"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."
-- Former Citigroup CEO Charles Prince, July 2007

Well, he got that one right: Things are … uh … definitely complicated for Citigroup (NYSE:C) these days. Not only did the music stop, but the entire dance hall also seems to be burning down.

Shares of the beleaguered bank have been cut in half this week; they've fallen 85% year to date. One share will currently put you back less than five bucks -- roughly what Citi earned per share in 2006. Formerly the largest company in the world, Citi now sports a market cap less than US Bancorp (NYSE:USB) -- a bank with almost one-tenth the assets.

Get the point? There's a riot in the Citi. But what are people so angry about?

Here are a few factors bewildering investors in recent days:

  • Fears that $25 billion injected by the Treasury last month won't be enough to cover the massive slug of impending write-offs.
  • Word that it would move $80 billion in assets into a category that doesn't rely on market prices.
  • Citi's decision to purchase more than $17 billion in off-balance-sheet SIV investments.

Let's address a few of these issues, shall we?

Too little, too late
Citigroup is far too big to start throwing around the dreaded 10-letter "B" word. With the government as one of its largest shareholders, and more than $2 trillion in assets, there's simply no way Citigroup can fail.

Nonetheless, that doesn't mean common shareholders can't be crushed, if not completely wiped out, if things get worse. Remember, AIG (NYSE:AIG), Freddie Mac (NYSE:FRE), and Fannie Mae (NYSE:FNM) were all "saved" while leaving their common shareholders holding scarcely more than penny stocks.

Citigroup had roughly $99 billion in common shareholders' equity at the end of October. That might seem like a lot, but remember, it's covering around $2 trillion in assets. With that said, it won't take much more than a stiff breeze from a credit-market trauma storm to put shareholders in an even more vulnerable position.

One big fear is that Citi will need to raise more capital to keep things under control, but it won't be able to do so with shares trading at such paltry levels -- much like the dilemma Lehman Brothers faced. If that were to happen, the fate of the company would likely be in the hands of Uncle Sam.

Shhh ... they'll never know
Making matters worse, judging what future losses might be just became a bit more complicated. Earlier this week, Citi announced that it would reclassify $80 billion in assets into categories that aren't marked to market -- such as Level 2 and Level 3 assets.

The obvious hitch here is that it gives investors the impression that management is trying to mask how dire the books are, playing a game of "catch me if you can" with its sketchiest assets. Citigroup already has 88.6% of its assets in those hard-to-value categories -- adding more just gives investors more reason to panic.

The urge to merge
One popular option to keep Citi going is to merge with a stronger bank. Within the past few weeks, some have thrown around Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) as possibilities, since both became bank holding companies and will eventually acquire some sort of deposit-bearing assets.

Unfortunately, any other financial institution will be hesitant about making a deal with Citi until it can be assured that the bank's books are done exploding. That ultimately means providing clarity to those Level 2 and Level 3 assets. Until it does so, Citi just looks like a ticking time bomb that no one wants to touch. Would you want to marry someone with that much baggage? Me neither.

Keep your distance, Fools
Unfortunately, investors buying at these prices are probably looking at a binary outcome -- they'll either lose everything or make a bloody fortune. If that kind of risk intrigues you, enjoy the ride. For most investors, I doubt Citi's upside potential is worth the risk.

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