Citigroup Bailout Critical for Economy to Recover

Many people are wondering why Citigroup should get a bailout, and the Big 3 automakers were told to go packing. After all, both companies made bad strategic decisions - Citigroup in using too much leverage in buying mortgage-backed securities, and the Big 3 in not retooling for more fuel-efficient vehicles. Both have thousands of employees that will be laid off if the companies go bankrupt. Are banks somehow more important to the economy than auto manufacturers?

Perhaps not morally, but financially they are. To get this economy back on its feet, it needs capital more than cars. Banks provide that. However, with last week's 800 point drop in the Dow, banks assets are too low to give them money to lend. That's why the Citigroup bailout included options to buy common stock, which shows government support of common stockholders. This caused the Dow to regain last week's loss in two days. This rally for financial stocks means more capital for banks, and more capital for them to lend.

The U.S. Treasury gave Citigroup a $20 billion cash infusion in return for $27 billion of preferred shares yielding 8% annual return, and warrants to buy no more than 5% of Citi's common shares at $10 per share. More importantly, the Treasury will guarantee $306 billion worth of toxic mortgage-backed securities, helping Citi to get these off of its balance sheet. In return, the bank will absorb the first $29 billion in these losses before the government guarantee kicks in. Citi also received $25 billion last month under TARP.