Dogs and Cats Living Together

You know by now what credit default swaps (CDS) are. When CDS go up that means the underlying thing is perceived as being riskier and when CDS go down the underlying thing is perceived as being less risky.

Well Citigroup’s (NYSE: C) recent earnings report got a recent boost because CDS it holds on itself went up. It’s almost like it benefited from being short itself. The improved earning report could then cause the CDS to contract which could in turn then hurt the company.

The opposite appears to have happened with Morgan Stanley’s earning report it was hurt because the CDS it held on itself went down.

It has been an upside down world for financial stocks for a long time with no visibility for right side up any time soon. Every rule or modification put into effect to try to deal with the crisis results, almost immediately, in some sort of unintended consequence or even obfuscation.

It is both sickening and disappointing.

In the early part of the decade my financial exposure was one domestic bank, one British bank, one Irish bank, one Australian bank and one Canadian bank. I was lucky to sell the British bank when I did (swapped it for a Chilean bank) and was also lucky with the sale of the Irish bank which has since been nationalized. The domestic bank was Bank of America which I sold upon the news of the Merrill Lynch merger.

The Canadian bank went down a lot but I am glad I did not sell it, the Australian bank is down more but Australia does not have the same sort of financial problems (no subprime) and the Chilean bank is only down a little from where I bought it 17 months ago. Along the way I added one of the publicly traded exchanges (that purchase was about a month too early).

At some point I will buy another financial stock but I doubt it will be a domestic bank. If I wanted to start looking at banks perhaps this list of the worlds 50 safest banks might be a good place to start. I have heard good things about the banks in Singapore but there are only two Singaporean banks on the list and they are pretty far down. It might make sense to buy a publicly traded exchange from another country as sort of a financial infrastructure play. The two big credit card companies could be interesting, the collect a little fee every time their cards are used without taking credit risk. I’m not sure if there are any micro-finance stocks (you know these they make tiny loans and the repayment rates are fantastic) but this could be an area to look as well.

The most toxic of banks have had a great call option-like bounce and it may continue but if you don’t want to bet on that trend continuing then you will need to look elsewhere.