Manic Melon

Was today’s market turmoil the pretense to the fact that friday 10/10 the Lehman Brothers Credit Default Swaps settle out?

The Fannie and Freddie CDS settlements were between 91 and 95 cents on the dollar, but Lehman’s settlements are likely to result in HUNDREDS OF BILLIONS in losses.

More: http://bigpicture.typepad.com/comments/2008/10/lehman-cds-unwi.html

Update from the WSJ:

NEW YORK — The final result in the settlement of the credit default swaps on Lehman Brothers was even lower than a disappointing early estimate, which leaves dealer banks facing higher than expected payouts on multi-billion dollar insurance contracts.

The recovery rate on the bankrupt firm’s senior debt was fixed at 8.625 cents on the dollar, just below the 9.75 cents published in the first estimate Friday. That means the sellers of insurance on these defaulted bonds are on the hook for the remaining 91.375 cents. That’s well above the approximate 88 cents envisaged earlier this week, when increased demand for paper to present in return for compensation inflated the market price.

The low final rate qualifies this as one of the most expensive defaults ever in the credit derivatives market. Following the default of Italian food company Parmalat back in 2003, its debt was valued at just below 10 cents on the dollar.

The result nevertheless shouldn’t come as a painful surprise for the sellers of protection on Lehman.

Since Lehman’s Sept. 15 bankruptcy filing, there has been considerable anxiety that dealers who had underwritten some $400 billion of credit default swaps on the bank would be caught short in a massive payout.

But sharp market moves in the value of these insurance-like contracts would have obliged most sellers of these insurance-like contracts to post additional collateral to cover their potential losses. As a result, they should have sufficient funds set aside to handle their liabilities in this settlement.

“Worries over ex-broker-dealer exposures and their knock-on impact are misguided,” said Tim Backshall, senior credit analyst with Credit Derivatives Research.

What’s more, the result is to the benefit of those banks that were buyers of the CDS.

“Keep in mind that the extra few billion to be paid will wind up in the hands of lucky buyers, making it a zero-sum game in reality,” said Tony Crescenzi, strategist at Miller, Tabak & Co.