This we all know. But what if all goes wrong? What if the people the bank lends to don’t pay them back? What if too many savers want their deposits back? Basically, what if the bank runs out of cash?

Northern Rock posed this question last year. As well as using deposits, the Rock also topped up its lending from the money markets. But then the money markets seized up, and it was game over.

So the question was asked – what should be done now that it’s all gone wrong? It stumped the powers that be. The FSA, the Government, the Bank of England – they all scratched their heads. They scratched and they scratched, for several months, until they’d worn holes in the tops of their heads.

A bank is a private business. A bank that runs out of money, like any business that fails, can expect to go bust.

But, as we all know, that didn’t happen with Northern Rock. Once the head scratching was over, Northern Rock was nationalised. This marked a major deviation from the way private enterprise is supposed to work.

So now, the Treasury is drawing up plans for something called the special resolution regime (SRR). The idea is that in future the SRR would swiftly liquidate a failed bank, strip it of its assets and appoint new executives. Just as would happen with a failed business in any other sector.

But there’s a problem. Who will run the show? The FSA didn’t come out of the Northern Rock crisis very well. But the regulator would no doubt argue that its past performance should not be taken as a reliable indicator of the future.

Bank of England governor Mervyn King has reservations. He suggests there could be reluctance on the part of the FSA to pull the trigger if another bank fails. His reasoning is that this would be an admission of failure on the part of the regulator who allowed said bank to fail in the first place.

But the FSA counters that involving the Bank with a final decision would mean it would also inevitably become involved in monitoring, duplicating the FSA’s role.

Personally, I don’t really care who wins this little turf war. If I had to pick a side I’d go for the Bank. Call me a traditionalist.

A more fundamental question is how on earth have we got into this situation? As noted above, a failing bank should… well, fail. Adam Smith’s Invisible Hand is supposed to allocate the spoils of business to those most deserving. Those who get it wrong get less… if they get it really wrong they get nothing.

But the workings of the market have been gummed up by regulation. That and political fear (runs on banks don’t look good on the telly. Better do something, quick!)

It’s this political fear that creates moral hazard. The banks knew the Government would never risk letting them fail. So they were happy to take big risks.

Now an institution, the SRR, is being created to effectively force punishment upon banks that mess up.

Welcome to the age of the Visible Hand.

Hold your nerve, Merv!

Hurrah! It’s the day before the Bank of England’s Monetary Policy Committee (MPC) meets to decide what to do with interest rates.

Because I’m a sad man, I set up our very own Fleet Street Daily shadow MPC. Better-looking than the official MPC, our committee comprises seven wise men, one wise woman and Glenn, a bloke from Grimsby.

And my, was it close! A five-four split in favour of a quarter-point cut.

Not that this is what we expect the Bank will do. Nor necessarily what it should do.

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“And there’s also talk of US interest rates rising,” adds colleague Frank Hemsley. “That would put sterling in serious trouble! Especially if the Bank of England cuts our rates.”

Indeed. A weak pound would make imports – including food and energy – even more expensive. Meaning more inflation, and pressure to put rates back up if the Bank adopts a US Fed-style aggressive rate cutting policy.

Personally, I’d favour keeping rates on hold. Businesses and consumers are rational. They see the economy is struggling, and they’ve changed their behaviour accordingly. This is why each day we see new ‘bad data’. Cutting the base rate by a quarter-point will do little to change prevailing sentiment.

What it will do, though, is further undermine the Bank’s reputation as an independent inflation fighter. So I’m hoping the Bank stands firm and leaves rates where they are. It won’t be popular, but being popular is not the Bank’s job.

The Royal Institute of Chartered Surveyors (RICS) reports that the number of surveyors reporting lower valuations exceeded those reporting gains by 78.5 percentage points in March. This was up from a 65.7 percentage point gap in February.

Of course, we don’t know by how much prices are falling. But this is yet more evidence of housing market weakness. Pain in store for homeowners, then. But let’s not get too maudlin here.

Yes, some people may soon find themselves with negative equity. But for most, if they’ve borrowed sensibly, can manage their repayments and stay living in their house for a few years, they should find this is a temporary phenomenon.

But what of the wider economy? Does this news herald the Great Housing Crash that will plunge us into recession? It’s easy to see why people think that — and why they’re worried. The RICS survey began in 1978, and its findings last month were the worst since it started. Small wonder, then, that this morning’s headlines proclaimed the biggest housing slump for 30 years.

