naked capitalism

Miguel_Swanstein says:

Less than 10 cents recovery? So Lehman was less a bond house than a Potemkin village. I’d try to whip up some fresh outrage but I have the feeling that I’ll need to keep some in reserve for the coming months.

doc holiday says:

Because the over-the-counter credit derivatives market is murky, as The Deal's Vipal Monga states, it makes it difficult to know who has what exposure to Lehman CDSs. The most likely holders of the debt will include big banks such as Morgan Stanley, Goldman, Sachs & Co. and J.P. Morgan Chase & Co. The banks have been apparently hoarding cash in preparation for payouts.

FYI: Lawyers in most sophisticated jurisdictions have had difficulty signing off on any of these (derivative) structures because a transfer of value from the borrower to a creditor is occurring after the date of bankruptcy.

For these structures to work properly, it seems necessary, at a minimum, that all transfers of value from the borrower to the creditor should occur unambiguously on the same date as the original funding.

doc holiday says:

Basel Committee on Banking Supervision

http://www.fma.gv.at/cms/basel2//attachments/2/4/3/CH0329/CMS1143724698746/joint13.pdf

One of the most challenging issues associated with the development of the ISDA documentation has been the question of whether the contracts should cover restructuring events as well as bankruptcy or other more clear-cut default events.

Another issue in relation to the documentation of transactions is whether the trade documents are matched and confirmed in a timely fashion.

In regard to legal risk more generally, market participants are cognizant that legal issueshave previously arisen in the broader financial derivatives market in several areas. These include the risk that counterparties did not have the appropriate legal authority to enter into the transactions and the risk that a counterparty or customer may seek to avoid payment based, for instance, on the market participant’s failure to make adequate disclosures, or to assess the appropriateness of the transaction and its risks for the counterparty or customer.

Recommendation 7: Legal Documentation Risk All market participants need to pay careful attention to the legal documentation relating to CRT instruments, such as the range of credit events covered by the instruments and to the clear and unambiguous identification of underlying reference entities. In particular, credit hedging firms should specifically assess whether the reference entity in the underlying contract is the one to which they have credit exposure. A clear understanding of documentation is of particular importance for complex, structured CRT products.

>> Send me a check!

bena gyerek says:

imo this will be a damp squib. i reckon aig will turn out to be one of the biggest net writers of these contracts. if bonds were trading at 13c, then protection sellers will already have handed over 87c in cash collateral. i suspect it was lehman cds margin calls that contributed to aig’s capitulation (and reason why fed just had to lend aig a load more cash). mind you, the gap from 13c to 9.75c is not small, so could be some pain there..

doc holiday says:

This seems like an example related to this general mess:

SECURITY CAPITAL ASSURANCE LTD
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENT

On March 17, 2006, XL Capital Ltd (“XL Capital”) formed Security Capital Assurance Ltd (“SCA”), as a wholly owned Bermuda based subsidiary holding company.

Establishment of case basis reserves for unpaid losses and loss adjustment expenses on the Company’s in-force insurance and reinsurance business and assessing the amount of anticipated claims and recoveries on the Company’s in-force credit derivatives requires the use and exercise of significant judgment by management, including estimates regarding the likelihood of occurrence and amount of a loss on an guaranteed obligation.

As a result of the Company’s adoption of this revised presentation, changes in fair value of the Company’s credit derivatives are recorded in the line item of the accompanying consolidated statement of operations entitled “Net change in fair value of credit derivatives” which is required to be classified in the revenue section of the statement of operations. This line item consists of two components, which are also separately presented in the statement of operations: (1) “Realized gains (losses) and other settlements” and (2) “Unrealized gains and losses”. The “Realized gains (losses) and other settlements” component includes (i) net premiums received and receivable on issued credit derivatives, (ii) net premiums paid and payable on purchased credit derivatives, (iii) losses paid and payable to credit derivative counterparties due to the occurrence of a credit event and, (iv) losses recovered and recoverable on purchased credit derivatives due to the occurrence of a credit event. The “Unrealized gains and losses” component includes anticipated claims payable and anticipated recoveries, as well as all other changes in fair value.

