now, that HBOS shareholders have a choice of the bird-in-hand, Lloyds - which may not be as plump as they may like - and that nebulous thing in the bush spotted by the duo of banking knights who want HBOS to remain independent.

Except that there may be nothing in the bush.
How so?

Well I thought that the that Lloyds TSB has lent £10bn to HBOS was highly significant (and, for the avoidance of doubt, Lloyds has lent its prey this tidy sum).

That £10bn is more than Lloyds would normally be allowed to lend to a single bank, under the 's strictures on how much any bank can be financially exposed to another bank.

It's only been allowed to make the loan because the City watchdog - like the Treasury - believes the takeover by Lloyds is a good thing and expects it to go through.

Which is unambiguous evidence that almost any other solution for HBOS's woes would be seen by the authorities as a poor second best.

And that, in turn, is enough to tell any putative bidder - Bank of China or anyone else - that it may be a fair old waste of time and money to prepare a counter-offer.

Also, in the unlikely event that another bidder were to emerge, it would probably have to pay back Lloyds pretty sharpish - which, with money markets still pretty dysfunctional, would not be easy.

Although in theory that £10bn could be replaced by an expensive taxpayer-underwritten issue of new debt securities by HBOS.

The inescapable conclusion to be drawn from the extraordinary support being given by the Treasury and the FSA for the Lloyds takeover is that they don't believe HBOS has a viable long-term business model.

Ministers and officials fear that HBOS has made serious strategic errors both in the way it funds itself and in the way it lent money.

Put crudely, HBOS is too dependent on finance from a mortgage-backed securities market that remains almost completely paralysed.

And HBOS lent too much to homeowners, and also to construction and commercial property companies - which are among the worst victims of our economic woes.

Here are two chilling statistics. As of 30 June, HBOS had to refinance £156bn of wholesale funding over just 12 months.

That's a huge amount of cash to raise in wholesale markets that have run dry. Which bank of its size anywhere in the world could comfortably raise so much right now?

And HBOS has £35bn of loans on its books to the crashing property and construction industries - a strong indicator of losses yet to be incurred.

What does that all mean?

Well the authorities became convinced in September and still believe that the most likely alternative for HBOS, were Lloyds not to buy it, would be nationalisation - which is not a bird in the bush that many HBOS shareholders will find attractive.

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• - What's this?

Some 2m small shareholders in HBOS and many thousands of HBOS employees may hope the two Scottish banking knights' plans to preserve the bank's independence receive a proper hearing - although there is no guarantee that what they propose will enhance the wealth of HBOS investors or the job prospects of HBOS staff.

But it's impossible to ignore the very formidable obstacles faced by Sir Peter Burt and Sir George Mathewson. The odds of them pulling it off are pretty slim (see my earlier note, HBOS takeover challenged, for the relevant background).

First there is the question of whether a bank with HBOS's exposure to the battered British housing market and with its dependence on flighty wholesale funding can be seen as a terribly attractive standalone business: whether it is viable in a very basic sense.

This is what Alistair Darling, the Chancellor, said last week to MPs about what would happen to HBOS if it wasn't taken over by Lloyds TSB:

"HBOS...both will have to go back to the FSA and we will have to recalculate the capital requirements and proceed accordingly. However, you should look at what the OFT report says about HBOS because it makes it clear that the most likely outcome without the merger would not be a strong, independent HBOS continuing to exist and exerting the same competitive pressures as it was in the past, because it recognizes that HBOS has a number of problems...You should look at the OFT report because it did make the point that if this does not go ahead, it does not mean that HBOS is out of the woods. Far from it; it still has very substantial problems we need to resolve."

Those are not the words of a Chancellor enthusiastic about HBOS's future as a standalone business.

Then there is the matter of how much additional capital HBOS would have to raise from taxpayers if it remained independent.

Mathewson and Burt think it would be not be very much, a few hundred million pounds (not trivial for most of us, but smallish relative to the £11.5bn that HBOS is already being forced to raise from the Treasury).

