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Citigroup Gets Dismantled

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Sacrificing the parts to save the whole.

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John Mack, CEO of Morgan Stanley (MS), has certainly made good use of the $10 billion his firm received courtesy of US taxpayers last October.

Citigroup (C), under pressure to shrink its massive global finance operations, announced last night it sold its Smith Barney brokerage to unit to Morgan Stanley for $2.7 billion. Citi will retain a minority stake in the newly formed joint venture, Morgan Stanley Smith Barney, and will book nearly a $10 billion accounting gain for writing up the value of the deal.

The sale comes amidst Citigroup's efforts to shed assets: Mounting losses are putting increased pressure on CEO Vikram Pandit to break up the storied bank. Next week, Citi will announce plans to more aggressively spin off underperforming business units (along with its abysmal fourth-quarter earnings).

The urgency has only increased in recent weeks, as many experts believe the federal government is acting behind the scenes to protect its investment. Late last year, the Treasury Department, Federal Reserve and FDIC teamed up to rescue the ailing bank, pouring in new equity and backstopping losses on over $300 billion of the firm's assets. Now, unconvinced that Citigroup can survive in its current form, officials may be pushing for a break-up.

The Wall Street Journal reports Citi will refocus its business on wealthy individuals and corporate accounts, which means unloading units of its consumer finance division, as well as its private-label credit-card business. There are concerns, however, that potential buyers will use the bank's desperation to their advantage, forcing Citi to sell assets below their long-term intrinsic value.

For Pandit, who replaced former CEO Chuck Prince after the firm lost billions on bad mortgages and corporate debt, this marks a distinct change in strategy and rhetoric. Since he took the helm in late 2007, the former Morgan Stanley banker has vowed to keep Citi together, resisting calls to carve up the bank. The internal fight over the strategic direction of the firm came to a head last week, as Robert Rubin, former Treasury Secretary and influential Citigroup senior counselor and director, announced he was leaving the firm. Rubin had long opposed the idea of breaking up Citi.

For the banking system at large, Citi's new strategy is indicative of the kind of dramatic reshuffling our financial system sorely needs. Bank of America (BAC), JPMorgan (JPM) and Wells Fargo (WFC), perceived to be the strongest banks in the country, are all struggling to assimilate now-defunct rivals. These behemoths have grown too large and unwieldy to manage; their fingers are in nearly every corner of the US economy, not to mention in hundreds of countries around the world.

The inevitable downsizing, shrinking and deleveraging of our banks is a necessary, albeit painful, step on the path to a stronger financial system. And as bank executives focus on layoffs and shedding assets, adept entreprenuers will step into underserved markets, capitalizing on the turmoil gripping the nation's economy.

Such is the nature of recessions, panics and manias gone bust - such are the workings of capitalism.
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