It pains me deeply to announce that, despite the massive government
rescue, yesterday’s collapse of Citigroup could ultimately lead to a
shutdown of the global banking system.

For many years, I hoped this would never happen, and I thought we might be able to avoid it.

Indeed, that’s why, my firm, Weiss Research, first began rating the
safety of the nation’s banks in the early 1980s, and why I later
founded Weiss Ratings, a separate subsidiary dedicated exclusively to
safety ratings — on thousands of banks, insurance companies, brokerage
firms, mutual funds and stocks.

I subsequently sold the Weiss Ratings subsidiary to Jim Cramer’s
organization, TheStreet.com; and today, my former company is called
TheStreet.com Ratings. I continue to own and run Weiss Research, Inc.,
the publisher of Money and Markets. Moreover, Weiss Research continues
to review all financial institutions for their safety; and to support
that effort, we acquire TheStreet.com’s ratings and data for our
analysts.

For you, the benefit is that you can now get these independent and
accurate ratings for free on the Internet. Plus, you can check our free
updated lists of the strongest and weakest bank and insurance companies on our Money and Markets website.

My philosophy was that, to find safety, your primary task was to
identify the weak institutions, move your money to the strong ones, and
then monitor them periodically to make sure your money was still safe.
If all of us — savers, investors, bankers and banking regulators — used
this kind of objective data to make rational, informed decisions, we
would reward the safest institutions and help prevent the growth of the
riskiest. Not only would we be safer individually, but our banking
system as a whole would be more solid.

Unfortunately, however, that’s not how history has unfolded.

Few people were interested in bank ratings; they blindly assumed all
banks were safe. And over the years, regulators have followed a
parallel path. Rather than proactively restrict or shut down the
weakest, large institutions, they have encouraged their massive growth,
making it very difficult for the smaller, safer institutions to compete.

More recently, in the wake of the biggest financial failures in
history — Bear Stearns, Lehman Brothers, Washington Mutual, Wachovia
and others — rather than liquidate the failed firms’ bad assets, the
authorities have been engineering shotgun mergers. The end result is
that they have been sweeping most of the bad assets under the carpet of
larger banks like Bank of America, Citigroup, and JPMorgan Chase, each
of which already had abundant bad assets of its own. Adding insult to
injury, Treasury Secretary Paulson’s decision this month — not to buy
up the bad assets from many of these banks — has only heightened this
concern. Rather than dispose of the toxic waste, the regulators have
been rolling up the garbage to the larger banks.

And now, here we are, nearing the end of the road with the largest
banks of all endangered and with no larger bank that can swallow them
up. It’s a day of reckoning that leaves me no choice but to issue this
three-part warning:

* Despite the U.S. government’s massive Citigroup bailout, it is
going to be difficult for the global banking system to survive the
shock to confidence for very long.

* Even if insured depositors do not pull out their funds, uninsured
institutional investors are likely to run with their money, threatening
to bring the system down.

* And alas, even if you have your money in a safe bank with full FDIC coverage, you could be adversely impacted.

How will the events unfold? That’s a massively complex question that
demands an extremely cautious and thoughtful answer. That’s why, this
past August, we devoted a full hour to this question in our “X” List
video, naming the most likely candidates for bankruptcy. So let me
review its primary conclusions and then take this discussion to the
next level.

Most prominent on our August “X” List was Citigroup, America’s
second largest banking conglomerate with over $2 trillion in total
assets. The bank was already suffering crushing losses in mortgages.
But at mid-year, it still had close to $200 billion in other mortgages
on its books, denoting the strong possibility of many more to come.

In addition, Citigroup had a massive portfolio of credit cards — 185
million accounts worldwide — that we felt could be the final nail in
its coffin. Even before the most recent episode of the global financial
crisis, Citigroup’s losses on bad credit cards had surged by 67% from a
year earlier. Worse, the number of credit cards 90 days past due was
going through the roof, foreshadowing more large losses on the way. All
of these weaknesses were detailed in Citigroup’s financial statements.
Not detailed, however, was …

The Highly Dangerous Derivatives

Derivatives are bets made mostly with borrowed money. They are bets
on interest rates, bets on foreign currencies, bets on stocks, bets on
corporate failures, even bets on bets. The bets are placed by banks
with each other, banks with brokerage firms, brokers with hedge funds,
hedge funds with banks, and more.