My Government sources say that the Financial Services Authority, the City watchdog, would probably require an independent HBOS to raise considerably more than Mathewson and Burt appear to believe to be the case.

And my sense is that the Treasury is not keen to put more taxpayers' money into HBOS.

In that context, it is relevant that Burt and Mathewson have not raised a bean of new capital to inject into HBOS.

Finally there is the unseemly issue of politics. In March of last year, Mathewson wrote this to the Scotsman newspaper: "I do not share the fear of independence which is currently being fostered by those who have most to lose by a change in the status quo and those who see Scotland as a source of safe seats thus guaranteeing their rule over the UK."

That is the sort of thing that the UK's pro-Union Prime Minister tends to notice. And Gordon Brown has been very publicly pro another union, that of Lloyds and HBOS.

The chances of the Prime Minister abandoning his backing for the takeover by Lloyds of HBOS are, I would estimate, slim to none.

UPDATE 17:00

Lord Stevenson, HBOS's chairman, has now replied formally to Mathewson and Burt, He has written to them that his board sees "no basis for future discussion" - which can be paraphrased as "hop off".

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• - What's this?

A pair of the best known and most respected bankers in the UK, Sir Peter Burt and Sir George Mathewson, are attempting to blow up the takeover of HBOS by Lloyds TSB.

Burt and Mathewson - the former chief executives of Bank of Scotland and Royal Bank of Scotland respectively - are convinced that HBOS and its shareholders would be far better off if the bank were to remain independent.

Their intervention will be difficult for the board of HBOS to ignore, not least because Burt is credited with creating HBOS. He was chief executive of Bank of Scotland when it merged with Halifax to form HBOS.

Burt and Mathewson are persuaded that HBOS would be viable as an independent, thanks to the massive taxpayer support offered to all the banks in October by the Treasury.

They have today written to the chairman of HBOS, Lord Stevenson, saying that he and the HBOS chief executive, Andy Hornby, should resign with immediate effect - and that Mathewson should become the new chairman of the bank and Burt should be its chief executive.

Their letter says: "It is our intention to create a detailed alternative plan that we believe will represent better value for both the HBOS shareholders and stakeholders alike by keeping HBOS as an independent bank".

If the board of HBOS were to refuse to appoint Mathewson and Burt, they plan to "canvass shareholder support with a view to requisition an EGM (an emergency shareholders' meeting) to seek your and Andy Hornby's removal from the board" - and their appointment.

Burt and Mathewson would stay in post long enough to ensure that HBOS was once again perceived to be on a sound footing. They would commit to recruit new credible management for the top positions at the bank, to make themselves redundant just as soon as the bank's owners felt that was prudent.

Their initiative may be particularly welcomed in Scotland, where there has been widespread concern that the takeover would lead to significant job losses and could damage the position of Edinburgh - the location of HBOS's historic and imposing head office - as a financial centre.

The Scottish National Party has been highly critical of the takeover.

By contrast, Lloyds TSB's proposed acquisition of HBOS has been supported and facilitated by the prime minister, Gordon Brown.

When announced in September, the takeover was effectively a rescue of HBOS, which had lost the confidence of many of its creditors.

The argument of Burt and Mathewson is that HBOS no longer needs to be rescued by Lloyds TSB, because the Government and Bank of England has offered vital funds to replace those that could be withdrawn by money managers and other creditors. "In the light of new capital from HMG for HBOS, the takeover is no longer necessary to ensure financial stability", their letter says.

They also contend that the terms of the takeover massively undervalue HBOS. The letter adds: "HBOS shareholders should be receiving more than 1 Lloyds share for every HBOS share rather than the 0.605 to which Lloyds have reduced their offer".

One complication is that both Lloyds and HBOS would be forced by the City watchdog, the Financial Services Authority, and by the Treasury, to raise more capital than they are currently doing, if the takeover were not to take place - because they would both be perceived as weaker as independents than if combined together in a new superbank.

