Feds ready another deal to save Citigroup

The government is on the verge of closing a deal to significantly boost its ownership stake in Citigroup. In return, it will demand changes be made on the troubled banking giant’s board and other conditions, according to a person with knowledge of the discussions.

The increased stake in Citigroup Inc. will not require additional money from taxpayers and the bank will still have to undergo a "stress test," such as those that banking regulators started conducting this week on the nation’s biggest banks, said the source, who spoke on condition of anonymity because a deal hasn’t been officially announced.

An announcement is anticipated later Friday.

The government would convert some of its preferred shares in Citigroup to common shares only if the bank can get private investors to do the same, the source said. If that were to happen, the government’s stake in Citigroup could jump to 40 percent, from less than 8 percent now, the source said.

The New York-based bank already has received $45 billion in U.S. bailout money made up primarily of debt-like preferred shares, and it has received federal guarantees to cover losses on some $300 billion in risky investments.

Converting the shares of preferred to common stock would help bring Citigroup closer to the mix of capital that the government will want to see when it conducts the stress tests.

The tests, which should be completed by the end of April, will help regulators decide whether the banks have sufficient capital — and the right mix of it — to withstand any additional shocks to the economy over the next two years.

The results will help regulators decide whether banks may need additional assistance so they can carry out the critical mission of boosting lending to customers, a key ingredient to the economic turnaround.

The stock-conversion option was laid out by the Obama administration earlier this week as an option for providing relief to banks. It gives the government greater flexibility in dealing with ailing banks. It also gives the government voting shares, and therefore more say in a bank’s operations.

But common shares absorb losses before preferred shares do, which means taxpayers would be on the hook if banks keep writing down billions of dollars’ worth of rotten assets, such as dodgy mortgages, as many analysts expect they will.

On the other hand, common stock in banks is incredibly cheap, and taxpayers would reap gains if the banks come back to health and the stock price goes up.

Citigroup has not been the only financial institution to be clobbered by the collapse of the housing market, which sent home prices tanking, home foreclosure soaring and financial companies racking up multibillion dollar losses in soured mortgage investments.

Last year, Bear Stearns Cos. collapsed, Lehman Brothers Holdings Inc. went bankrupt, and American International Group Inc., Fannie Mae and Freddie Mac got bailed out and taken over by the government. As an insurer of the toxic assets plaguing the credit markets, AIG has hemorrhaged far more money than Citigroup.

The first two months of 2009 have seen Citi shares slide another 64 percent, giving the bank a market cap below $14 billion, a far cry from the more than $100 billion market cap it held a year ago.