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Colossal Financial Collapse
The Truth behind the Citigroup Bank "Nationalization"
By F. William Engdahl
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.’
November 25, 2008 "Global Research" -- 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 alarming one.
‘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 sworn in.
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 jobs.
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, 2008