The Treasury is currently offering to provide £11.5bn of capital to HBOS and £5.5bn of capital to Lloyds TSB.

The Government might not be delighted if it was forced to provide more taxpayers' funds to the two banks.

However, Burt and Mathewson believe that HBOS would require very little additional capital, perhaps a few hundred million pounds, whereas Lloyds has announced that as an independent it would need an extra £1,5bn.

The competition authority, the Office of Fair Trading would be pleased if the takeover collapsed, because it fears that the combination of the two banks could make the British banking market less competitive, to the detriment of consumers.

UPDATE 11:10

The big imponderables are:

1) whether this intervention will cause anxiety for those who finance HBOS, whether it will cause an erosion of deposits and credit lines, and thus shake the stability of the bank;

2) whether the Treasury would be prepared to commit additional capital from taxpayers to support the banks as independent entities.

If the Treasury won't back them as independents, or if the possibily of the deal not happening appears to be damaging HBOS (or Lloyds TSB), then the authorities will instruct the two venerable Scottish banking knights to ride away into the sunset.

UPDATE 17:00

HBOS has now formally told Mathewson and Burt to hop off. The chairman, Lord Stevenson, has written to them saying he sees "no basis for future discussion".

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• - What's this?

Spare a thought for those poor misunderstood chaps who run our big banks.

They've been bashed and battered for causing our current mess, by lending far too much too cheaply in the years preceding the onset of the credit crunch in August 2007.

And now they're being duffed up for making a more realistic assessment of the true risks of lending, and therefore failing to pass on all of the 1.5% reduction in the Bank of England's policy rate to borrowers.

I'm not being flippant, by the way. There is a serious point here.

We can't have it both ways. If, which is the case, the cause of our woes is that lenders lost sight of the true risks of lending - and you'll also have heard that diagnosis from the Bank of England and the Financial Services Authority - we can't really react with total outrage when the banks attempt to set the interest rates they charge us at a level that captures the probability that some of us won't be able to repay.

And, to tell you what many of you know from painful personal experience, the risk of a borrower defaulting rises when the economy shrinks in just the painful way that it is doing right now.

But, you'll say, the economy would shrink less if only the banks would lend more to small businesses and homeowners and at cheaper rates.

The banks are surely shooting themselves in the foot by restricting the flow of credit and increasing its cost, because in doing so they are turning our troubling economic plight into something rather worse.

You'd be right.

Where as it's wholly rational for any individual bank to take a much more cautious and conservative approach to lending, it's wholly irrational for all of them to do so at precisely the same time, especially when the economy is so weak.

That's of course why the Bank of England has reduced what it calls its Bank Rate by far more, 1.5 percentage points, than it's ever cut before (or at least since taking control of setting rates in 1997).

The Bank of England knows it can't be certain that the Bank-Rate reduction will be passed on in full in lower mortgage rates or cheaper money for businesses.

It's slashed enough, however, to be confident that a useful proportion of the reduction - perhaps half - will be passed on.

Now the really important point to understand is that the Bank of England can influence the cost of money for the banks, which in turn determines the rates that they can afford to charge us, but it does not set the cost of money for them in a mechanistic and precise way.

If banks were able to borrow from the Bank of England all the money which they then lend to us, then of course the Bank of England could set the interest rate we all pay.

But most of banks' cash resources, what they need to provide loans, comes from elsewhere.

It comes from us, in the form of the balances in our current accounts and whatever savings we have in our deposit accounts.

It comes from managers of hundreds of billions of pounds, who lend to banks for short period and for longer periods.

And it comes from other banks, since banks also look to each other for funds, to smooth out the peaks and troughs in their cash needs - via the now famous interbank market.

To a great extent, what really matters for the banks, when setting the interest rates they charge us, is what all the money raised from all those many different sources actually costs them, when it's all lumped together and averaged out.

