The Secret Plan for Citigroup

Why won’t the government put Citi out of its misery and let it fail? Sources tell Charlie Gasparino the Feds have a new strategy to leave the bank in a coma.

Why won’t the government put Citi out of its misery and let it fail? Sources tell Charlie Gasparino the feds have a new strategy to leave the bank in a coma.

Is Citigroup being given another lease on life?

The “financial supermarket” created by Sandy Weill and Bob Rubin during the boom years of the 1990s was supposed to revolutionize banking with a model that offered just about every service imaginable. Consumers could cash a check and walk to the corner of the branch and buy a mutual fund. Corporations didn’t have to borrow money from one bank, and issue debt through another. Citi could do it all.

By leaving Citi comatose, it could still trigger a run as consumer confidence in the bank diminishes over time.

It sure could, including (nearly since the day the firm was created) putting its customers in great peril through questionable sales practices, and later by taking such excessive risks in trading bonds that it needed government assistance that could cost U.S. taxpayers tens of billions of dollars. The bailout couldn’t repair Citigroup (that would be a near impossibility given the size and scope of its losses) but it was enough to keep the company on life support so it could avoid a bankruptcy and liquidation that would have made the market fallout following Lehman’s look tame.

Once Citi received bailout money, the Weill experiment was supposed to be over. The supermarket was dead and would be disbanded, finally, by its current CEO Vikram Pandit. Prodding the company along in this direction was its new owner, the federal government. All those billions came with a price; though the feds are Citigroup’s single largest shareholders, and they were said to want the company broken up into its more profitable pieces, something investors had been demanding for years.

Now comes word from sources close to the bank that the government—namely the Federal Reserve and Treasury, which basically run the bank after bailing it out—isn’t looking to put Citigroup out of its misery as some investors and even FDIC chief Sheila Bair had hoped. According to these people, the plan is to let Citigroup linger, half-dead and half-alive because in its current, near-vegetative state as its stock price falls below $3 a share and its trading and investment-banking departments fall far behind Wall Street rivals, Citigroup propped up by guarantees and bailout money can’t do much harm.

This decision has given Pandit another burst of life as head of the bank. Just a few weeks ago, Pandit, who consistently defended Citigroup’s business model in the face of overwhelming evidence to the contrary, seemed like a goner. Bair even leaked to the press she wanted him out. But as top officials in the Treasury have begun leaning toward not immediately dismantling Citigroup, but allowing it sit and rot they’ve also come to the conclusion that they need a “caretaker,” said one high-ranking Wall Street executive who regularly deals with government officials on banking matters. Pandit is as good as anyone for the job, because as this person put it, “the feds are just happy to watch Citi linger.”

I can understand the feds’ logic even if I don’t agree with it. The billions of guarantees, direct cash infusions, and stock jammed into Citigroup since the dark days of the financial crisis last fall seems to have taken a major worry off the table--Citigroup’s implosion, which with its nearly $1 trillion in deposits and a balance sheet bigger than many governments, would have set off a global bank run of immense proportions.

Now that Citigroup has been stabilized, regulators can turn their attention to another troubled bank, Bank of America, which is burdened by much of the same problems facing Citi (subprime exposure and consumer loans that will likely crater as unemployment rises to 10 percent), not to mention bad assets inherited from its purchase of Merrill Lynch last year that led to its own need for a government bailout.

In some ways there are regulators who believe BofA is an even bigger headache than Citigroup. Unlike Citi, Bank of America has a real business—Merrill’s investment bank, brokerage operations and a large, well-functioning branch system in the U.S. Citigroup has almost none of the above. That’s why regulators have turned their attention to BofA, including the competence of its current management and CEO Ken Lewis (sources say board members have been quietly calling potential successors to Lewis to see if they would join the firm even before his official exit date is set in stone).

In other words, if Citi went under, the damage would be relatively contained; if BofA folds, systemic risk would be compounded by the implosion of viable businesses.

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There’s just one problem with this approach: With Citigroup lingering, there’s still a chance for it to get into trouble. By leaving Citi comatose, it could still trigger a run as consumer confidence in the bank diminishes over time. The firm is so big, so unwieldy that it can’ t be managed, never could, and it never would. As bad as the Wall Street executives have been at managing Citi, I can make a good case that the government, which now signs off on just about everything Pandit & Co., does, will be worse.

Need I mention Freddie Mac and Fannie Mae?

In some ways Citigroup reminds me of this nasty neighbor I had as a kid. He was a hazard to both the community and his wife and kids whom he used to abuse on a daily basis. Then one day he got into an accident; I believe he fell off the back of a truck, cracked his skull and was in a coma. We prayed for his timely exit from this world but he hung on, first for weeks and then for months.

“Neither God wants him nor the devil wants him,” my father remarked with a laugh one afternoon as we laid odds on whether he would live or die.

The man did in fact live, miraculously given to size and scope of his head injuries, and once he was able to function again, he returned to his nasty old self. It was a shame, we all thought, if he had died, it would have spared everyone so much trouble.

I can’t but help feeling the same way about Citigroup.

Charles Gasparino is CNBC's On-Air Editor and appears as a daily member of CNBC's ensemble. He is a columnist for the Daily Beast and a frequent contributor to the New York Post, Forbes, and other publications. His book about the financial crisis, The Sellout, is scheduled to be published later in 2009.