But the news can be viewed in a positive light. Or, to be more accurate, in a lesser-of-two-evils light (it’s still evil… no happy ending here, I’m afraid).

British houses are really expensive. So the question we need to ask is, do we want them to stay that expensive (and unaffordable), or do we want the market to do its job and bring prices down?

Of course, if you’re selling a house you pick the first option; if you’re buying – the second. But let’s take a step back and look beyond mere self-interest. Everyone’s worried about a housing crash, so let’s examine option number two first. What might happen?

Well, house prices fall. People whose wealth is tied up in their house are poorer… they feel poorer… and they spend less. Businesses make less money… they invest less… the economy slows down. Maybe even shrinks a little. Not a rosy outcome.

So what if (as many would love) we managed, somehow, to keep house prices where they are. Forget for a second that any effort to do so would be, in all likelihood, futile (the cat’s out of the bag on this one — buyers know sellers are scared, and prices only go one way in a buyers’ market).

To keep prices high would require diverting resources from elsewhere in the economy. It would require more new buyers to borrow up to the hilt. In other words, they’d have to hand over larger shares of their future incomes to existing homeowners, imposing a significant constraint on their future spending.

So, in the coming years, they’ll spend less than they otherwise would have had their house been cheaper when they bought it. And businesses will make less money… they’ll invest less… sound familiar?

The housing market needs to correct. Trying to cheat the system will impact our long-term growth negatively.

So neither scenario is rosy. I’d love to wrap up with something that is, but the best I can do is to tell you inflation hasn’t gone up. In February, Consumer Price Index (CPI) inflation was 2.5%. It was 2.5% again in March.

That’s kind of good news… isn’t it? I would go out and celebrate, but have you seen how much a pint costs these days?

A bunch of bankers… and Gordon Brown

The chief executives of Britain’s biggest banks are meeting Gordon Brown today to drink tea, sample the delights of the Downing Street kitchen… oh, and see if they can’t do something about this here credit crisis.

The King of Barclays, the Earl of HBOS, Lord Royal Bank of Scotland and Mr HSBC-man will all take turns bending the prime minister’s ear.

“They have a lot in common,” says Fleet Street Letter editor Brian Durrant. “Both the banks and the PM overplayed their hands in the good times. The banks now have no confidence in each other and the people have lost confidence in Mr Brown.”

Brian tells me that in a speech in east London yesterday, the prime minister said the economy remains his sole focus.

“No wonder people are worried,” he quips.

Tesco profits jump 12%

First quarter earnings season rumbles on. Tesco’s results have caused a storm in a teacup. Tesco decided not to separately publish the results of its new US subsidiary Fresh & Easy. Analysts kicked off about it, taking it as clear evidence that Fresh & Easy was struggling.

“This overlooked the fact that Fresh & Easy accounts for a marginal amount of Tesco’s net income,” says Theo Casey, our master of the level-headed analysis.

The supermarket’s pre-tax profits rose 12%. Happily the market has ignored the analysts’ wailing — at the time of writing Tesco shares are up 22p.

It’s April Bio-fools day

“It’s madness, utter, utter madness!”

Today is not a great day for Manchester’s most vocal biofuels opponent. Commodities maestro Garry White has long argued that they are a con, but it seems only the Germans are listening.

Germany has decided to ignore an EU target that would require 5% of all fuel to come from biofuels by 2010. Sadly, Britain hasn’t. The Renewable Transport Fuel Obligation becomes law today. It requires 2.5% of fuels to come from biofuels as of today — rising to 5% by 2010.

“And guess where we’re getting it from,” says Garry. “Importing it from America. In ships. I bet they don’t run on biofuel!”

Stupid though this policy may be, it’s thrown up an intriguing investment opportunity, and Garry’s going to tell you all about it.

“Let’s get ready to rumble!”

In the blue corner we have the undisputed heavyweight champion, the United States of America. Big, powerful… it has the experience… but maybe it’s a bit too long in the tooth, maybe it’s taken a few to many to the jaw in its time….

In the red corner we have the challenger, China. Lean, hungry… and with quick feet. But China’s moved up a division. Does it have enough to get the better of its opponent?

There’s a lot riding on this bout. The purse is one quarter of all US oil imports by 2015. The venue, the Gulf of Guinea.

“Let’s get ready to rumble!”, booms an excited Manraaj Singh.

China and America are squaring up to each other in the battle for Africa’s oil reserves. Who will win?

