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As Gordon Brown patted himself on the back for saving the British banking system last week, Neil Parkin stood in the chilly wind outside his bungalow near Barnstaple in Devon and wondered who was going to save him.

Parkin is the human face of a crisis that has seemed deceptively abstract until now. A self-reliant individual, he wanted to run his own business, buy his own home and be a family man. Modest dreams — now dashed by the Great Crunch of 2008.

First he had to lay off four staff in his decorating business as work in the housing industry dried up. Then his own income began to wither and he struggled to meet mortgage payments on the home he has been renovating for himself and his fiancée, Tobi.

Now he finds the property is worth less than the £180,000 it has cost him. Early next month he will attend a repossession hearing and is likely to go bankrupt to avoid falling further into the mire. The enormous government bailout of the banks announced last week has come too late for him. “I haven’t got any commercial work,” said Parkin, 29. “I’ll be lucky if I can do a few domestic jobs, but they don’t last long. People aren’t thinking about spending money. That’s why I couldn’t pay my mortgage.

“It’s odd, but in a way I feel a sense of relief at the repossession. I have been living under a cloud for too long and I don’t want it to drag me down. I try not to feel angry and bitter because they are destructive emotions, and ultimately I have no one to blame but myself.”

Parkin is one of many thousands of ordinary people now at risk of losing their jobs and houses, or seeing their pensions disappear, or having their savings frozen in some foreign bank. The bewildering financial meltdown that started on Wall Street and in the City of London has become frighteningly personal.

This weekend, the world’s most powerful nations have been conferring in Washington but seem unable to agree on the joint rescue plan that financial experts say is the only way of halting a stock market rout that has been on a scale unseen since the 1980s.

“We commit to continue working together to stabilise financial markets and restore the flow of credit, to support global economic growth,” said finance ministers of the G7. Big deal, said many. In the face of the greatest financial panic for decades, they were hoping for concrete proposals not platitudes.

As markets collapse, the UK government’s £400 billion bank rescue plan is about to be tested. By Friday, shares in Royal Bank of Scotland (RBS) had fallen by more than 80% from their level a year ago. It may need the government to take a significant stake in it this week.

The government’s resolve is also being tested by the Icelandic banking collapse. Will it succeed in rescuing the money of 300,000 British savers and a host of British local authorities?

Every week in this crisis leaders say the worst is over. Every week another downturn strikes, and every week the effects become more shocking as they hit real lives. Is there no end in sight? How tough is it going to get? And how severe must the remedies be?

Memories of the past few days might be quickly wiped out by worse dramas to come, but they demonstrate just how rapidly events have outpaced the efforts of politicians and officials to grapple with them.

Last Monday, before the latest turmoil erupted, members of the House of Commons Treasury select committee were in Japan seeking to learn from that country’s experience of financial crisis 20 years ago.

Through the 1980s share and property prices in Japan had roared and soared, with the Nikkei stock market index peaking at just under 39,000. After the bubble burst in 1989, the Nikkei slumped by 80%, finally bottoming out at just over 7,600. Property prices also crashed. For years the economy stagnated and the stock market never fully recovered.

Japanese officials were keen to explain to the British MPs why the sclerosis has persisted so long. One big problem, they said, was the banks. They were slow to own up to the full scale of their losses, so the financial authorities wasted years fighting fires in individual banks instead of reforming them at one stroke. That meant that Japan’s banking system remained too weak to do its job of sustaining economic activity by borrowing and lending. Only government action eventually forced the issue.

“The Japanese told us that we will have to nationalise not just a few banks — that would be just the first step,” said Michael Fallon, the deputy chairman of the Treasury committee. “They told us that we would have to nationalise the entire banking system.”

Such radical advice seemed fantastical at the beginning of last week. Few thought that the UK, home to some of the world’s largest private banks, would have to resort to such drastic measures. Yet events in financial markets were moving so fast that within days the government had to act on a previously unimaginable scale.

