Friday, October 10, 2008

Indicated Size of Payments Due on Lehman CDS: $270 Billion

That is much larger than the markets thought just two days ago. It will lead to some hedge fund bankruptcies and strain the banks and insurance companies, further shrinking the pool of loanable funds and tightening the credit markets like a corset on a fat banker.
From Bloomberg:

Lehman Initial Swap Auction Indicates Larger Payout
...Based on the results, sellers of protection may need to make cash payments of about $270 billion, BNP Paribas SA strategist Andrea Cicione in London said. The potential payout is higher than investors anticipated, based on trading in Lehman debt, and caused the bonds to fall. The bonds fell to about 9.5 cents on the dollar today. They traded at an average 13 cents yesterday, indicating a payout of 87 cents was expected.

``The bottom line is that the final recovery will be below current market prices,'' said Tim Brunne credit analyst UniCredit SpA in Munich. ``Possibly far below.''

No one knows exactly how much is at stake because there's no central exchange or system for reporting trades. It's that lack of transparency that has increased the reluctance of financial institutions to do business with each other, exacerbating the global credit crisis and prompting calls for regulation of the market. More than 350 banks and investors signed up to settle credit-default swaps tied to Lehman.

Selling Assets

The list of participants includes Newport Beach, California-based Pacific Investment Management Co., manager of the world's largest bond fund, Chicago-based hedge fund manager Citadel Investment Group LLC and American International Group Inc., the New York-based insurer taken over by the government, according to the International Swaps and Derivatives Association in New York.

Hedge funds, insurance companies and banks typically buy and sell credit protection, which is used either to insure a bond against default or as a bet against the company's ability to pay its debt. The required payments may force some funds to dump assets, BNP Paribas's Cicione said.

``Banks can go to the Federal Reserve, or use the commercial paper market where it is still functioning'' to meet protection payments, said Cicione, who said a 5 cent recovery rate may lead to payments of about $285 billion. ``But fund managers or hedge funds, once they've used their cash, have only one option: to sell assets.''>>>MORE