What Happens When Citigroup (C) Fails?

If the markets are to take bond guru Bill Gross at his word, the world’s financial markets could go through a cataclysmic failure. The head of fixed income fund operation Pimco says that a rapid sale of assets by banks, brokers, and hedge funds will cause the credit system to collapse. Almost all of these companies need cash and none of them wants to be left holding the bag if housing and commercial markets go to pieces.

The unusually eloquent Gross recently wrote "This rarely observed systematic debt liquidation is what confronts the U.S. and perhaps even the global financial system at the current time. Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami."

Gross wants the US Treasury to move into the market and buy distressed assets to stop the knife from falling.

The problem with the Gross program is that the US Treasury may be nearly broke. To get it "unbroke" tax-payers will have to be tapped for extra dollars. American citizens are not exactly flush with cash.

If the financial industry is forced to continue selling holdings at prices well below where they were set eighteen months ago, some of the nation’s largest banks and brokerages are going to get into much deeper trouble. At some point, their ability to borrow money or sell equity will be deeply compromised. A panic will set in as investors realize that the huge firms may have more liabilities than assets.

Gross’s worst case would mean that some operations like Citigroup (C), Merrill Lynch (MER), Wachovia (WB), and Lehman (LEH) might not make it as independent entities. If the Treasury is asked to make a series of rescues, the tax-payer will end up owning them. The problem is that he is stretched too thin to afford the down payment.

Douglas A. McIntyre