Can Citigroup and Bank of America survive?

The question of what Barack Obama is going to do about the financial sector of the economy appears to have come back with a vengeance today. Both have dropped significantly in the market because of the trouble they are in, so now Felix Salmon recommends that they be nationalize instead of bailed out.

Both Citigroup and Bank of America are down more than 20% in early trade today, 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.

Citigroup's severe problems with mortgage-based investments are well known at present, but Bank of America is the bank the feds have gone to in order to takeover other failed banks. That appears to be BoA's problems. They bought Countrywide, the nations largest mortgage broker, last Spring when it was effectively bankrupt, paying the $4 billion price in BoA stock. Then when the financial crisis hit last Fall and wiped out the big Wall Street investment banks, BoA took over Merrill Lynch. They got a $25 billion subsidy from the Secretary of the Treasury to take Merrill Lynch on, but it wasn't enough. TPM reprts that BoA is getting ready to ask for an additional $100 to $200 billion.

The problem with the great deal BoA got on Countrywide is the sloppy and very frequently dishonest methods they used to sell mortgages. At the time BoA took Countrywide over, it looked like a good deal by one of the few remaining very large banks that was still solvent. Let's not forget, though, how deep Countrywide was in causing the entire Wall Street Credit crisis.

Countrywide Home Loans was a division of Countrywide Financial Corp., which in 2007 was the nation’s largest mortgage lender and serviced $1.4 trillion in loans. It was labeled “the company perhaps most responsible for the mortgage crisis” by Rep. Henry Waxman, D-Calif., chairman of the House Committee on Oversight and Government Reform. Waxman last year blasted the company’s executives for taking astronomical salaries and bonuses as Countrywide’s stock plummeted amid staggering losses from an orgy of subprime lending. The losses ultimately led to Countrywide’s sale last year to BofA. Meanwhile, attorneys general from states across the nation sued Countrywide over deceptive lending practices before 15 of them negotiated an $8.4 billion settlement on behalf of borrowers in the fall.

Both deals depended a lot on what BoA thought the books said the companies were worth. But that was in part before the economic problems had been determined to be so bad that the economy was declared to be in Recession since December 2007, and before the criminal ponzi scheme of Bernie Madoff was exposed. The latter has demonstrated both that Wall Street is rife with fraud and criminality. Taken together it also shows that the audit firms doing the auditing are completely inadequate.

The fact is that nothing today is going to do more than simply allow further digging to find more problems, and the history is that the problem will continue to be of staggering cost. The real question is how much longer the banks will be bailed out using taxpayer money.

It should be clear by now that the banks cannot be trusted to run their own business. The management is complicit in the criminality, fraud and incompetence even if they did not instigate it. The entire American financial structure needs to be rebuilt, with the current managers generally replaced (and the replacements should get paid a lot less.)

So can Citigroup and Bank of America survive? Good question. It looks less and less like they can.