So far China’s looked impressive, but America’s just landed a big right hander — it’s sent in the troops. Manraaj has the latest from ringside, including why this new “Cold War” will actually be a good thing for Africa (and why investors would be mad to miss it).

Until tomorrow,

Ben Traynor

But according to the Bank of England’s latest quarterly Credit Conditions survey, over the next three months lenders expect to cut lending further, raise charges, and be more demanding on terms, such as hiking deposit levels, for example.

So it’s little wonder that the IMF reckons Britain is one of the countries most vulnerable to a property crash…

Along with France and the Netherlands, the IMF believes Britain has one of the world’s most precarious property markets. It calculates that at least 30% of the value of homes cannot be explained by fundamentals such as demand or rising incomes, reports The Times.

Of course, this has been obvious to anyone with any sense and has been for a long time. High house prices aren’t about supply and demand, or rising incomes – they’ve been all about availability of credit for years now. And that’s vanishing rapidly, even for wealthy buyers. C&G now demands a £200,000 deposit if you want to borrow £1m, double what it was at the start of this week. So much for the unassailable London market.

The worst fall in commercial property prices in 20 years

As David Wighton points out in The Times, if residential housing follows commercial property, then times are set to get very hard indeed. Since June last year alone, the average commercial property price has fallen by 15%, according to the Investment Property Databank. The City reckons that by the end of this year, prices will have fallen 26% in 18 months.

This is the worst fall in commercial property prices seen since records began. That was a little more than 20 years ago, but of course, that includes the recession of the 1990s. And most of this has so far been driven by the credit squeeze, though it will soon be exacerbated by job cutting in the City and banks reining in expansion.

If the commercial property crash has so far been worse than the 1990s, then it’s not much of a jump to imagine that the coming residential housing crash could also be worse.

Business owners are suffering too

But mortgages aren’t the only things that banks and financial players need to worry about. Banks have apparently seen default rates on medium-sized and large companies rise more sharply than expected over the past three months.

The same over-confidence that infected the mortgage market also seeped into all other forms of lending. At the high point of the credit bubble, lenders were happy to dole out large sums of money against minimal assets at tiny interest rate levels. Now the same credit squeeze hurting commercial and residential property owners is also squeezing business owners.

Consumers are borrowing desperately to pay their bills, via the only route available to them. The surge in personal loans and credit card borrowing in February (up £2.4bn from £900m) wasn’t down to consumers going on a retail bender. It’s because they can no longer remortgage cheaply to help them pay the bills. Now they need to move towards more expensive forms of credit. The same thing happened in the US as the mortgage market dried up there.

This is what happens in a credit crunch. Debts that people believed they’d never have to pay off suddenly crystallise, as refinancing becomes impossible. And for many people, those debts simply won’t be affordable. Particularly as the businesses employing them are facing the same problems, and are unlikely to be able to increase wages to compensate, even if they wanted to.

While energy and food prices may well continue to rise, ultimately this scenario of falling house prices, and little real growth in wages, is a recipe for deflation, as James Ferguson points out in the latest issue of MoneyWeek. And that has serious implications for your investments. If you’re not already a subscriber, you can get your first three issues free by clicking here: Free trial

Turning to the wider markets…

In London, the FTSE 100 fell 24 points to close at 5,891. Retailers were among the main risers after gains earlier in the week.

Across the Channel, the Paris CAC-40 fell 25 points to end the day at 4,886. And in Frankfurt, the DAX-30 shed 35 points to 6,741.

On Wall Street, US stocks were little changed, despite first-time applications for unemployment benefits rising to levels not seen in more than two years. The Dow Jones gained 20 points to end at 12,626. The broader S&P 500 climbed 2 points, to 1,369, while the tech-heavy Nasdaq rose 2 points to 2,363.

In Asia, Japanese stocks slipped back, with the Nikkei down 96 points at the close, at 13,293.

Crude oil was trading at around $104.34 this morning, while Brent spot was broadly flat, at $103.28.

Spot gold was trading at back above the $900 mark, climbing to $906 an ounce this morning. Platinum was also higher at around $1,979, while silver was trading at $17.44.

Turning to forex, sterling was trading at 2.0025 against the dollar, and at 1.2739 against the euro. The dollar was last trading at 0.6363 against the euro and 102.32 against the Japanese yen.

And this morning, British nuclear group British Energy has risen sharply amid reports that Electricite de France has been given approval to bid for the company.