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Citigroup bailout doesn't calm jitters over 'toxic' assets

Rescue plan leaves troubled mortgage-backed securities on bank's balance sheet.

By Staff writer of The Christian Science Monitor / December 2, 2008

The US government's titanic battle against the credit crisis keeps escalating – and a key reason is that despite bailout efforts, the risk of "toxic" assets lingers on.

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The bailout of Citigroup last week is the latest example, but the challenge goes beyond a single giant bank.

Just a few weeks ago, Citi was among the big financial firms that received an infusion of capital from the US Treasury. The injection was designed to help them weather the current storm of sour mortgage loans, falling real estate values, and a weakening economy.

The Treasury's recapitalization program had an impact. Borrowing-cost indicators of stress retreated somewhat from panic levels seen in October.

But the new capital reserves didn't wipe away the problem that's been weighing on financial firms for 16 months: large and murky risks remaining on their books.

The best way to alleviate the credit crisis, many financial experts say, is for the positive boost of recapitalization to be matched by effective measures to address the negative drag of troubled assets.

But how to do that is a difficult question, and one that affects both the duration of the crisis and its ultimate toll on taxpayers and the economy. The Citigroup bailout offers one possible path, but not the only one.

"The American taxpayer has bought a lot of exposure to Citigroup's bad assets," says Pete Kyle, a finance professor at the University of Maryland. "As near as I can tell, Citigroup failed but the government wanted to pretend like it didn't fail."

Citi could have contributed more in bailout

Citi is so big that it couldn't really be allowed to fail, but Mr. Kyle says that in mounting a rescue the government would have been justified in seeking a larger fee for the service it provided.

The Treasury, the Federal Reserve, and Federal Deposit Insurance Corp. agreed to shoulder large amounts of Citi's risk, while a sizable share remained with the bank itself.

In return, the government took a stake representing about 8 percent ownership of Citi, whose stock market value had sunk to about $20 billion at the time of the bailout, down more than 90 percent from its peak. Kyle says he'd prefer to see a government ownership stake of 50 percent.

Some other finance experts see benefits to treading lightly on existing shareholders during the current crisis. When government intervention wiped out shareholders at other banks this year, it fanned investor uncertainty – pushing bank stocks even further down.

In any case, the Citi rescue offers one possible model for dealing with bad assets at some other big banks. The bailout includes both new capital and a transfer of bad-asset risk to the government.

The government is compensated by getting an ownership stake and fees (dividends) on the money it puts into the bank.

The bailout focused on a pool of risky assets on Citi's books now valued at $306 billion. Analysts say these assets may end up being worth about half that amount.