Downgrade SeriousCM's credit default swaps will shoot-up. These Monkeys have taken this situation to this level. Can't remember when any Cdn bank had negative credit watch implications.
The insurance on hedges are no good. Its not like car insurance. Or even hurricane insurance. When a hurricane hits it hits only a specific area and doesn't destroy everything. Those in unaffected areas pays for the damage. But insuring CDO's is totally different. If its goes bad it all goes bad. A car insurance company would go bankrupt if every other car got into an accident at once. But that is statistic impossibility.
So if CM has $5B of unrealized losses covered by insurance do you think the insurance companies can really come up with the money if the event is real? Of course not.
CM may actually be forced to writedown $5B!!! It would be painful and CM will need a minimum $1.5B equity injection. But that's what cM should do. Go out and make a $1B equity injection at $65 and then writedown $4B next quarter. After deducting $1B of pre-tax normal income, the net pre-tax is $4B, which is $2.5B after-tax. Equity injection covers $1.5B. CM's capitalization can tolerate a straight-up $1B after-tax reduction and stay above 7.5% Tier 1 capital.
If they take that road then they can start the road to recovery. If they dicker around things will get worse short-term as their reduced creditworthiness will affect its business in counterparty risk and higher funding costs.
Of course, if they choose to glide through this mess over 2008 (and can survive with similar strength) then shareholders may be best off (which is what mgt is pursuing), but that is high-risk strategy.