Citigroup will buy the banking operations of Wachovia in a deal brokered by the Federal Deposit Insurance Corp, the FDIC said on Monday.

The deal comes as authorities step in to rescue three European banks and as U.S. lawmakers prepare to vote on a $700 billion bailout of U.S. financial firms.

Federal Reserve Chairman Ben Bernanke said in a statement the FDIC action "demonstrates our government's unwavering commitment to financial and economic stability.''

But a fixed income manager, William Larkin, said the Wachovia deal and the European bank rescues were taking the shine off the bailout plan and could spook world markets.

Under the deal, struck in consultation with the Federal Reserve, the Treasury and President Bush, Wachovia depositors will be fully protected, and no cost to the Deposit Insurance Fund is expected, the FDIC said.

"Wachovia did not fail; rather, it is to be acquired by Citigroup Inc on an open bank basis with assistance from the FDIC,'' the agency said in a statement on its website.

Shares of Wachovia [WB 10.00 --- UNCH (0) ], the sixth-biggest U.S. bank by assets, tumbled more than 80 percent in pre-market trading to below $2 per share.

Citigroup [C 19.83 -0.32 (-1.59%) ] shares were initially higher after the news but were recently trading flat.

The FDIC said it would share losses with Citi on certain Wachovia loans.

"The FDIC has entered into a loss-sharing arrangement on a pre-identified pool of loans,'' the agency said. "Under the agreement, Citigroup will absorb up to $42 billion of losses on a $312 billion pool of loans."

"The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk.''

Citigroup also said it plans to cut its quarterly dividen to 16 cents a share, and will raised $10 billion in common equity.

Earlier, The New York Times reported that Citigroup and Wells Fargo were looking at Wachovia but that neither was likely to bid more than a few dollars a share for the bank.

"One thing that Citigroup has been wanting to do for a while is to expand its retail operations because they are in very limited areas, so this would basically allow them to do that,'' said Rose Grant, managing director of Eastern Investment Advisors in Boston.

Citigroup will buy the bulk of Wachovia's assets, including five depository institutions, and assume its senior and subordinated debt. Wachovia will retain ownership of AG Edwards, a big retail brokerage it bought a year ago, and its asset-management division, Evergreen.

"We will continue as a focused leader in retail brokerage and asset management,'' Wachovia spokeswoman Christy Phillips-Brown said. She declined to comment on other terms of the deal.

Wall Street's alarm about the freeze in credit markets and the state of the $700 billion bailout plan was heightened by the deal and the bank rescues in Europe.

Larkin, fixed income manager at Cabot Money Management in Salem, Massachusetts, said, "These announcements couldn't have worse timing because they're taking the shine off the potential bailout (in Washington).''

He added, "That's going to spook people looking at the global markets. They're thinking this thing is spreading.'' David Buik, strategist at Cantor Index in London, said, ''This cannot be allowed to go on like this. This is hopeless. They need to be taking this stuff off the street sooner rather than later. The trouble is toxic.''