E*Trade Falters, Despite Cash Infusion

"So it's clear that they were very familiar with the company and had studied it for their own investment purposes and so things started ahead from first base," Layton said. "They were somewhere between first and second."

Layton said Citadel does not have any current plans to own E*Trade bank because that would subject the hedge fund to rigorous regulation.

Brad Hintz, an analyst at Sanford Bernstein, said the sale portended bad things to come for anyone else holding unloved mortgage-related paper.

"Nervousness and general disorder in the money markets is only likely to get more severe towards year end, when demand for funding 'over the turn' is intense," he wrote. "Fear of counterparty risk and the unwillingness to take illiquid [asset-backed] collateral at the 'reasonable' prices is going to put pressure on hedge funds, brokers and banks around the world over the next five weeks."

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