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The Treasury is making a classic investing mistake. They are desperately waiting for that loser stock in their portfolio to catch a bounce.

The loser in this case is Citigroup (NYSE: C). And it actually did catch a bid Friday afternoon, closing at $3.40.

The government’s cost basis is $3.25. But if they were to dump $25b+ of common stock on the market, C shares would crumple into a pitiful heap. The government owns fully 34% of Citigroup.

The result of dumping all those shares on the market would not be pretty. But we should do it anyway.

Look at the recent offering, which was priced at $3.15 (notably below the government cost-basis of $3.25). Interest in the offering was tepid, even with undoubtedly intense pressure to keep the price above government cost.

The point is —if Geithner was to unload Treasury’s shares, the price they’d fetch would make the public “investment” a clear loser.

We should take that loss, ASAP. The sooner we get rid of every scrap of involvement with the zombie banks, the sooner they’ll be forced to act like real businesses (which means failure for many). We should dump it all. If investors think Citi has a future, they’ll buy.

The administration is doing everything they can to avoid a paper loss. For example, so as to not scare away the suckers new Citi investors, Treasury announced it won’t start selling their 34% stake for at least 3 months. From the WSJ:

Faced with a potential paper loss of $770 million on its Citigroup stake, the Treasury said it had decided to hold off selling any of its shares until next year. Bowing to pressure from institutional investors, officials agreed not to sell the government’s shares for at least 90 days.

Look at the $38b tax break Citigroup just received, as reported by the Washington Post. The government is taking a $38b loss in tax revenue, on hopes that they can squeak out a much smaller paper-gain on the public investment. A pitiful PR coup — “See, we told you the bailouts would be profitable*“.

I say we sell now. Yeah, we’d take a hit. But a 20% loss is preferable to a 100% loss. People need to realize that there is still a real chance Citigroup goes to zero.

If not for mark-to-imagination accounting, implicit government backing, and various accounting tricks, they’d probably be bankrupt already. See Worse Than Enron, by Nomi Prins (former director at Goldman Sachs), for more on these accounting schemes.

Stop-Loss

Seasoned investors know to cut their losses on bad investments. Hoping for a bounce (or trying to force one through proxies) isn’t an acceptable investment strategy. Especially when you’re dealing with other people's money.

So far, thanks to Rubin and his disciples, Citigroup has been kept alive through herculean taxpayer-funded efforts, and changes to accounting rules. But how long can that last, really?

Citi is not a good long-term investment. Praying for a bright future does no one any good. Dump it, Geithner.

I suppose there is a (slim) chance of Citi having a bright future. If the V-shapers are right, and everything has been fixed (near zero probability of that) and banks are allowed to continue abusing their TBTF status, the US may be able to sell for a decent profit one day. But that’s a lot of ifs.

And the cost required to achieve these hypothetical profits are huge. The $38b tax-break Citi just got wipes out any “profits” the U.S. can reasonably hope for. It’s not like Citigroup is cheap, either. Despite their deceptively low ~$3 stock, the market cap is still $79b. More dilution is coming, too. At least $20b.

There’s no good reason Treasury should wait to sell Citi. It’s a $100b disaster waiting to happen. Most likely it’s technically insolvent already. We could lose a lot more if we hold off.

There are also the moral hazard implications, which are immeasurable. Memo from D.C. to bankers – Get too-big-to-fail, get lobbyists = get rich forever.

Disclosure – No position in C.

Source: Citigroup: Take the Loss, Tim