Earlier this week, a fellow Fool and I discussed the absurdity of Citigroup (NYSE:C) and Bank of America (NYSE:BAC) taking massive write-ups on the blowout of their credit spreads -- a sign that investors were betting on the possibility of default. "By this notion," he noted, "are strengthening banks going to have to report massive non-cash losses if their spreads narrow once again?"

Yep. Case in point: Morgan Stanley (NYSE:MS). The Wall Street bank announced what would have otherwise been a solid quarter without a $1.5 billion mark-to-market writedown on tightening credit spreads. That, ironically enough, is one of the first real signs that confidence is trickling back into the financial system.

"In fact, Morgan Stanley would have been profitable this quarter," said CEO John Mack, "if not for the dramatic improvement in our credit spreads -- which is a significant positive development." It's almost like banks would be better off if credit markets stayed in Threatcon Delta mode. How's that for bizarre incentives?

All odd accounting quirks included, Morgan Stanley lost $177 million, or $0.57 per share on net revenue of $3 billion. Without credit spreads tightening, the bank would have earned $0.37 per share. It also announced a dividend cut to $0.05 per share per quarter. Not too surprising there -- bank dividends have been dead for a while now. The move will bolster common capital by about $1 billion per year.

Which, to be honest, it might not even need. Tier 1 capital now stands at 16.4%, which is about as good as it gets for major Wall Street banks. It's higher than even Goldman Sachs (NYSE:GS) and JPMorgan Chase (NYSE:JPM). Even if Morgan Stanley paid back TARP funds in full, it made a point of noting that Tier 1 capital would still stand at a meaty 12.9%. Tangible common equity sits at 4.3%, which isn't strong by any means, but still superior to many of its peers. The bank also declared in a conference call this morning the desire to get the TARP monkey off its back as soon as possible. Don't they all?

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Fool contributor Morgan Housel doesn't own shares of any of the companies mentioned in this article. The Fool has a disclosure policy.