Why does this matter? Isn’t this mostly about a relatively small number of overpaid and reckless investment bankers getting their comeuppance?

When a widget maker goes bust, the ripples are relatively minor. Banks are plugged much deeper into the global economy via loans to, and bets with, thousands of other organisations. Banks, moreover, are by their nature highly unstable, because they borrow over the short term and lend for the long term. Finally, the numbers are colossal. Lehman had outstanding liabilities of around $613 billion (£342 billion). There are now individuals, companies and other banks around the globe not sure whether they are going to get their $613 billion back. The risk is contagion.

Contagion?

The danger that the difficulties at one financial institution spread to others. Every bank depends on confidence. Not one could pay up if all its depositors simultaneously asked for their money back. Clients owed money by Lehmans may now themselves get into trouble, although Henry Paulson, the US Treasury Secretary, would have bailed it out if he thought the financial system too vulnerable to deal with the inevitable aftershocks. Administrators also create uncertainty with the need to sell Lehman assets, unwind its bets, possibly at fire sale prices.

Fire sale prices?

The liquidator needs to sell Lehman assets in order to pay the creditors. The sale of these assets is likely to lead to a fall in their market prices. That has an effect on other banks and institutions, which by law have to value their assets according to the prevailing market price. If their own assets plunge in value, that could tip them into insolvency, creating more fire sales and a vicious spiral of failures and plunging asset values. Shares in Halifax Bank of Scotland plunged by as much as 40 per cent yesterday, over worries its US mortgage-backed securities might be less valuable, though they later rallied. Virtually all bank shares were sharply down.

Are my savings safe then?

In most cases, yes. The Government made it plain after Northern Rock that it would step in if necessary to guarantee ordinary UK bank and building society deposits, as it did explicitly with Rock. On top of this is the Financial Services Compensation Scheme, which pays out 100 per cent of the first £35,000 of any depositor. Beyond that, however, there are no explicit guarantees of compensation.

So there’s nothing to worry about?

The FSCS is unfunded. In other words there is no money in the kitty. It might take time to get savings back in the event of a bank failure. And in the event of financial Armageddon, the banks that are meant to chip into the scheme might be in no position to do so. However, it is hard to see the Government allowing any depositors to lose their first £35,000 even if - in extremis - it meant resorting to the printing presses. However, not every penny is always guaranteed.

What about the wider economy?

The collapse is bad news and has intensified the credit crunch. Banks are more fearful about lending to one another or to customers. They are hoarding cash. Movements in the wholesale money markets yesterday showed conditions dramatically worsening. It will be harder to get a loan, credit card or mortgage. Debt will cost more. Businesses will find it harder to borrow. Lack of credit and diving house prices are slowing consumer spending. That hits sales, sours business confidence and leads to job losses and wage freezes. Economists predicting a mild recessionmight now have to brace themselves for something darker.

And my pension?

Impossible to say. The slide in stock markets around the world yesterday will quickly be reversed if the paralysis in the money markets eases and if no more casualties are flushed out. But if more financial institutions fail, world economic growth could be seriously braked. Share markets would sink and take longer to recover. Millions of people in defined contribution pension schemes could have their prospective retirement incomes reduced.

And for the Government?

Ministers have been able, legitimately, to blame much of the credit crunch on forces outside their control. But the impact of the latest financial crisis on government finances will be brutal. UK banks were a major contributor to the Exchequer through corporation tax. The wider economic malaise will also reduce receipts from income tax, VAT and national insurance.

Any good news?

Yes. In allowing Lehmans to fail, central bankers have sent a clear signal to the financial community that it will not always be bailed out of its self-inflicted problems by the public purse. That should encourage less reckless behaviour by bankers in future.

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