It’s hard to know whether the unfolding drama with Bank of America and Citigroup Inc. represents history repeating itself as farce, or whether the markets have a few more go-rounds with tragedy first. Sure, shares are higher on the day on news that the U.S. Treasury has driven an armored truck full of large bills to the front of headquarters, even as similar amounts are being sent into the incinerator in a back office somewhere. But many see the situation as untenable, believe the government is throwing good money after bad, and believe the resolution will look similar to a liquidation.

Citigroup and Bank of America are receiving another round of funding to shore up their capital bases even though the outlook remains depressing. Economic weakness, the fractured real estate market and the horrific-looking balance sheets of these financial-services companies are likely to translate to losses for an ongoing period of time, until the market somehow recovers, or the institutions collapse.

The bailouts are akin to replacing the windshield and tires on this vehicle.

We’re funding operating losses and we’re only buying time,” says Christopher Whalen of Institutional Risk Analytics.

Citigroup is receiving at least $45 billion to stabilize itself after announcing an $8.3 billion loss amid plans to split into two businesses. Bank of America, meanwhile, reported big losses and nailed down plans to receive $20 billion from the government to handle losses related to its acquisition of Merrill Lynch.

But when does all of this end? That’s the germane question here — and to some, it points to an eventual takeover by the Federal Deposit Insurance Corp., where the bank deposits and certain other assets are sold off, piecemeal, to other banks, and the company’s debt remains with a shell company. Debtholders eventually lose a ton of money in bankruptcy.

“The debt must be reduced — if it means the debtholders lose money along with shareholders and depositors it must occur,” says Chris Wang, portfolio manager at hedge fund SYW Capital Management LLC in New York, who has short positions in the financial sector. “It’s not politically viable to let depositors lose money so it’s only through debtholders losing money can credit flow again. Then, we’ll be able to let companies that bought them operate in a stronger situation, because they’ll be able to conduct business.”

That all sounds incredibly easy on paper, but one only need look at the wrangling that has accompanied the slow spiral into nothingness of the U.S. automakers to see that debtholders won’t go gently into the night, particularly if the perception remains that the underlying company in question still remains viable (which is how people see Bank of America and its stronger brethren, J.P. Morgan Chase).
But Campbell Harvey, professor of finance at Duke University says taxpayers shouldn’t have to subsidize a bad bet by Bank of America when it purchased Merrill Lynch at $29 a share. “We’re in a situation where the government is continuing to bail out mistakes and continuing to throw good money after bad and then take a back-seat position — they have to stop or [management] will continue to do this,” he says.

For his part, Mr. Whalen believes the industry has reached an inevitable point; Citigroup’s restructuring into two units will only buy a bit of time. “You’re basically going to liquidate these guys and break them up into bite-sized pieces by geography,” he says. “If you want the economy to recover, you go to US Bancorp on down and you tell them you’re going to give them more TARP money, on more concessionary terms than Citi or B of A, and they can use that to buy other banks, and breathe life into these moribund assets.”