Citigroup Offered Another Government Safety Net

The intricate plan marks the government’s biggest move yet
to rescue a single bank during the ongoing effort to end the financial crisis.

The Treasury Department, the Federal Reserve and the Federal
Deposit Insurance Corp. jointly announced the plan to shore up the huge
financial institution whose collapse would wreak havoc on the already crippled
financial system and the U.S. economy.

“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 three agencies said in a statement.
“We will continue to use all of our resources to preserve the strength of
our banking institutions, and promote the process of repair and recovery and to
manage risks.”

The sweeping plan is geared to stemming a crisis of
confidence in Citigroup, whose stock was hammered in the past week on worries
about its financial health. Analysts said a Citigroup failure would have seized
up still fragile lending markets and caused untold losses among institutions
holding debt and financial products backed by the company.

“Clearly, this will stabilize the (banks) group near
term, and the stocks this morning should reflect it,” Oppenheimer & Co
analyst Meredith Whitney told Reuters. “We are still cautious on the
potential future dilution from further prospective capital raises for the group
as well as continued higher losses related to credit and asset deflation.”

Citigroup’s battered stock surged more than 55 percent in
the first half hour of trading Monday morning. But the stock was still down
more than 81 percent of its value from a year ago.

Not all investors were pleased. “You’re seeing an inept
management team being rewarded by the U.S. government,” said William
Smith, chief executive of Smith Asset Management in New York, which owns
Citigroup stock, according to Reuters.

Citigroup’s latest rescue came after a weekend of marathon
discussions led by Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke.
Timothy Geithner, president of the Federal Reserve Bank of New York, who is
being tapped by President-elect Barack Obama as his Treasury chief also
participated.

Vikram S. Pandit, Citi’s chief executive officer, welcomed
the action. “We appreciate the tremendous effort by the government to
assure market stability,” he said in a statement, according to the
Associated Press.

The $20 billion cash injection by the Treasury Department
will come from the $700 billion financial rescue package. The capital infusion
follows an earlier one of $25 billion in which the government also received an
ownership stake in Citigroup.

As part of the plan, Treasury and the FDIC will guarantee
against the “possibility of unusually large losses” on up to $306
billion of risky loans and securities backed by commercial and residential
mortgages.

In return for the bailout, Citigroup’s dividend will be
effectively wiped out. The bank cannot pay out more than 1 cent per share per
quarter over the next three years without government consent. The quarterly
dividend is now 16 cents.

The move is the latest in a string of high-profile
government bailout efforts. In March, the Fed provided financial backing to
JPMorgan Chase’s buyout of ailing Bear Stearns. Six months later, the government
was forced to take over mortgage giants Fannie Mae and Freddie Mac and throw a
recently revamped financial lifeline to insurer American International Group.

Critics worry the actions could put billions more of
taxpayers’ dollars in jeopardy and encourage financial companies to take
excessive risk on the belief that the government will bail them out of their trouble
spots.

Under the loss-sharing arrangement unveiled Sunday,
Citigroup Inc. will assume the first $29 billion in losses on the risky pool of
assets. Beyond that amount, the government would absorb 90 percent of the
remaining losses, and Citigroup 10 percent. Money from the $700 billion bailout
and funds from the FDIC would cover the government’s portion of potential
losses. The Federal Reserve would finance the remaining assets with a loan to
Citigroup.

In exchange for the guarantees, the government will get $7
billion in preferred shares of Citigroup.

Importantly, the agreement calls on Citigroup to take steps
to help distressed homeowners.

Specifically, Citigroup will modify mortgages to help people
avoid foreclosure along the lines of an FDIC plan that was put into effect at
IndyMac Bank, a major failed savings and loan based in Pasadena, Calif.

Under the IndyMac plan, struggling home borrowers pay
interest rates of about three percent for five years. Rates are reduced so that
borrowers aren’t paying more than 38 percent of their pretax income on housing.