How Banks Make Money

Citicorp reported earnings this morning.  Would you believe that in the middle of this malaise they managed to surprise on the upside? How did they manage to do that? Better loan management? More credit card transactions? (gasp) Better cost management? None of the above.  The answer is ....higher credit risk from....Citicorp!

Really, you can't make this stuff up.  It turns out that the same banks who argue that loans, mortgages and other "complex" instruments cannot be marked-to-market (i.e. use independent prices as opposed to those dreamed up by the banks) have no trouble marking down their own debt and reporting the difference as profit.

Take a look at the earnings report as posted on Yahoo finance.  The second paragraph of the press release reads

Third quarter revenues included $1.9 billion of credit valuation adjustment (CVA) reflecting the widening of Citi’s credit spreads during the third quarter. Excluding CVA, third quarter 2011 revenues were $18.9 billion, 8% below the prior year period and 8% below the second quarter 2011. CVA increased reported third quarter earnings by $0.39 per share.

What this means in plain English is that Citicorp reported $1.9 billion of gains because their own credit was priced lower by the market (half their earnings were due to this adjustment).  Say what? Say Citi owes $3 trillion dollars.  Say the market believes they are more likely to go bankrupt, the debt, naturally, is worth less (because fewer investors want it), Citi gets to say it owes less and book the difference as a gain.  The worse they do, the higher their chances of going bankrupt, the less the debt is worth, the more they make.

This is our banking system America.  No wonder they do not have any credibility.