Analysis: It says much about the government�s need to find an urgent solution for embattled bank HBOS that it is pulling out the stops to facilitate a �merger� with Lloyds TSB.

It says much about the government's need to find an urgent solution for embattled bank HBOS that it is pulling out the stops to facilitate a "merger" with Lloyds TSB to create an institution commanding 28% of the UK mortgage market.

In 2001, Lloyds TSB was blocked from buying Abbey National by then Trade Secretary Patricia Hewitt because this deal would have given it a total 27% share of the current account market.

It almost goes without saying that the current backdrop is entirely different.

The priority must be to maintain financial stability at almost any cost. The bill so far for governments around the globe has been colossal as the credit crisis has raged, and private sector solutions are certainly cheaper for the taxpayer.

Prime Minister Gordon Brown can therefore, with great justification, argue public interest in helping broker what would in effect be a rescue takeover of Bank of Scotland and Halifax parent HBOS.

There could, should a deal go through, be some further collateral damage for the benighted UK consumer. Many people are already paying the price for the financial sector's mistakes through higher mortgage interest rates and jaw-dropping arrangement fees, so the last thing they need is any reduction of competition in an already unfriendly market-place.

However, there is little the Government can do about this.

HBOS shares were, before news of the bank's "merger" talks with Lloyds TSB leaked out, driven down by a further 52% from Tuesday's close to 88p yesterday morning. This is a far cry from their all-time highs near 1200p in early 2007.

Yesterday morning's precipitous fall, which followed days of extremely heavy losses for HBOS shares, occurred even as the Financial Services Authority was emphasising in its capacity as regulator that the Edinburgh-headquartered bank has "a strong capital base and continues to fund satisfactorily".

So it is easy to under- stand why the Government views the situation as urgent, and why it will argue that public interest outweighs competition issues.

The blame game regarding HBOS kicked off months ago now.

Short-sellers, who sell shares they do not own in the expectation these will fall and they can then buy them more cheaply before they have to deliver to the buyer and so turn a profit, have been cast as the villains of the piece.

They no doubt have exacerbated the fall in HBOS shares.

But HBOS directors, including chief executive Andy Hornby and chairman Lord Dennis Stevenson, must put their hands up as thousands of their employees worry about the future of their jobs. Thousands would seem likely to lose their jobs, at a time when unemployment has started to surge.

The short-sellers would seem unlikely to have taken HBOS on had it been perceived by analysts and fund managers to be in as solid shape as HSBC, Standard Chartered, or Lloyds TSB.

HBOS, to the man in the street, must have looked among the most immune of the UK banks to the global credit crisis.

Unlike Barclays and Royal Bank of Scotland, it did not have a huge financial markets business.

HBOS talked much about the size of its savings book. It made much of its cautious approach to overseas expansion.

However, it has suffered substantial writedowns on assets affected by the global credit crisis, significantly greater than those taken by Lloyds TSB.

On July 31, HBOS announced a plunge in interim pre-tax profits from nearly £3bn to £848m with bad debts rising and corporate banking profits tumbling.

And HBOS did have to go to its investors for £4bn of capital this summer in a rights issue. Lloyds TSB did not have to tap its shareholders in this way.

The dislocation in interbank lending markets has increased substantially the cost of the wholesale funds which HBOS relies upon heavily to lend on to its customers.

The international ratings agencies have meanwhile noted HBOS's exposure to the property market, not just through mainstream mortgage lending but through interests in housebuilders acquired towards the top of the market and commercial property activities.

Standard & Poor's and Fitch both cut their ratings on HBOS on Tuesday.

S&P said then: "The corporate book is a further cause for concern. We consider that the overall profile of this book is weaker than peers."

Predicting earnings would be affected by rising bad debts and lower revenues from HBOS's corporate investment portfolio, S&P added: "This (portfolio) comprises a number of private equity style investments across the capital spectrum and contributed about £1bn, or 8% of group net operating income in 2007. While the portfolio is well diversified by number, type, and vintage, performance weakened markedly in the first half of 2008 reflecting reduced exits, weaker trading performance, and impairments on investment securities. We expect these trends to continue."

Bank of Scotland, with its proud history dating back more than three centuries, survived as an independent when Standard Life put its 32.2% stake up for sale in 1996 amid some warning signals from senior politicians to any potential predators.

In 2001, Bank of Scotland agreed a merger with Halifax. The pair agreed the headquarters of the enlarged group would be in Edinburgh, and lack of agreement on this score looked like it would have been a deal-breaker.

Leaving aside the commonly-held view that Royal Bank of Scotland is "more Scottish-headquartered" than HBOS, given Halifax's taking of the top posts in the merger, the 2001 deal was a relatively good one for the economy north of the Border.

It was certainly more of a "merger" than the one being discussed with Lloyds TSB, which is very clearly in the driving seat. Any deal with Lloyds TSB would be no merger of equals, not least in terms of negotiating clout.

Lloyds TSB long talked about a big mainland European expansion but found these ambitions frustrated. Having dealt with the fact it bought Scottish Widows at the top of the market nearly a decade ago, it has been viewed by some in recent years as boring.

The current shambles in financial markets has shown boring is not so bad.

The current shambles in financial markets has shown boring is not so bad.

James Crosby, the life assurance industry veteran who is now advising the Government on the UK mortgage market, moved from being chief executive of Halifax to the same post in the enlarged HBOS at the time of the 2001 merger.

Former Asda executive Andy Hornby, Crosby's protege at HBOS, took over from him in 2006. Lord Stevenson, who came from the Halifax side of the merger, has been chairman of HBOS since it was formed.

Sir Peter Burt, chief executive of Bank of Scotland, settled for the post of executive deputy chairman in HBOS in 2001. The talk at the time was that this was an honourable move to secure the Scottish headquarters. Burt left HBOS less than two years later.

One cannot help but wonder, as Bank of Scotland employees face this difficult time, what might have happened had the top jobs been allocated differently at the time of the merger. We will never know.

What can be said with certainty is that, back in 2001, few would have predicted HBOS employees would be having to deal with the prospect of massive job losses in what might be hailed as a merger but looks for all the world like a fire sale.

It is a sorry state of affairs indeed although, as the Government's anxiousness to do what it can to facilitate a transaction shows, it is at this stage the best deal on the table for all concerned.