- On Friday November 21, the world came within a hair's
breadth of the most colossal financial collapse in history according to
bankers on the inside of events with whom we have contact. The trigger
was the bank which only two years ago was America's largest, Citigroup.
The size of the US Government de facto nationalization of the $2 trillion
banking institution is an indication of shocks yet to come in other major
US and perhaps European banks thought to be 'too big to fail.'
- The clumsy way in which US Treasury Secretary Henry Paulson,
himself not a banker but a Wall Street 'investment banker', whose experience
has been in the quite different world of buying and selling stocks or bonds
or underwriting and selling same, has handled the unfolding crisis has
been worse than incompetent. It has made a grave situation into a globally
- 'Spitting into the wind'
- A case in point is the secretive manner in which Paulson
has used the $700 billion in taxpayer funds voted him by a labile Congress
in September. Early on, Paulson put $125 billion in the nine largest banks,
including $10 billion for his old firm, Goldman Sachs. However, if we compare
the value of the equity share that $125 billion bought with the market
price of those banks' stock, US taxpayers have paid $125 billion for bank
stock that a private investor could have bought for $62.5 billion, according
to a detailed analysis from Ron W. Bloom, economist with the US United
Steelworkers union, whose members as well as pension fund face devastating
losses were GM to fail.
- That means half of the public's money was a gift to Paulson's
Wall Street cronies. Now, only weeks later, the Treasury is forced to intervene
to de facto nationalize Citigroup. It won't be the last.
- Paulson demanded, and got from a labile US Congress,
Democrat as well as Republican, sole discretion over how and where he can
invest the $700 billion, to date with no effective oversight. It amounts
to the Treasury Secretary in effect 'spitting into the wind' in terms of
resolving the fundamental crisis.
- It should be clear to any serious analyst by now that
the September decision by Paulson to defer to rigid financial ideology
and let the fourth largest US investment bank, Lehman Brothers fail, was
the proximate trigger for the present global crisis. Lehman Bros.' surprise
collapse triggered the current global crisis of confidence. It was simply
not clear to the rest of the banking world which US financial institution
bank might be saved and which not, after the Government had earlier saved
the far smaller Bear Stearns, while letting the larger, far more strategic
Lehman Bros. fail.
- Some Citigroup details
- The most alarming aspect of the crisis is the fact that
we are in an inter-regnum period when the next President has been elected
but cannot act on the situation until after January 20, 2009 when he is
- Consider the details of the latest Citigroup government
de facto nationalization (for ideological reasons Paulson and the Bush
Administration hysterically avoid admitting they are in the process of
nationalizing key banks). Citigroup has more than $2 trillion of assets,
dwarfing companies such as American International Group Inc. that got some
$150 billion in US taxpayer funds in the past two months. Ironically, only
eight weeks before, the Government had designated Citigroup to take over
the failing Wachovia Bank. Normally authorities have an ailing bank absorbed
by a stronger one. In this instance the opposite seems to have been the
case. Now it is clear that the Citigroup was in deeper trouble than Wachovia.
In a matter of hours in the week before the US Government nationalization
was announced, the stock value of Citibank plunged to $3.77 in New York,
giving the company a market value of about $21 billion. The market value
of Citigroup stock in December 2006 had been $247 billion. Two days before
the bank nationalization the CEO, Vikram Pandit had announced a huge 52,000
job slashing plan. It did nothing to stop the slide.
- The scale of the hidden losses of perhaps the twenty
largest US banks is so enormous that if not before, the first Presidential
decree of President Barack Obama will likely have to be declaration of
a US 'Bank Holiday' and the full nationalization of the major banks, taking
on the toxic assets and losses until the economy can again function with
credit flowing to industry once more.
