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Latest Comments63 Comments
This Recession Will Be Anything but Deep
Lehman Debt: When a Senior Bond Is Very Junior
Fred78, CDS and other derivatives counterparty claims don't help anybody. They dilute recovery for all debt holders. However, if you bought bonds as well as CDS on Lehman from Lehman, then your loss on bonds will be compensated by the super-seniority of your CDS claim. Depending on recovery of CDS and the ratio of your bond vs CDS positions, you could even be over-compensated, recovering >100% of your bond. Self-referencing CDS is basically an accounting scam and should be banned, IMO.
Lehman CDS Net Settlement Only $6B: What Does It Mean?
If some hedge funds fail on 10/21, their prime brokerages would be left holding the collateral. Whatever shortfall they have, they'll need to recover in bankruptcy court. This is consistent with the reported massive margin calls all big prime brokerages have issued recently.
Lehman Debt: When a Senior Bond Is Very Junior
Lehman's CDS Mess: Who's on the Hook?
Lehman's CDS Mess: Who's on the Hook?
Lehman CDS Net Settlement Only $6B: What Does It Mean?
Lehman CDS Net Settlement Only $6B: What Does It Mean?
Preferred, Lehman's debt holders haven't even begun recovering their claims. Derivatives counterparties can go thought bankruptcy protection and force liquidation.
Lehman's CDS Mess: Who's on the Hook?
My original title was "10/21: The Bottom". Maybe the editor(s) thought it was too provocative? ;>
Zulu, I think it's sure the world will wake up on 10/22 with fewer hedge funds. But the one thing nobody seems to know is whether some failure could trigger a chain reaction through some derivatives-based amplifier link that nobody has thought of. It's the classical unknown unknown. I just hope somebody with access to more info and in position of power has given this some serious thoughts...
amarksp, no CDS seller ever has the expected loss fully collateralized. It would kill any economic incentive to sell it, or otherwise the premium would be so high nobody would buy them. Furthermore, the loss on Lehman CDS turned out to be much higher than "expected".
Lehman's CDS Mess: Who's on the Hook?
The Wonderful World of Self-Insurance
Effectively, so-called "senior debt" of all bond issuers who're derivatives counterparties are subordinated. I wonder if rating agencies and regulators have taken this into consideration when giving such bonds their seniority labels and credit ratings. I wonder when somebody will sue them on such ground...
Senior debt holders of Lehman have been wiped out, without ever knowing the risk they were taking nor getting the reward for taking such risk.
From now on, bond cost for banks should be much higher, if people have learned the Lehman lesson.
Is the End of the Crisis Near?
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10/21: The Bottom
If anybody has anything to do with financial stocks but hasn't paid attention to an "obscure" thing called CDS, while such investor should not exist in theory, now is the time for such non-existent, hypothetical investors to take notice.
Let's cut to the chase. On Oct 21, somebody A will have to pay somebody B $C in cash to settle CDS on Lehman. Estimates on C range from 100 billion to 400 billion. Group A will almost certainly include AIG, the biggest net seller of CDS, and many hedge funds, who have been using CDS selling as their cheap (HA!) financing source for the past few years. Besides single-name CDS specifically on Lehman, other credit derivatives such as CMCDS, CDS options, or Nth to Defaults, CDX indices and bespoke CDOs with Lehman in it will also settle, partially or in full.
This will be arguably the biggest cash-exchange day in human history to date. I don't care how much tax-payer's money the government will use to bail them out, somebody will fail.
Group B includes two types. One has Lehman bonds. They will be made whole by the settlement although Lehman bonds changed hands at 8.625 cents on the dollar at today's auction. The other doesn't have Lehman bonds. They bought naked CDS on Lehman. They will have a HUGE windfall -- for every dollar notional, they'll get over 91 cents. If they could collect, that is.
Back to the more immediate concern. Who is A?
You could pore over the CreditFixings' auction info and guess. I think a lot of people did just that today. They pounced on MS, GS, CS, and DB, who happen to be the biggest Physical Settlement Sellers (meaning they sold CDS on Lehman). JPM shot up the whole day, which happens to be the biggest buyer.
But I don't know how productive this guessing game is. The dealers could be placing orders and requests for their hedge fund clients. Short of serious insider info, there's no way of knowing how much of those requests are for themselves vs clients. More importantly, physical settlement will almost certainly be just a small portion of the overall settlement size. Today's auction had $5.7B sell orders. Cash settlement will most likely be at least 10, maybe 100 times bigger than that. People learned the lesson from Delphi. Furthermore, it'd be very unusual for banks to have a huge net position on CDS, with the possible exception being their proprietary desks and funds. Again, most likely suspects are AIG and hedge funds.
Now you know what the government bailout of AIG is for, the initial $85B and then the additional $37.8B (suspiciously precise isn't it?). Don't be surprised if the number goes up again before 10/21. Will tax-payers get the money back after 10/21? Fat chance. Is the money really for saving AIG or making sure others who bought CDS on Lehman will get their windfall? Take your pick.
On to hedge funds. They knew how much they would need to pay since Lehman bankruptcy. Reportedly JPM, GS, and MS have issued massive margin calls to their hedge fund clients, which is consistent with their sell requests (except JPM who, being the clearing bank for Lehman, may have bought protection) at the ISDA auction and my suspicion that a big part of their requests are on behalf of their clients. Some hedge funds are forced to cash out. And since Thursday some apparently went shorting in desperation, trying to make a quick buck before the doomsday. The 900 point surge Friday 3PM in half an hour showed how nervous and desperate they are.
In the meantime, of course, hedge fund investors must be withdrawing as fast as they possibly could, adding to their misery. Bankruptcy law will be the golden profession for many years to come.
WaMu CDS settles on Nov 7. Its impact is expected to be much smaller, although nobody can be sure, as for all CDS. We may get some rough idea on its auction date, 10/23. If there're high-profile bankruptcies on 10/21 (banks, AIG), then market would be spooked and all eyes would turn to WaMu; otherwise it'd likely be a non-event in comparison.
If there were bankruptcies of anything other than hedge funds on 10/21 (or 11/7, though less likely), then we could be in a serious chain reaction. But governments all over the world would band together to stop it. Governments may be stupid and inept, but they're not suicidal. Fed window will stay open late on 10/21. For banks (or AIG) who cannot post enough collateral, Paulson will be ready to buy stocks in a heartbeat. If the initial $250B runs out that day, they can let foreign sovereign funds to buy perferred stocks. It's a wonderful world.
Moreover, I suspect the pending doomsday is a big reason why banks have shied away from lending to each other over the past few weeks. Nobody knows how much anybody else owes on that day. Coming 10/22, assuming no banks fail, it'd be a huge cloud gone. Back to business as usual, or as usual as it gets nowadays.
Hedge funds' fire-sale exit may be creating a very rare buying opportunity in many financial markets (stocks, bonds, commodities, maybe even dreaded CDOs and mortgages). Two days ago I wondered if the bottom is near. Now I'm convinced the bottom will be around 10/21, if not earlier. The way back up may be painfully fast or painfully slow. But the crisis is essentially over unless we let the chain reaction take place.
Then we'll only have to deal with the massive debt, recession, and inflation. Piece of cake.
Is the End of the Crisis Near?
The Unwinding of the Moral Hazard Trade
Is the End of the Crisis Near?
It's as if someone wants to make a statement and rub it in, over and over again. Doesn't make sense. But this is too big to be random.
It'd be interesting to see if they can bring Dow down to <9000 today.