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Global Economic Crisis Leading Banks To Financial Armageddon

January 22nd, 2009
President Barack Obama was greeted on his first day in office by a 21-gun inauguration salute and a volley of synchronized demolitions on Wall Street. The Dow Jones tanked, not so much as a repudiation of the 44th President, whose election victory actually sparked a rally on Wall Street, but rather due to news emerging about the state of the banking industry. It is bad, very bad. However, new data on the full impact of the global financial and economic crisis makes it clear that the banking industry worldwide will sink to even lower depths, entering an abyss so dark that not even the most adroit spin-masters on Wall Street can create a rosy scenario to justify a fool’s rally on the Dow Jones.
The 4th quarter posting of an eight billion-dollar loss at Citigroup, taking the year’s negative figure to $18 billion in losses, was sobering and depressing news. Bank of America posted a 4th quarter loss in excess of $2 billion. The news out of the largest American banks was appalling in itself, however, this melancholy manifestation of the American banking industry was compounded in its misery by the revelations emerging across the pond, namely in the United Kingdom.
As described in a recent posting on GlobalEconomicCrisis.com, the British banking system is in morbid distress. A recent report on the state of British banking described the UK’s banks as “technically insolvent.” This dismal overview was followed by the realization that the Royal Bank of Scotland had incurred a loss for the year in excess of $40 billion, a sum of red ink that dwarfed Citigroup’s atrocious results. However, while the destructive contagion of the Global Economic Crisis is devastating the banks of the UK and elsewhere, it is in America that the next nails in the coffin of the financial industry are about to be hammered.
Nouriel Roubini is acknowledged as the leading economist on the global financial crisis, based on his repeated warnings about an impending credit crunch that earned him the moniker of “Dr. Doom.” His predictions turned out to be prophetic, yet even he acknowledged that the crisis evolved at a pace more rapid than he anticipated. That is why his latest forecast, issued during a conference held in Dubai, warrants urgent attention.

According to Roubini, his latest calculations indicate that U.S. banks face potential losses from the credit crisis in the region of $3.6 trillion, a figure that is both stratospheric and apocalyptic, reaching a level previously beyond the worst nightmares of major financial analysts. Professor Roubini points out that with only $1.4 trillion in total capitalization, this means if his projection is accurate, the entire U.S. banking sector is insolvent. This is the equivalent of economic and financial Armageddon.

Last October, Treasury Secretary Paulson warned Congress that without an immediate injection of $700 billion into the financial system (all of it borrowed money) the entire global credit system faced imminent collapse. It appears that this money, designated TARP, has been used almost entirely by banks and financial institutions to shore up their rapidly eroding balance sheets. What Roubini’s numbers suggest is that the TARP is nowhere near enough money to recapitalize a banking sector that appears to be collectively insolvent.

Is the solution more TARPs? Putting aside the issue of moral hazard, we must comprehend that this is an economic and financial crisis that is global, not national. That means if the United States decides to bail out its banks through the largess of the taxpayers, it will either have to borrow the money, print it, or raise taxes to a level that will be draconian.

As the U.S. is reliant on foreigners to finance its fiscal and current account deficits, it will have to compete with many other countries also seeking deficit financing to salvage their own insolvent banks, the UK being a conspicuous example. Even with higher interest rates, it is unlikely that there is enough credit available to cover the total cost of bailing out the U.S. banking industry (it must also be factored in that the Obama administration plans on borrowing one trillion dollars for an economic stimulus program, not directly related to salvaging the banks). Printing the money and monetizing debt will lead to crippling inflation and the inevitable destruction in the value of the U.S. dollar. Finally, the level of increased taxation required to pay for full recapitalization of the American banks without resort to credit markets would be so severe, it is probably both politically and fiscally unsustainable.

With the numerical analysis of Nouriel Roubini adding a quantitative reality to the impending meltdown of the global banking sector in general and U.S. banks in particular, it appears that a bankers hell is in store for us all. In a perverse paradox, instead of banks lending to people, it will be the people called upon to save what can be salvaged from an insolvent banking system, even at the cost of economic ruin that may endure for generations.

 

 

 

 

 

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