On his first full day in office President Obama is facing a global banking crisis that has been getting worse instead of better, with an initial application of help from governments around the world having little impact. The figures are staggering, with losses mounting at an alarming rate and investors fleeing these stocks in droves. Yesterday’s stock market results were driven by the escalating flight from financial stocks.

Some of the results show a worldwide banking crisis is now upon us. The Royal Bank of Scotland announced a loss of over $40 billion, Citi Group lost over $19 billion last year and is trying to break itself up, large regional player Regions Financial has announced a fourth quarter loss of over $6 billion, and trouble is showing up at institutions thought to be safe from the storm, including Bank of America. And with the problems rising in this sector equity investors not only will not buy stock, but are dumping these stocks as fast as they can in anticipation of potential government intervention that will wipe out equity holders.

The banking sector has been heavily criticized for failing to lend after receiving government infusions of cash, but it now appears likely that this non lending policy has been implemented to insure that individual banks do not fall below federally mandated capital theshholds. They are continuing to hemmorage cash, and in many cases false valuations of balance sheet assets are the only thing between these banks and insolvency. From the Washington Post:

Until banks can attract fresh capital from debt or equity investors, it will be difficult to stabilize and jump-start lending, said Binky Chadha, chief U.S. equity strategist at Deutsche Bank in New York. But the government’s patchwork approach to the bailout has would-be investors sitting on the sidelines, he said.

“In each episode of financial intervention, the rules have been a little different,” Chadha said. “Hopefully [the new administration] will lay out the rules, and it will be a lot clearer. In the meantime, the textbook model of wiping out the equity holders is clearly a concern, and should be a concern.”

The basic problem facing the financial industry, and the new administration, is that banks lack the money to cover their losses. The capital reserves that banks are required by regulators to maintain against losses have been badly eroded.

The banking industry has acknowledged losses of roughly $1 trillion since the start of the financial crisis. Goldman Sachs last week projected that this total could more than double. Nouriel Roubini, a professor at New York University’s Stern School of Business noted for his pessimism, said yesterday that losses could hit $3.6 trillion.

New York Times columnist Paul Krugman believes that nationalization, on a temporary basis, is the only thing that will clean up this mess. And it is that fear that has many investors heading for the sidelines. Krugman gives a hypothetical that illustrates the problem as he sees it:

To explain the issue, let me describe the position of a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout.

Krugman speculates on the potential solution to this “hypothetical” Bank’s problems, including the government buying the “toxic” assets, which Krugman argues strongly against as a gift to shareholders. He urges a government takeover, a shedding of the banks toxic assets to a new institution similar to the Resolution Trust Corp, recapitalization and sale to new ownership. Krugman at this point is likely correct. If there was going to be a point where these toxic assets were going to be moved off of the balance sheets of banks it should have happened as part of TARP part I. The balance sheets of these institutions are crumbling, and the threat of shareholders being wiped out will likely forestall private equity from saving them. That leaves only the Krugman solution as far as I can tell. As the problem escalates in size (losses of three trillion?) even national governments will have difficulty dealing with them. President Obama will need to try to fix this sector quickly, before a death spiral makes it impossible to cure. Read the Krugman piece here.