U.S. will boost stake in Citigroup to 36%

updated 1:01 p.m. ET Feb. 27, 2009

NEW YORK - The U.S. government will exchange up to $25 billion in emergency bailout money it provided Citigroup Inc. for as much as a 36 percent equity stake in the struggling bank, greatly increasing the risks to taxpayers as voter unhappiness about the broader bailout program rises.

The deal announced Friday by the company and the Treasury Department represents the third rescue attempt for Citigroup in the past five months. It is contingent on private investors agreeing to a similar swap.

The administration decided to restructure the bailout package for Citigroup again in the hopes that converting $25 billion of preferred shares into common stock would give investors more confidence the bank has sufficient capital reserves to withstand mounting losses on its holdings of mortgages and other loans. While the conversion to common stock will dilute current shareholders' investments, a wider equity base could calm investors since there would be more reserves in place to guard against further losses as the economy sours.

Besides a stronger capital base, the company is getting a critical boost to its cash flow as it forgoes its 4 cent annual dividend on its common shares. That is giving Citi an additional $2.18 billion a year.

But the deal does not affect one of Citi's greatest problems, the billions of dollars in failed mortgage-backed securities that still sit on its books. As those investments have fallen in value, they have exacerbated Citi's losses.

The plan comes one day after the Obama administration laid the groundwork in its first budget request for greatly increasing the size of the $700 billion bailout program that Congress passed in October. Administration officials said no decisions had been made yet but suggested the size of the effort could be expanded by as much as another $750 billion.

The swap of $25 billion of preferred shares into common stock will expose the government to the same risks facing other holders of the bank's common stock. Shares of Citigroup and many other financial companies have plunged as the sector undergoes its worst crisis in seven decades.

But the administration is mindful about growing unhappiness among voters and lawmakers in the huge sums that have been provided to the nation's banks, money that so far seems to have done little to stabilize the situation.

In his first address to a joint session of Congress on Tuesday, President Barack Obama stressed that the government effort was not aimed at bailing out bank executives who had made bad loans, but instead in getting credit flowing again to consumers and businesses.

"I know how unpopular it is to be seen as helping banks right now, especially when everyone is suffering in part from their bad decisions," Obama said. "I promise you — I get it."

The aim of the government's rescue effort is to keep the New York bank holding company alive and bolster its capital as it faces growing losses amid the intensifying global recession. Existing Citi shareholders would see their ownership stake shrink to as little as 26 percent.

Investors appeared disappointed in the deal and expected dilution of their stake, sending shares plummeting 91 cents, or 37 percent, to a new 52-week low of $1.55 in afternoon trading. Stocks tumbled early but pulled off their lows as the Dow Jones industrial average came within 34 points of breaching the 7,000 mark for the first time in more than 11 years.

Underscoring its precarious nature, the company also disclosed that it recorded a goodwill impairment charge of about $9.6 billion due to deterioration in the financial markets.

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