They are often high risk. And they are huge. According to the U.S.
Comptroller of the Currency (OCC), on June 30, 2008, U.S. commercial
banks held $182.1 trillion in notional value (face value) derivatives.1
And, according to the Bank of International Settlements (BIS), which
produced a tally six months earlier for the entire world, the global
pile-up of derivatives, including institutions in the U.S., Europe and
Asia, was more than three times larger — $596 trillion.2

That was ten times the gross domestic product of the entire planet …
more than 40 times the total amount of mortgages outstanding in the
United States … nearly 60 times greater than the already-huge U.S.
national debt.

Defenders of derivatives claim that these giant numbers overstate
the risk. They argue that most players hedge their bets and don’t have
nearly that much money at stake. True. But that isn’t the primary risk
these players are taking.

To better understand how all this works, consider a gambler who goes
to Las Vegas. He wants to try his luck on the roulette wheel, but he
also wants to play it safe. So instead of betting on a few random
numbers, he places some bets on the red, some on the black; or some on
the even and some on the odd. He rarely wins more than a fraction of
what he’s betting, but he rarely loses more than a fraction either.
That’s similar to what banks like Citigroup do with derivatives, except
for a couple of key differences:

Difference #1. They don’t bet against the house. In fact, there is no house to bet against. Instead, they bet against the equivalent of other players around the table.

Difference #2. Although they do balance their bets, they do
not necessarily do so with the same player. So back to the roulette
metaphor, if Citigroup bets on the red against one player, it may bet
on the black against another player. Overall, its bets are balanced and
hedged. But with each individual player, they’re not balanced at all.

Difference #3. As I said, the amounts are huge — millions of times larger than all of the casinos of the world put together.

Now, here are the urgent questions that, as of today, remain largely unanswered:

Question #1. What happens if there is an unexpected collapse?

Question #2. What happens if that collapse is so severe it drives some of the key players into bankruptcy?

Question #3. Most important, what happens if these players can’t pay up on their gambling debts?

This is the question I have asked here in Money and Markets month
after month. Almost everyone said it was far-fetched, that I was
overstating the risk. Yet, each of the hypothetical events I cited in
the above three questions have now taken place in 2008.

First, we witnessed the unexpected collapse of the largest credit market in the world’s largest economy — the U.S. mortgage market.

Second, we witnessed the bankruptcy or near-bankruptcy of
three key players in the derivatives market — Bear Stearns, Lehman
Brothers and Wachovia Bank.

Third, we also got the first answers to the last question:
We saw the threat of a major, systemic meltdown in the entire global
banking system.

What Is a Banking Meltdown
And Why Is it Possible?

On October 11, 2008, a single statement hit the international wire services that provides more specific clues:

“Intensifying solvency concerns about a number of the largest
U.S.-based and European financial institutions have pushed the global
financial system to the brink of systemic meltdown.”

This statement was not the random rant of a gloom-and-doomer on the
fringe of society. Nor was it excerpted from a twentieth century
history book about the Great Depression. It was the serious, objective
assessment announced at a Washington, D.C. press conference by the
Managing Director of the International Monetary Fund (IMF).

The unmistakable implication: So many of the world’s largest
banks were so close to bankruptcy, the entire banking system was
vulnerable to a massive collapse. The primary underlying cause: Derivatives.

The Mafia knows all about systemic meltdowns of gambling networks.
In the numbers racket, for example, players place their bets through a
bookie, who, in turn is part of an intricate network of bookies. Most
of the time, the system works. But if just one big player fails to pay
bookie A, that bookie might be forced to renege on bookie B, who, in
turn stiffs bookie C, causing a chain reaction of payment failures.

The bookies go bankrupt. The losers lose. And even the winners get
nothing. Worst of all, players counting on winnings from one side of
their bets to cover losses in offsetting bets are also wiped out. The
whole network crumbles — a systemic meltdown.

