U.S. Offers Citigroup Expansive Safety Net

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 think 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 for the company.

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 March rescue of investment bank Bear Stearns or the 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 deal was struck with Vikram Pandit, who has been chief executive of Citigroup for less than a year. Pandit inherited a difficult challenge and has made only limited progress in stabilizing Citigroup by slashing staff and expenses. The steep drop in the stock price last week reflected doubts among investors about whether Pandit can turn Citi around and make it eventually profitable.

The federal efforts to buttress Citigroup are a shift in approach in the government's massive efforts to stabilize the financial system. For most of the year, the Treasury and Fed 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.

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 combined 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.