Something I would stress generally, which is hard to get in context given _last_ week, is that a significant element in a panic is just that, panic rather than substantive losses. We have real asset losses in the financial system which will become more severe, and equities will come down because their prices do not reflect the economic context or their earnings. But the dysfunction of the credit markets has a significant factor of, well, _panic_ because transactions are not happening to give a context for accurate assessment. This is why the subterfuges of the public authorities to conceal solvency problems and suspend mark-to-market actions are so harmful: they promote actual panic. When assets need to come down, public authorities need to accept this and stabilize the build down, rather than oppose unwinds and blow the stress sideways. Or that’s my view.

I’m not in a condemnatory mood with regard to public financial authorities, but they need a wider perspective of their responsibilities than they have shown over the last five quarters. May we reach that day without having to prise to great a volume of systemic wreckage from off our persons.

I wouldn’t say the CDS risk has been wildly overblown. This is a huge sum of money, and we’re not yet sure everybody will be able to pay. It does indicate the situation is not as bad as many feared, but people were most upfront with the fact that we really didn’t know.

However, looking at the quote carefully suggests an interpretation of the 6 billion which makes sense: it’s not the total net; it’s the total net *which isn’t already reserved*. So all the net transfers for settling at 13% (the market price before the auction) are going to be real numbers but excluded from the 6 billion). Since Lehman debt dropped about 5% (20 billion) that suggests the “average” Lehman debt goes through 3 transactions rather than the 60-something we’ve been estimating.

3 transactions is not wildly different from the 2 you’d expect from the official policy of market makers like JPB to offset all net trades. So that would be consistent with a reasonable market. The story would be, then:

Roughly 100 billion in net transfers, already reserved and accounted for.

6 billion in new net transfers based on the settlement coming in low.

If these numbers are typical and – very importantly – the payors are generally creditworthy and have indeed reserved for their losses – then the cascading cross-default risk is probably manageable and we are likely to make it out of this with a functioning financial system. It doesn’t rule out an old-fashioned panic, but it does indicate that solvent insitutions can survive a panic rather than being sucked into a giant bankruptcy tangle.

Any guesses on who the weak link is?
I’ll give ya a hint. Re-read the post!

Thank you for the frank and substantive discussion about this complex subject. I pretend to no special knowledge regarding the markets, just a keen curiosity, and a desire to learn, but I must say, that if no one understands these instruments, or can explain how they work, then it’s only logical that they be eliminated immediately from the financial landscape, pronot. Can anyone tell me whether these “financial weapons of mass destruction” are still being written, by whom, and why aren’t these people regulated?

Thanks!

http://www.youtube.com/watch?v=ABXPICWjFIo

Here is a short blurb on Taleb:

http://en.wikipedia.org/wiki/Nassim_Taleb

Matt Dubuque