To avert this kind of a disaster, the Mafia henchmen know exactly
what they have to do, and they do it swiftly: If a gambler fails to pay
once, he could find himself with broken bones in a dark alley; twice,
and he could wind up in cement boots at the bottom of the East River.

Unlike the Mafia, established stock and commodity exchanges, like
the NYSE and the Chicago Board of Trade, are entirely legal. But like
the Mafia, they understand these dangers and have strict enforcement
procedures to prevent them. When you want to purchase 100 shares of
Microsoft, for example, you never buy directly from the seller. You
must always go through a brokerage firm, which, in turn is a member in
good standing of the exchange. The brokerage firm must keep close tabs
on all its customers, and the exchange keeps close track of all its
member firms. If you can’t come up with the money to pay for your
shares, the broker is required to promptly liquidate your securities,
literally kicking you out of the game. And if the brokerage firm as a
whole runs into financial trouble, it meets a similar fate with the
exchange. Very, very swiftly!

Here’s the key: For the most part, the global derivatives market has
no brokerage, no exchange, and no equivalent enforcement mechanism. In
fact, among the $181.2 trillion in derivative bets held by U.S. banks
at mid-year 2008, only $8.2 trillion, or 4.5%, was regulated by an
exchange. The balance — $173.9 trillion, or 95.5% — was bets placed
directly between buyer and seller (called “over the counter”). And
among the $596 trillion in global derivatives tracked by the BIS at
year-end 2007, 100% were over the counter. No exchanges. No overarching
enforcement mechanism.

This is not just a matter of weak or non-existent regulation. It’s
far worse. It’s the equivalent of an undisciplined conglomeration of
players gambling on the streets without even a casino to maintain
order. Moreover, the data compiled by the OCC and BIS showed that the
bets were so large and the gambling so far beyond the reach of
regulators, all it would take was the bankruptcy of one of the lesser derivatives players — such as Lehman Brothers — to throw the world’s credit markets into paralysis.

That’s why the world’s highest banking officials were so panicked
when Lehman Brothers failed in the fall of 2008. As the IMF managing
director himself admitted, the threat was not stemming from just one bank in trouble; it was from many; and those banks weren’t lesser players; they were among the largest in the world. Which U.S. banks placed the biggest bets? Based on mid-year 2008 data, the OCC provided some answers:

Citibank N.A., the primary banking unit of Citigroup, held $37.1
trillion in derivative bets. Moreover, only 1.7% of those bets were
under the purview of any exchange. The balance — 98.3% — was direct,
one-on-one bets with their trading partners outside of any exchange.

Bank of America was a somewhat bigger player, holding $39.7 trillion
in derivative bets, with 93.4% traded outside of any exchange.

But JPMorgan Chase was, by far, the biggest of them all, towering
over the U.S. derivatives market with more than double BofA’s book of
bets — $91.3 trillion worth. This meant that JPMorgan Chase controlled half
of all derivatives in the U.S. banking system — a virtual monopoly that
tied the firm’s finances with the fate of the U.S. economy far beyond
anything ever witnessed in modern history. Meanwhile, $87.3 trillion,
or 95.7% of Morgan’s derivatives, were outside the purview of any
exchange.

One bank! Making bets of unknown nature and risk! Involving a dollar
amount equivalent to six years of the total production of the entire
U.S. economy! In contrast, Lehman Brothers, whose failure caused such a
large earthquake in the global financial system, was actually small by
comparison — with “only” $7.1 trillion in derivatives.

The potential havoc that might be caused by a Citigroup failure, with bets that involve five times
more money than Lehman’s — and the financial holocaust that might be
caused by a JPMorgan failure with close to 13 times more than Lehman —
boggles the imagination. How bad could it actually be? No one knows,
and therein lies one of the primary dangers. In the absence of
oversight, the regulators simply do not collect the needed
who-when-what information on these bets.

In an attempt to throw some light on this dark-but-explosive scene,
the OCC uses a formula for estimating how much risk each major bank is
exposed to in just the one particular aspect I cited a moment ago — the
risk that some of its trading partners might default and fail to pay up
on their gambling debts. Bear in mind: We still don’t now how much they
are risking on market moves against them. All the OCC is estimating is
how much they’re risking by making bets with potentially shaky betting
partners, regardless of the outcome on each bet — win, lose or draw.

