Today is Bash Wall Street day in Washington, as a herd of bankers gets rounded up to sit for a presidential tongue lashing. But Washington can't afford to alienate Wall Street too much because of the $5 billion in campaign contributions and lobbying fees that financial institutions have funneled to politicians in the last decade. So, today's announcement that Citigroup (C) will pay back the $20 billion in TARP funds is good for Citi's bonus-hungry bankers -- but not so great for America.

Before examining that repayment, let's explore the delicate relationship between Wall Street and Washington a bit more. The first thing to understand is that Wall Street isn't admired so much on Main Street -- 66% of Americans take a dim view of financial executives, according to Bloomberg News.

Maybe that's because... they caused a near collapse of the global financial system last year, got a bailout with the potential to reach $23.7 trillion in taxpayer cash and guarantees, and are now using some of that to pay themselves record bonuses. For example, as I posted, Goldman Sachs Group (GS) appears on track to pay itself 20% more per worker than it did in its record 2007, thanks to its profitable bets with $52 billion in low-cost financing backed by the Federal Deposit Insurance Corp.

And it's those bonuses that are motivating Citi to repay its $20 billion -- a move on which I posted last week. The The New York Times reports that Citi will repay the $20 billion by raising $17 billion by selling stock to investors -- possibly this week -- and issue another $4.2 billion in so-called tangible equity units and subordinated notes. The U.S. plans to unload its 34% common equity stake in Citi through a series of sales over the next year -- beginning this week with a $5 billion disposition of Citi common shares.

Getting Out of the Government's Yoke

This announcement came hours before Bash Wall Street day. President Obama wants to urge bankers to lend more to home buyers and small businesses, and encourage them to back off the huge bonuses. Citi is among the banks that have been using the government cash for purposes other than lending more. CNNMoney reports that Citi's loans have fallen 15% in the year ending Sept. 30.

Citi is paying back the money because it doesn't like having to take orders from Washington -- particularly when it comes to bonuses. And it's good that private investors are willing to step in to help repay Citi's obligations to taxpayers. Yet the real reason Citi needed government money in the first place was that it was deemed too big to fail. And it was essentially a failed bank when it got the money, which still includes $301 billion in government guarantees against bad investments (although Bloomberg News reports that Citi plans to end that deal).

The question is whether Citi is still a failed bank. As I posted, Citi has $996.6 billion in off-balance sheet assets -- in so-called special purpose entities (SPEs) (the same financial creature that sank Enron) -- which are backed by shaky collateral like subprime mortgages and student loans. Those SPEs are seven times more than Citi's entire capital base of $140.8 billion. (The SPEs are just one of many other risks, like Citi's $1.3 trillion in credit derivatives.)

Time to Face the Marketplace

It all sounds pretty uncertain to me. Instead of jawboning banks and preserving the system that got us here -- we ought to attack the problem at its roots. First, the U.S. economy is way too dependent on borrowing and spending -- 67% of GDP comes from some form of consumer borrowing and spending, and we ought to shift that to a dependence on corporate investment. This would make Wall Street a far less important player in our economy.

Second, we ought to break up oversize banks and other financial firms that got us into this mess because their failure dragged down too much of the economy. Then, if those financial institutions get into another cash crunch, they'll just suffer the punishment that the free markets dole out to failure: bankruptcy that's not propped up by taxpayers who had nothing to do with the problem in the first place.

Citi's move to pay back its TARP funds -- and today's Bash Wall Street ceremony in Washington -- make no advance on either front.

Peter Cohan is a management consultant, Babson professor and author of nine books, including Capital Rising (due in June 2010). Follow him on Twitter. He owns Citi shares and has no financial interest in the other securities mentioned.

Meet Peter Cohan at The World Money Show Orlando, February 3-6, 2010 at The Gaylord Palms Resort.


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