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You see in this world there's two kinds of people, my friend. Those with loaded guns, and those who dig. You dig. (The Good, the Bad, and the Ugly)

Some folks believe it should not be a fundamental requirement for financial survival that every private investor be an expert in forensic accounting. Thus, it is with more than our usual dash of skepticism that we look at the number – $1,593 – representing Citigroup’s (NYSE:C) net profit for the first quarter. This comes on the back of a year where the company lost $27.6 billion. One need not be the proverbial rocket scientist to know that this “earnings” number should have an asterisk.

Along with these earnings, Citi issued a press release, explaining that Citigroup has been stripped of its nonperforming and toxic assets, all of which have been bundled into an entity called Citi Holdings. CEO Pandit explains,

The creation of Citicorp and Citi Holdings reflects our strategy to refocus the company on its greatest strength: our global institutional and consumer banking businesses, while exiting non-core businesses and reducing risk assets.

The drama unfolding alongside this financial restructuring is CEO Pandit’s juggling of personnel in the inner circle. Friday’s release came a day after the public removal of Ned Kelly from the CFO position – a post he occupied for all of four months – to be replaced by Citi’s long-serving chief accountant, John Gerspach, who was likely far more suitable for the job in the first instance.

The ongoing Night of the Long Knives at the Citi boardroom was “not something the FDIC ordered” (Financial Times, 10 July, “Citigroup Finance Chief In Reshuffle”). While there are clear political motives for this management restructuring, it certainly would appear Vikram Pandit is more concerned with his own agenda than with the best interests of Citi’s shareholders.

In fairness to Pandit & Co., the pilot for this long-running series – The Great Global Financial Meltdown – included the first appearance of TARP, wherein then Treasury Chief Paulson floated a version of a good bank / bad bank model. Using the TARP funds to remove toxic assets from the balance sheets of major US institutions would unclog the markets – so went the argument – and permit credit to flow once again. Indeed, that was what got voted on and passed.

But good bank / bad bank did not materialize. Instead, we got uber-bank / lick your wounds bank, as Goldman (NYSE:GS) and JP Morgan (NYSE:JPM) pocketed tens of billions of dollars they did not need, and segments of the economy desperate for liquidity (in economic jargon they are called “small businesses” and “consumers”) were instructed to pound salt.

Now Citi is bringing the good / bad model to the firm level. The canonization of "too big to fail" may be Obama’s downfall. It shows that he lacks the guts to wrestle the bad guy to the floor, disarm him, then stand over him brandishing his own weapon. President Obama does not seem to understand that perpetuating very bad ideas launched under the Bush Administration does not get him off the hook.

We fear that President Obama and Speaker Pelosi think they will get to point to their failures and say “don’t blame us – look at the mess we inherited!” As Petey, in the old neighborhood, used to say – someone should tell them what time it is.

Skeptics though we have been, we think institutions like Citi, which bear the formal government designation of 2B2F, may be the only place the good / bad model can be made to work.

In a perverse way, Citi’s restructuring may be the bellwether of sound economic thinking. It appears to have been structured for the benefit of the shareholders – that would be us, the American taxpayer. (Indeed, the American tax avoider will benefit as well, which adds another layer of unfairness to the tax system. But we digress…)

The fundamental problem underlying TARP and its countless begats is that governments can not repair markets. When they seek to do so, it is always a disaster. The only question is the extent of the damage, and the time and cost to recover.

As a side bet, it seems Pandit and Geithner have mounted an effort to shove Sheila Bair out of bounds, just when she is about to run for daylight. Bair has stated publicly that Pandit should not be CEO of a bank. Her convoluted logic holds that people who are not bankers, and who do not understand either the business or the regulation of banking, should not be given free hand to own and operate banks.

This led her to clash with Mr. Geithner in the early stages of TARP, and it is setting her on a collision course with the major private equity firms as she insists they post credible protection for depositors and other assets in the banks they seek to acquire (using government money, mind you.)

Ms. Bair has long worn the mantle of digger-in-of-heels in chief. As even regulatory agencies are suffering hiring freezes, it is interesting that the Fed has increased its bank examiner staff by ten percent, with more growth in the offing. Amidst the proposals to make it the systemic risk regulator, the Fed is arming itself to replace the FDIC.

Similarly, Mr. Pandit’s internal reshuffling is clearly designed to keep as many of his cronies as close as possible – Mr. Kelly, a longtime FOV (“Friend of Vikram”) remains on in a strategic and dealmaking capacity – while giving up just enough to make colorable the argument that he should stay on as CEO, and have access to FDIC guarantees.

We anticipate that Secretary Geithner will beat Chairman Bair over the head with this before too long. In this battle, as in so many others, we are rooting for Chairman Bair, if only as a needed corrective to pervasive Geithnerism.

The ultimate rescue of Citi will be a long and arduous process. Back in the dot-com boom America enjoyed global handshake credibility. This credibility allowed our banks to abuse the goodwill of all our trading partners. When Chairman Greenspan admitted to the UK’s central bankers that the losses in the swap contracts – very real ones, at that – had been borne by European insurance companies, he was disclosing a nasty truth: the US, which considered itself 2B2F, had maneuvered its financial trading partners into serving as a landfill for all our toxic paper.

This was far beyond good bank / bad bank. It was good country / bad continent. With our handshake credibility gone, we must now use our own shovels to dig ourselves out.

Perhaps by bringing good bank / bad bank to the firm level, Citi is actually showing leadership. It will take a long time to work out the toxic paper that has been rolled into Citi Holdings, but at least now we know where it is, and there is hope of transparency for both shareholders and the markets.

We hate to admit it, but CEO Pandit may have actually engineered "change we can believe in."