For now, Citigroup Is in the Clear

In early September, I made a bold prediction that Citigroup (C) would be the next big bank to fail. After the bankruptcy of Lehman Brothers, it was no longer a question of if another bank would fail, but when.

So why was my money on Citigroup? Well, those toxic structured investment vehicles, or SIVs—the primary culprit in Lehman’s demise—have completely torn apart the financial sector in the last six months. And Citi is the biggest player of all in SIVs. Due to its tremendous exposure from these risky derivatives, it only made sense that Citigroup would be the next bank to fail.

Well, Washington had other plans for the financial firm. Sunday night, it became clear that federal officials were scrambling to piece together a second bailout package. The multibillion-dollar rescue shot through Wall Street like a burst of adrenaline Monday, as investors extended Friday’s 500-point rally another day.

Essentially, the government has agreed to guarantee a pool of toxic assets valued at $306 billion. Citigroup will also receive a $25 billion cash infusion to help pad its balance sheet.

The big bank’s share price rallied yesterday, as did the shares of its biggest rivals—Bank of America (BAC) jumped 27%, JPMorgan Chase (JPM) jumped 21% and Wells Fargo (WFC) jumped 20%.

The may be a great short term fix, as the risk of Citigroup’s sudden failure has been dramatically reduced. But the longer term leaves much to be desired. Think about it: This move could encourage banks to take on greater risks now that Uncle Sam has shown (repeatedly) that it’s willing to step in if they run into trouble.

The reality is we’re dealing with a recession, and all banks should brace for more consumers to default on their loan payments, particularly those that have to due with mortgages, autos and credit cards. The government can only foot the bill for so long, and it’s only a matter of time before the cost filters down to the taxpayers.

For now, Citigroup is in the clear, but I’ll be sure to fill you in as this situation unfolds.