Citigroup Rescue Triggers Improvement in Credit Default Swaps

Yesterday’s announcement of a $306 billion toxic asset safety net for Citigroup (C) was warmly received in the equity markets and has the potential for helping triggering the first three day rally in stocks since what seems like the Eisenhower administration.

Perhaps even better than the news in the equity markets is the impact that the Citigroup rescue has had in the pricing of credit default swaps (CDS) of financial institutions. Yesterday, for instance, the cost of credit default insurance at Citigroup was essentially cut in half, which is not surprising, given the nature of the agreement. The domino effect at other troubled financial institutions was notable, with CDS prices improving as follows:

• Goldman Sachs (GS): 68 basis points (18%)
• Berkshire Hathaway (BRK-A): 86 basis points (19%)
• Morgan Stanley (MS): 74 basis points (14%)
• Hartford Insurance Group (HIG): 214 basis points (10%)

For those not versed in the details of credit default swap pricing, each basis point translates into $1000 per year for 5 years to insure $10 million worth of debt, so a 5 year $10 million CDS for Goldman Sachs became $68,000 cheaper in the wake of the Citigroup deal.

The market likes the deal. I think the approach makes sense. Better yet, the Citigroup rescue may provide a workable template for how to best deal with troubled financial institutions in a manner than the government, firm, and market all find acceptable.