At March 31, 2008 and December 31, 2007, the notional amount outstanding of the Company’s in-force CDS contracts was $63.3 billion ($58.3 billion net of back-to-back protection purchased by the Company) and $65.3 billion ($59.6 billion net of back-to-back protection purchased by the Company), respectively. The remaining weighted average life of such CDS contracts at March 31, 2008 was 10.9 years. In addition, based on such notional amount as of March 31, 2008 and December 31, 2007, approximately 69% and 93%, respectively, of referenced assets underlying such in-force CDS contracts were rated (based on Standard & Poor’s ratings) “AAA”, 20% and 7%, respectively, were rated at or above investment-grade, and 11% and less than 1%, respectively, were rated below investment-grade at such dates, respectively.

fresno dan says:

First, I’ll grant I’m none too bright. Now that is out of the way, why do I hear the CEO of Lehman complaining why he wasn’t saved. Should he have been backstopped until recovery was only 1 cent on the dollar (O, right, the economy was magically suppose to return to 4.5% growth per annum and Lehman could have leveraged to 130)

Joe In Morgantown says:

Can someone explain something to me?

If the total value of the CDSs is greating than the amount of the bonds, why don’t the holders of the CDSs get together and pay off the bonds?

m says:

Anonymous asked:

“Can I get someone to clarify the mechanics of this? My quick read is that CDS buyers paid funds to CDS sellers in order to guarantee Lehman Bonds against default. At auction those Lehman Bonds are only generating purchase prices of $0.0975-on-the-dollar, so the CDS sellers who up to this time were paid to provide the CDS coverage must pay $0.925-on-the-dollar for every dollar of coverage provided. Accurate? Inaccurate?”

Inaccurate.

As I read the news story, this auction is to determine the value of the Lehman bonds. If the bonds were worth $0, then the CDS sellers (insurers) would have to pay 100% of the face value of the bonds. The bonds are said to be worth $.098 on the dollar, so the CDS sellers have to pay 91+% of the face value, which is more than previously revealed in the Lehman accounting. Whether the CDS sellers have the funds to pay off is the big question.

Yves Smith says:

Joe in Morgantown,

In the first big bankruptcy involving CDS, Delphi, the amount of CDS, as with Lehman, considerably exceeded the amount of bonds. The CDS documentation required that you deliver the bond. However, a massive scramble for bonds would have led to prices that in no way represented their settlement value in bankruptcy, and more important to all the participants, would have thrown the entire CDS market into chaos, since for pretty much every “reference entity”, there have been far more CDS written than the face amount of related bonds. They they devised the auction/settlement process and do NOT require delivery of bonds.

In hindsight, it might have been better to blow up the market back then, but no one was willing to do that.

bena gyerek says:

results:

http://www.creditfixings.com/information/affiliations/fixings/auctions/current/lehbro-res.shtml

still trying to determine the implications.

note that the final price is actually 8.625% (reflecting the overhang of offers in the net open interest).

ciccocicco says:

If I remember well from my times at the bank, often the same bank was at the same time writer of CDS and buyer of CDS as part of a trading strategy.

This would mean that, assuming no counterpart bk, the net payment will be much less then total outstanding.

Also, looking at the net payments, somebody will be giving out money, others will be receiving a lot o money, who ?

dlr says:

So when will the money actually start changing hands? When will we know, if ever, if someone or many someones are going to default? Do they have a time limit before they settle up, like a month or a day or? Do the holders of the contracts have to take them to court if they drag their feet, or make excuses?

Seems like the payoff/failure to payoff could drag out for months. How long did it take for things to get settled in that Delphi case?

Kady says:

@yves Thanks for your explanation about Delphi’s bankruptcy and its role. That was the final piece in the puzzle for me. I knew I had read something about a scramble for bonds under one of these contracts but it was so long ago, my addled brain simply couldn’t recall.