On Monday night, British bank chiefs met Alistair Darling, the chancellor. The news sparked panic in the stock market. In the space of a few hours on Tuesday, some banks saw their value plunge by 30% or 40% as investors sold out, suspecting huge new losses among the banks were looming.

It is not an unreasonable suspicion because, as Fallon points out, the banks have not been truthful so far — echoes of Japan.

“Many of these banks have lied to us,” Fallon said, referring to Treasury committee hearings. “They have told us they have solid loan books when they didn’t. They told us they weren’t exposed to the US sub-prime market or the buy-to-let nonsense, when they were. That happened with Northern Rock, Bradford & Bingley and HBOS.”

As bank shares collapsed, ordinary depositors feared for their money. Lindsay Cuthill, an estate agent, was in a post office in west London where he saw wealthy people waiting to transfer money into safe havens.

“The queue was unquestionably a rather different profile from the norm,” Cuthill said. “People were clutching investment savings application forms. The man behind the counter told me that he’d never seen so many big cheques in one day. One man paid in a cheque for £1m.”

A run on the banks was once again close to erupting. It threatened to throw the entire system into chaos.

In Downing Street, Brown and Darling hastily met Mervyn King, the governor of the Bank of England, and other officials. With the help of £245-worth of takeaway curry, they and their advisers worked into the early hours of Wednesday to hammer out a rescue. They had tried individual solutions with Northern Rock and HBOS, and the crisis had simply got worse. Now it was time for a knockout blow — or so they hoped. At breakfast-time on Wednesday, Darling announced that the government was offering to inject £50 billion into the banks as new capital, effectively taking a stake in them to shore up their financial bases.

In addition he offered to guarantee £250 billion of new loans made by the banks in the hope of encouraging them to resume normal business; plus he offered a further £100 billion to try to ease the lack of “liquidity” — readily available money — in the banking system.

It wasn’t outright nationalisation, on the scale recommended by the Japanese, but the scheme is the biggest peacetime intervention the UK financial system has ever seen.

The Treasury will have to borrow the money to meet the commitments. If the banks fail to repay all the funding (and many experts believe there will be losses) the Treasury will have to recoup the money later through higher taxes or spending cuts.

As Ken Clarke, the former chancellor, put it: “Borrowing is taxation deferred.” He should know: he put up taxes to pay off borrowing incurred during the recession of the early 1990s.

At first, Brown seemed to have pulled off a remarkable coup. As he and his newly minted National Economic Council gathered in the Cobra emergency meeting room in Whitehall, financial markets were delivering their judgment on his rescue plan.

Flanked by Peter Mandelson, the new business secretary, and Paul Myners, the new City minister, Brown studied plasma screens displaying television news and stock market prices.

The FTSE 100 was down. Not good. But shares in HBOS and RBS, the two banks most in need of rescuing, were rising. Perhaps Brown, who had also engineered a global 0.5% cut in interest rates — raising eyebrows about the Bank of England’s independence — had done enough to steady the City’s jittery nerves.

Politically and personally, a remarkable transformation was taking place in the prime minister under the gaze of the anxious public. A man who had become so exhausted that he seemed on the verge of being hounded from office by his own MPs was suddenly seen to be taking charge, confident, smiling.

After months of dismal ratings, Brown had found his poise again. A YouGov poll for The Sunday Times this weekend shows his personal rating has shot up and that the Tory lead over Labour has almost halved in the past month from 19% to 10%.

Brown felt comfortable back on his old stamping ground of economics and revelled in the attention. In one speech he even managed to crack a spontaneous joke. When he was interrupted by a mobile phone ringing in the audience, he quipped: “I don’t know if another bank has fallen.”

He relaxed with television interviewers, and even allowed a female newspaper columnist to gush over his fatherly rapport with his four-year-old son John, at home above the shop in Downing Street. So much for not using his children “as props”.

Yes it was spin, but it was effective spin on a scale Mandelson and Tony Blair would applaud. And he was also being praised for the rescue plan.

