It’s not quite as laughable as it might seem at first glance that the latest
tranche of investment-bank earnings reports showed hundreds
of millions of dollars in profits from the fact that those banks’ bonds
had fallen in value. Morgan Stanley alone booked $390 million, or about 26%
of its third-quarter profit, from the fact that its bonds are now worth substantially
less than they were when they were issued.
That kind of profit might not, as Moody’s says, constitute "high-quality,
core earnings". But it’s not entirely an accounting fiction, either. After
all, a bank can make money on the asset side of its balance sheet if it buys
assets at a low price and then they rise in value: it’s called mark-to-market
accounting. So the same bank sells bonds at a high price and then they fall
in value, there’s a mark-to-market profit there, as well.
Any investment bank worth its salt is at all times actively managing its liabilities.
That means it’s on the lookout for the kind of opportunities available to the
quick and the market-focused: it might see an attractive swap rate between dollars
and Chilean pesos, for instance, quickly issue a bond in a Chile, and swap its
liability into sub-Libor funding in dollars. Banks’ CFOs can also buy back their
own debt in the secondary market, especially if they think it’s trading at a
substantial discount to fair value. In that case, the profit on the bonds’ fall
in price isn’t just mark-to-market, it’s real. If I sell you a bond for $1 and
then buy it back for 90 cents, I’ve just made 10 cents in cash.
Which is not to say that these are the kind of earnings that banks like to
crow about. But in times like these, they’re not about to look a gift horse
in the mouth, either.