Australia is in recession

Apparently Australia is in recession, and has been since the start of the year. And here I was thinking Australia was strong...

In real news, major US banks have been making profits - but by less than the markup on their own debt. This is a piece of accounting genius: Suppose company XYZ sells $15 Billion of debt due in 5 years for a total of $10 Billion. Next, the market realises that there's a real risk that XYZ will not last 5 years and the debt is going to be paid only partially and only through bankruptcy proceedings, so the debt falls in value to $7.5 Billion. XYZ records a profit of $2.5 Billion because the present value of their outstanding debt has fallen.

In theory, XYZ could buy its debt back for $7.5 Billion - but there were any way it could do this, the market would not have discounted the debt quite so harshly. This windfall profit comes with the catch that it is guaranteed to go away over time - firstly, if the health of the company improves, an equal amount of loss is incurred, and secondly, as the debt matures the present value approaches the face value, making an equal amount of loss.

And on the dangerous side, let's take a look at CDS rates. Rio Tinto is currently around 7.25%, while Macquarie Bank managed to hit 12.65% at the market bottom. Loosely speaking,
CDS rate = Risk of bankruptcy per year * Expected recovery on debt after bankruptcy
At a recovery rate of 2/3rds (probably low for Rio, high for Macq Bank unless they're telling the truth), this gives a market expectation of over a 20% chance on Rio bankruptcy this year and briefly rated almost 40% on Macquarie Bank.

Disclosure: Currently short Macquarie Bank and Rio Tinto in a variety of ways.