Brown and Darling had come up with a better proposal than any other governments so far. For weeks independent experts had advocated that the best way of tackling the crisis, rather than piecemeal firefighting, was to stage a widespread injection of new money into the banks.

This “recapitalisation” would strengthen their foundations, which should restore their confidence and encourage them to resume lending. Brown’s plan offered a way of doing it.

“The UK has taken what steps I think it should do, and the government’s measures were very well designed,” said Charles Goodhart, professor of financial markets at the London School of Economics (LSE). “At this kind of stage what you need is to have the government playing a larger role.”

Brown was further bolstered when America changed tack to follow the British lead. The original US government rescue had envisaged buying up “toxic assets” — sub-prime mortgage loans and other loss-making instruments — from the banks. This would help, but it would not rebuild the banks’ foundations. So last week the US authorities decided they, too, would inject capital directly into banks, taking some sort of stakes in return. Such state intervention is anathema to many in the land of the free but nothing else seemed to be working.

Tiny signs of hope emerged as the details of the UK rescue sank in. HSBC, one of the biggest banks in the world, offered a few billion pounds for other banks to borrow in the international money markets. Abbey, a British unit of one of Spain’s biggest banks, offered a billion.

By the standards of normal lending, however, it was peanuts. Stock markets tanked again. Investors baled out, screens turned red, fear and irrationality ruled again. The cost of interbank borrowing — the test of the Brown plan — went up. It should have gone down.

By the close of play on Friday, the plunge in share prices had sliced billions more off people’s investments and pensions. In London the FTSE 100 index ended at 3,932; a year ago it was at 6,751. In the US, the Dow Jones index fell to 8,451; a year ago it stood at 14,118.

Brown kept smiling, a dour man rejuvenated by the gloom. He said he was leading the world in tackling the crisis and he urged others to follow his example. “This is a global problem and I’m trying to get other countries to do what we have done,” he said.

Perhaps — like the US — they will do so. But a desperate downward spiral gripped the markets at the end of the week, fuelled by fear that other huge dislocations still lurk in the global financial system.

“Everyone is in a state of funk,” Goodhart said. “There is panic in the air. People have suddenly realised we are going into a recession.”

Goodhart says the banking crisis threatens to intensify the economic downturn that was already under way before the financial meltdown began four weeks ago when Lehman Brothers collapsed.

Brown’s rescue plan is designed not just to persuade banks to lend on reasonable terms to each other but to customers like Richard Vaux, 43, who runs a small marketing company in Farnham, Surrey. He knows only too well how their fear of lending is hitting the economy and ordinary lives.

“Ten days ago I got a letter saying the rate on our overdraft was increasing from 6.78% to 10.78% above base rate,” said Vaux, whose company banks with Barclays. “That’s almost what you would pay on a credit card.

“It will add around £1,500-£2,000 a year to what I’m already paying in interest. There are very few options for small businesses as we rely so much on our overdrafts. We are a captive audience for banks, so it’s profiteering really.”

Times have got even tougher for Steven Brown, a 27-year-old entrepreneur in Manchester. He started a car valeting business that employs 20 people and had hoped to expand with a loan of £200,000 from RBS. That offer has evaporated.

In London, Nick Williams-Howes, who founded a firm handling payrolls for other companies, has had to turn away £19m of business after his bank suddenly reneged on a loan deal.

“I’m having to turn away business because the main banks have said, ‘We’re not going to play for a while until the market is less scary’,” said Williams-Howes. He’s making six staff redundant.

As the banks scrabble for cash they are also brutal in disposing of assets such a repossessed homes. Some are dumping them at half their value of only a year ago, according to Costa Geogiades, a property auctioneer. “The real housing crisis is only just beginning,” he reckoned.

In Devon, Sarah Dunkley, a case worker with the Citizens Advice Bureau, is being overwhelmed with people crushed by debt. “We have 650 cases currently on our books which are almost entirely debt-related and the vast majority of those are repossessions,” she said. “In the past 12 months we have dealt with debt problems totalling £9m, which is a phenomenal amount of money in a place like north Devon where the average salary is £23,000.”