- Citigroup and the government have identified a pool of
about $306 billion in troubled assets. Citigroup will absorb the first
$29 billion in losses. After that, remaining losses will be split between
Citigroup and the government, with the bank absorbing 10% and the government
absorbing 90%. The US Treasury Department will use its $700 billion TARP
or Troubled Asset Recovery Program bailout fund, to assume up to $5 billion
of losses. If necessary, the Government's Federal Deposit Insurance Corporation
(FDIC) will bear the next $10 billion of losses. Beyond that, the Federal
Reserve will guarantee any additional losses. The measures are without
precedent in US financial history. It's by no means certain they will salvage
the dollar system.
- The situation is so intertwined, with six US major banks
holding the vast bulk of worldwide financial derivatives exposure, that
the failure of a single major US financial institution could result in
losses to the OTC derivatives market of $300-$400 billion, a new IMF working
paper finds. What's more, since such a failure would likely cause cascading
failures of other institutions. Total global financial system losses could
exceed another $1,500 billion according to an IMF study by Singh and Segoviano.
- The madness over a Detroit GM rescue deal
- The health of Citigroup is not the only gripping crisis
that must be dealt with. At this point, political and ideological bickering
in the US Congress has so far prevented a simple emergency $25 billion
loan extension to General Motors and other of the US Big Three automakers-Ford
and Chrysler. The absurd spectacle of US Congressmen attacking the chairmen
of the Big Three for flying to the emergency Congressional hearings on
a rescue loan in their private company jets while largely ignoring the
issue of consequences to the economy of a GM failure underscores the utter
lack of touch with reality that has overwhelmed Washington in recent years.
- For GM to go into bankruptcy risks a disaster of colossal
proportions. Although Lehman Bros., the biggest bankruptcy in US history,
appears to have had an orderly settlement of its credit defaults swaps,
the disruption occurred before-hand, as protection writers had to post
additional collateral prior to settlement. That was a major factor in the
dramatic global market selloff in October. GM is bigger by far, meaning
bigger collateral damage, and this would take place when the financial
system is even weaker than when Lehman failed.
- In addition, a second, and potentially far more damaging
issue, has been largely ignored. The advocates of letting GM go bankrupt
argue that it can go into Chapter 11 just like other big companies that
get themselves in trouble. That may not happen however, and a Chapter 7
or liquidation of GM that would then result would be a tectonic event.
- The problem is that under Chapter 11 US law, it takes
time for the company to get the protection of a bankruptcy court. Until
that time, which may be weeks or months, the company would need urgently
'bridge financing' to continue operating. This is known as 'Debtor-in-Possession
or DIP financing. DIP is essential for most Chapter 11 bankruptcies, as
it takes time to get the plan of reorganization approved by creditors and
the courts. Most companies, like GM today, go to bankruptcy court when
they are at the end of their liquidity.
- DIP is specifically for companies in, or on the verge
of bankruptcy, and the debt is generally senior to other outstanding creditor
claims. So it is actually very low risk, as the amount spent is usually
not large, relatively speaking. But DIP lending is being severely curtailed
right now, just when it is most needed, as healthier banks drastically
cut loans in the severe credit crunch situation.
- Without access to DIP bridge financing, GM would be forced
into a partial, or even a full liquidation. The ramifications are horrendous.
Aside from loss of 100,000 jobs at GM itself, GM is critical to keep many
US auto suppliers in business. If GM failed soon most, possibly even all
of the US and even foreign auto suppliers will go under. Those parts suppliers
are important to other auto makers. Many foreign car factories would be
forced to close due to loss of suppliers. Some analysts put 2009 job losses
from a GM failure as high as 2.5 million jobs due to the follow-on effects.
If the impact of that 2.5 million job loss is seen in terms of the overall
losses to the economy of non-auto jobs such as services, home foreclosures
caused and such, some estimate total impact would be more than 15 million
- So far in the face of this staggering prospect, the members
of the US Congress have chosen to focus on the fact the GM chief, Rick
Wagoner, flew in his private company jet to Washington. The Congressional
charade conjures up the image of Nero playing his fiddle as Rome goes up
in flames. It should not be surprising that at the recent EU-Asian Summit
in Beijing, Chinese officials mooted the idea of trading between the EU
and Asian nations such as China in Euro, Renminbi, Yen or other national
currencies other than the dollar. The Citigroup bailout and GM debacle
has confirmed the death of the post-1944 Bretton Woods Dollar System.
