U.S. to Citi shareholders: Drop dead!

And by taking a 40% stake, the U.S. can help Citi increase the odds of passing that test. How so? The government's preferred shares are treated as debt for accounting purposes and by converting those shares to common, Citi can reduce its debt and increase its tangible common equity. The U.S. thinks this boost in tangible common equity will give Citi the balance sheet strength it needs to pass the stress test.

This move also puts pressure on the sovereign wealth funds (SWF) that bought Citi preferred. Should they also convert their holdings to common? These SWF investors include the Government of Singapore Investment Corp. (GIC), Abu Dhabi Investment Authority and Kuwait Investment Authority. But if GIC's $6.9 billion stake is converted into 4% of Citi common, it will give up a 7% yield on the preferred and still face the risk of dilution by the U.S. And if the SWFs do convert, it will mean more bad news for Citi common shareholders.

Let's be real for a second. The U.S. is trying to keep Citi from a bankruptcy filing. The idea is that Citi is too big to fail. But isn't there some way to unwind Citi's obligations in an orderly way so that a bankruptcy doesn't roil the markets? Does the world really have enough capital to cover all of Citi's potential losses and those of the other large banks that are not in shape to pass the stress test? How much good money will we continue to throw after bad before we say that enough is enough?

Meanwhile, common shareholders are bearing the cost of the failures of the boards and executives who got these banks into such a perilous state. That means anyone who invested their 200.5-K in stocks by believing the idea that stocks for the long-run are the best way to go will be lucky if they can keep a job long enough to make up for the losses.

Unfortunately, the common shareholders are wiped out whether the government takes over the banks or lets them file for bankruptcy. This means that capitalism is in trouble over the long-run if people have memories of what is happening today. How so? Capitalism depends on the willingness of people to finance growth by buying common stock, but we're now seeing why common stock is a terrible investment.

Fool me once, shame on you. Fool me twice, shame on me.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He owns Citi shares.