The better-off can also be hit. Dunkley cited the case of a “quite well-to-do couple” who were forced to sell a house in a desirable area. “They had it on the market, the price kept falling and they were trapped until they got to a point where they decided something had to give.

“If they stayed put for another year their debts could have reached £40,000. The bank repossessed and the house sold the other day for £100,000 less than the price the couple had it on the market at. That’s how fast things are falling.”

The sale of repossessed properties is dragging down the market. Last week figures from the Halifax showed that house prices fell 16% in the past year. The accountant KPMG predicts more repossessions than in previous recessions because household debt is so high. In America, nearly one in six homeowners is in negative equity, owing more than their home is worth.

As more individuals and businesses go under, banks instinctively tighten credit even further. It is a vicious vortex.

The American economist Nouriel Roubini, who has done better than most at predicting the course of the meltdown, said: “It will take a significant change of leadership of economic policy and very radical, co-ordinated policy actions . . . to avoid economic and financial disaster.”

He fears we are now close to being too late to stop it wreaking havoc — particularly in the corporate world, where a collapse would send destructive ripples through the lives of employees.

Giant US motor companies such as Ford, General Motors and Chrysler are struggling. Even General Electric — the huge manufacturer and bellwether of the American economy — is in trouble because of losses in the financial arm it set up to exploit the boom in derivatives that have now turned toxic.

“Corporate defaults will surge during the recession,” Roubini predicts. This will in turn mean “massive losses will occur among the credit default swaps that provided protection against corporate defaults”.

Credit default swaps (CDSs) are unregulated complex financial instruments that insure against losses when credit deals turn bad. In little more than a decade, the market in them has grown from nothing to an estimated $50 trillion.

Financial services companies used them to rake in fees or boost assets on the way up. But on the way down their value evaporates if parties to them cannot pay up. On Friday CDSs linked to Lehman Brothers were being valued at less than nine cents per dollar.

The losses can spread far through the system. Their destructive power has already forced a government rescue of AIG, the giant insurance company, and stock markets fear worse could be to come.

The speed with which supposedly safe insurance systems can suddenly unravel is also being played out on a national scale with the collapse of Iceland’s main banks.

After expanding aggressively, these amassed liabilities estimated in excess of £50 billion, dwarfing Iceland’s £12 billion economy. When they collapsed last week, a bitter argument erupted over who should, and could, compensate whom.

After Iceland refused to guarantee it would repay all British customers, the British government seized the banks’ assets in the UK. This weekend officials from both countries are haggling over who will get what.

British individuals with savings accounts in the Icelandic banks will eventually receive their money back under UK guarantees; but an estimated £3 billion belonging to British local authorities, charities, hospitals and other organisations is hanging in the balance.

It illustrates a point that may yet strongly influence the course of the crisis. Nations, like banks, tend to fall back on self-preservation.

“You should never expect too much of the co-ordinated stuff,” Goodhart said. “In these circumstances the power still lies with the nation state. They have the capacity to tax, therefore they have the capacity to get money and can control resources.

“You can dress it up as wonderful international co-ordination, and that’s fine. But effectively what happens is every country in a panic looks after its own.”

Just who is being looked after, however? Just as in America, the crisis is sparking a public backlash in Britain. Through blogs and comment threads, people last week vented fury at having to bail out rich bankers.

It seemed mad to them that the taxpayer should have to borrow money to give to bankers so that they could lend it back to the taxpayers at higher interest. Many asked why bankers who have made millions should be rescued by the poor and elderly whose pensions they have effectively destroyed.

Politicians could only agree, while reiterating that the bailout was a necessary evil to prevent an even worse crisis.

David Cameron, the Tory leader, said: “Taxpayers will rightly be infuriated if they see their hard-earned money going on bonuses that are rewards for failure.”

Brown went further. “I am angry at irresponsible behaviour,” he said. “Our economy is built around people who work hard, who show effort, who take responsible decisions, and where there is excessive and irresponsible risk-taking, that has got to be punished.”

