On Friday November 21, the world came within a hairs 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 Americas 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 banksstock, 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 publics money was a gift to Paulsons
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 windin 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
Governments 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.
Its 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.
Whats 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 financingto
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 Administrations 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 banksassets into some form of ‘good bankand ‘bad bank,similar to what
the Government of Sweden did with what it called Securum, during its banking
crisis in the early 1990s, 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 capitalistsin 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 nations 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 todays 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 Paulsons entire $700
billion in one gulp.

That reality is the real reason Paulson was forced to abandon
his original ‘crony bailoutTARP 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 arrivalas 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 ‘troubledassets.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 Paulsons 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 ‘miraclefrom
an Obama Presidency is no longer an option for the rest of the world.