Lehman's massive debt swaps settle smoothly
Tuesday, 21 October 2008
NEW YORK (MarketWatch) -- A settlement in billions of dollars in Lehman Brothers credit-default swaps finalized without any big hitches, an industry clearing organization said Tuesday, adding a note of support to the recent recovery in credit markets.
"The liquidation process for forward open commitments involving Lehman has been completed," said the Fixed Income Clearing Corporation, a unit of the Depository Trust & Clearing Corp., in a notice on its Web site.
It said it was "pleased to announce that no loss allocations will be imposed on [mortgage-backed securities division] member firms as a result of the liquidations of these forward trades."
The exchange between the buyers and sellers of credit-default swaps, a type of derivative contract that pays out when a company reneges on its debt, had spooked markets Tuesday. Some investors worriedsellers would be unable to come up with the cash to pay their counterparties, and these no-shows would usher in a new round of bank or fund failures.
This type of domino effect turned what started as a U.S. housing market collapse into a global credit crisis.
"Settlement of Lehman's CDS is what has the market on the nervous side," said Peter Cardillo, chief market economist at Avalon Partners, said earlier Tuesday.
Global interest rates spiked and lending contracted after Lehman Brothers (LEHMQ:0.05, -0.01, -11.1%) declared bankruptcy in mid-September, a failure that risked taking some of the firm's numerous trading partners down with it.
Its bankruptcy also triggered a relatively rare event in the $50 trillion market for credit-default swaps: the requirement that holders of protection on Lehman debt get paid by the sellers of these swaps.
An Oct. 10 auction determined terms of the payout. Buyers of protection against a Lehman default were slated to receive 91.375 cents for every dollar of Lehman debt they held. See full story.
The overall size of the payout was expected to be as much as $400 billion. But if the counterparties' offsetting trades are taken into account, the Depository Trust and Clearing Corp. had forecast that sellers of the protection may only have to cough up about $6 billion.
"It looks as though there was no major fallout from the settlement to member firms," said analysts at Action Economics. But they cautioned: "We'll have to wait to see if there was a broader market impact, however."
The credit-default swap settlement came as stressed credit markets showed some early signs of recovery.
The cost of short-term borrowing continued its recent fall Tuesday.
The London interbank offered rate, or Libor, for three-month dollar loans fell to 3.83375% from 4.05875% the previous day. The decline follows a sharp drop of about 35 basis points, or 0.35 of a percentage point, on Monday. See Libor story.
Still, there are more companies at risk of default and more debt outstanding than in several years, and credit-default swaps may cause continued headaches for credit markets, said John Atkins, a fixed-income analyst at IDEAGlobal.
Going forward "workouts can be much more convoluted," he said. "This doesn't mean things can't go wrong."
Deborah Levine is a MarketWatch reporter, based in New York.
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I posted this on the other thread discussing this issue, but I think that it is an interesting theory to ponder:
I think what we might be witnessing is the "let's just tear all these mfers up" phenomenon. Think about it - if you...
- WetheFreeple