Government moves to rescue Citigroup

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By Patrice Hill

UPDATE:

The Treasury and Federal Reserve Sunday night were moving to stabilize Citigroup to prevent the giant New York bank from being the latest to succumb to a death spiral in financial markets, according to a source familiar with the plan.

In what would be the government's most momentous and perhaps most desperate action to date to stem the banking crisis, the Fed would take on some of the monumental losses that Citigroup is likely to face on its gargantuan portfolio of troubled loans.

In exchange for the assistance, the Fed would receive warrants giving taxpayers a stake in the company, and it would impose limits on the compensation of the bank's executives.

Citigroup has seen a run on its stock and bonds in the last week, with its stock plummeting by 60 percent to little over $3 a share, in a scenario that has become familiar as a prelude to a major bank failure. The company scrambled to shore up its finances to prevent a potentially even more devastating run on deposits by bank customers, and started talking with the Treasury and Fed this weekend about getting some help.

The bank is by far the largest yet to seek assistance, with a balance sheet over $2 trillion and another $1.25 trillion of questionable loan assets that it is taking onto its balance sheet from a previously off-balance sheet entity the bank used to shield its riskiest investments from scrutiny. It is those dicey loans that are now clouding the outlook for the bank, as they have spawned a host of speculators who are making money placing bets against Citigroup stocks and bonds, forcing the bank to its knees.

Citigroup is in a way a victim of Treasury Secretary Henry M. Paulson's recent announcement that he would not use any of Treasury's $700 billion bank bailout fund to purchase troubled bank assets, as originally intended by Congress. After that announcement, banks like Citi with huge toxic loan portfolios that they cannot get rid of came under siege once again from speculators.

Other eminent banks, including J.P. Morgan & Co. and Bank of America, also have suffered a renewed downturn in the stock market.

The plan the Fed is considering to take on some of Citigroup's losses from troubled assets, beyond a certain level of losses that would be borne by Citigroup, is one that could be applied to other banks that continue to be weighed down by bad loans, analysts note.

The plan draws from the structure of previous bailout packages for American International Group and Wachovia, the source said.

Rob Cox, analyst at Breakingviews.com, said Citigroup and the Fed had few good options to restore faith in the mega-bank. Not only is it too big to fail, but potential buyers like the giant European bank HSBC are put off by Citi's enormous bad loans.

"Investors have simply lost confidence in the ability of Citigroup and its management to weather the financial and economic crisis," he said.

Citigroup already has received a $25 billion cash infusion from the Treasury's bailout fund, and a second one "might not be sufficient to allay concerns" about the bank, he said. Thus, that left the Treasury and the Fed with trying to piece together a plan that will at least tide the bank over the crisis.