Jan. 12 (Bloomberg) -- The cost of protecting Citigroup Inc. bonds from default climbed to a four-week high on reports the bank plans to sell control of its brokerage to Morgan Stanley to rebuild capital.

Credit-default swaps tied to bonds from New York-based Citigroup jumped 40 basis points to 250 basis points, according to broker Phoenix Partners Group. The jump was the biggest since Nov. 21, the last working day before the U.S. government intervened to rescue the bank from a crisis of confidence that had sent its stock plunging 55 percent in three days. Contracts on other banks, including Bank of America Corp. and Wells Fargo & Co., also rose.

Citigroup, which had to get $45 billion of rescue funds last year from the U.S. government, may book a gain of as much as $10 billion by selling control of its Smith Barney unit, a person familiar with the talks said. While offering a short-term boost, the sale will mean Citigroup loses part of a business with “attractive long-term earnings prospects,” Gimme Credit LLC analyst Kathleen Shanley wrote in a note to investors today.

“The government support provided to the bank gives it the chance to survive,” Shanley said. “But Citigroup has essentially lost control of its own destiny, with government regulators calling the shots on strategic decisions.”

Contracts on a benchmark gauge of U.S. credit risk also rose. Credit swaps on the Markit CDX North America Investment- Grade index of 125 companies in the U.S. and Canada rose 12 basis points to 214 basis points as of 4:29 p.m. in New York, according to Phoenix.

An index that tracks credit swaps tied to 14 of the world’s largest banks rose to the highest in more than two weeks. The CDR Counterparty Risk Index climbed 10.4 basis points to 168.9 basis points, according to index creator Credit Derivatives Research LLC.

Writedowns, Losses

Citigroup’s “desperation” is renewing concerns that bank losses haven’t passed, following $1 trillion of writedowns and losses since the beginning of 2007 by the world’s financial institutions, Tim Backshall, chief strategist at Credit Derivatives Research in Walnut Creek, California, said in an e- mail today.

Investors should use the widening in credit swaps to sell protection on banks, while betting against their stocks, Backshall said. “We still see it unlikely that the government lets these guys fail,” he said.

Credit-default swaps, used to hedge against losses or to speculate on the ability of companies to repay their debt, typically rise as investor confidence deteriorates and fall as it improves.

Bank of America

Contracts on Charlotte, North Carolina-based Bank of America rose 28 basis points to 163 basis points, according to CMA DataVision. San Francisco-based Wells Fargo, which completed a $12.7 billion purchase of Wachovia Corp. on Dec. 31, rose 16 basis points to 150 basis points. JPMorgan Chase & Co. climbed 17 to 145, according to CMA.

A basis point on a credit-default swap contract protecting $10 million of debt for five years is equivalent to $1,000 a year.

“We’re looking at Citi literally selling the diamond they have in a bucket full of coal,” Ralph Silva, research director at Tower Group Plc in London said in a Bloomberg Television interview.

Contracts on Morgan Stanley rose 18.5 basis points to a mid- price of 388 basis points, according to CMA. Goldman Sachs Group Inc. contracts rose 10 basis points to 280, CMA data show.

Bondholder Protection

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase indicates deterioration in the perception of credit quality; a decline signals the opposite.

In London, contracts on the Markit iTraxx Europe index of 125 companies with investment-grade ratings rose 8.5 basis points to 163.5 basis points, JPMorgan prices show. The Markit iTraxx Crossover Index of 50 European companies with mostly high-risk, high-yield credit ratings climbed 28 basis points to 968, according to JPMorgan.

To contact the reporters for this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Abigail Moses in London Amoses5@bloomberg.net

Last Updated: January 12, 2009 16:48 EST