By F. William Engdahl - Global
Research
November 23, 2008
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 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.
F. William Engdahl is a frequent contributor to Global Research.
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