Government Priority Is to Inject Equity into Citigroup

The U.S. government's main priority is to give Citigroup a $10 billion to $20 billion equity infusion, Capitol Hill sources close to the ongoing negotiations tell CNBC. Any government infusion would be in addition to the $25 billion that it gave Citi in October.

Oliver Quillia for cnbc.com

The Citigroup infusion plan is provisional and subject to change. The plan will probably be a multi-layered one, which means the government could backstop losses on Citigroup's troubled assets as well. In exchange, Citi may issue preferred stock to the government

Sources add that other actions are "not off the table", meaning that even the government plan of buying the troubled assets could be revived.

The problem with buying the assets from Citi is political: People close to the deal know that other firms will line up and ask the government to purchase their troubled assets as well. Brokerage stocks got crushed when Treasury Secretary Hank Paulson reversed his plan on the TARP to direct capital infusions to the banks and away from buying troubled assets.

The Bottom line: This is very fluid and the situation may change again. But as of now, the government is getting cold feet on plan to buy troubled assets, which leaves direct capital infusion on the table.

Negotiating A Deal

The government is mulling the purchase of a substantial amount of assets from Citi, similar to a good bank, bad bank structure. The government would absorb much of the losses for Citi if there are losses and Citi would issue preferred stock to the government.

While the Fed could buy more than $100 billion or more in the bad assets if the plan goes through, that doesn't mean it will pay Citi $100 billion, depending on the final valuation of those assets. According to people with knowledge of the discussions, the plan for Citi resembles the original TARP proposal, in which the government would buy bad assets for financial firms at some price higher than what's being offered in the market.

Charles Gasparino
On-Air Editor

People close to the matter underscore that none of this is a done deal: Other deals, such as the Lehman Brother Good bank / Bad bank proposal blew up at the last minute. Citigroup had no immediate comment. CNBC is still waiting on comment from the Treasury and Federal Reserve.

Reports from Washington say the White House is unaware of any government talks with Citigroup. It also declined comment on whether President Bush would back a government rescue of Citigroup.

Citi officials are reportedly working on a plan that could include a capital injection from the Federal government—among other possible ideas. The details have yet to be hammered out and it's not clear when such a plan would be announced.

No Plans For Federal Takeover Of Citi

As of Saturday afternoon, the general consensus between officials from Citi and government officials from the US Treasury department and US Federal Reserve is that the government will not takeover Citigroup in the way it took control of AIG — by lending the firm massive amounts of money and in return assuming a huge equity position.

Government officials fear taking over Citigroup would create a precedent: Unlike AIG, Citigroup's balance sheet is relatively healthy, with relatively strong levels of capital particularly compared to most of its competitors.

Still, officials from the Treasury and Citigroup are unsure what it would take to restore confidence in the company, including a possible smaller capital injection or some sort of statement that Citigroup is financially sound.

For that reason, Citigroup officials are continuing to explore possible merger possibilities and a spin off of some of Citigroup's businesses, even as SEP Vikram Pundit publicly stated the sale of the firm's massive and coveted broker business, Smith Barney is off the table, these people say.

"CNBC Reports: Saving Citi" Tonight, Sunday Nov. 23rd, 8pm - 9pm EST

Both officials at Citigroup and in the government concede the situation facing Citigoup is daunting. Because of Citigroup's size and scope—it operates in just about every country and competes in just about every financial business, the company's survival is a national concern.

Citigroup has spent the past week telling investors that its capital position is strong, but investors have lost confidence in the current management led by CEO Vikram Pandit who has been in the job less than a year, and the firm's board, which appeared to ignore widespread calls by analysts to integrate the firms operations and slash its massive workforce until recently.

Meanwhile, various merger possibilities seem slim. A deal with investment banks Morgan Stanley or Goldman Sachs would create massive overlap and would lead to huge layoffs. There aren't many banks with a strong deposit base that Citigroup can buy with its depressed stock price.

Pandit, for his part, has cut the workforce to 350,000 from 375,000 and just announced another 50,000-job cut by early 2009. But for investors, those moves were too little too late. Just a year ago, Citigroup's share traded at around $50.

Citigroup's shares fell 60 percent last week to $3.77 amid concerns about the bank's loan exposure amid a recession hurting many economies globally. Citi shares failed to rebound on Friday, even as the Dow Jones Industrial Average of large company stocks spiked nearly 500 points on the news that President-elect Barack Obama will name NY Fed President Tim Geithner as his new Treasury Secretary.

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Because Citigroup is a bank it has access the the Federal Reserves discount window, and because of its size, there is virtually no possibility of the bank failing and filing for bankruptcy as investment bank Lehman Brothers did. "Citigroup is too big to fail; the government wont allow that because the firm is involves in so many business both institutional and consumer around the world," said one bond trader with detailed knowledge of Citigroup's operations.

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But the lack of confidence coupled by the falling stock price could pose other problems, such as a run on bank deposits, where worried depositors yank their money from their Citigroup accounts, or investors pulling their funds from their Smith Barney brokerage accounts. A Citigroup spokesman declined to say if the company is experiencing either of those scenarios.

For that reason, Citigroup officials continue to work over the weekend to possibly unveil some sort of plan of action by Monday morning. "Everyone knows saving Citigroup is important to saving the economy, but no one knows what to do," said one person close to the firm.

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