U.S. Putting Together Rescue for Citigroup

Aim Is to Restore Confidence in Critical Bank

By Neil Irwin and David Cho - Washington Post Staff Writers

Monday, November 24, 2008; A01

The government was moving ahead last night with a new rescue for Citigroup, revising emergency efforts yet again to head off the failure of a company more deeply intertwined with the financial system than nearly any other, sources said.

The Treasury Department, Federal Reserve and Federal Deposit Insurance Corp. were finalizing the details of a plan to make billions of dollars in government money available to Citigroup, one of the nation's largest banks, if troubled assets on its books were to lose significantly more of their value, said a government official and an industry source. They spoke on condition they not be named because the deal was still being crafted last night.

The goal would be to give investors and lenders faith in Citigroup's ability to continue operating, after a week in which Citigroup's stock fell about 60 percent, to $3.77. The government has already invested $25 billion in Citigroup this fall to shore up its capital, but those urgent efforts are no longer preventing a dramatic erosion of confidence in the company.

An announcement of the federal plan was expected as early as last night, sources said.

Under discussion last night was the creation of a so-called "bad bank" into which Citigroup could offload billions of dollars of distressed assets. The goal would be to cleanse Citi's books of these investments, which represent a fraction of the company's overall assets. The toxic assets that have provoked such great concern include securities backed by mortgages and commercial real estate loans.

It remained unclear yesterday evening how much taxpayer money would be put at risk and whether it would come from the Treasury's $700 billion Troubled Asset Relief Program or another source. Nor was it certain what concessions the government might require in return, though federal officials might demand either shares of preferred stock in Citigroup or warrants to buy more stock.

The federal initiative would represent yet another massive government intervention in the financial system meant to try to contain a crisis that has already brought down a dozen of the nation's banks and investment companies.

This time, though, the company in jeopardy is truly gigantic. Citigroup is the largest U.S. bank by assets, with $2 trillion on its books. By contrast, Wachovia, which became the largest bank to be done in by the financial crisis after being forced to sell itself to Wells Fargo this fall, has just over one-third as many assets.

Citigroup engages in almost every form of financial transaction that a bank or investment firm can engage in, making it heavily involved with almost every other large financial institution in the world. It is also deeply integrated into the nation's financial history.

In the 1920s, a firm called National City Bank started repackaging bad loans from Latin America and selling these to investors as safe securities. These investments collapsed in grand fashion after the 1929 stock market crash and eventually led to a new wave of securities regulation. National City Bank became Citibank, which in turn became a major unit of Citigroup.

Citigroup has incurred billions of dollars in losses in the past 18 months, once again by partly repackaging bad loans into what were viewed as safe securities.

As investors intensified their pressure on Citigroup stock last week, federal officials assured that the company was capitalized and urged calm.

Officials at the Fed and Treasury do not generally get agitated over changes in the stock price of even a large bank as long as they believe the underlying bank is sound. But in this case, the stock price has dropped so much that it raised the risk of a downward spiral.

Senior government officials feared that a low stock price would prompt those who do business with Citi -- who loan it money, make deposits in its bank and brokerage units or engage in complicated financial contracts with it -- to pull their money out or refuse to do any more business with the firm for fear of its future.

That, in turn, could drive the stock down further, creating a vicious cycle. That is the scenario government officials are trying to prevent by promising to protect Citi against catastrophic losses.

So government officials view their initiative to save Citigroup as different from the rescue of investment bank Bear Stearns in March or takeover of insurance giant American International Group in September. In those cases, the institutions were considered insolvent, justifying action by federal officials to punish shareholders and fire the chief executives.

Heavily involved in the government's negotiations with Citigroup is Timothy F. Geithner, who is scheduled to be named President-elect Barack Obama's Treasury secretary today. Geithner is president of the New York Fed, which is Citi's primary regulator.

The Citigroup action reflects a shift in approach in the government's massive efforts to stabilize the financial system. For most of the year, the Treasury Department and Federal Reserve have used an improvised approach to rescuing, or not rescuing, failing firms. They engineered takeovers of Bear Stearns and Wachovia, allowed Lehman Brothers to go bankrupt and nationalized AIG, Fannie Mae and Freddie Mac.

When Congress passed the Troubled Asset Relief Program on Oct. 3, the expectation was that Treasury Secretary Henry M. Paulson Jr. would use the $700 billion to buy mortgages and other toxic assets from the banks. Instead, he has used the bailout fund to directly inject capital into banks, including Citigroup. Meanwhile, federal officials have been arranging mergers between weak banks and stronger ones, sometimes offering financial help through either the Troubled Asset Relief Program or the FDIC to get a deal done.

The new backstop contemplated for Citigroup represents a different strategy, however, combining elements of several of these earlier approaches. It is similar to the original plan for the TARP because the initiative would deal directly with the troubled assets on the firm's books. But the government does not propose purchasing them; rather they would stay on Citi's books.

During its history, Citibank has been responsible for some of the banking industry's best-known innovations, including modern checking accounts and certificates of deposit. Citi was a pioneer in the development of ATMs.

After the 1929 stock market crash, spurred in part by those abuses at the former National City, the government passed a law separating ordinary banking from stock brokerage and other investment services. That law, the Glass-Steagall Act, was dismantled in the 1990s in part to allow the creation of Citigroup, which comprised the merged Citibank, Salomon Smith Barney brokerage, Travelers Insurance and other entities.

The idea behind the mergers, engineered by then-Chairman Sandy Weill, was to have an all-purpose financial services powerhouse. However, the units have never worked together as effectively as envisioned, and the company spun off the insurance unit in 2005.