At Bank of America, the OCC calculated that, at mid-year, the bank
was exposed to the tune of 194.3% of its capital. In other words, for
every $1 of capital in the kitty, BofA was risking $1.94 cents strictly
on the promises made by its betting partners. If about half of its
betting partners defaulted, the bank’s capital would be wiped out and
it would be bankrupt. And remember: This was in addition to the risk that the market might go the wrong way, and on top of the risk it was taking with its other investments and loans,

At Citibank, the risk was even greater: $2.58 cents in exposure per dollar of capital.

• A d v e r t i s e m e n t

And if you think that’s risky, consider JPMorgan Chase. Not only was
it the largest player, but, among the big three U.S. derivatives
players, it also had the largest default exposure: For every dollar of
capital, the bank was risking $4.30 on the credit of its betting
partners.

This is why JPMorgan was so anxious to step in and grab up
outstanding trades left hanging after the fall of Bear Stearns and
Lehman Brothers: It could not afford to let those trades turn to dust.
If it did, it would be the first and biggest victim of a chain reaction
of failures that could explode all over the world.

This is why super-investor Warren Buffett once called derivatives
“financial weapons of mass destruction.” This is why the top leaders of
the world’s richest countries panicked after Lehman Brothers failed,
dumping their time-honored, hands-off policy like a hot potato, jumping
in to buy up shares in the world’s largest banks, and transforming the
world of banking literally overnight.

This is also why you must now do more than just find a strong bank.

You also must find a safe place that has the highest probability of
being immune to these risks. The reason: As I warned at the outset, at
some point in the not-too-distant future, governments around the world
may have no other choice but to declare a global banking holiday — a
shutdown of nearly every bank in the world, regardless of size,
country, or financial condition.

What could happen in the banking holiday? In the past, we’ve seen
some financial shutdowns that eventually helped resolve the crisis. And
we’ve seen others that only made it worse. Often, savers are forced to
leave their money on deposit, giving up a substantial portion of their
interest income for many years. And, in other cases, the only way they
can get their money back sooner is by accepting an immediate loss of
principal. But no matter how it’s resolved, when banks have made big
blunders and suffered large losses, it’s the multitude of savers that
are invariably asked to make the biggest sacrifices and pay the biggest
price. No one else has the money.

Are Bank Runs and National Shutdowns
Really Possible in Today’s Modern Era?

Most observers think not. “If deposits are insured,” they ask, “why
would anyone want to pull them out?” The reason: Most bank runs are not
caused by insured depositors. They’re caused by the exodus of large,
uninsured institutions who are usually the first to run for cover at
the earliest hint of trouble. That’s the main reason Washington Mutual,
America’s largest savings and loan, lost over $16 billion in deposits
in its final eight days in 2008. That’s also a major reason Wachovia
Bank was forced to agree to a shotgun merger soon thereafter.

During the many banking failures of the 1980s and 1990s, the story
was similar: We rarely saw a run on the bank by individuals. Rather, it
was uninsured institutional investors — banks, pension funds and others
— that jumped ship long before most people even realized the ship was
sinking. They’re the ones who hammered the last nail in the coffin of
big savings and loans, banks and insurance companies that failed.

How Long Would a Global Banking Shutdown Last?
How Would It All Be Sorted Out?

No one can say with certainty. But based on other banking holidays
in modern history, it’s safe to conclude that it could last for quite
some time and cause severe hardship for hundreds of millions of savers
around the world.

The first and most obvious hardship is that you could be denied
immediate access to most or all of your money for an indefinite period.
What about government agency guarantees like FDIC insurance? A large
proportion of those guarantees, unfortunately, would have to be
suspended in order to give banking regulators the time they need to
sort out the mess.

It is simply not reasonable to expect that governments will have
the resources to immediately meet the demands of thousands of
institutions and millions of individuals if they all want their money
back at roughly the same time.

“Your money is still safely guaranteed,” banking officials will declare. “You just can’t have it now.”

