Anatomy of a Panic

Scare talk from [ The Financial Ninja ]: Citigroup, Bank of America: Prisoner's Dilemma, Electronic Bank Runs and Nationalization.

Citigroup © 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.

To some extent, talk like this can be a self-fulfilling prophecy…and sometimes market manipulation by short-sellers.

In any case, depositors are as safe as the FDIC. It's the shareholders, and the bondholders, who are at risk, perhaps deservedly so. Which is where the race to the bottom comes in:

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.

What interests me most about this is that it adds a foreign-relations dimension to the pressure on the Treasury to not just nationalize, but to do so in a way that benefits shareholders at the expense of taxpayers. But of course they could never say that.

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