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Is a “Bad Bank” The Answer?

As banks struggle to navigate the financial crisis, a late report from the WSJ suggests the feds may create a government bank that would buy up bad assets.

And earlier in the day Citigroup revealed that it is, in fact, splitting into two operating units -- going forward with its own version of a "good bank/bad bank" strategy.

Good Bank

Citigroup's core commercial, retail and investment banking worldwide -- the good bank -- will be reorganized as Citicorp and led by Citigroup Chief Executive Vikram Pandit.

Bad Bank

The other unit -- to be called Citi Holdings -- will include brokerage, retail asset management, consumer finance and a pool of risky assets. The bank is considering selling off Citi Holdings assets, or letting them mature.

The retail brokerage assets include its remaining stake in Smith Barney, and Nikko Cordial Securities, as well as Primerica Financial Services.

The bank said it was searching for someone to run Citi Holdings.

Critics of the bank, who argue it had become too big and complex to manage, have demanded a break-up for some time, although most envisioned Citigroup splitting into separately capitalized companies, instead of separate operating units consolidated onto the same balance sheet.

Bridge Banks

Will it work? Fast Money consulted former FDIC Chairman Bill Seidman who also had to deal with collapsing banks when he ran the FDIC during the S&L crisis.

He likes the general concept and reminded the gang that during his tenure at the FDIC he created bridge banks. In this case the feds seized banks that were insolvent and then, “as soon as possible sold it back to the private sector.”

However, if the government follows a similar strategy it won’t go well for anyone holding common stock. “If you create a bridge bank shareholders lose everything.”

Is there a trade here?

If the government sets up a bad bank it’s probably bullish for the market, says Tim Seymour. You could get long the S&P .

I would also get long crude oil and things that are massively deflated, adds Joe Terranova.

I think it will end poorly, counters Jeff Macke. So far it always has....

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Trader disclosure: On Jan 16, 2009, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s Fast Money were owned by the Fast Money traders; Macke Owns (C), (BAC), (SDS), (TM), (MCD), (DIS), (MSFT); Seymour Owns (AAPL), (BAC), (EEM), (F), (COP); Finerman's Firm Owns (DSX), (MSFT), (COP); Finerman's Firm Is Short (IYR), (IJR), (IWM), (MDY), (SPY), (USO), (VNO), (BBT), (COF);

Terranova Is Co-Portfolio Manager Of The Virtus Diversifier PHOLIO; Virtus Diversifier PHOLIO Owns (IGE), (DBC), (DBV)

Virtus Investment Partners Owns More Than 1% Of (ABD), (ARE), (BIG), (DLR), (EPR), (EXR), (IGE), (SLB), (MAC), (DBC), (DBV), (SKT), (UA), (CLB); Virtus Investment Partners Owns More Than 1% Of Seagate Tax Refund Rights; Virtus Investment Partners Owns More Than 1% Of Corporate Office Properties Trust SBI MD; Virtus Investment Partners Owns More Than 1% Of Goldman Sachs Financial Square Fund - Money Market Fund