U.S. Government Unveils Sweeping Citigroup Rescue

Updated from 3:33 a.m. EST

By Jeannine Aversa

WASHINGTON -- The government unveiled a bold plan Sunday to rescue troubled Citigroup(C), including taking a $20 billion stake in the firm as well as guaranteeing hundreds of billions of dollars in risky assets.

The action, announced jointly by the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp., is aimed at shoring up a huge financial institution whose collapse would wreak havoc on the already crippled financial system and the U.S. economy.

The sweeping plan is geared to stemming a crisis of confidence in the company, whose stock has been hammered in the past week on worries about its financial health.

"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 issued late Sunday night. "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 move is the latest in a string of high-profile government bailout efforts. The Fed in March provided financial backing to JPMorgan Chase's (JPM) buyout of ailing Bear Stearns. Six months later, the government was forced to take over mortgage giants Fannie Mae (FNM)and Freddie Mac (FRE) and throw a financial lifeline -- which was recently rejiggered -- to insurer American International Group(AIG).

Critics worry the actions could put billions 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 messes.

The Citigroup 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.

"We reached an agreement based on an innovative market solution to further strengthen our capital ratios, reduce risk, and increase liquidity," said Citigroup CEO Vikram Pandit in a statement Monday. "We appreciate the tremendous effort by the government to assure market stability."

Pandit said the company is "committed to streamlining our business and providing outstanding banking services to our clients around the world. We will continue to focus on opportunities and alternatives to further enhance the company's overall position and value."

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

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.

Under the loss-sharing arrangement, Citigroup (C) will assume the first $29 billion in losses on the risky pool of assets. Beyond that amount, the government would absorb 90% of the remaining losses, and Citigroup 10%. 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.

As a condition of the rescue, Citigroup is barred from paying quarterly dividends to shareholders of more than 1 cent a share for three years unless the company obtains consent from the three federal agencies. The bank is currently paying a dividend of 16 cents, halved from a 32-cent payout in the previous quarter. The agreement also places restrictions on executive compensation, including bonuses.

The agreement also 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 3% for five years. Rates are reduced so that borrowers aren't paying more than 38% of their pretax income on housing.

The IndyMac plan also was used as a model for a new program by mortgage finance companies Fannie Mae and Freddie Mac and for two other failed thrifts taken over by the government on Friday. FDIC Chairman Sheila Bair has been pressing Treasury to use $24 billion from the $700 billion bailout program to put the mortgage modification program on national footing, but Paulson is opposed to that idea.

Citigroup said its board unanimously approved the government plan.

The once mighty Citigroup, which had at one time been the largest U.S. bank by assets, has seen its shares lose 60% of their value in the past week, reflecting a crisis of confidence among skittish investors. They are worried all the risky debt on Citigroup's balance sheet will turn into losses as the economy worsens and the markets stay turbulent -- losses that could be nearly impossible to reverse.

Citigroup shares are down 87% for the year.

Citigroup is such a large, interconnected player in the financial system that it is seen by Washington policymakers as too big to fail. The company has operations stretching around the globe in more than 100 countries.

Analysts consider Citigroup the most vulnerable among the major U.S. banks -- especially after it failed to nab Wachovia (WB), which was bought instead by Wells Fargo (WB) That was a missed opportunity for Citi to gets its hands on much-needed U.S. deposits that would bolster its cash position.

Citigroup was especially hard hit by the meltdown in risky, subprime mortgages made to people with tarnished credit or low incomes. Foreclosures on those mortgages spiked, leaving Citi and other financial companies wracking up huge losses on the soured investments. The company has failed to turn a profit during the past four quarters and has announced plans to slash thousands of jobs.

Citigroup shares jumped $1.93, or 51.2%, to $5.70 in premarket trading.

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