US Economic Crisis Deepens: Federal Government Agrees to Rescue Struggling Citigroup

Detroit community residents and organizers came out to defend the home of Rubie Curl-Pinkins who was facing foreclosure by Bank of America. This demonstration was held on July 18, 2008. (Photo: Alan Pollock).
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U.S. Agrees to Rescue Struggling Citigroup

Plan Injects $20 Billion in Fresh Capital, Guarantees $306
Billion in Toxic Assets

By DAVID ENRICH, CARRICK MOLLENKAMP, MATTHIAS RIEKER, DAMIAN PALETTA and JON HILSENRATH
Wall Street Journal

The federal government agreed Sunday night to rescue Citigroup Inc. by helping to absorb potentially hundreds of billions of dollars in losses on toxic assets on its balance sheet and injecting fresh capital into the troubled financial giant.

The agreement marks a new phase in government efforts to stabilize U.S. banks and securities firms. After injecting nearly $300 billion of capital into financial institutions, federal officials now appear to be willing to help shoulder bad assets, on a targeted basis, from specific institutions.

Citigroup is one of the world's best-known banking brands, with more than 200 million customer accounts in 106 countries. Its plunging stock price threatened to spook customers and imperil the bank.

President George W. Bush said Monday there could be more decisions like the Citigroup rescue if other institutions need help. Mr. Bush also said he consulted with President-elect Barack Obama on the rescue. "There is close cooperation" between his administration and the Obama camp, he said.

If the government's rescue plan is a success, it could help bring stability to the entire financial system. If it doesn't, even deeper doubts about the industry's future could spread.

On Monday, Citigroup's stock traded up 58% -- a sharp reversal for the shares, which lost 60% of their value during last week alone. The bounce helped drive a rally in the broader financial sector. The Financial Sector SPDR ETF was up by nearly 12% in late-morning trade.

The cost of protecting a notional amount of $10 million of Citigroup bonds against a possible default for five years recently fell to $255,000 a year -- a nearly 50% drop from $500,000 on Friday -- according to Phoenix Partners, a New York-based inter-dealer broker.

After a weekend of marathon talks between Citigroup executives and top federal officials, the parties late Sunday night nailed down a package in which the government will help protect the company from its riskiest assets.

Shares of battered Citigroup jumped on Monday after a $326 billion plan was unveiled to help the company avoid a collapse.

Under the plan, Citigroup and the government have identified a pool of about $306 billion in troubled assets. Citigroup will absorb the first $29 billion in losses in that portfolio. After that, three government agencies -- the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp. -- will take on any additional losses, though Citigroup could have to share a small portion of additional losses.

The plan would essentially put the government in the position of insuring a slice of Citigroup's balance sheet.

That means taxpayers will be on the hook if Citigroup's massive portfolios of mortgage, credit cards, commercial real-estate and big corporate loans continue to sour.
In exchange for that protection, Citigroup will give the government warrants to buy shares in the company.

In addition, the Treasury Department also will inject $20 billion of fresh capital into Citigroup. That comes on top of the $25 billion infusion that Citigroup recently received as part of the broader U.S. banking-industry bailout.

Long Negotiations

The government and Citigroup had hoped to unveil the plan early Sunday evening, but negotiations dragged on longer than expected. Treasury Secretary Henry Paulson began briefing Congressional leaders about the plan later in the evening.

Asian markets were mostly lower in early Monday trading as news of the discussions surfaced. Japan's markets were closed for a holiday.

The sweeping rescue plan underscores how concerned the government had become about letting Citigroup's fortunes continue to deteriorate. The company has been pounded by mortgage-related losses and is on track to suffer further from the weakening economies in the U.S. and around the world.

Last week, with Wall Street rapidly losing confidence in the company, its shares tumbled 60% to a 16-year low. Still, Citigroup Chief Executive Vikram Pandit and other top executives insisted last week that the company remained on solid financial footing.

While Citigroup's recent woes don't appear to be as severe as the problems that ultimately felled Bear Stearns Cos. and Lehman Brothers Holdings Inc., the U.S. government seems to have decided it can't afford to gamble on whether Citigroup will weather the storm.

At the same time, the Treasury Department is already facing a political backlash over the use of taxpayer funds to stabilize the banking sector, and has nearly exhausted the $350 billion that Congress allotted to the first phase of the industry rescue.

The planned arrangement with Citigroup appears to be an attempt to thread that needle by giving the company some breathing room until markets calm.

