UPDATED: Credit And Equity Disconnect?

UPDATE 12:50 (10:50 GMT) on March 19th:
Obviously, the bank equity buyers are not considering the issues like the Willem Buiter does it by suggesting "slaughtering sacred cows". That would be a party! It is more convenient to hide under the skin of my favorite Ken Lewis.

I was reading the latest note by James Montier of Societe Generale today, that also touches upon the issues related to Citi's Spinning Tuesday, and he quotes John Hussman:

The excitement of investors last week about Citigroup posting an operating profit in the first two months of the year simply indicates that investors may not fully understand the term "operating profit". Citigroup could burst into flames while Vikram Pandit sells lemonade in the parking lot, and Citi would still post an operating profit. Operating profits exclude what happens on the balance sheet.

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ORIGINAL MESSAGE FOLLOWS:

It is not new to the readers of this blog that I have been wondering about many ideas surrounding the banking industry. "Mark-to-bankers-dream" is my favourite, among others, and I am still mentally struggling to accept my inability to capture the magic rationale ...

I do not claim having the brain to understand the pervert option games, but analysts at BNP Paribas have a credit story that, I still believe, I understand:

As the chart below illustrates, senior benchmark bonds issued by US financial institutions on government life support have now broken through the lows reached in the aftermath of Lehman’s collapse. In our view, this means that investors do no see the implicit backing of these institutions by the Fed or the Treasury as a reason for comfort, as prices continued to fall relentlessly regardless of the significant fall in Treasury yields. With investors preferring to buy only FDIC-backed debt, the market is telling us that receivership and haircutting of senior bond holders is a distinct possibility; particularly for those financials that have received the most government help, where political pressure to start sharing the bailout pain across the entire capital structure – not only between shareholders and taxpayers – keeps
mounting.

I am putting the AIG (American Insatiable Group?) aside. The equity of Citigroup is an option, or second derivative of option? But I noted the BAC for reference. Stupid bondholders? Is it not clear that shareholders get paid first, and creditors only thereafter? Or what the stock market and the financial sector, especially, is trying to tell me? Stupid me!