Some of that money still costs them nothing or almost nothing. I'm talking about the funds that some of us still keep in current accounts that pay zilch.

But, as I pointed out in my recent note ("Why interest rates aren't falling") the cost of obtaining any substantial funds - especially from those money managers that look after squillions - has been rising since the onset of the Credit Crunch. And the main reason is that money managers believe the risk of lending to banks has risen very sharply, and they therefore want to be compensated for that additional risk.

So what is the average cost of money for our banks?

Well, it's not the Bank of England's 3% Bank Rate. Apart from anything else, that's a rate for borrowing overnight - and it would be foolish even by their standards for banks to set interest rates on loans to us with maturities of three months, or two years or five years on the basis of what they have to pay to borrow for 24 hours.

A traditional proxy for their average cost of money has been the three-month LIBOR rate, which is what banks pay for unsecured loans from other banks of three-month duration.

However, there is controversy over whether that rate is quite as accurate a measure of the genuine cost of funds as it once was.

But, for what it's worth, those who operate in the market believe that three-month LIBOR will fix at just under 5% this morning.

Which would mean that the Bank of England's 1.5 percentage point cut had reduced the cost of money for banks by around 0.75 of a percentage point, perhaps a tiny bit more.

There is therefore an argument that mortgage rates and loans to businesses should be reduced by at least 0.75%.

And if banks fail to do this, well then the Chancellor - and the rest of us - are probably entitled to biff the banks.

That said, the Chancellor is not quite the innocent bystander in all of this.

As you'll recall, he recently rescued the banks with a £400bn taxpayer-funded package of capital injections, guarantees and loans.

A very important part of that was a commitment to provide taxpayer-backing for £250bn of tradable debt issued by banks with maturities of up to three years.

To translate, we - as taxpayers - will stand behind a bank when it borrows from financial institution. We're saying we'll repay the banks' debts if it can't do so.

The Chancellor understandably took the view that if taxpayers are in a sense insuring the money being borrowed by banks, we should be paid for that insurance.

But the cost of that insurance isn't cheap. It's working out at between 1.2% and 1.7% per annum of the amounts being borrowed for most banks.

That's 1.7% that has to be added to the 4 per cent or so interest-rate cost of the funds being raised.

In other, the price of money for banks under the government's own sponsored scheme is somewhere over 5%.

It's therefore very difficult to see how the banks can charge us less than the 5% that the Treasury is demanding they pay for the vital taxpayer-backed funds they need.

Unless, that is, the Chancellor were to decide that the banks should be transformed into loss-making public utilities.

UPDATE: 13:05

Three month sterling LIBOR has in fact fallen just over 1 percentage point to 4.49%. There will be intense pressure on the banks to pass this cut on in full, at the very least in the rates for new tracker mortgages.

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• - What's this?

The Bank of England has some explaining to do.

In September, it said there was a case for raising interest rates - that there was a risk inflation would remain above the 2% target.

Since then, the Bank of England has cut interest rates by two full percentage points, including today's cut of 1.5 per cent - a bigger cut by far than any it has made since it took full control of setting what's known as the official Bank Rate.

And in slashing that interest rate, it said there was now a serious risk of inflation undershooting its target - because the economy is shrinking so rapidly.

How on earth - you might ask - could economic conditions change quite so fast?

How could inflation be the worry in September and a deep dark recession be the fear today?

Is it possible that just two months ago the Bank of England failed to assess properly the weakness of the economy.

This really matters - because the Bank of England's success for a decade after 1997 in controlling inflation and providing a firm foundation for stable economic growth stemmed in part from its credibility.

It succeeded because the important economic players - businesses, employees and consumers - negotiated to set prices on the basis that the Bank's judgement about the outlook for inflation was probably right.

If the Bank's judgement were no longer trusted, its ability to do its job - to control inflation - would also be seriously impaired.

UPDATE 20:30: The IMF has tonight published a forecast that the British economy will shrink by 1.3% in 2009. That's a full 1.2 percentage points worse than the prognostication made only a few weeks ago by the ambulance service for the global economy.