The second and more long-lasting hardship is the possibility that,
by the time you do regain access to your money, you will suffer losses.
In this scenario, the government would likely create a rehabilitation
program for the nation’s weakest banks, giving depositors two choices:

* Opt in to the program by leaving your funds on deposit at your
bank for an extended period of time, earning below-market interest
rates. The bank is then allowed to use the extra interest to recoup its
losses over time — income that, by rights, should have been yours.

* Opt out of the program and withdraw your funds immediately,
accepting a loss that approximately corresponds to the actual losses in
the bank’s investment and loan portfolio.

Needless to say, neither the opt in nor the opt out choice is a good one:

If you opt in, you take the chance that the government’s rehab
program may not work on the first attempt and that it will be replaced
by another, even tougher program in the future. Moreover, even if it
works out as planned, you will suffer a continuing loss of income and
access to your cash over an extended period of time.

If you opt out, instead of lost income, you suffer an immediate loss
of principal. Moreover, in order to discourage savers from opting out,
the government would typically structure the program so that everyone
demanding immediate reimbursement suffers an additional penalty.

Again you ask, “What about government guarantees?” By rights, in a
fair plan, insured depositors would suffer less severely than uninsured
depositors. And if the plan is structured properly, those in strong
banks should come out whole, or almost whole, while those in weaker
banks should suffer the larger losses. That’s how it should be handled. But there’s no guarantee that’s how it will be handled.

To avoid all of these risks, I recommend seriously considering
moving (a) nearly all of your bank deposits and accounts, plus (b) a
modest portion of the money you currently have invested in securities
to the safest and most liquid place for your money in the modern world:

Short-Term U.S. Treasury Securities

True safety has two elements. The first is capital conservation — no losses, no reduction in your principal. But it’s the second element that most people miss: Liquidity
— the ability to get a hold of your money and actually use it whenever
you want to, without waiting, penalties, bottlenecks, shutdowns or
disasters of any kind standing in your way.

Absolute perfection is not possible. But on both of those aspects —
capital conservation and liquidity — the single investment in the world
that’s at the top of the charts is short-term U.S. Treasury securities.
These enjoy the best, most direct, and most reliable guarantee of the
U.S. government, over and above any other guarantees or promises they
may have made in the past, or will make in the future.

I know you have questions. So let me do my best to anticipate them and answer them right here.

Question #1. You might ask: “The FDIC is also backed by the
U.S. government. So if I have money in an FDIC-guaranteed account at my
bank, what’s the difference? Why should I accept a lower yield on a
government-guaranteed 3-month Treasury bill when I can get a higher
yield on a government-guaranteed 3-month CD?”

Without realizing it, you’ve answered your own question. If the
yield is higher on the bank CDs, that can mean only one thing — that,
according to the collective wisdom of millions of investors and
thousands of institutions in the market, the risk is also
higher. Otherwise, why would the bank have to pay so much more to
attract your money? Likewise, how can the U.S. Treasury get away with
paying so much less and still have interested buyers for its securities?

It’s because the risk is higher for CDs, but much lower for
Treasury securities. It’s because even within the realm of government
guarantees, there’s a pecking order.

* The first-priority guarantee: Maturing securities that were issued by the U.S. Treasury department itself.

* The second-priority guarantee: Maturing securities that were issued by other government agencies, such as Ginnie Mae.

* Third: The Treasury’s backing of the FDIC.

This is not to say the Treasury is not standing fully behind the
FDIC. Rather my point is that, in the event of serious financial
pressures on the government, the FDIC and FDIC guaranteed deposits will
not be the first in line.

Question #2. You might also ask: “Isn’t the United States
government also having its own share of financial difficulties with
huge budget deficits? If those difficulties could get a lot worse, why
should I trust the government any more than I trust other investments?
Why should I loan my money to Uncle Sam?”

The United States is the world’s largest economy, with the most
active financial markets and the strongest military in the world.
Despite Uncle Sam’s financial difficulties, this has never been in
doubt; and even in a financial crisis, that’s unlikely to change
because the crisis is global. So its immediate impact on the finances of other governments is likely to be at least as severe.

