Remember October 1, 2008? Citigroup announced it was acquiring Wachovia with the help of the FDIC. You had to be strong to do a favor to the government like that.

Citi was also a recipient of $25 billion in the first tranche of the $125 billion TARP money.

However, we know now Citi was not healthy. On Friday, Citi stock closed at $3.77 implying an approximate market cap of $19 billion  — just a few weeks after the Treasury had injected $25 billion in capital.

This implied that the government was throwing $25 billion at something that was worth -$6 billion! It is the classic throw of good money at bad.

I am fully aware that some type of intervention was necessary. Citi falling would have created even worse chaos in markets.

But the injection of a further $20 billion and huge government guarantees on troubled assets is a spectacularly bad deal for the American taxpayer.

Déjà vu

The Citi deal is remarkably similar to the government sponsorship of Citi’s failed acquisition of Wachovia on October 1, 2008 – except there is no Wachovia!

The Citi -Wachovia paid about $1 for each Wachovia share. The FDIC helped by covering some of Wachovia’s troubled assets. Citi was supposed to cover the first $42 billion in losses and the FDIC would cover the next $270 billion. These loses were on Wachovia’s assets.

Now let’s reel forward to November 23, 2008.

The government injects $20 billion in fresh capital (so the total is now $45 billion). Citi covers the first $29 billion in losses. The government covers 90% of the losses on rest of the portfolio which amounts to $306 billion.

Can you imagine what a disaster it would have been if the Citi-Wachovia deal went through?

When I knew there was trouble

The clue to me that Citibank was in far worse shape than people suspected came when they backed off the legal intervention with Wells Fargo.

After the Citi-Wachovia deal was agreed to, Wells Fargo offered a far sweeter deal. $7 per share and no government intervention.

Initially, Citi went to court to fight this – but then they backed off.

I speculate that the FDIC told them to address their own problems and the Wachovia deal seemed to magnify their problems.

The other stuff in the deal

There is other stuff in the term sheet such as a plan to modify mortgages, a one cent dividend, executive comp approved by government, and $7 billion in preferred stock with an 8% dividend.

However, one of my sticking points is the small size of the equity stake. The government is getting only 254 million warrants. Citi has over 5 billion shares – so this amounts to less than a 5% stake.

To make things worse, the strike price for the warrants is $10.61 per share – triple the Friday close.

Look, this is a firm that probably would not have survived until Monday.

The government dumps another $20 billion of cash and the backstops more than $300 billion of their troubled assets.

The government gets chump change — some preferred stock and deep out-of-the money warrants.

This is a raw deal of the American taxpayer.

The elephant in the closet

Almost no attention has been paid to what is “off-balance sheet”.

We know that Citi has approximately $1.2 trillion in “Special Purpose Entitites”. Little is known about what is in these entities. Approximately $325 billion are “off balance sheet”.

This is a big deal. Why is there no discussion of the other troubled assets? Why is all the attention paid to the stuff on the balance sheet?

Gravy train

The real cost of the Citigroup deal is the future long line up of banks that will want a similar deal.

In case it isn’t obvious, the $700 billion in TARP will not be enough.

A year ago, we could have prevented this crisis with about $500 billion. I estimate to clean up the balance sheets will cost $1.5 trillion – and that does not include bailout dough for non-financials like autos, airlines, retailers, etc

Transparency?

Opaque is the wrong word. Shrouded seems better.

Citi was considered a good bank. Now it is a bad bank. What about the other 8,500 financial institutions?

The wild swings in the market are being influenced by the acute uncertainty. It is hard to say which banks are good and which are bad.

A banking system relies on confidence of both depositors and borrowers. The lack of transparency works against confidence building.

We cannot get back on track until we, at least, know how dire the situation is.