The Real Truth behind the Citigroup Bank Nationalization
By F. William Engdahl, 24 November 2008
On Friday November 21
the world came within a hair’s breadth of the most colossal financial collapse
in world 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.
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 one compared 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, an economist with
the US United Steelworkers union, whose workers face devastating job 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 will not be the last. Paulson demanded, and got from a labile US Congress
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
Bros. fail, was the proximate trigger for the present global crisis. Lehman
Bros.’ surprise collapse triggered the current global crisis of confidence,
because it was 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 more strategic
Lehman Bros. fail.
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 major US Government funds in the past two months. Ironically,
only eight weeks before the US Government had designated Citigroup to take over
the failing Wachovia Bank. 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 major US banks are 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 is by no means certain
they will salvage the dollar system.
The reason is that 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. The total
global financial system losses
could exceed another
$1,500 billion according to an IMF study by Singh and Segoviano.
The health of Citigroup
is far from the most 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 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 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, appeared to have 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 in turn was
a major factor in the horrific downdrafts 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 overlooked. 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 come to
pass, and a Chapter 7 or liquidation of GM would be a seismic 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 to shepherd a company through the bankruptcy process 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 likely be forced into a partial, or even a full
liquidation. The ramifications are nightmarish. Aside from the loss of 100,000
jobs at GM itself, GM's business 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 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 chose to focus on the
fact the GM chief flew in the private company jet to Washington. It 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 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.
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 and reorganize the 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,
allowing 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, Paulson and his ‘crony capitalists’ have
turned a bad situation into a globally catastrophic one.
His apparent realization
of the error of his initial refusal to nationalize, deeming it in effect
‘un-American’ 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 securtities of the banks with his $700 billion TARP
taxpayer money, he never revealed why.
Under the original
Paulson Plan, as Dimitri B. Papadimitriou and Research Scholar L. Randall Wray
of the respected 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
states, ‘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.’
The dilemma he 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 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.