In addition to $2 trillion in assets Citigroup has on its balance sheet, it has another $1.23 trillion in entities that aren't reflected there. Some of those assets are tied to mortgages, and investors have worried they could cause heavy losses if they are brought back on the company's books.

The assets affected under the government plan are largely loans and securities backed by residential and commercial real estate. Such assets have been devastated by the meltdown of the housing markets and have started coming under even greater strain in recent weeks as the U.S. economy slows.

"With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy," the Treasury Department, Fed and FDIC said in a joint statement issued late Sunday.

Quick Action Needed

Even as they assured employees and investors last week that the company was on sound financial footing, Citigroup executives and directors knew they needed to do something fast to stabilize their company. By Friday, bank officials were hoping for a public expression of confidence from the government, believing that would help reassure clients and customers.

Top government officials, including the heads of the Treasury Department and the Fed, also started scrambling to draw up contingency plans in case Citigroup's troubles intensified.

On Sunday evening, government officials were locked in meetings to hammer out the final terms of an arrangement that will leave the government deeply enmeshed in the inner workings of one of the world's largest financial institutions.

The government didn't require Citigroup to make changes to its executive ranks or its board in return for government assistance. However, Citigroup agreed to "comply with enhanced executive compensation restrictions," the government said Sunday, and also will implement a government-backed plan to modify distressed mortgages that is designed to curb foreclosures.

Despite the unprecedented scope of the rescue plan, it's not clear whether it will be enough to stabilize Citigroup. The roughly $300 billion pool of assets that are included in the rescue plan represent only a sliver of the company's more than $3 trillion in assets, including its holdings in off-balance-sheet entities.

Jitters about such "hidden" assets helped trigger the nose-dive in Citigroup's stock last week. Among the off-balance-sheet assets are $667 billion in mortgage-related securities.
Citigroup has tried repeatedly to rid itself of its exposure to those assets -- and nearly hammered out a similar arrangement with the government nearly two months ago.

In late September, the company reached an agreement for a government-financed acquisition of Wachovia Corp. Under that planned deal, Citigroup and the government were going to divvy up the losses on $312 billion of assets, with Citigroup absorbing the first $30 billion in losses and the government shouldering the remainder.

Citigroup described that arrangement as intended to insulate it from Wachovia's risky mortgage assets. But Citigroup also would have been able to unload some of its own assets, according to people familiar with the matter.

That deal unraveled in less than a week, after Wells Fargo & Co. emerged with a higher bid that didn't require direct government backing. That deprived Citigroup not only of a way to dump its risky assets but also of a deep pool of deposits, which would have substantially strengthened its access to stable low-cost funding.

Shortly after the Wachovia deal fell apart, Citigroup pitched the idea to the government of it helping to protect the company against some of its losses. Citigroup executives argued that the government should help the company after Wachovia slipped away, according to a person familiar with the matter. But federal officials balked at the idea.

As recently as one month ago, Citigroup had hoped to be able to unload some of those assets to the U.S. government through its Troubled Asset Relief Program, according to people familiar with the bank's plans. But when Treasury Secretary Paulson earlier this month shelved plans to use TARP to purchase banks' bad assets, that option vanished.

Last Monday, Mr. Pandit said in a meeting with employees that Citigroup was scrapping plans to try to sell about $80 billion in risky assets. Investors and analysts interpreted the move as a sign that Citigroup either was unable to sell the assets, or would have had to incur hefty losses in the process.

Two days later, Citigroup announced it was buying $17.4 billion in assets from its structured-investment vehicles -- complex entities whose holdings included risky mortgage-linked securities -- and faced a $1.1 billion loss due to their diminished values.

The back-to-back moves, coupled with existing fears about Citigroup's massive off-balance-sheet holdings, stoked investor fears that Citigroup could be swamped by toxic assets flooding back onto its books. That helped ignite the current panic, which was exacerbated by a drumbeat of bleak economic news.

Government officials could face requests from other banks for similar help shoring up their balance sheets. Banks, hedge funds, and private equity firms have urged Capitol Hill and government officials to restart the asset-purchase program in recent weeks.

"The problem is that other banks would want to get in line" for such government support, says Thomas B. Michaud, a vice chairman of investment bank Keefe, Bruyette & Woods Inc. "Is there enough money to do that?"

—Marshall Eckblad contributed to this report
Write to David Enrich at david.enrich@wsj.com, Carrick Mollenkamp at carrick.mollenkamp@wsj.com, Matthias Rieker at matthias.rieker@dowjones.com, Damian Paletta at damian.paletta@wsj.com and Jon Hilsenrath at jon.hilsenrath@wsj.com