Here’s how the liquidity put worked:

Let’s say you had something you wanted to sell, but you couldn’t.
To sweeten the deal, you guaranteed the buyer, you’d buy back whatever you sold at what you sold it for.
Since you didn’t have to tell anyone, you kept this deal off your books, and you only had to put up $1 for every $800 to cover the deal.

The buyer “put” back to you the thing you sold, and wanted their money back. You had the $1, but not the $800. Poof!

Some reminders from Bloomberg:

Citigroup is getting extra attention from the FCIC panel because it got a $45 billion emergency infusion and $301 billion of government asset insurance. That represented the biggest taxpayer bailout for a U.S. bank.

If you watched the FCIC hearings on Session 3: Citigroup Subprime-Related Structured Products and Risk Management recently you saw comments like, we didn’t know, this never happened before, we didn’t understand, 800:1 leverage is risky kinda comments. Astounding. Either obvious fraud or obvious incompetence.

From Business Week:

The rules, which took effect in January and give lenders a year to comply, will force banks to account for most such trusts as assets instead of reporting them separately as guaranteed off-the-books affiliates, said Kevin Bailey, the OCC’s deputy comptroller for policy. Once on the balance sheet, the trusts will require 10 times as much capital support.

The shift “fundamentally changed the dynamics of these financing vehicles,” because higher capital requirements make the guarantees too expensive to offer, Bailey said in an interview this week.