Trillions, billions, all in dollars; are these words being repeated so often that we are simply becoming immune? Here is another story for those still susceptible to shock and awe. The name of Bernard Madoff was legendary among Wall Street traders; he had even served a stint as Chairman of the Nasdaq Stock Market. He was arrested on December 11 and accused of $50 billion fraud – that is not much less than twice the annual GDP of Lanka! The Associate Director of New York’s Securities and Exchange Commission, reading the indictment, referred to it as "a stunning fraud of epic proportions"; it may be the largest single fraud in financial history; though the way things are going that record may soon be broken! Madoff Investment Securities held $17 billion directly from clients and the remainder as investments from European banks (Spain’s Santander $3.1 billion, HSBC $1 billion, BNP Paribas, RBS and other banks smaller, amounts), mutual funds and institutional investors. The company employed hundreds of traders.

How was it done?

Elementary my dear Watson; simplicity is the answer to any challenge. Bernie Madoff was a jolly fellow, much liked by people around him; he also ran a gargantuan pyramid (Ponzi) scheme. For those not familiar with the word, it’s breathtakingly simple. Letstart with, in the simplest case, just one investor, to whom we guarantee a very high rate of return. Then we dance the merry with the money – invest some, party with the rest. Next round we attract two investors and use their capital to pay our first investor the promised handsome return. Our reputation is spreading far and wide, so third round we have four, five or six suckers banging on our door, cash bulging from pockets. No problem, we use their capital to pay rich dividends to round two investors, and the also second year dividends to our first chap. So long as the number of dummies added to the scheme each year is growing, the game can go on, hence the name pyramid.

The music stops if the base stops growing, such as when an economic recession hits and investors dry up, or folks already in the scheme want their capital back. Then the whole pyramid collapses like a pack of cards within weeks. There is no money to return; it’s all gone into Bernie’s yacht, mansion and premier-cru Rothschild, and the bloated dividends paid out to greedy investors. Auditors now say that there is just $200 to $300 million left in Madoff Securities funds of the $50 billion that numerous suckers had handed over.

To moralists, the lesson is about human greed; if anything sounds too good to be true, it is. To political scientists it is about how asset and investment bubbles that develop in capitalism, at the latter stages of a periodic cycle, is the breeding ground for scams, and also for not illegal financial engineering transactions, all of whose economic impact is the same; a systemic crisis.

What has happened to Citibank?

A few years ago Citi Group was the largest bank in the world with a market capitalisation in excess of $250 billion; looking back, the 52-week high for the share price is $35.29. The Great Crash of 2008 exposed the huge toxic debts that the bank was snowed under and its credibility collapsed. The 52-week low for the stock price crumbled to $3.05 per share and the Groups market capitalisation nosedived to $32 billion on 24 November (market capitalisation is not strictly proportional to share price for certain technical reasons). Citi Group was done for, either Uncle Sam stepped in or it would have to lie down and die, like Lehman Brothers. But the Lehman experience had already scared the excrement out of the authorities, and impact of Citi’s demise would be rather like a sub-prime foreclosure of the property standing at 1600 Pennsylvania Avenue.

The Treasury stepped in and used the $700 billion TARP fund (Troubled Asset Relief Programme) to "inject" $20 billion in cash into Citi Group and underwrite hundreds of billions of dollars of risky assets. But this would imply, if the cash injection was a purchase of bank equity, that the US government is now the owner of about 62.5% of America’s largest international bank – assuming the bank was valued at $32 billion. I have scoured the web and asked a banker in exactly what capacity the $20 billion was injected, but whether it was in fact a purchase of a controlling interest remains shrouded in secrecy.

If things go on like this the whole roof will cave in; the USA will become a state capitalist economy. OK, I am exaggerating a little, but consider; AIG the worlds largest insurance company and Freddie Mack and Fanny May the worlds largest mortgage companies have been fully nationalised, a large number of US banks, large and small, have been part nationalised, and what will happen to the auto industry?

Will the auto industry go belly up?

