Going back a year, it would be inconceivable that a large American bank might need to be bailed out. But, Citigroup (C) is facing two daunting problems. One is that Moody’s is probably going to downgrade another $103 billion in SIV assets. According to Bloomberg, the agency is taking the action in part because "20 SIVs sponsored by banks including New York-based Citigroup Inc. and ING Groep NV declined to 55 percent from 71 percent a month ago."

In addition, the Citadel purchase of banking assets from E*Trade (ETFC) set a price on similar assets of 26 cents on a dollar. "The portfolio sale, one of the few observable trades of such assets, has very clear, generally negative, implications for the valuation of like assets on brokers’ balance sheets," Credit Suisse analyst Susan Roth Katzke told Reuters.

Based on the E*Trade math, Citi cold face a total of $26 billion in after-tax write offs.

Citi may not be able to survive this kind of drop in big parts of its balance sheet, at least not with the company intact and in its current form.

Will the government step in to help the bank? It may not have to. The E*Trade deal could be done, on a much larger scale, to get Citi out of its current jam.

A bail-out of Citi may well be done by private equity interests. That could involve a purchase of $60 billion in distressed assets by a group of buy-out firms. There is the money in place to do it. And, the value of Citi’s battered portfolio will almost certainly come back. It may not be to a dollar on a dollar. But, it will almost certainly be better than 26 cents. Buy-out operators could clear billions of dollars in a year or two.

Citi cannot afford to keep the assets. It cannot afford the write-downs because of banking regulations and because it is a public company.

Citi may have to pay a monumental price for a bail out. If a company buys the distressed assets, it will want a big convertible preferred in the big bank which will flip to common stock. And, it will want to have that set up so that it gets a big coupon and a chance to make a fortune if Citi’s stock price rises.

That’s that. Citi is going to have to be bailed out. It will cost the bank, but it will save it.

Douglas A. McIntyre

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