Tue, October 21, 2008
Markets Wait for Lehman CDS Payouts to Settle
The parties involved in the Lehman credit default swap (CDS) auction are settling up today, and everyone is hoping that none of the participants got too badly burned (even if they're hedge funds).
As noted in a postscript to an earlier post, settlement payouts for about $400 Billion in CDS on Lehman Brothers debt are due today. There are fears that some European banks may have significant net losses in the settlement, and since the payments have to be settled in US dollars, there are rumors that European counterparties are hoarding dollars in preparation for significant Lehman CDS payouts. Declines in the British pound and the Euro versus the dollar are being blamed on European banks and others that sold swaps on Lehman debt.
The Depository Trust and Clearing Corporation, the exchange responsible for handling the auction at which Lehman CDS final prices were set, issued a news release complaining that fears of massive counterparty payments are unfounded and that the total net amount that will be paid out by all parties is a mere $6 Billion dollars.
As previously explained, the sellers of CDS must make up the difference between the final value of Lehman bonds and the original bond face values. Forbes notes that although the buyers of the CDS will be $365 billion richer, there are buyers who were sellers and vice versa. Since no one knows all of the transactions entered into by the buyers and sellers of Lehman CDS, the final outcome is a mystery until losses are reported.
Insurance companies like AIG may well have been big net sellers of Lehman CDS, and there are probably some hedge funds that used the swaps to bet on a Lehman bailout that did not materialize. The hope, of course, is that there are no large, important financial institutions who were big losers. If there were, it will trigger more worries about the highly-interconnected global financial system. The Lehman bankruptcy undoubtedly helped precipitate AIG’s need for a massive bailout; the failure of another major player, it’s feared, might push over some more dominoes. In this case, “no news” will be good news.
Related Post:
Lehman CDS Auction Should Reveal Winners and Losers