Citigroup: 4 Bailout Questions

Will confidence endure?

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The government's decision to prop up Citigroup opens a new chapter in the ongoing financial crisis. This latest rescue, larger by far than the bailouts of Bear Stearns or American International Group, sets the newest precedent for how far the government will go in its continuing efforts to keep the financial sector afloat.

The basics:

Citi is on the hook for the first $29 billion in losses. After that, the dominos fall like this: The Treasury will be responsible for 90 percent of the next $5 billion in losses. Then, the FDIC will handle 90 percent of the next $10 billion. Lastly, the Fed takes 90 percent of losses beyond that. The government is also injecting a total of $27 billion into Citi on top of $25 billion it issued just weeks ago. In return, Citi is giving the government preferred equity with an 8 percent dividend. Citi is being required to issue $7 billion in preferred stock to the government.

Four big questions :

1. Will it work?

It's not clear. Backstopping Citigroup is the latest attempt to keep market confidence steady, and it appears to have succeeded, at least for the day. Clarity on how the government plans to move on bad assets (especially after flip-flopping on the initial plan to buy toxic mortgages) is a helpful signpost. That a similar offer would likely be extended to other troubled banks is helping the sector rebound today. "Clearly, this will stabilize the [banks] group near term, and the stocks this morning should reflect it," Oppenheimer & Co. analyst Meredith Whitney said. "We are still cautious on the potential future dilution from further prospective capital raises for the group as well as continued higher losses related to credit and asset deflation." In the end, banks aren't out of the woods, but they have bought more time. The SPDR KBW Bank ETF is up 11 percent today, and Citi shares jumped more than 50 percent. Still, it's worth noting that credit is still tight at the bank. Early in the day, Citi's credit default swaps weren't showing much improvement. CDS spreads tightening by 19 basis points to 481.75, making the cost of insuring $10 million of Citi debt $481,750 a year. 2. What about Citi shareholders?

All in all, shareholders can breathe a little easier, at least compared to last week when markets were facing the threat of the bank's failure. Analyst David Trone at Fox-Pitt Kelton says that the deal cuts the risk of a counterparty or depositor "revolt" at Citigroup. Sandler O'Neill analyst Jeff Harte also notes the plan leaves some hope for common shareholders, implying Citigroup "was not on the verge of insolvency in the government's eyes." That's the good news. The bad news is a tough future. The near elimination of common dividends for three years and government approval of executive compensation will weigh on everyday investors. So will the ailing economy. While this deal covers a huge chunk of Citi's mortgage debt, the rest of its businesses still face a tougher economic environment. Fox-Pitt Kelton notes the deal doesn't include $150 billion in non-U.S. consumer loans, $129 billion in nonresidential consumer loans like credit cards, auto, small business or personal loans, and the firm's corporate loan portfolio. Basically, even if the mortgage losses are handled under this plan, pressure on those businesses from a recessionary global economy will continue. Also, a lot of investors can't be happy beleaguered CEO Vikram Pandit gets to stay on for the time being, unlike more than 52,000 Citigroup workers. 3. What about taxpayers?

The largest question there remains what exactly the losses on that $306 billion will total. Losses come with the hope, but no guarantee, that Citigroup will rebound and the government will make a profit on its latest emergency investment. 4. Can stocks bottom now?

Maybe, but we've seen this sort of day before. Stocks are up broadly today on the Citigroup plan and the news that President-elect Barack Obama will try to jump-start the economy with a massive new economic stimulus plan that could include $500 billion in tax cuts and new spending over the next two years. (That's on top of new estimates for the price of this bailout, which now total an eye-popping $7.4 trillion, according to Bloomberg). Treasuries, which had surged in recent days as investors ran for cover in the safest of government-backed assets, also cooled a bit. Unfortunately, in this environment both loser credit and equities can reverse on a dime. The problem is we've seen this sort of rally before: Stocks continually jump following bailout announcements before falling further on worsening realities from banks, the consumer, and the global economy. There's nothing revolutionary enough in today's news to change that.