What are the scenarios (or how bad could it get)?

Recession.
As recently as the summer of 2008, most of the commentators of economics were speculating that the chances of the UK economy falling in to recession (technically, 2 consecutive quarters of negative growth) in the near future were about 50/50.
Today, the question is not whether there will be a recession but how deep will it be and how long will it last?
The recent actions to pump (taxpayers) money in to the system and cut interest rates weren’t designed to avoid a recession but to reduce its severity and to prevent some even more serious consequences.

Stagflation.
That’s high unemployment AND high inflation.
On the face of it, the chances of inflation running out of control seem remote. Today the rate of inflation is historically low compared to the 20%+ rates of the early/mid 1970’s. Economic slowdown should depress demand and therefore depress prices. The price of oil has also fallen back dramatically recently. However, the government’s abandonment of its borrowing rules in addition to the huge extra amounts it has had to borrow to pump in to the banking system has increased the risk of inflation rising again. There may come a time when the government could resort to printing more money (Mugabe economics). The more money that’s printed, the less it’s worth, the less it buys. This in turn could delay the economic recovery.

Tax rises/Public Spending Cuts.
As an alternative to printing more money the government (because it can’t borrow for ever) will be forced to balance the books by raising taxes and/or cutting spending.
Tax increases could lead to loss of competitiveness, spending cuts to decay in the infrastructure. Both these things will have a long term detrimental effect on the economic well being of the country.
It’s possible the government may be forced to cut welfare (or let inflation erode the value of social security payments). This of course will lead to real hardship for many people.

A lot depends on how much of the governments ‘investment’ in the banks is returned to the taxpayer. The Prime Minister and the Chancellor would have you believe that in time the taxpayer will get it all back + more. But if it’s such a one way bet it beggars the question as to why the money couldn’t be found in the private sector.

At best we can hope for a short lived recession, government coffers being bolstered by a decent return on the investment of tax payer’s money followed by a strong recovery and a financial sector behaving in a much more responsible manner.

At worst we can look forward to high unemployment, high inflation, massive cuts in public services, real social hardship and a few living the high life based on the misery of the many. Attendant with this would come high rates of crime, social tensions and the rise of political extremism.

We have nothing to fear but fear itself.

So said Franklin D. Roosevelt in his inaugural speech. Perhaps this phrase is as relevant today as ever, because what’s needed more than anything at the moment is confidence in the system; i.e. confidence in the financial institutions to continue to function in the ways we have hitherto taken for granted and confidence in the governments to be willing and able to fulfill their promises to guarantee personal savings.
I have always taken it for granted that my money which is being held in accounts of High Street banks will be safe and available to me on demand. For the 1st time in my life I am beginning to seriously doubt this assumption.
I am all for people in authority being open and honest but I am astounded that such a senior figure as the head of the IMF should be so candid. The worst thing that could happen now is for there to be a worldwide run on the banks. The head of the IMF is presumably aware of this and is also presumably aware that sometimes the smallest thing, such as a misplaced comment could tip the balance between relative stability and all out panic.
My fear is that when I wake up on Monday morning and turn the radio on, the news I will hear is that people in Asia (who will already have been up several hours before I wake up in the U.K.) will be queuing up outside the banks to withdraw their savings.
There is a part of me which is saying I am being unduly pessimistic, but nevertheless, that’s the way I’m thinking at the moment, so I reckon that many others are thinking along similar lines.
It’s a nice, calm, sunny, Sunday afternoon here, so all this talk about wild panic seems like fiction at the moment but I’ve observed the herd instinct before. Here in the UK there have been strikes and protests by the drivers of fuel tanker Lorries in the past. As soon as the general public get wind of this I have seen queues at the petrol stations (even fights breaking out as someone tries to jump the queue) and supermarket shoppers filling their trolleys with bread (based on the fears that the shops will run out of bread due to reduced deliveries – a fear which would almost certainly be unfounded if everybody remained calm and continued to shop the way they normally do but suddenly become real because of the selfish acts of a few). At such times of fear, one sees the worst in people.
So the worst thing to fear is fear itself, confidence is everything and the head of the IMF ought to keep his mouth shut.