The Fed Chairman, the Treasury Secretary, and Congress have now done more to bail out financial institutions

and pump up financial markets than any of their counterparts in history.

But it’s not nearly enough; and, at the same time, it’s already far too much.

Two years ago, when major banks announced multibillion losses in subprime mortgages, the world’s central

banks injected unprecedented amounts of cash into the financial markets. But that was not enough.

Six months later, when Lehman Brothers and American Insurance Group (AIG) fell, the U.S. Congress rushed to

pass the Troubled Asset Relief Program, the greatest bank bailout legislation of all time. But as it turned out,

that wasn’t sufficient either.

Subsequently, in addition to the original goal of TARP, the U.S. government has loaned, invested, or

committed $400 billion to nationalize the world’s two largest mortgage companies, $42 billion for the Big

Three auto manufacturers; $29 billion for Bear Stearns, $185 billion for AIG; $350 billion for Citigroup; $300

billion for the Federal Housing Administration Rescue Bill; $87 billion to pay back JPMorgan Chase for bad

Lehman Brothers trades; $200 billion in loans to banks under the Federal Reserve’s Term Auction Facility

rescue various credit markets; $620 billion in currency swaps for industrial nations, $120 billion in swaps for

emerging markets; trillions to cover the FDIC’s new, expanded bank deposit insurance plus trillions more for

Total tally of government funds committed to date: Closing in on $13 trillion, or $1.15 trillion more than the

tally just 24 hours ago, when the body of this white paper was printed. And yet, even that astronomical sum is

hundreds of billions, the wealth destruction taking place at the household level in America is occurring in the

trillions — $12.9 trillion vaporized in real estate, stocks, and other assets since the onset of the crisis,

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However, based on our analysis, a total of 1,568 banks and thrifts are at risk of failure with assets of $2.32

trillion due to weak capital, asset quality, earnings and other factors. (The details are in Part I of our paper,

and the institutions are named in Appendix A.)

strong institutions; that the funds would go primarily toward stabilizing the markets or the economy. But

even before the check could be cut, they learned that the money would have to be for a very different

purpose: an emergency injection of capital to prevent Citigroup’s collapse. Based on our analysis, however,

Citigroup is not alone. We could witness a similar outcome for JPMorgan Chase and other major banks.

(See Part II.)

collapse. And indeed, its counterparties alone have $36 trillion in assets. But AIG’s CDS portfolio is just one

of many: Citibank’s portfolio has $2.9 trillion, almost a trillion more than AIG’s at its peak. JPMorgan Chase

has $9.2 trillion, or almost five times more than AIG. And globally, the Bank of International Settlements

(BIS) reports a total of $57.3 trillion in credit default swaps, more than 28 times larger than AIG’s CDS

portfolio.

Clearly, the money available to the U.S. government is too small for a crisis of these dimensions. But at the

same time, the massive sums being committed by the U.S. government are also too much: In the U.S. banking

industry, shotgun mergers, buyouts and bailouts are accomplishing little more than shifting their toxic assets

like DDT up the food chain. And the government’s promises to buy up the toxic paper have done little more

than encourage banks to hold on, piling up even bigger losses.

Hidden in an obscure corner of the derivatives market is a unique credit default swap that virtually no one is

talking about — contracts on the default of the United States Treasury bonds. Quietly and without fanfare, a

small but growing number of investors are not only thinking the unthinkable, they’re actually spending money

on it, bidding up the premiums on Treasury bond credit default swaps to 14 times their 2007 level. This is an

early warning of the next big shoe to drop in the debt crisis — serious potential damage to the credit,

credibility and borrowing power of the United States Treasury.

We have no doubt that, when pressed, the U.S. government will take whatever future steps are necessary to

sufficiently control its finances and avoid a fatal default on its debts. However, neither the administration nor

market’s perception of the U.S. government’s credit is falling, as anticipation of a possible future default by

the U.S. government, no matter how unlikely, is rising.