That deterioration in our economic prospects helps to explain why the Bank of England has acted so decisively today.

But the IMF is also predicting that the performance of the UK will be the worst of the developed economies - which puts more pressure on the Bank of England to explain why it was inappropriate to make such a cut in interest rates rather earlier in the autumn.

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• - What's this?

I've just had a call from an astonished individual who has several hundred million pounds that he puts on deposit in various banks.

As of 10 minutes ago, a leading British bank was offering to pay him almost 7% interest for his cash.

That was after the by 1.5 percentage points to 3% - an unprecedented reduction in the history of the Bank's Monetary Policy Committee.

Why does it matter that this holder of squillions is still being offered almost 7%?

Well, if he's being paid almost 7%, what chance is there that small businesses will be able to borrow at less than 10, 12, 14% or more (with the actual rate depending on an assessment of their credit-worthiness)?

Those who most need a substantial cut in the interest they pay - hard-pressed businesses, cash-strapped households - are unlikely to enjoy more than a small reduction.

As I described in my note on Sunday ("Why interest rates are not falling") the transmission mechanism from the Bank of England's policy rate to the interest rates we pay has broken down.

Lenders have - understandably - concluded that the risk of lending has risen very sharply, and are therefore demanding much greater rewards for providing credit.

So at a time when all the indications are that we are in a fairly severe recession, and many companies and individuals are struggling to keep afloat, it's a serious worry that even the kind of evasive action attempted today by the Bank of England may provide only modest succour.

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• - What's this?

Barack Obama's economic and business policies are, on paper, more conventionally left wing than those of Gordon Brown.

They include:

a) a windfall tax on the "excess" profits of oil companies;

b) a redistributive tax cut for those on middle and low incomes, funded by a claw back of tax cuts received by the wealthiest 2% during President Bush's two terms;

c) serious public spending on roads, bridges, transport and infrastructure;

d) subventions for renewable energy and for the development of green technologies, especially in the automotive industry;

e) tax penalties on US companies that relocate jobs overseas and tax breaks for companies that create jobs in America;

f) greater rights for trade unions to recruit;

g) curbs on what credit-card companies can charge and increased rights for homeowners struggling to pay their debts.

In theory, it represents a significant shift of money and power from private sector to public sector and from the super-rich to those on middle and low incomes.

In a UK context, Obama's decisive victory may provide cover for a leftward move by the Labour government, to the delight of many Labour MPs and the anxiety of many in the City and in business.

But I couch all this in hypothetical terms.

Because Obama may turn out to be less red in the practice of his presidency than his words and aspirations would imply.

For example, on that windfall tax - which much of the Labour Party would love to see imitated here - there's already been a strong hint from Obama's advisers that it's on hold, following the collapse in the oil price.

That said, the oil giants have been making stupendous, record-breaking profits. And if Obama were to fail to skim off some of these, it's difficult to see how and where he will raise the money for his significant tax cutting and spending commitments.

The point is that he is inheriting an economic estate that has been pillaged by his predecessor.

US public sector debt is well over $10,000bn, equivalent to around 80% of US economic output (roughly double the share of GDP taken by our government's debt - though most economists would say that the Treasury significantly understates the British national debt).

And the rising burden of bailing out America's battered banks and financial institutions means that US government debt is on a strong rising trend.

That worries foreign investors who are supposed to buy all this debt in the form of US Treasuries.

If these investors see no realistic prospect of Obama cutting public borrowing on any meaningful time horizon, that would put further downward pressure on the dollar against the currencies of China, Japan and the eurozone (though probably not against sterling, since the UK is perceived to have too many structural weaknesses in common with the US).

Which perhaps would be no bad thing for US exporters. But it would be a problem if it led to a painful rise in the cost for Obama's administration of servicing all that debt.

The US government, US banks, US consumers and US business all remains precariously dependent on borrowing from Asia and the Middle East.

