Both Citigroup (C) and Bank of America (BAC) were down more than 20% in early trading Thursday, and I imagine that Hank Paulson and Tim Geithner are starting work on yet another weekend deal of some description, since at this rate it seems that neither institution is capable of surviving in its present form much longer. They should embrace the inevitable and just nationalize the two banks.
Any deal will be necessarily complicated by the fact that Paulson dragged his heels when it came to requesting the second tranche of TARP funds, even after he blew through the first $350 billion in no time. As a result, it's far from clear what money Treasury can use to shore up two of America's most systemically-important financial institutions.
On the other hand, this isn't a bank run: Citi and BofA aren't suffering from liquidity problems. They have all the liquidity they need, thanks to the Fed. The problem is one of solvency: the equity markets simply don't believe that the banks' assets are worth more than their liabilities.
I can't see a solution to this problem short of nationalizing both Citi and BofA, and summarily firing the hapless Vikram Pandit along with the overambitious Ken Lewis. Lewis thought he could buy his way out of trouble, by acquiring Merrill Lynch; instead, he was simply tying his own already-troubled institution to an even more troubled institution. Pandit, it's worth noting, tried the same hail-Mary technique, when he put together a deal to buy Wachovia, but that didn't last long.
Citigroup, at $3.50 a share, simply doesn't have the time to implement its new plan to get smaller slowly. And Bank of America, at $7.75 a share, doesn't have the capital needed to absorb Merrill Lynch (MER). Both are now trading at option value: on the hope, essentially, that somehow equity holders won't be wiped out entirely. But they should indeed be wiped out, as part of a nationalization, along with preferred shareholders, including the government. TARP will show an immediate loss on its investments, which will serve as a salutary reminder for whoever is in charge of disbursing the second tranche.
Nationalization is a messy solution, and one which will make no one happy. But it's better than desperately trying to kick the ball down the field until the banks come back in a few weeks for even more money. If we've learned anything from the last Citi bailout, it's that small interventions don't work. What's needed now is a complete revamp of both banks' capital structures, and a brand-new owner.