Citi: Time for Heroic Measures?

Calls to nationalize are growing as lifelines fall short and the bank drags down the rest of the market

By Mara Der Hovanesian and David Henry

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Andrio Abero

Should the government put Citigroup (C) out of its misery and just nationalize the massive money center bank?

Citi has been in crisis mode for a while. On top of $44 billion from private investors, Treasury injected $45 billion more. Regulators agreed to eat the majority of losses on $306 billion of assets. Then on Jan. 13, the bank ceded control of its brokerage Smith Barney and alluded to a bigger breakup.

Nothing seems to be working at Citi, whose woes have helped drag down the entire stock market this year. Since the government's first infusion of capital in October, shares of Citi have fallen by 76%, to 4.53, vs. 43% for the banking index. Citi's share price was down sharply in early trading on Jan. 15, sliding 16% to 3.82 as of 1:15 p.m. With faith eroding fast, a growing number of economists, analysts, and investors thinks the government needs to take more drastic action and seize the bank. "[Citigroup] may have to be nationalized," says Anil Kashyap, an economics professor at the University of Chicago and a former economist at the Federal Reserve. Says analyst David Hendler of CreditSights: "Until Citi is put on steady ground, they hurt everybody in the marketplace." Citi declined to comment before its earnings announcement on Jan. 16.

While Citi appeared to be stabilizing last quarter, at least on paper, the financial picture could deteriorate quickly. As of Sept. 30, Citi's bank assets (what it owns) exceeded its liabilities (what it owes) by $63 billion, or 5.2% of assets. That's a slim margin. A bank is insolvent when its assets don't cover its liabilities. Even before that, a bank can fall into the government's hands.

Close to the Edge

The big worry now is on the asset side of Citi's ledger. Just a modest decline in the value of its $1.2 trillion banking portfolio would put Citi close to the edge of insolvency. And there are plenty of toxic securities lurking. Citi owns roughly $400 billion of consumer and real estate loans. With the economy continuing to sour, those areas are particularly vulnerable to further losses and writedowns. "The sooner these toxic assets can be identified and quarantined, the sooner the healing process starts," says Jonathan M. Duensing, head of corporate credit at money manager Smith Breeden Associates.

Despite the inevitable pain to stock- and bondholders, a federal seizure could have a soothing effect on the rest of the market. By taking over Citi, the government could separate the good assets from the bad, much like after the savings-and-loan crisis in the 1990s. Back then, the government shut down hundreds of failed banks, paid depositors, and then sold off the portfolios of loans and real estate to restructuring specialists. The orderly process set a price for banks' bad loans, giving investors confidence in the value of those assets.

The market could use that sort of clarity today. Buyers and sellers have been at an impasse for months over the piles of toxic debt clogging up the system. Private equity firms, vultures, and other potential investors who think asset values are still unrealistically high, are sitting on the sidelines. Sellers, including banks, don't want to cut their asking prices for fear of further battering their balance sheets. The standoff has been exacerbated by the flip-flops in government strategy. "The toxicity of the assets is perceived to be much greater by the marketplace" than the banks, says Tom Barrack, founder of Colony Capital and a veteran manager of distressed assets. "We're in this massive fight to regain financial credibility."

With Matthew Goldstein and Emily Thornton.
Der Hovanesian is Banking editor for BusinessWeek in New York. Henry is a senior writer at BusinessWeek.

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