The urgent need for the US to become more financially self-sufficient, for its economy and the global economy to be better balanced, may conflict with Obama's determination to spend in order to make his country (in his view) a fairer society.

UPDATE, 13:50: Whoops. Mea culpa. I omitted a "0" from US national debt in the initial published version of this note (if you're a creditor of the US, I guess you might mind if nine trillion dollars was wiped from what it owes by a missing keyboard stroke).

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Stephen Hester has today signalled that will make .

In an interview with me for the Today Programme, the new chief executive of the battered bank said that "people may conclude that profits will be difficult to achieve" for 2008 and that it "wouldn't surprise" him if analysts forecast a loss.

And although we've become inured over the past few months to the world's biggest banks announcing losses, it's still momentous that RBS is heading for the first full-year loss in its history.

After all, RBS owns NatWest. It's supposed to be solid and dull, concentrating on providing very basic banking services to millions of individuals and businesses.

Banks like RBS aren't supposed to make losses, ever.

So where did it all go wrong?

Well Hester puts the blame squarely on "leverage", on the RBS's decision to lend far too much in the boom years.

It became far too exposed, though its investments, to those disastrous subprime loans to US homeowners with poor credit histories.

RBS increased this exposure through its imprudent, top-of-market takeover of a huge chunk of the giant Dutch bank, ABN.

But, perhaps as damningly, it provided excessive loans of a more mainstream sort to businesses and households that are beginning to have difficulty keeping up the payments.

So RBS - like HBOS - has just survived one set of multi-billion pound losses on the subprime phase of the credit crunch. And it's now being tested by rising impairment charges on more conventional lending, because the recession into which we're careering is making life tough for those with big debts.

That's why Hester was parachuted in as new chief executive. That's why RBS has gone cap in hand to the Treasury for £20bn of new capital from taxpayers.

Hester is determined to fix the bank, and fast. There will be job losses, he told me. Assets will be sold.

And he's desperate to redeem the £5bn of preference shares he's selling to the taxpayers as quickly as possible, so that he'll regain the freedom to pay dividends as and when he likes to shareholders.

He said that he would be "disappointed" if he couldn't pay dividends in 2010.

Strikingly, he didn't sound like an executive who feels that his room for manoeuvre is being excessively constrained by the supposedly stultifying interference of the Treasury.

He does, for example, believe that he can make increased credit available for small businesses and house purchase, as the Treasury wishes - although he's not promising that the credit will be cheap.

Here's the odd thing. Although it's profoundly humiliating for RBS that it's heading for a loss, in a way that's history - the inevitable consequence of previous mistakes.

RBS's darkest hour was a few weeks ago, in late September and early October, when the entire banking system was close to total paralysis.

As Hester conceded, a number of big banks suffered a flight of vital funds that took them to the brink of collapse.

RBS - and others - have been bailed out by taxpayers, to the tune of £5,000bn in support provided by governments across the world.

Without that support, Hester would now be - in essence - a financial undertaker, rather than a chief executive determined to restore strength and resilience to a pillar of the British economy.

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The great fear in the City about the Treasury taking stakes in three of our biggest banks is that this partial nationalisation will turn them into non-commercial public services.

No bad thing, some might say.

But it's not what the chancellor and prime minister want.

So they are putting the shares that will be acquired for taxpayers in Royal Bank of Scotland, HBOS and Lloyds TSB into a new company that will be owned by the Treasury, but will be managed at arms length.

That company will be chaired by a former finance director of Lloyds TSB, Sir Philip Hampton, who is currently chairman of the supermarket group Sainsbury.

He knows banking better than most.

And his job will be to force the banks to:-

• continue lending to homeowners and small businesses,
• to prevent the banks senior directors from being paid more than is deemed to be fair and appropriate, and
• to make sure that the banks grow their profits in a sustainable way.

Is there a contradiction between the Treasury's determination to sell its shares at a profit as soon as possible and its insistence that the banks must keep the lending taps open as the economy contracts, with the attendant risk some of the new loans will go bad?