This trend packs a powerful message — that there’s no free lunch; that it’s unreasonable to believe the U.S.

government can bail out every failing giant with no consequences; and that, contrary to popular belief, even

Uncle Sam must face his day of reckoning with creditors.

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We view that as a positive force. We are optimistic that, thanks to the power of investors, creditors, and the

people of the United States, we will ultimately guide, nudge and push ourselves to make prudent and

courageous choices:

1. We will back off from the tactical debates about how to bail out institutions or markets, and rethink our

figures and damage to our nation’s credit — are far too high.

achievable goal of rebuilding the economy’s foundation in preparation for an eventual recovery.

the solution being offered is to encourage banks to lend more and people to borrow more.

savings needed for healthy capital formation, investment in better technology, infrastructure, and

education. Yet, the solution being offered is to spend more and, by extension, to save less.

These disconnects will not persist. Policymakers will soon realize they have to change course.

3. When we change our goals, it naturally follows that we will also change our priorities — from the battles we

can’t win to the war we can’t afford to lose: Right now, for example, despite obviously choppy seas, the

prevailing theory seems to be that the ship is unsinkable, or that the government can keep it afloat no matter

how bad the storm may be.

With that theory, they might ask: “Why have lifeboats for every passenger? Why do much more for hospitals

that are laying off ER staff, for countless charities that are going broke, or for one in 50 American children who

are homeless? Why prepare for the financial Katrinas that could strike nearly every city?”

very expensive. We have the infrastructure. And we’ll have plenty of volunteers.

debates but pushed out in time. Regulatory changes are mapped out in detail, but undermined in practice.

Soon, however, with more reasonable, achievable goals, theory and practice will fall into synch.

5. Instead of trying to plug our fingers in the dike, we’re going to guide and manage the natural flow of a

cost of living, a healthier work ethic, an enhanced ability to compete globally.

Then we’re going to step up, bite the bullet, pay the penalty for our past mistakes, and make hard sacrifices

gratification. We will assume responsibility for the future of our children.

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7. We will cease the doubletalk and return to some basic axioms, namely that:

cleansing of bad debts. The market price will not frighten us. We can use it more universally to value assets.

if the asset is worth less than what it was purchased for, it’s a loss.

advantages that may never be reaped.

capital is gone, then the institution has failed.

Kansas City Federal Reserve President Thomas Hoenig recommends that “public authorities would be directed

to declare any financial institution insolvent whenever its capital level falls too low to support its ongoing

operations and the claims against it, or whenever the market loses confidence in the firm and refuses to

provide funding and capital. This directive should be clearly stated and consistently adhered to for all financial

institutions that are part of the intermediation process or payments system.” We agree.

9. We will build confidence in the banking system, but in a very different way: Right now, banking authorities

are their own worst enemy. They paint the entire banking industry with a single broad brush — “safe.” But

when consumers see big banks on the brink of bankruptcy, their response is to paint the entire industry with

an alternate broad brush — that the entire banking industry is “unsafe.” To prevent that outcome, we will

challenge the authorities to release their confidential CAMELS ratings on each bank in the country. And to

restore some risk for depositors, we will ask them to reverse the expansion of FDIC coverage limits, bringing

back the $100,000 cap for individuals and businesses.

Although these steps may hurt individual banks in the short run, it will not harm the banking system in the

long run. Quite the contrary, when consumers have a reason to discriminate rationally between safe and

unsafe institutions, and when they have a motive to shift their funds freely to stronger hands, they will

strengthen the banking system.

I am making these recommendations because I am optimistic we can get through this crisis. Our social and

physical infrastructure, our knowledge base, and our Democratic form of government are strong enough to

make it possible. As a nation, we’ve been through worse before, and we survived then. With all our wealth

and knowledge, we can certainly do it again today.

But my optimism comes with no guarantees. Ultimately, we’re going to have to make a choice: The right

choice is to make shared sacrifices, let deflation do its work, and start regenerating the economic forces that

have made the United States such a great country. The wrong choice is to take the easy way out, try to save

destroy our society.