Word on Wall Street is that Bank of America and Citigroup have failed the Treasury's stress tests, and to bolster their capital, the government will convert its combined $95 bn preferred stakes in the two banking giants into common shares with voting rights.

That stake would swamp their combined $76 bn market capitalization, though the swap exchange could have US taxpayers owning less than 50%.Ken Lewis

So, which private equity investor will want to sink money into Citigroup (C) whose stock trades at the level of an ATM fee, and Bank of America (BAC), at the cost of two Starbucks grande lattes?

The way it would work is, the government would convert its $95 bn investment in the banks' preferred shares into common stock with voting rights, wiping out the dividends on the preferreds that the taxpayers would get.

The conversion would act like blood thinner to existing shareholders. Citi may also convert some trust preferreds.

The conversion would boost the banks' tangible common equity ratio, a bare-bones net worth measure that the government is using to stress test the banks, and which does not include preferred shares. In the capital structure, preferred shares are considered to be akin to debt instruments, since they pay out hefty dividends.

How Much Do They Need?

BofA needs anywhere from $36.6 bn (says Oppenheimer Research) to $70 bn in more capital (says Friedman, Billings, Ramsey Group). Citigroup needs even more. That's the word on the Street.

The Treasury, the Federal Reserve, and the FDIC have given Citigroup a $306 bn insurance backstop to its balance sheet, and the government is guaranteeing $118 bn in bad assets at Bank of America. That means Citi and BofA can unload massive amounts of bad assets onto the US taxpayer.

The way the government has structured its backstop to these banks gives an indication of how much more capital they may need.

In the $306 bn bailout of Citi, the bank must take the first hit of $56.7 bn in writedowns, with the government taking on the remaining $249.3 bn in bad assets. At BofA, the bank takes the first $20.8 bn hit, with the government swallowing the remaining $97.2 bn.

The US Treasury Dept. and the FDIC are now guaranteeing a total of $428 bn in bad assets taken on from Bear Stearns ($29 bn), American International Group ($52.5 bn), Citigroup ($249.3 bn) and now BofA ($97.2 bn effectively).

Deutsche Bank analyst Matthew O'Connor says that of the 19 banks being stress tested by the government, a near-term capital raise is possible at Bank of America, Wells Fargo (WFC), Key Corp (KEY), Regions Financial (RF), and SunTrust Banks (STI).

What to Watch Out For at BofA

It's got $138.9 bn in tangible common equity. That's its barebones net worth, after you subtract its liabilities from its tangible, hard assets (stripping out ephemera like the overpayments the bank made to buy other banks called goodwill, or the money it expects to get from servicing mortgages down the road).

The government is assessing the banks' capital strength by using this tough measure, tangible common equity-it's essentially what can be immediately retrieved in a bankruptcy.

Teetering atop that $138.9 bn are $2.3 tn in assets and $2.1 tn in liabilities. BofA has a razor-thin 3% tangible common equity ratio (as a percentage of risk-Vikram Panditweighted assets).

BofA's Balance Sheet Holes

It's got:

$51.5 bn in bad derivatives and assets on its balance sheet

$25.7 bn in bad loan assets

$81 bn in off balance sheet assets

*A new accounting rule that takes effect this November says all companies, including banks, must start putting back on their balance sheets these off-balance sheet sums.

That will cause capital reserve ratios to gyrate faster than a compass held over the North Pole.

What to Look Out For at Citigroup

Citi has got just $82.1 bn in tangible common equity. Again, that's Citi's barebones net worth. Perched perilously atop that sum are $1.9 tn in assets and $1.8 tn in liabilities. Citi has a wafer-thin 3% tangible common equity ratio

Citi's Balance Sheet Holes

$145.9 bn bad derivatives, assets

$81.5 bn bad liabilities

A stunning $1.2 tn in off balance sheet assets

Air Obama Flyover

Let's take a break from all these numbers to recap an unusual visit earlier this week to Manhattan.

First, though, the president says this, that the infrastructure spending plan in his budget (get out your magnifying glass), is under budget and on time. He has also hired Speedy McFeely, Edward Scissorhands and the Road Runner to work on it.Edward Scissorshands

Do any of you believe that either Sen. John McCain or President Obama would have won the election on the president's $3.6 tn budget that the CBO now says will blow out the deficit to $9.3 tn fm 2010 to 2019-more than the present, combined GDP of Britain, Russia, France and Brazil?

Do any of you agree that all of this government borrowing will vacuum up any spare private capital out of the markets and could drive 10-year treasury yields higher, causing mortgage rates to rise and sheer bedlam at the Federal Reserve, which has been blowing out its balance sheet, buying Treasurys to keep mortgage rates low?

Do any of you agree that this government's fiscal recklessness (which also occurred under President Bush) is now a national security issue, given that China holds massive amts of our debt?

And that our taxes are going to have to rise to pay for all this, right when inflation socks us because of the bailouts, now fast approaching the country's entire GDP-as we struggle with a tax system that has a mass exodus of companies offshoring their profits because the code is a tangled barb wire of stupidity?

Obama-Manhattan Flyover

Earlier this week, Wall Street and parts of the business district of New Jersey across the Hudson River were panicked to see a jetliner flying at deeply low altitudes past Wall Street, accompanied by military jets.

The flyover, turns out, was ordered by the White House Office of Military Affairs so it would have souvenir photos of Air Force One with the Statue of Liberty in the background.

The Federal Aviation Administration's James Johnston said the agency was aware ahead of time of "the possibility of public concern regarding DOD (Department of Defense) aircraft flying at low altitudes" in an around New York City, says WCBS 2 New York, based on a government memo it said it obtained.

But the FAA demanded total secrecy from the NYPD, the Secret Service, the FBI and even Mayor Michael Bloomberg's office and threatened federal sanctions if the secret got out, the station says.

President Obama said: "It was a mistake. It will never happen again."

The mayor was outraged, as was New York City Police Commissioner Ray Kelly. Kelly said: "Did it show insensitivity to the psychic wounds New York City has after 9/11? Absolutely. No questions about it. It was quite insensitive."

The cost to taxpayers of the frivolous, phony flight, including the flight by an VC-25, a modified Boeing Co. 747, and two F-16 fighter including, was about $328,835, Air Force spokeswoman Vicki Stein told WCBS.

My estimated cost of a computer generated, photo-shopped image of Air Force One over the Statue of Liberty: $25.

Wag the Dog Results

Meanwhile investors are seeing computer-generated, Wag the Dog first quarter results at Citigroup and Bank of America, where artificial paper gains generated by accounting maneuvers and one-off asset sales helped both banks make their first quarter numbers.

A $1.9 bn pre-tax gain from the sale of a slug of BofA's stake in China Construction Bank and a $2.2 bn accounting paper gain because of the declining value of some Merrill Lynch structured notes (accounting rules enable banks to book such gains on the expectation that they will eventually repurchase the debt at a lower price) virtually covered BofA's entire $4.25 bn first quarter operating profits.

That has analysts and company insiders shaking their heads.

"Why unload this really great investment in this Chinese bank when China is shovel ready with its massive stimulus spending, and is growing like gangbusters?" a Merrill Lynch insider asks. "It was done just to make the first quarter look better than it really was."

Meanwhile, BofA set aside $13.4 bn in loan loss reserves to cover rotten bananas-a stunning 58% increase from just the prior quarter.

I Ask Again: Has Your Head Exploded?

And looking at Citi's numbers, my head just popped off my shoulders, it's flying out of the building. I have to go get it now.