Something quite major happened in finance this morning. All week, officials like Ben Bernanke and Tim Geithner have been hinting that nationalization is not the way to save the banking system.

So today they only nationalized Citigroup halfway.

As part of the TARP plan, and also in a supplemental purchase, you the taxpayer have purchased about $45 billion worth of convertible preferred stock in Citigroup. Today, the government has made a deal with Citi to swap about $27 bn of that preferred for common.

Since the entire market value of Citigroup's common stock was slightly below $27 bn as of yesterday's close, the deal amounts to creating about as much new stock as existed beforehand. So each existing share is now worth about half as much.

And in pre-market trading, they're down just about... half. See, financial modeling works after all. The massive dilution and the fear of more to come (possibly affecting other banks) is weighing heavily on stocks this morning, and they will open sharply lower.

I don't have time now for a fuller explanation, but you're probably wondering why they did this after a week of saying nationalizations are bad. I would say it's because of the unique character of Citigroup.

Remember how we (*cough* Larry Summers and Robert Rubin *cough*) repealed the Glass-Steagall Act ten years ago and made possible the creation of an American version of Europe's "universal banks"? That was done mostly to enable the ambitions of Sandy Weill, then Citi's CEO.

Citi went farther than anyone else in this direction and thus is perhaps half bank and half broker dealer.

Ok, hang with me, this gets a bit tricky. A commercial bank doesn't necessarily need to mark their toxic assets to market if their intention is to hold them to maturity. Therefore, you could make a case that, based on reasonable financial accounting, banks like JP Morgan Chase are indeed undercapitalized but NOT insolvent.

Citi is different, because so much of what they do involves securities held for sale that have now landed on their balance sheet, and because of their large trading operations. It's consistent to argue that Citi's assets should be aggressively marked to market. And on this basis, Citi is unquestionably insolvent.

Today's move was only a matter of time.

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Tags: Citigroup