"Political leaders must make the sound decisions critical for economic success, even when the politics are difficult."
-- Citigroup annual report, 2006

Ah, the irony.

Another day, another Citigroup (NYSE:C) bailout. I don't know what we call this one: Grandson of TARP? The Pandit special? Bailout round three? I've lost count.

Nothing's written in stone just yet, but The Wall Street Journal reports that Uncle Sam is set to convert most of its $45 billion of preferred stock into common stock, for an ownership stake worth as much as 40%. That would open the doors to quasi-nationalization of what once was the largest company in the world. The new ownership structure would be something akin to the government's partial takeovers of AIG (NYSE:AIG), Fannie Mae (NYSE:FNM), and Freddie Mac (NYSE:FRE) last year.

Good news? It has its ups and downs. For Citigroup shareholders, this plan is certainly better than a platoon of government officials marching in with American flags and employing full nationalization, as the market has feared for the past few weeks.

For Citigroup the company, converting preferred stock to common stock provides some breathing room, at least for now. By axing preferred shareholders, the burden of having to directly repay taxpayers is eliminated. With a new slug of common equity, asset writedowns will have a fresh capital cushion to charge against. At last count, Citigroup had about $23 billion in tangible common capital supporting almost $2 trillion of assets -- about as close to failure as you can get without collapsing.

For other banks, this should quell fears over the specter of all-out nationalization. Bank of America (NYSE:BAC), in particular, was beaten down to Reagan-era lows last week, as dark nationalization clouds  loomed overhead. Even relatively strong banks like Wells Fargo (NYSE:WFC) and JPMorgan Chase (NYSE:JPM) fell off a cliff as the thought of a universally insolvent banking system gained acceptance.  

Don't miss the buy-one-get-mugged-free sale
For taxpayers, this is a pretty raw deal. While no new money will be added to the tens of billions already ponied up, the money we've already injected gets immediately hacked down in value.

Let's say all $45 billion of preferred stock already injected gets converted into a 40% ownership stake. Citigroup currently has a market cap of $10.8 billion, so a 40% stake is worth about $4.3 billion. Since first injecting preferred shares in mid-October, common shares have plunged about 90%. If taxpayers' preferred shares were converted into a 40% stake today, it'd essentially act like a 90% loss as well. In other words, "preferred" shareholders have fared about the same, if not slightly worse, as common shareholders. In case you're wondering -- no, it's not supposed to work that way.

For taxpayers who feel they've been mugged, you've now been sucker-punched, too. Citi's common stock will have to produce something in the neighborhood of a 10-bagger for taxpayers to recoup their initial investment. Adding insult to injury, bailout part deux back in November slashed common dividends to $0.01 per share, rather than the 5% dividends the preferred shares were receiving.

Will any of this work?
The biggest question, of course, is whether this approach will work. I have my doubts. Switching to common equity is a big step in the right direction, but -- like all other bailout attempts over the past six months -- it's likely too little, too late.

A recent report by independent research firm CreditSights predicts that Citigroup could be in store for another $101 billion in future credit losses. If those estimates are even in a ballpark range of accuracy, converting $45 billion of taxpayer funds into common stock will simply ignore how dire this problem really is.

As politically unpopular as all-out nationalization is, we can't keep crossing our fingers and hoping that maybe, possibly, the credit crisis has just been a figment of our imagination and everything will be OK if we keep implementing derisory measures. Someone, someday, has to bite the bullet and make tough decisions in the face of the pants-wetting news we're facing today.

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