More importantly, the United States government’s borrowing power —
its ability to continue tapping the open market for cash — is, by far,
it’s most precious asset, more valuable than the White House and all
public properties; even more valuable than all the gold in Fort Knox.
Those assets are like Uncle Sam’s home, land and pocket change. His
borrowing power, in contrast, is like the air he breathes to stay alive.

Remember: The U.S. Treasury Department is directly responsible for
feeding money to the utmost, mission-critical operations of this
country, including defense, homeland security, and emergency response.
The Treasury will do whatever it takes to continue providing that funding, and that means making sure they never default on their maturing Treasury securities.

Even in the 1930s, when a record number of Americans were
unemployed, and when we had a head-spinning wave of bank failures,
owners of Treasury bills never lost a penny.

Even in the Civil War, Treasuries were safe. Investors financed 65
percent of the Union’s war costs by buying Treasury securities. But the
war was far worse than those investors had anticipated, leaving over
half of the entire economy in shambles, raising serious concerns among
those investors. However, the U.S. government made the repayment of its
maturing Treasuries it’s number one priority over all other wartime obligations. Investors got back every single penny, and more.

My main point is this: The crisis ahead will not be nearly as severe
as the war that tore our nation apart. If Treasury securities were safe
then, we have no reason to doubt they will be safe today.
Unfortunately, however, I cannot say the same for all of the money
you’ve entrusted to a bank.

Question #3. “Suppose there’s a bank holiday and I need to
cash in my Treasury bills. Since the Treasury Department and the
Treasury-only money market funds use banks for transfers, won’t I be
locked out of my money too?”

We actually have a real precedent for a similar situation.
In Rhode Island in 1991, when the governor declared a state-wide bank
holiday, all the state-chartered savings banks were closed down. Every
single citizen with money in one of those banks was locked out.

At the time, one of our Safe Money Report
subscribers happened to have a checking account in one of the closed
Rhode Island banks. Thankfully, he had almost all of his money at the
Treasury Department in Treasury bills, so his money was safe. But he
called and asked: “The Treasury is set to wire the money
straight into my bank account, which is frozen. Will the money the
Treasury wires me get frozen too?”

In response, I told him to check his post office mailbox. Instead of
wiring his funds, the Treasury had taken the extraordinary measure of
cutting hard checks and mailing them out immediately. They wanted to
make absolutely sure he got his money without any delay.

The moral of this story is that, even in a worst-case banking
scenario, the Treasury will do whatever is necessary to get your money.
We can’t forecast exactly how. But they will probably send you hard
Treasury checks. And they’ll probably designate special bank offices in
every city in every state where you can cash them in. Ditto for
Treasury-only money market funds.

Question #4. “Throughout history, many governments have
defaulted on their debts in a more subtle way — by devaluing their
currency. Why are you recommending Treasury bills, which are
denominated purely in dollars, if one of the consequences of this
disaster could be a decline in the dollar?”

The trend today is toward deflation, which means a stronger
dollar. But even if that changes, the solution will not be to abandon
the safety and liquidity of Treasury bills. It will be to separately
set some money aside and buy hedges against inflation, like gold or
strong foreign currencies that tend to go up in value when the dollar
falls.

How to Buy Treasuries

For funds that you do not need immediate access to on a daily basis,
consider the U.S. Government’s Treasury Direct program. They offer a
variety of choices, but I recommend you use strictly the 13-week
(3-month) Treasury bills.

Meanwhile, for most of your personal or business, savings or
checking, you don’t need a bank, an S&L or any other financial
institution. All you need is a money market fund that invests in
short-term U.S. Treasury bills or equivalent. The Treasuries it buys
enjoy the same U.S. government guarantee as Treasuries bought through
any other venue. So deposit insurance is simply not an issue.

Moreover, the Treasury-only money fund gives you the additional
advantage of immediate availability of your money. You can have your
funds wired to your local bank overnight. Or you can even write checks
against it, much as you’d write checks against any bank checking
account.

For my family and business money, we use the Weiss Treasury Only Money Market Fund.
Plus we also use the fund that was founded by James Benham, a good
friend of my father’s. That’s Capital Preservation Fund, which Jim sold
to the American Century family of funds. Use either of these or your choice of the fund in the list below.

Good luck and God bless!