Nov. 9 (Bloomberg) -- U.S. taxpayers may face mounting costs on federal guarantees of $301 billion of Citigroup Inc. loans and securities after unemployment reached a 26-year high, according to the Congressional panel overseeing bank-bailout programs.

The Federal Reserve Bank of New York projected a year ago that losses on the assets would surge if unemployment hit 9.5 percent and might ultimately cost the Treasury Department $3.96 billion over the 10-year life of the guarantees, the panel said in a Nov. 6 report. The jobless rate rose to 10.2 percent in October, the Labor Department said last week.

The government hashed out the guarantees over a weekend in November 2008 to help shore up confidence in New York-based Citigroup and head off a run on deposits. The New York Fed’s analysis, previously undisclosed, shows how high the cost to taxpayers may go as unemployment exceeds the projections government officials used to negotiate the guarantees.

“It looks like Citigroup got the better end of that deal,” said Joshua Rosner, an analyst at investment research firm Graham Fisher & Co. “The taxpayer will be the ultimate loser.”

The panel overseeing the government’s Troubled Asset Relief Program, led by Harvard Law School Professor Elizabeth Warren, included the New York Fed’s analysis in a report last week and criticized the Treasury for being too secretive about the loss projections. Neither Citigroup nor any government agency previously had published estimates of the government’s potential losses.

U.K. ‘Cash Lockup’

The Treasury, Federal Deposit Insurance Corp. and Federal Reserve said in a joint statement on Nov. 24, 2008, that they agreed to provide the guarantees amid concern that a Citigroup collapse could rock the financial system. At the time, both Citigroup and its regulators projected the bank “would likely be unable to pay obligations and meet expected deposit outflows the following week without substantial government intervention,” according to the panel, which cited Treasury and FDIC officials.

Several trading partners were demanding that Citigroup post additional collateral, and the U.K. Financial Services Authority imposed a $6.4 billion “cash lockup” to protect the interests of Citigroup’s British brokerage arm, the FDIC told the panel.

Under the terms of the guarantees, the Treasury and FDIC will absorb a combined 90 percent of any losses beyond Citigroup’s $39.5 billion deductible, up to $16.7 billion. The Fed would absorb 90 percent of any further losses.

Effect of Unemployment

The New York Fed estimated that losses on the assets would reach $34.6 billion under a “moderately adverse” economic scenario with unemployment at 8.2 percent in the fourth quarter of 2009, the oversight panel said in its report.

Under the “severely adverse scenario” of 9.5 percent, the losses would rise to $43.9 billion, the reserve bank projected. At that point, Citi would have exhausted its deductible, forcing taxpayers to begin paying out.

“The unemployment assumptions used in both scenarios have in fact already been exceeded,” the oversight panel said.

Citigroup said in a filing last week that the guaranteed assets lost $2.8 billion in the third quarter, bringing the total losses in the pool to $8.1 billion as of Sept. 30. The value of the covered assets has shrunk to $250.4 billion from the original $301 billion because of asset sales, loan payoffs and the losses, the bank said.

Second Audit

Citigroup paid for the guarantees by issuing $7.06 billion of preferred shares to the Treasury Department and FDIC. Those require Citigroup to pay an 8 percent coupon, or about $565 million annually. The Treasury has not detailed how the price or deductible was determined, as it was supposed to under the Emergency Economic Stabilization Act of 2008, the panel said.

A Treasury spokeswoman, Meg Reilly, said the department’s expected losses from the asset guarantees were reviewed “to ensure that the expected value of the premium received from Citigroup is no less than the expected value of the losses to TARP from the guarantee.”

Neil Barofsky, inspector general of the Treasury Department’s $700 billion TARP bailout, began a separate audit of the guarantees in July.

In a Sept. 23 report, bank analystDavid Trone of Fox-Pitt Kelton Cochran Caronia Waller wrote that total losses on the assets were “unlikely to exceed” the $39.5 billion that is solely Citi’s obligation.

Raising Capital

Citigroup Chief Executive Officer Vikram Pandit has raised capital to help the bank withstand its losses. In September, Citigroup converted about $58 billion of preferred shares into common stock, diluting existing shareholders by 76 percent. The Treasury got a 34 percent stake in the bank, after converting $25 billion out of $45 billion in bailout funds.

“The government actions took the risk of insolvency off the table for Citigroup,” said Jeffery Harte, an analyst at Sandler O’Neill & Partners who rates Citigroup “buy.”

The bank’s employees are benefiting from the rescue. Citigroup plans to give 19 top executives annual salaries of about $500,000 along with more than $100 million in stock awards, according to an Oct. 22 report by the Treasury Department’s special paymaster, Kenneth Feinberg.

On Oct. 29, the bank gave more than a hundred million stock options to about 75,000 other Citigroup employees, people familiar with the matter said last week. The options, which don’t fully vest for three years, carry a strike price of $4.08, meaning the options collectively would be worth at least $100 million for every dollar the bank’s share price climbs.

Taxpayers Could Gain

“These options vest over time and only have value if Citi’s stock price goes up,” bank spokeswoman Shannon Bell said in an e-mailed statement. The stock has tumbled more than 90 percent since the end of 2006. Today it rose 13 cents, or 3.2 percent, to $4.19 as of 11:47 a.m. in New York Stock Exchange composite trading.

Because of the Treasury’s stake, taxpayers also stand to gain from Citigroup’s performance, Harte said. Based on the current market value of the Treasury’s 7.7 billion shares, the government has a $6 billion paper profit. “I’m not so sure the government’s going to lose money,” he said.

The pool of Citigroup assets included $154.1 billion of mortgages, $16.2 billion of auto loans, $21.3 billion of “other consumer loans,” $12.4 billion of commercial real estate loans and $13.4 billion of corporate loans, Pandit said in a Jan. 27 presentation. The assets also included $31.9 billion of distressed securities and $51.5 billion of off-balance-sheet lending commitments.

To contact the reporter on this story: Bradley Keoun in New York at bkeoun@bloomberg.net.

Last Updated: November 9, 2009 12:13 EST