Give Thanks for the Citigroup Bailout

The plan announced Sunday night to rescue Citigroup (C) is a critical milestone in the history of the banking crisis that began almost two years ago, and has resulted in the worst bear market for stocks since the two that occurred during the Great Depression.

The Citi rescue doesn't necessarily mean that all our problems are over. There are other troubled banks — although they are all smaller than Citi — and they may have to be rescued in much the same way. What the rescue does mean is that the Treasury, the Fed and the FDIC are finally all working together to truly put a safety net under the banking system. That's quite a change from what these same agencies have been doing most of this year — destroying the very system they're supposed to be rescuing.

There were clues before this that the government was finally going to do the right thing. But now we know for sure. And that is terrific news for stocks.

Think about all the so-called bailouts, starting with Bear Stearns in March. They weren't bailouts at all. They were wipe-outs. Bear, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch, AIG, Washington Mutual and Wachovia — all destroyed by government agencies in the name of "protecting the system."

It wasn't even effective protection. Those companies were destroyed for nothing. Every time one of these companies was wiped out, seized by the government, allowed to fail, or forced into a fire-sale merger with a competitor, the system just got weaker and weaker.

Things began to change in October with TARP — the "Troubled Asset Relief Program." Yes, TARP went through some confusing change-ups in its approach, and took too long to be implemented. But its Capital Purchase Program announced in mid-October, in which it bought preferred stock in banks and brokers, marked the first time that the government really supported the banking system, rather than punishing it.

The program provided desperately needed capital to over-leveraged banks, and it provided it on very generous terms. The interest rate was low, and existing shareholders were hardly diluted at all. I totally understand if you object to that on the grounds that wealthy banks and their executives ought to take their medicine if they screw up. But we're all in this lifeboat together, and if they go down they all go down. Anyway, if we are going to rescue them at all, at least we should do it right.

Stocks continued to fall after the Capital Purchase Program was put in place. Several of the big banks that received capital infusions lost half their market value in a matter of weeks. Why? Because investors didn't really know for sure what would happen next time a bank needed government help. Would the approach be generous and helpful again? Or would it be back to the bad old days earlier this year when companies in trouble got wiped out by the agencies that were supposed to rescue them?

Citigroup became the test case. Who knows if there was any real reason for the sudden collapse of its stock last week. But for whatever reason or no reason, the stock did collapse — and it started to look just like the kind of death spiral that claimed Bear Stearns, Fannie, Freddie, Lehman and all the others.

But then something wonderful happened. When put to the test by the Citi crisis, the Treasury, the Fed and the FDIC did the right thing. Instead of wiping out Citi "for the good of the system," they arranged an enormous rescue package, and offered it to Citi on terms that preserved the company's profit potential and its shareholder value.

Make no mistake about it. Citi was over a barrel last weekend. The government could have done anything it wanted. It could have seized Citi lock, stock and ATM machine, and wiped out every one of its stockholders and bondholders. That would have pleased plenty of people out there for whom that would be nothing more than simple justice.

But if it had happened, the stock market would have gone to zero. Not because Citi's stocks and bonds are worth so much, but because it would have sent the signal that the government was once again in the business of destroying banks, not saving them. Once that signal was sent, every bank stockholder and bondholder would dump every last penny's worth, and in the process bring about the very collapse they fear. A classic vicious cycle.

But the government didn't make that mistake. Instead of repeating the mistakes of the wipe-outs earlier in the year, it repeated the genuine bailout that it had begun in October. And then on Tuesday, the Fed followed it up with a massive new program to support asset-back securities issuance and mortgage-backed bonds.

Now investors know that the generous approach taken with the banks under TARP in October wasn’t just a fluke. With Citi, what might have been a fluke has become a pattern. A very good pattern.

Making things even brighter, it's terrific news that Timothy Geithner will be the next Treasury secretary. As president of the New York Federal Reserve Bank, he's been a key player in all the bank interventions this year — both the bad ones and the good ones. He's personally seen what works and what doesn’t.

There aren't many seasoned bailout professionals in the world. Geithner's one of them. If the Treasury is going to play a key role in backstopping the banking system, we're very lucky to have Geithner at the helm.

By my way of measuring stock market value — which compares stock prices to forward earning and prevailing interest rates — last week stocks were the cheapest they've been at any time during my lifetime. Literally. I was born in April 1954, and stocks have never again been as cheap as they were that month of that year — until last Friday.

With valuations that once-in-a-lifetime overstretched, stocks were poised for a huge relief rally. All they needed was a news catalyst. With the Citi deal and the Geithner nomination, we have two of them. I think the rally now has a lot further to go.

If that's right, then Thanksgiving couldn't come at a more appropriate time. Give thanks!