Citigroup (NYSE:C) is headed back to square one. Apparently, mulligans are allowed on Wall Street.

For starters, the beleaguered bank sealed the deal on a joint venture with Morgan Stanley (NYSE:MS) to divest its Smith Barney asset-management unit. We've known that for a few days now, of course. That real groundbreaking news is that beyond Smith Barney, Citi's taking a hatchet to many other chunks of its more than $2 trillion medley of assets.

According to The Wall Street Journal, Citi will unveil a complete overhaul of the supermarket bank structure pushed over the past decade, shifting its focus to "wholesale banking for large corporate clients and retail banking for customers in selected markets around the world." Translation: More responsible lending, less financial sorcery.

The new structure might be something akin to JPMorgan Chase (NYSE:JPM) or Bank of America (NYSE:BAC) -- primarily old-fashioned commercial banks, with a smidgen of other products on the side. Sleeker. More organized. More focused. Less bumbling. 

Good news? It's better than the "cross your fingers, close your eyes, and hope for the best" strategy Citi had been pursuing. Why the company took more than $20 billion in losses, $45 billion in government handouts, and far more than a year to realize that its business model was defunct is anyone's guess.

And maybe that's the point. Citi's going to start shedding bad assets smack in the middle of the worst recession in decades. There are two ways to do this: Sell assets to other companies/investors, or spin off units as independent bodies.

The first strategy, to be frank, doesn't stand a snowflake's chance in hell. After the Smith Barney deal is completed, Citi will have two major divisions it could sell off: global consumer banking, and markets and investment banking.  Here's how those two look in terms of net profits after tax:

Segment

Most Recent Quarter

Trailing 12 Months

2007

2006

2005

Global Consumer

($1.1 billion)

($92 million)

$7.9 billion

$12.1 billion

$10.9 billion

Markets & Banking

($2.0 billion)

($10.1 billion)

($5.3 billion)

$7.1 billion

$6.9 billion

Both are complete and utter disasters, and neither has any light at the end of the tunnel. Trying to sell bad assets in a bad economy is like trying to sell broken jetskis to the Inuit -- there's no market for them, even if they weren't junk to begin with.

The second option, spinning off divisions, could create a "good bank, bad bank" structure, forming a dumping ground for bad assets and giving more promising assets a place to recover without the burden of toxic siblings. However, the "bad bank" could conceivably become so "bad" that the only organization strong enough to ingest its woes -- the U.S. government -- might have to swallow the entire entity. Two bailouts and nearly $300 billion in guarantees later, I doubt Citi could pull that off without a hitch.                      

So is all hope lost? For Citigroup, perhaps, but I'm more optimistic on what this Great Unraveling means for the finance industry as a whole.

Back to Day 1
Citigroup was formed in October 1998 after merging with Travelers Insurance -- thumbing its nose at the depression-era Glass-Steagall Act that prohibited commercial banks and securities firms from joining forces. By November 1999, Glass-Steagall was toast, paving the way for banks to stick their fingers in just about anything that could be monetized.

Not only did the repeal of Glass-Steagall let the finance world run amok, but it also allowed firms like Citigroup to grow naively and dangerously large, paving the way for 2008's favorite phrase, "too big to fail."

What's encouraging about Citi's unwinding is that it's the first time since the credit crisis began that a major firm has downsized and simplified itself in a meaningful way. Save for the bank-holding-company scramble that turned Goldman Sachs (NYSE:GS), American Express (NYSE:AXP), and the finance arm of General Motors (NYSE:GM) into "banks" (and really made them more complex), Citigroup's reformation is the first indication that Wall Street may finally realize the old way of doing business does not work, and serious changes are in order -- the kind of changes that may include throwing up your hands, admitting defeat, and salvaging what's left of a broken business.

Ironically enough, after pulling strings and fighting politicians to repeal Glass-Steagall a decade ago, Citigroup is essentially reinstating the rules by dismantling itself. Let's hope that's a sign of things to come.

Further fiscal Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase and Bank of America are Motley Fool Income Investor selections. American Express is a Motley Fool Inside Value pick. The Fool owns shares of American Express. The Motley Fool is investors writing for investors.