It’s far easier than you think. Even though Citi is being more or less forced by the government to sell one of its most valuable assets at a time of immense market distress, even though Morgan Stanley will only pay Citi something between $2 billion and $3 billion, Citi is expected to book a gain of $10 billion.
That $10 billion will replenish its capital, off-setting nearly all of the net losses Citi suffered in the first nine months of 2008.
Of course, it won’t suddenly have $10 billion of cash sitting around. It will simply have an asset—half of the joint venture that is being created by combining its wealth management business with Morgan Stanley’s—that it can count as $10 billion.
That’s right. Because of the magic of accounting, putting its assets into a joint venture half owned by a competitor will allow Citi to suddenly mark-up the value of those assets. The $3 billion paid by Morgan Stanley represents the “make whole” price—the difference between Morgan’s contribution and Citi’s—and could give the whole thing a value of as $20 billion. Citi will own just under half of the JV, which gives it around $10 billion.
To put it another way, the $2 billion paid by Morgan Stanley to Citi creates a new price for Citi’s wealth management assets. Up till now, Citi was presumably carrying Smith Barney at something like $1 billion, slightly more than what it cost when Primerica bought Smith Barney decades ago. It now gets to include the repriced assets at that higher value on its books. And that’s how a $2 billion transfer from Morgan Stanley to Citi nets Citi $10 billion before taxes.
Nice maths if you can get it.