Fallout: The Financial Crisis

Lehman settles credit default mess

Marketplace Staff Oct 21, 2008
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Fallout: The Financial Crisis

Lehman settles credit default mess

Marketplace Staff Oct 21, 2008
HTML EMBED:
COPY

TEXT OF STORY

Kai Ryssdal: Today was a day of reckoning in the credit default swaps market. Those are the contracts that companies make with each other to protect against losses in the bond markets. Specifically, today, we’re talking about the market in Lehman Brothers swaps.

When Lehman went under a month ago, there were fears that it would take as much as $400 billion in swaps with it and leave everybody else holding the bag. But, as our New York Bureau Chief Amy Scott reports, nobody knows yet exactly how big that bag’s going to be.


Amy Scott: After Lehman Brothers filed for bankruptcy just over a month ago, some analysts predicted a tsunami of losses from credit default swaps. Here’s one analyst on CNBC a few weeks ago.

Tape from CNBC show: We really think that there could be multiple trillion dollars of notional exposure out there to these Lehman credit default swaps.

Remember, those swaps are kind of like insurance on Lehman Brothers bonds. When Lehman filed for bankruptcy, the sellers of that insurance had to pay up. Today is the deadline.

Initial estimates put the price tag at close to $400 billion. But Bob Pickel says only about $6 billion will actually change hands. Pickel is head of the International Swaps and Derivatives Association. He says many of the dealers who sold insurance on Lehman bonds also bought insurance, essentially canceling out their exposure.

Bob Pickel: So, in fact all this talk about these amounts of money that need to move on Tuesday, October 21, we think are very overstated.

Still, some institutions stand to lose a lot of money. Puneet Sharma is a credit strategist at Barclays Capital in London. His bank bought most of Lehman Brothers after the bankruptcy. Sharma says hedge funds have been badly bruised by the market downturn. He says, if some now have to pay insurance on Lehman’s bonds, they may have trouble coming up with the cash.

Puneet Sharma: In the background of everything else which has happened over the last month, we’ve seen unprecedented moves in the market across asset classes. And I think this could just be the straw which breaks the camel’s back.

It may be a while before we know the extent of the damage. The swaps market is largely unregulated, so it’s hard to know bought insurance and who sold it.

Michael Greenberger is a former regulator with the Commodity Futures Trading Commission. He teaches law at the University of Maryland. Greenberger says that lack of certainty about who owes what to whom is what this credit crisis is all about. He says if the Lehman payout ends up in the hundreds of billions of dollars it could further paralyze the markets.

Michael Greenberger: Contrarily, if the amount owed is on the more optimistic side, that could unfreeze the credit markets because it will demonstrate that even in a cataclysmic failure like Lehman Brothers, that the system was set up in a way to protect itself.

The system will get another test this week. On Thursday, an auction will determine the value of bankrupt Washington Mutual’s bonds and how much insurers will have to pay.

In New York, I’m Amy Scott for Marketplace.

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