Despite the bailout, the party is certainly over for bankers. The Centre for Economics and Business Research estimates that 62,000 workers in the City will lose their jobs in the next two years and that bonuses dye to be paid in that time will be 60%-70% lower than in 2006 and 2007.

In addition, governments are going to have to take a more intrusive role, including tougher regulation, to solve the crisis. Willem Buiter, professor of European political economy at the LSE and a former member of the Bank of England monetary policy committee, said: “When systemically important markets fail comprehensively, only the coercive power of the state . . . offers a way out.”

Tougher regulation will limit scope for big risks and the big rewards that went with them. The chances are, however, that what comes afterwards will be a reformed but not fundamentally different world.

Kenneth Rogoff, a Harvard economist and former adviser to the International Monetary Fund, said: “The current crisis hardly marks the end of financial globalisation, which will surely resume in due course, albeit almost certainly at a slower pace than in the last decade.” Jeffrey Sachs, director of the Earth Institute at Columbia University and a leading international economist, believes the US and UK are heading for recession and that there is a serious risk it could spread worldwide, because “the sense of panic and gloom is deep, and the amount of financial correction is very, very large”. But he believes it won’t be armageddon.

“We have cyclical economies . . . this \ looks, with luck and management, less than catastrophic,” he said. “All of them you do come out of. The one dramatic exception in history is the Great Depression. That is the shadow cast over all this. That is what everyone wonders — could this be the big one hitting them? I think it is unlikely.

“Are we going to have a recovery after a downturn? I would say yes. Can we avoid catastrophe? I would say yes. Is it frightening right now? Obviously the answer is also yes.”

However, Sachs does believe that other issues, perhaps even more powerful, will still force changes as economies recover.

Shortages of energy and food, and the impact of climate shocks will influence the nature of the recovery. “Those longer-term structural issues, which are hard to think about when you’re in the midst of a slowdown, are real and will remain,” he said. “And they will require a new kind of political direction, a much more activist role of government in overcoming some of them.”

Outside his bungalow near Barnstaple, Parkin, one of those at the sharp end of the downturn, had his own philosophical take on how the Great Crunch will play out.

“I had a nagging feeling about four years ago that the property market couldn’t carry on the way it was,” he said. “If prices keep going up there comes a point where no one can afford to get on at the bottom of the ladder, and if no one can do that no one can move up. Prices had to come down and in my own head I reckoned the figure would be about 40%. I look like I’m going to be proved right, sadly. The banks have to accept some responsibility for the way they have behaved, just as homebuyers have to accept some responsibility for their desire to live beyond their means.

“But I hope at the end of it all we will emerge leaner and fitter and more responsible as a society.”

Next threat?

As losses and panic spread through the financial system, some experts predict that the next big problem will be the market in credit default swaps.

These obscure financial instruments began to be widely used in the 1990s as a way for companies to insure themselves against borrowers who failed to pay their debts. In simple terms, a company worried that it might not get paid by a borrower strikes a deal with another party to compensate it if the borrower defaults. The risk is transferred and thus it is called a “credit default swap” (CDS).

Later these contracts came to be traded, further spreading the risk — and the exposure. The market has grown rapidly and is now worth more than $50 trillion.

The problem is that the trading is unregulated and the deals are struck between private companies. Exactly what the mountain of CDS deals are worth — or whether parties can actually meet their obligations — is not easy to find out. In good times the temptation, as Warren Buffett, the legendary US investor, warned, is for all parties to overestimate the value of their contracts.

As companies run into difficulty in the recession, loan defaults will rise. That, in turn, will put pressure on the CDS market. If firms that have offered default protection find they cannot now pay, it could have a domino effect — one firm’s default could cause a different one to go bankrupt.

That, and the proliferation of the market, is why Buffett warned that the CDS and other derivatives are “financial weapons of mass destruction”.

Additional reporting: Jonathan Oliver, Simon Trump and Brendan Montague

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