GM is the motif of the American way of life; until not long ago it was also one of the world’s largest and richest companies. Today it is broke and has hired bankruptcy lawyers to file papers (called Chapter 11 action) if a desperate request to the government for $14 billion in bailout funds is refused. The Senate said ‘no’ as Republicans demanded tough conditions such as workers’ pay cuts, concessions from bond holders and tighter controls on executive packages. General Motors carries $62 billion in debt, $30 billion of which is health-care obligations in respect of about one million retirees and spouses and the current 250,000 workforce and families. Negotiations are now taking place with the White House to have the monies released from TARP funds (already released by Congress to the Administration).

GM has been losing market share for years. It lost the quality and reliability race to Toyota, Honda and Mazda long ago, and its wage and executive pay bill is unsustainable. Now with the threat of bankruptcy looming no one wants to buy a GM car, truck or SUV; the market is freezing up. Would you buy a vehicle from a supplier who may not be around to service your guarantee and supply your spare parts? What will happen to the second-hand resale market? Chrysler is in equally dire straits; Ford is holding its head above water for now, but only just. A few weeks ago the big three importuned Congress for $25 billion and were told to go home and sort their problems out themselves.

If GM, Chrysler and Ford go belly up it’s not just the final nail in the coffin of symbolic ‘America as she was’; it will get much worse when the economic effect is factored in. Directly, about 350,000 jobs will disappear, but a network of small companies in the vast component supply chain will fold up, dealerships will close, the steel industry will take a blow; in total about three million jobs will disappear. And it won’t be a bonanza for the likes of Toyota, Honda and Mazda, at least not in the short run, because the collapse of component suppliers in the supply chain will disrupt their production lines as well. There will be some international repercussions as well. GM owns Vauxhall in the UK and if it folds up 5,000 jobs in Vauxhall’s Luton, Millbrook and Ellesmere Port plants will go.

There is little public sympathy for auto industry executives. GM’s CEO Richard Wagoner got a 33% pay rise to $2.2 million pay plus equity package in 2007 although the company lost $38.7 billion that year. GM’s top five executives are paid $7 million between them. Ford’s Alan Mullay is paid $2 million in basic salary and $4 million in bonuses; he also received stock options valued at $11 million. Mullaly has collected $50 million since taking the helm of the company. Chrysler will pay out $30 million to its top executives in June 2009. The auto industry is in terminal decline but its incompetent executives reap a killing.

Some Republicans perhaps want a recession to discredit the incoming Obama administration sufficiently in time for the 2010 mid-term elections, but more generally neo-liberal economists are opposed to a rescue for ideological reasons. "The best solution is bankruptcy" says Briggs Armstrong of the Ludwig von Mises Institute referring to the auto giants. He represents a school of thought; von Mises (1881-1973) founded the extreme rightwing neo-Austrian school which advocates untrammelled free markets, unhampered right to private property and says ‘no’ to socialism and government intervention. Neo-Austrans also do not need to contest elections and presumably he would not mind dispensing with them altogether! The upshot is that there is an ideological contest in the US between the Democrats and Obama who are pressured by the unions and the electorate to save jobs and jumpstart the economy and the neo-liberals who think an economic purge is essential. The Keynesians will have their way after Obama’s inauguration, but the recovery, in the absence of spring cleaning, will be hard and slow. Did I hear you asking me to guess how long? Not less than five years says I.

A few more bits of bad news

Two more mournful snippets and I would have spoilt your Sunday morning sufficiently. Ecuador has decided default on its foreign debt; its debt audit commission determined that the 2012 and 2030 bond issues were "illegal and illegitimate", providing President Rafael Correa with the legal basis for defaulting on $30 million interest payment now due on the $510 million 2012 sovereign bond issue. Ecuador’s three sovereign bonds (2012, 2015 and 2030) sum up to $3.9 billion, which is 39% of the country’s total foreign debt of $10 billion which in turn is 23% of annual GDP ($44 billion). Who will follow suit? How many more will follow?