Word: swapping
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...that business had been good. But bank financial statements are never that simple: Citi's overall investment-banking earnings were boosted by a $2.5 billion derivatives valuation adjustment "mainly due to the widening of Citi's CDS spreads." In somewhat dumbed-down but still utterly flummoxing language: credit-default swap (CDS) spreads represent the cost of insuring against Citi's default. That cost went up in the quarter as investors fretted about Citi's solvency, so Citi was able to book $2.5 billion in gains. Got that? Without that boost, Citi's $1.6 billion in quarterly profit would have been...
...credit default swap is an insurance policy on an investment. Wall Street took out insurance on risky investments, like taking insurance out on your car. The party that issues the CDS agrees to insure an investment in the event of a loss, and, in return, the CDS buyer agrees to pay a monthly premium. However, a CDS is not your average insurance policy. Insurance is highly regulated, and CDSs are unregulated, creating many dangers...
...There have been other recent hassles with dollar-based trade. When U.S. financial institutions like AIG and Lehman Brothers began to disintegrate in 2008, global money markets were so roiled it became expensive for any trade to be done at all in dollars. "What precipitated [China's swap agreements] was the collapse of Lehman Brothers and the worries over trade financing at that time," says Johanna Chua, a regional economist with Citigroup in Hong Kong. "If the dollar is extremely volatile it costs more to hedge...
...swap agreements China has hashed out circumvent most of these problems. A Malaysian clothing store, for example, that buys shirts and dresses from China can now use its local currency, the ringgit, to pay for its purchases. Because it no longer has to pay a bank a fee to convert ringgit into dollars, transaction costs are reduced. Similarly, a Chinese company buying Malaysian palm oil can make its purchases in yuan. (Read about the economies of South Korea, Taiwan, Hong Kong and Singapore...
...surprisingly, the yuan agreements have so far drawn an indifferent response from the private sector. Intel, the world's largest semiconductor maker, has manufacturing facilities in both Malaysia and China. Yet so far Intel hasn't used the currency-swap facility Malaysia has in place with China. Much of Intel's internal trade is still transacted in dollars, according to Loo Cheng Cheng, a Penang-based corporate-affairs executive with Intel. According to Citigroup's Chua, companies in South Korea, which was the first to sign a swap facility with China, have so far also declined to utilize it. Indeed...