Lehman Brothers CDS Auction

[SeekingAlpha]

For those that are not familiar with the Credit Default Swap (CDS) I highly recommend researching this topic because it gets to the heart of the current economic meltdown.

In short there is over $50 trillion gambled on the CDS market and today $400 billion worth of CDS bets related to Lehman Bros are being auctioned. Preliminary numbers are showing that the settlement amount for the Lehman's CDS is about 9.25%. What that means is that the counterparties that are on the hook to pay out for these bets will have to pay out 90.75 cents on the dollar if this settlement amount is finalized later on today. As you can see, there are going to be entities that will be on the hook to pay out a lot of money. Can these parties pay up on what they owe? We don't know. But, I would go as far as to say that since $400 billion is such a huge amount of money, there will be quite a few entities that are going to fail because of this bet. Hence, making our credit crisis much worse than what it is right now.

[ATYT]

yes the scare over the CDS is what is going to further feed the fierce furnace of the "Great Crash of 2008" . . this article expands into these well.

http://www.guardian.co.uk/business/2...fscotlandgroup

[SeekingAlpha]

The CDS and Derivatives markets are the catylists to this economic crash.

If it was just the subprime mess in isolation, that would cost US taxpayers $400-500 billion to clean up. A huge mess, but not big enough to take down the global economy that has a GDP of $60 trillion.

If people add derivatives and the CDS market, both account for $70 trillion in risky bonds and bets made on those bonds and institutions. This mess will cost at leasts $10 trillion to clean up globally. This is enough to crash many economies around the world.

[Merlyn]

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Lehman Brothers (Oct 10) and also coming up Washington Mutual (Oct 23)

Moment of truth for default derivatives

Valuing of swaps will test the system
By Sean Farrell, Financial Editor
Friday, 3 October 2008

The credit derivatives market, worth some $54 trillion (£31trn), began its biggest test yesterday as an unprecedented round of settlement operations on derivatives contracts began,including those covering the debt of Lehman Brothers, Fannie Mae and Freddie Mac.

At stake is how much will be paid out on credit default swaps (CDS) – a type of insurance contract against acompany defaulting on its debt which is sold by investment banks and major insurers such as AIG.

The "auctions" to decide the value of bonds in default and the amounts the derivative insurance will have to pay out on them are organised by theInternational Swaps and Derivatives Association (ISDA), based in New York. ISDA has held only nine auctions since 2005, but this month will see five that will include many of the former giants of the US financial scene. The CDS market is opaque because contracts are only registered between the buyer and seller of the insurance, with no central record of the value or whereabouts of outstanding contracts.

With massive debt defaults taking place, and more predicted as the economy slows, the lack of clarity has raised fears of mounting losses at issuers of CDS paper who may not have the capital to pay out on their guarantees.

The auctions will also be a big test of investment banks' procedures when the authorities are scrutinising certain securities firms for lapses.

"It is significant because it is probably going to be a good opportunity for investment banks to prove to regulators that they have their house in order. Any big investment bank will want to make sure that nothing is dropped on the floor," said an analyst at one investment bank.

A record 409 firms had already registered for the Fannie and Freddie auction yesterday, with 300 having signed up in the previous 24 hours and hundreds more in the pipeline. The value of derivatives contracts covering the two US mortgage finance agencies, which were effectively nationalised last month, is estimated at between $400bn and $600bn.

The size of the Fannie and Freddie auction dwarfs the previous biggest default in credit derivative markets, which was for Delphi, the US car-parts producer that went bankrupt in 2005.

The auction system was put in place seven years ago to centralise agreement of the recovery rate on company bonds in default.

ISDA calculates an average value for the underlying bonds from various submissions by market makers. If the average is 40 per cent, for example, then the issuer of the protection pays the "lost" 60 per cent to the CDS buyer.

Before the system was brought in, the buyer of protection had to physically find some bonds and present them to the insurer in return for the payment. The insurer then had to get back as much as possible from the defaulting company. The system has become increasingly important because, as the CDS market has grown, for many companies the value of outstanding CDS contracts vastly exceeds the value of the actual bonds issued.

A spokesperson for ISDA said: "It is really a straightforward process. The only difference here is the volume, and we don't see any reason why it shouldn't go smoothly despite the anticipated high volumes of trade."

Freddie and Fannie will be settled on 6 October, with Lehman on 10 October and Washington Mutual on 23 October.

First up in the process yesterday was Tembec Industries, a US business of Tembec Inc, the Canadian paper and timber producer.

Link:
http://www.independent.co.uk/news/bu...es-949823.html

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[gwynned]

Originally Posted by Merlyn

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Lehman Brothers (Oct 10) and also coming up Washington Mutual (Oct 23) ==

Geeze, is it me or is it really that hard to wrap your head around all this. But if I can attempt to cut to the chase perhaps too quickly, does it all boil down to the fact that a lot of banks/institutions owe a lot of other banks/institutions a boat load of money and (1) no one knows really how much money; (2) no one knows the price at auction so they can't quantify the debt; and (2) nobody knows for certain who will be holding the bag after one of these auctions.

Here is the auction info:

http://www.creditfixings.com/informa...s/fixings.html

[Zarathustra]

Originally Posted by gwynned

Geeze, is it me or is it really that hard to wrap your head around all this. But if I can attempt to cut to the chase perhaps too quickly, does it all boil down to the fact that a lot of banks/institutions owe a lot of other banks/institutions a boat load of money and (1) no one knows really how much money; (2) no one knows the price at auction so they can't quantify the debt; and (2) nobody knows for certain who will be holding the bag after one of these auctions.

that's pretty much it...

[Love/Light 13]

Z-

Haven't seen you around the forum that much lately. Hope all is well and I have enjoyed all of your economic (among other) contributions to Avalon.

I personally don't know what to think of the current circumstances. My intuition is telling me we are transitioning into an entirely new economic and societal time period, and the changes are chaotic yet positive for the planet as a whole.

It is inevitible the banking system as we know it will be revamped, probably with much stricter ethical guidelines they must follow.

Some say the economy cannot fully "collapse" because it is what is known as a complex adaptive system, and while the reorginization we are seeing today may appear chaotic, the truth is the changes are part of a complex reconfiguration of the world economy. It will be interesting to see the final results.

Any thoughts?

L/L 13

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may WISDOM guide COMPASSION

"out of MANY, we are ONE"

[SeekingAlpha]

Here is an article about the result of the Lehman Brothers CDS auction and the news is not good.

http://www.reuters.com/article/marke...38084520081010

If you do the math, that means entities that lost on their Lehman bets are on the hook for about $365.5 billion. Ouch!

Next week will be Wamu on the CDS auction block. I don't see the total bets being as high as Lehman, but we are still looking at multi billion dollar payouts for Wamu as well.