Hampton, who is a shrewd banker, not only thinks that these are reconcilable ambitions, but that the interests of his new company will be closely aligned with those of other shareholders in the banks.

Which is as much to say that he could easily find himself siding with the City and not with ministers, if there were a dispute over - for example - whether the banks were lending quite enough to those viewed in Westminster as deserving cases.

So the Treasury is taking something of a risk by appointing him.

And there's a further risk in its decision to create the vehicle for owning the bank stakes as a formal Companies Act company.

How so?

Well as the chairman of a proper company, Sir Philip could not be formally directed to take this or that action by ministers.

If they were to dislike how this new company operates, they could sack him. But that would be jolly embarrassing for them. So, in practice, Sir Philip - and his chief executive, John Kingman, who is being seconded from the Treasury - will have considerable autonomy.

Oh, and by the way, the new company will also take control of Northern rock and the rump of Bradford & Bingley.

So Sir Philip is not taking on a small enterprise. In fact, what the Treasury has dubbed UK Financial Investments Limited will end up as one of the biggest bank holding companies in the entire world.

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This is what struck me from s by Lloyds TSB and HBOS on how they are trading and on Lloyds' planned takeover of HBOS.

1) HBOS is reaping a bitter harvest from having piled into lending to property and housebuilding businesses. Its corporate lending impairment charge (a charge for loans that are going bad) has risen by £1.3bn in just the three month to September 30 and is £1.72bn for the first nine months of the year.

2) The charge for mortgages that are going bad remains quite low at £440m for the first nine months of the year. However the trend is distinctly worrying, since the charge for the past three months of £227m is more than the charge for the whole of the first six months of 2008. The biggest contributor to this rise in the impairment charge has been the fall in house price prices (as and when the value of security backing a loan falls, banks are forced to take a charge). The value of impaired mortgages rose 9.4% to £5.1bn, equivalent to 2.4% of the value of its mortgage book.

3) So HBOS is beginning to suffer from the inevitable difficulties that borrowers face when the economy shrinks (what follows is fairly technical. So those who bore easily may want to jump straight to point 5). The only bit of good news is that these rising losses on conventional loans probably come as losses on subprime and other ostensibly tradeable debt-securities may have reached a peak. Those losses due to "market dislocation" were £1.8bn for the first nine months of the year, with just over £700m being incurred in the last three months. They included £457m of losses on exposure to the two bashed-up US banks, Lehman and Washington Mutual. And there's a £150m charge relating to credit extended to Icelandic banks.

4) Another reason why time has been called on massive losses on notionally tradeable debt-securities is that accounting changes mean that banks can now assess in a more conventional way the realistic prospect of borrowers repaying debts, and take charges accordingly, rather than taking the whacking loss implied by the fall in the market price of these investments.

5) There has been a 50% rise to more than £1.5bn in Lloyds TSB's estimate of the cost savings it can make from buying HBOS. That's good news for holders of Lloyds TSB and HBOS shares, since it means bigger dividends in years to come. However it will be profoundly worrying for the 140,000 employees of the two banks, because it implies there could be job losses of perhaps 20,000.

6) Lloyds TSB says it has been told by the Treasury that it will be a "value investor" in the enlarged group (you'll remember that the Treasury has agreed to inject £17bn of new capital from taxpayers into the two banks). That implies the Treasury as a shareholder will neither interfere very significantly with the way that Lloyds lends (as some investors have feared), nor place restrictions on the cost cutting and job reductions planned by the bank.

7) The Treasury has bent over backwards to reassure Lloyds TSB's and HBOS's existing shareholders that they won't be spanked too severely for needing to take capital from taxpayers. In particular, the Treasury has "indicated its encouragement" for Lloyds TSB to redeem as soon as 2009 all of the £4bn of preference shares being bought by taxpayers. What would that mean? Well, Lloyds TSB would be able to resume paying dividends in cash to its shareholders as soon as next year (and see my note, "Bank dividends" of October 15).

