by F. William Engdahl
November 24, 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
‘Spitting into the
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
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
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
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
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
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
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
Total global financial system losses could
exceed another $1,500 billion according to an IMF study by Singh and
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
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
The Citigroup bailout and GM debacle has
confirmed the death of the post-1944 Bretton Woods Dollar System.
The real truth behind
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
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
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
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
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.