The UK financial sector is in collapse. Rather than let the banks fail, the government is risking it all in one giant high-stakes gamble to prop up the system. It is really a no-win situation, however: Even if the bet pays off, the best the economy can expect is a slow grind-down. If the bet doesn’t pay off, the UK faces national bankruptcy. The fate of Britain’s whole economy may hang on this gamble.

The UK banking system has reached a breaking point. “The country stands on the precipice,” wrote the Telegraph. “We are at risk of utter humiliation, of London becoming a Reykjavik on Thames and Britain going under. … [T]he possibility of national bankruptcy is not unrealistic.”

Over the first three weeks of this year, banking giant Barclays has lost 62 percent of its value. The Royal Bank of Scotland is down 78 percent, and Lloyds Banking Group has plummeted 69 percent. Even London-based international banking group hsbc Holdings has fallen 25 percent.

Without government intervention, Britain’s biggest names in high finance would experience a short but exciting end to life. So, for the second time in three months, the government has felt compelled to act.

And act it has—in a dramatic and risky fashion. The new bailout plan will provide an additional £100 billion in capital and a £250 billion bank credit line to endangered banks. The government will also purchase more shares in the Royal Bank of Scotland.

But most dramatic—and risky—is the government’s intentions to blanket guarantee the banking sector’s hemorrhaging balance sheets. The Telegraph’s Iain Martin described the plan as the creation of a “giant insurance scheme for bad debt, [and a] pledge to honor liabilities without limit.”

And therein lies the danger for Britain: Private banking risk has now become national taxpayer risk.

The money involved is astounding. Britain’s four big banks have leveraged themselves to the hilt with borrowed money. British banks have liabilities so vast they completely eclipse the entire UK economy.

The Royal Bank of Scotland alone has £1.8 trillion worth of liabilities—three times the annual UK government spending budget. The bank asserts that it has assets worth in excess of that amount, but as write-downs, surprise revelations and forced government nationalizations continue to rock the market, few seem to believe any British bank claims anymore.

In total, UK banks report liabilities that are roughly equivalent to 4½ times the size of the entire UK economy.

The problem is, nobody really knows just what the true market value of the assets backing those liabilities are. The banks don’t even know—though they have wishful estimates—and most are not in a hurry to find out. Last year, National Australia Bank and Merrill Lynch found out that certain of their mortgage holdings would only sell for between 10 and 22 cents on the dollar.

But the bigger problem is that UK banks may actually have liabilities far in excess of what they are reporting.

The Wall Street Journal says that with this latest bailout and blanket guarantee of the banking system, the UK government is now a major player in the derivatives credit–default-swap business—a market that is measured in the tens of trillions—and a market that has already unexpectedly and suddenly destroyed several major financial institutions.

If you recall, credit default swaps were what brought U.S.-based Lehman Brothers and the aig group down. In early 2008, aig said that its derivatives exposure was not material to the company—that at most it could lose $5 billion. Less than a year later, the company is nationalized and it has sucked more than $127 billion in U.S. taxpayer money down the drain with it—so far. Lehman experienced a similarly speedy and catastrophic collapse.

The important thing to know is that this financial product that was originally designed to help banks manage risk, morphed into an unregulated “investment” market where big banks and hedge funds (which often borrowed the money from the banks) borrowed incredibly vast amounts of money to wager Casino Royale-style leveraged bets on the ability of borrowers to pay back loans.

And now taxpayers are on the hook for all those bets—which, due to the severe housing bust, rising mortgage delinquencies and rising corporate bankruptcies, could be extremely costly.

The Wall Street Journal says the government guarantee is a “bet … that insuring against future losses makes them less likely to materialize.”

If politicians are wrong, then, as the Telegraph brings out, the nation could be facing a “bottomless pit” of losses.

The UK Treasury is now “wedded to the banks and all their sins,” says Ambrose Evans-Pritchard. Britain can no longer take the Iceland route. When Iceland’s big banks failed last year, after early attempts to prop up the banks, the government cut its losses. The banks failed, people lost billions, foreign creditors lost billions more, but the government still remained financially viable. Though struggling, the country continues to function.

But the UK government is now becoming the banking system. So if the banks go down, so does the whole society.

And if Britain goes back on its word and lets the big banks collapse, it wouldn’t be private banks that stiffed foreigners out of billions and set off an “asset price death spiral.” It would be the UK government that would be responsible for the collapse of what Marc Ostwald, a bond expert at Monument Securities, calls a “Western banking system … already on life support.” Foreign retaliation could get even uglier.

“I would urge you to sell any sterling you might have,” says famed investor Jim Rogers. “It’s finished. I hate to say it, but I would not put any money in the UK.”

Great Britain faces collapse. And now we see the events warned of by Herbert W. Armstrong, the best geopolitical analyst of his time, playing out just as predicted. You can read about why Herbert Armstrong knew the financial collapse of the U.S. and UK was just a matter of time in this book.