- The real truth behind Citigroup bailout
- What neither Paulson nor anyone in Washington is willing
to reveal is the real truth behind the Citigroup bailout. By his and the
Republican Bush Administration's adamant earlier refusal to take an initial
resolute action to immediately nationalize the nine or so largest troubled
banks, he has created the present debacle. By refusing on ideological grounds
to instead reorganize the banks' assets into some form of 'good bank' and
'bad bank,' similar to what the Government of Sweden did with what it called
Securum, during its banking crisis in the early 1990's, Paulson and company
have created a global financial structure on the brink.
- A Securum or similar temporary nationalization would
have allowed the healthy banks to continue lending to the real economy
so the economy could continue operating, while the State merely sat on
the undervalued real estate assets of the Swedish banks for some months
until the recovering economy made the assets again marketable to the private
sector. Instead, Paulson and his 'crony capitalists' in Washington have
turned a bad situation into a globally catastrophic one.
- His apparent realization of the error of his initial
refusal to nationalize came too late. When Paulson reversed policy on September
19 and presented the nine largest banks with an ultimatum to accept partial
Government equity ownership, abandoning his original bizarre plan to merely
buy up the toxic waste asset-backed securities of the banks with his $700
billion TARP taxpayer money, he never revealed why.
- Under the original Paulson Plan, as Dimitri B. Papadimitriou
and L. Randall Wray of the Jerome Levy Institute at Bard College in New
York point out, Paulson sought to create a situation in which the US 'Treasury
would become an owner of troubled financial institutions in exchange for
a capital injection-but without exercising any ownership rights, such as
replacing the management that created the mess. The bailout would be used
as an opportunity to consolidate control of the nation's financial system
in the hands of a few large (Wall Street) banks, with government funds
subsidizing purchases of troubled banks by "healthy" ones.'
- Paulson soon realized the scale of crisis, largely triggered
by his inept handling of the Lehman Brothers case, had created an impossible
situation. Were Paulson to use the $700 billion to buy up toxic waste ABS
assets from the select banks at today's market price, the $700 billion
would be far too little to take an estimated $2 trillion ($2,000 billion)
in Asset Backed Securities off the books of the banks.
- The Levy Economics Institute economists state, 'It is
probable that many and perhaps most financial institutions are insolvent
today -- with a black hole of negative net worth that would swallow Paulson's
entire $700 billion in one gulp.'
- That reality is the real reason Paulson was forced to
abandon his original 'crony bailout' TARP plan and opt to use some of his
money to buy equity shares in the nine largest banks.
- That scheme as well is 'dead on arrival' as the latest
Citigroup nationalization scheme underscores. The dilemma Paulson has created
with his inept handling of the crisis is simple: If the US Government paid
the true value for these nearly worthless assets, the banks would have
to write down huge losses, and, as Levy economists put it, 'announce to
the world that they are insolvent.' On the other hand, if Paulson raised
the toxic waste purchase price high enough to protect the banks from losses,
$700 billion 'will buy only a tiny fraction of the 'troubled' assets.'
That is what the latest nationalization of Citigroup is about.
- It is only the beginning. The 2009 year will be one of
titanic shocks and changes to the global order of a scale perhaps not experienced
in the past five centuries. This is why we should speak of the end of the
American Century and its Dollar System.
- How destructive that process will be to the citizens
of the United States who are the prime victims of Paulson's crony capitalists,
as well as to the rest of the world depends now on the urgency and resoluteness
with which heads of national Governments in Germany, the EU, China, Russia
and the rest of the non-US world react. It is no time for ideological sentimentality
and nostalgia of the postwar old order. That collapsed this past September
along with Lehman Brothers and the Republican Presidency. Waiting for a
'miracle' from an Obama Presidency is no longer an option for the rest
of the world.
- © Copyright F. William Engdahl, Global Research,