Wednesday, 22 April 2009

CDS spreads through the looking glass

Sometimes a blog posting has such delicious irony, as this one does from Professor Krugman, that it is worth repeating in full.

So the accounting rules say that a decline in the market value of a bank’s debt thanks to increased credit default swap spreads — that is, because investors think you’re more likely to fail — counts as a a profit. On the other hand, if your bank looks stronger, the spreads fall, and you book a loss.

FT Alphaville has the story. Citigroup reported

A net $2.5 billion positive CVA on derivative positions, excluding monolines, mainly due to the widening of Citi’s CDS spreads

while Morgan Stanley reported

Morgan Stanley would have been profitable this quarter if not for the dramatic improvement in our credit spreads - which is a significant positive development, but had a near-term negative impact on our revenues.

So Citigroup is profitable because investors think it’s failing, while Morgan Stanley is losing money because investors think it will survive. I am not making this up.
The only point I would make is that Lewis Carroll would have loved this story but might have favored it more for Alice Through the Looking Glass rather than Alice in Wonderland .

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