SCENARIOS: How the government might help Citigroup

By Dan Wilchins

NEW YORK (Reuters) - As Citigroup Inc's share price sinks, investors are wondering if the U.S. government will have to help the bank. How is an open question. Four investors that spoke to Reuters proposed some scenarios.

MORE PREFERREDS

The U.S. Treasury Department bought $25 billion of preferred shares and warrants from Citigroup in October when it injected capital into banks under the $700 billion Troubled Assets Relief Program.

It could buy more, boosting Citigroup's capital and a renewed government willingness to support the bank, which could soothe investors. Citigroup bonds, which have been sinking because of concern that a bailout would harm bondholders, would rally. That could lift prices for other bank bonds, reducing borrowing costs for lenders that rely on bond markets to fund themselves.

Preferred shares do not have voting rights, so a preferred stock investment would not provide new U.S. oversight over Citigroup's management or board, which some taxpayers and government officials may want. But the government could require the bank to add new management or directors as part of a deal.

A LOAN, OWNERSHIP STAKE

Another possibility is a bailout similar to the original $85 billion package for American International Group Inc. The government made a loan that would be first to be repaid if the insurer went bankrupt, and took an 80 percent ownership stake.

The loan's terms were so onerous that AIG trading partners demanded even more collateral, making the insurer's position more precarious. But a more lenient loan for Citigroup plus shares would ensure ample say for the government in how the bank is run, and would leave taxpayers with minimal risk compared to other investors.

But such an arrangement would erase much of Treasury's earlier $25 billion investment in Citigroup preferred shares. Plus, it would hurt investors in Citigroup's bonds, and bank bonds in general, making it harder for some banks to fund themselves.

LIQUIDATION

The Federal Deposit Insurance Corp has considerable leeway in how it sells a bank it seizes. It can, as with Washington Mutual Inc, protect deposits and leave bondholders and stockholders in the cold.

This could shelter the financial system from some of Citigroup's toxic assets, but at tremendous cost. No longer would any bank, or perhaps any company, be deemed "too big to fail." Investors could dump stocks of and corporate credits of all stripes, turning what could already be a deep recession into a punishing one.

"The too big to fail doctrine is being tested. Maybe the solution is to break these companies up like Ma Bell," said James Ellman, president of hedge fund Seacliff Capital in San Francisco. "Ma Bell" was a nickname for AT&T, which was broken up into smaller regional telephone companies in the 1980s.

GUARANTEES

The government could guarantee all of Citigroup's debt and derivative obligations. This could be a low-cost solution if investor confidence in Citigroup returns. But even a government guarantee does not necessarily ensure restoration of investor confidence, as Fannie Mae and Freddie Mac learned earlier this year.