Friday, October 10, 2008

A day of reckoning for financial counterparties

"The auction of Lehman CDS contracts will be a major event today as it will determine the level of what will be the biggest CDS payout to date. The proximity of this may have been a big reason why credit markets have remained frozen despite the considerable policy interventions. Counterparty losses could be considerable; Lehman's $128 billion of bonds were trading on Thursday at an average of 13 cents on the dollar, suggesting credit swap sellers may have to pay 87 cents on the dollar to the buyers of default protection. More than 350 banks and investors have signed up to settle credit-default swaps tied to Lehman. Earlier this week the value for bonds of Fannie Mae and Freddie Mac were priced as low as 8.5 cents on the dollar, at most, because the debt is backed by the government."

update Oct.10 4:19 p.m.: What a day in the markets!
Bloomberg reports:
Sellers of credit-default protection on bankrupt Lehman Brothers Holdings Inc. will have to pay holders 91.375 cents on the dollar, setting up the biggest-ever payout in the $55 trillion market. Based on the results, sellers of protection may need to make cash payments of more than $270 billion, BNP Paribas SA strategist Andrea Cicione in London said. The potential payout is higher than the 90.25 cents indicated by initial results from the auction earlier today. Lehman bonds traded yesterday at 13 cents on the dollar, suggesting a payout of about 87 cents was expected.

The auction started at 10:30 a.m. and ended at 2:00 p.m. NYT. Here are a few charts that illustrate the disappointment and the relief-rally which underscores tremendous volatility and uncertainty in the markets. The clearing of Lehman's credit default swaps is an encouraging sign but it is only a first step towards functioning credit markets.
click to enlarge

The global credit crisis might be on the mend, at least for now. "Lehman credit default swap sellers posted collateral and no firms failed", according to a statement from the International Swaps and Derivative Association.

source: Lehman Credit-Default Swaps (CDS) Auction on Tap - Debt Insurers Expect Losses, Friday, 10 October 2008 07:19:43 GMT

source: Lehman Credit-Swap Auction Sets Payout of 91.38 Cents on Dollar
By Shannon D. Harrington and Neil Unmack, Bloomberg, 10/10/08

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