8) The assurances Lloyds has won from the Treasury about its commercial freedom and ability to pay dividends may further upset shareholders in Barclays, some of whom feel that Barclays' horror of taking money from British taxpayers prompted it to raise capital on terms that are too expensive from the royal families and state funds of Qatar and Abu Dhabi.

9) The momentum behind the takeover of HBOS by Lloyds TSB looks unstoppable. The top jobs have been divvied up (most of them going to Lloyds executives, as you'd expect in a takeover). Peter Mandelson, the business secretary, has given his approval. And there's a formal timetable for shareholder votes on the deal. The needs to pluck up the courage to reveal itself if it's to have even the faintest change of frustrating Lloyds (that it hasn't even disclosed its identity to HBOS perhaps suggests that it's more spectator than potential bidder).

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Have you thought about taking your money out of the bank and stuffing it into socks under the mattress?

A few of you may even have hoarded a few extra notes, given the anecdotal evidence that demand for the fifty-pound denomination has been rising.

If it has crossed your mind to do just that, it's because you think there's been an increase in the risk of your bank running into the kind of trouble that meant you couldn't get your mits on your precious savings.

For what it's worth, I think it would be silly and irrational to empty your account.

But that's not really the point.

We all feel in an animalistic way that in an economic downturn, in a recession, the risk of lending - even to the bank - increases.

That's why banks are having to offer us higher interest rates to persuade us to put our money on deposit with them.

And really that's all you need to know to understand why the interest rates that households and businesses pay for loans have not come down as they normally do in line with the Bank of England's reductions in its policy rate, in what it calls its Bank Rate.

As it happens, the banking system is in better shape than it was only three or four weeks ago, when there was a genuine danger that our banks were going to stop lending anything to anyone at any interest rate.

But whoever you are, if you have money to lend, you want to be better rewarded for providing the loan - because you think (correctly) that the risks of lending have risen.

That's true if you are an individual depositing money in the bank (which is simply lending to the bank), if you are a bank lending to a small business or to someone wanting to buy a house, of if you are a money manager with billions to lend to other financial institutions.

To use the jargon, they (we) are all demanding a significantly increased "risk premium" for lending.

Now here's the bad news.

None of us can claim to know with total certainty how severe the coming economic downturn will be. Most of us are pretty sure we're in a recession, but we don't whether it will be short and sharp, or short and shallow, or long and shallow, or long and deep.

To put it another way, we can't be certain how many creditors - whether corporate or personal - will be unable to repay their debts.

Which means that this risk premium, the little extra we charge to compensate us for the possibility that we might not get all our money back, well that's floating around a bit at the moment.

We're feeling our way to an understanding of the appropriate margin over the Bank of England's policy rate that we should demand when lending.

What that means is that, right now, when the Bank of England cuts rates, it has the effect of boosting the profits of lenders - the banks and other financial institutions - rather than leading to sharp reductions in interest payments by borrowers.

If you are having difficulty keeping up the payments on a mortgage or a small-business loan, you'll think that's a scandal.

But it isn't a wholly terrible thing.

Even after raising all those billions in new capital from taxpayers, our banks need to strengthen their balance sheets further against rising losses on the tens of billions of pounds of imprudent loans they made over the past few years.

And one way to strengthen their balance sheets, to increase their capital resources, is to generate incremental profits.

Bust banks serve nobody.

That said, it would be very bad news for our economy if the Bank of England were to cut interest rates this week by the significant amount that most forecasters expect - somewhere in the range of 1/2 per cent to 1 1/2 per cent - and for almost none of that to have an impact on both the price and on the availability of credit in the real economy.

A contraction in the availability of credit is the main source of our current economic woes.

Even if mortgage rates don't fall much, even if the cost of loans to businesses doesn't drop signficantly, we may be in deep doo-doo if there isn't an increase in the supply of credit.

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