Citigroup, Bank of America: Prisoner's Dilemma, Electronic Bank Runs and Nationalization

Citigroup (C) declined 61% from a peak of $4.10 to an intraday low of $1.61 over just 10 trading days. Bluntly put: Citigroup is dead.

Bank of America (BAC) declined 64% from a peak of $7.05 to an intraday low of $2.53 over just 10 trading days. Bluntly put: Bank of America is dead.

Dead actually means dead. It is unlikely they can survive the weekend... and if they do, they most definitely cannot survive the week.

It used to be that bank runs were very public affairs. Crowds would rush the PHYSICAL offices of a stricken bank and demand PHYSICAL withdrawal. The large, panicked and angry mobs would make instant newspaper headlines. More importantly, bank runs could not be covered up and kept secret. Unruly mobs demanding their money don't tend to go quietly into the night.

Today, things are much different. Bank runs occur with a phone call... nah... a click of the mouse. There is absolutely no need to show up at office and demand paper money. Now the bank run is electronic. Without the mob, without the noise and the rage a bank can be entirely drained of reserves almost INSTANTLY.

With Citigroup and Bank of America reeling from massive losses from failed credit and investment policies, their common stock, bonds and credit default swaps are all now signaling their imminent failure.

The single largest investor in Citigroup is Saudi Prince al-Waleed bin Talal. in November 2008 the Saudi prince increased his stake from 4% to 5%, investing an additional $350 million. In January of 2007, Citigroup had a market capitalization of more than $250 billion. As of Friday's close, the ENTIRE bank is worth about $10 billion. The Saudi prince is down 96% on his 4% stake. Put another way, his original stake was worth about $10 billion in January 2007. Today, he could buy the whole damn mess for the same amount. The prince must be absolutely livid over these developments.

The prince is very exposed to Citigroup. Not only is he an investor, he also does extensive business with the bank. The assets and debts of his financial empire flow through Citigroup in the course of normal business operations. Although his financial dealings are very secretive and opaque, it stands to reason that his advisors would insist he manage this risk. Being long the bank via his ownership stake AND conducting business with the bank is now just too risky. It is the equivalent of doubling up or more in terms of risk on the very same trade. If the bank fails, everything fails. His investment and his business exposures both get severely impaired SIMULTANEOUSLY.

Therefore, the only rational action the prince can take is to shift his business AWAY from Citigroup and towards more stable banks. First the most liquid assets, such as cash deposits would be electronically routed to safer banks. Less liquid assets held in trust from stocks to bonds would be next... all the way down to the least liquid or least transferable assets. Second the credit provided by Citigroup would be swapped out. The prince can't be certain that Citigroup will have the ability to honor the requirements as they come due. This would in fact be an electronic run on the bank.

The prince is damned if he does and damned if he doesn't. The very action of reducing his exposure to Citigroup actually accelerates the death of the bank. If he does not act, he then runs the risk of being the final bagholder should the bank die anyways. Consequently, he can't act until he has determined beyond a reasonable doubt that the cause is lost. Then and only then will his hand be forced into action.

Unfortunately there will be no angry mob lining up at the bank. Like Bear Stearns and Lehman Brothers, the run will be overnight, instant, electronic and leave no trace.

When the tipping point is hit, the world at large won't know until AFTERWARDS.

Big money investors can't run the risk of waiting and hoping that everything will work out just fine. They find themselves in a Prisoner's Dilemma. Since they can't play nice as a team, they have to be first to act... and act they will. The first to panic wins.

Therefore, big money investors must now be pulling their deposits at both Citigroup and Bank of America and they must be doing it quietly and quickly with the click of a mouse. No mobs demanding paper money... just a 'click' and a string of ones and zeros blitzes from one end of the world to another over the internet.

In the immortal words of Charles O. Prince III, the disgraced former Chief Executive Officer of Citigroup;

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."

The music has stopped. Clearly. The dance is over. Time to panic... because the market has signaled quite ominously that Citigroup and Bank of America won't get to a chair in time...

Personally, I'm almost certain there simply aren't enough chairs. There never were.

Consequently, nationalization is guaranteed.