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E*Trade in Free Fall

The online broker's shares plummet after a Citi analyst sparks fears of a run on its bank.

Updated from 12:30 p.m. EST

E*Trade Financial

(ETFC) - Get Report

shares were in free fall Monday after a Citigroup analyst stoked panic about a higher "probability of a run on the bank."

Citigroup analyst Prashant Bhatia also downgraded the stock to a sell rating, sending E*Trade shares plummeting almost 60% to $3.55. While some other brokers also dropped on the news, the financial sector overall was rebounding slightly from last week's selloff.

"There may be layers of protection for customers (multiple charters, other forms of insurance, etc.), but in our view, customers may withdraw assets first and ask questions later," writes Bhatia, adding this could lead to forced selling of the firms' newly devalued asset-backed securities portfolio.

E*Trade posted a letter to customers and issued a statement Monday afternoon taking issue with the Citigroup report. In the statement, E*Trade says the bank is "well capitalized by regulatory standards," and calls the Citigroup report "irresponsible," and "sensationalism based on unfounded speculation."

But E*Trade President and Chief Operating Officer Jarrett Lilien couldn't offer too much comfort in the letter posted to customers Monday.

"Nobody knows for certain what the ultimate impact will be from these markets, but it is our expectation that news in the market will get worse before it gets better, and armed with these expectations, we are taking prudent measures to effectively manage the company's balance sheet," writes Lilien.

Bhatia's comments come on the heels of the banks' warning late Friday that recent ratings agency downgrades of asset-backed securities would result in more writedowns for E*Trade, based on its $3 billion portfolio of such securities. The firm also said the

Securities and Exchange Commission

has opened up an inquiry of the firm's loans and securities portfolios, according to a filing.

Writedowns are no surprise. Nearly every Wall Street brokerage and many large banks are announcing more hits tied to their mortgage lending or asset-backed securities portfolios. And most executives agree it's not over.

Private equity firm


(BX) - Get Report

chimed into the chorus of warnings Monday, after

swinging to a third-quarter loss. The firm's bottom line was weighed down by $802.6 million in non-cash charges related to its June IPO.

"We are somewhere near the bottom, but my own feeling is there is another shoe to drop," Chief Operating Officer Hamilton James said on the company's third-quarter earnings conference call, in response to a question about Blackstone's view on the asset-backed securities market.

What is new in Bhatia's comments is the notion of a run on the bank. But, as financial institutions'

reputations slide amid an avalanche of losses and turmoil for financial companies, investors are fearful about the security of their funds. Bhatia says that 50%, or $15 billion, of E*Trade deposits are over $100,000, the upper limit on an account that the Federal Deposit Insurance Corp. insures.

The notion of a run on E*Trade is not so far-fetched. In August, depositors in



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banking arm lined up outside branches in California after the first signs of the mortgage giant's lending losses in the first round of the summer's credit crisis.

Bhatia estimates that if E*Trade needed to liquidate assets to meet customers' withdrawal requests, selling loans and asset backed securities could end in a $5 billion loss. He adds that investors should expect fourth-quarter writedowns and provisions, or money set aside to cushion further loan losses, to amount to $500 million.

In the letter to customers posted Monday, Lilien writes: "As a matter of fact, we could absorb an immediate write down in excess of $1 billion and still remain well capitalized."

The news sent shares of some other brokers down as well, including

Merrill Lynch



Bear Stearns



Elsewhere, the financial sector is seeing a minor resurgence as some analysts and traders take the view that there's so much negative sentiment on the group that it's time to start picking

which financial stocks will outperform from these depressed levels. Shares of

Goldman Sachs

(GS) - Get Report


Lehman Brothers


, among others, are gaining ground Monday.

Punk Ziegel & Co. analyst

Dick Bove singled out Goldman Monday, upgrading the stock to market perform from sell on the idea that the firm's technology systems "may protect it from the worst of the excesses now in the market place." He says Goldman's investment in its databases and systems far outpaces its competitors, giving the firm an advantage in valuing illiquid securities like collateralized debt obligations or asset-backed bonds.

Goldman shares were up over 1.6% in afternoon trading to $214.71.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


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