Why 2 PM May Be the Next Key to the Financial Markets
Oct 10, 2008
Posted by Jody Eisenman | Filed under crisis
As noted earlier here, the Lehman Credit Default Swaps settle today at 2 PM. There are estimated to be roughly $400 billion coming due at a price below 10 cents. In other words, about 90%, or $360 billion, should be finalized to be paid out at 2 PM. Since the CDS market has been largely unregulated, no one is really sure who exactly owes the money, but it is believed that the large banks like Morgan Stanley, JP Morgan Chase and Goldman Sachs hold significant exposure. The question on everyone’s mind is whether they banks (and probably AIG) will actually pay off. Here’s why:
Unlike standard insurance policies, companies were generally not required to post any significant capital originally (it might even be zero; no one seems to be really sure). Therefore, no one is really quite sure if some of these policies will actually be paid. If, for example, Morgan Stanley has significant exposure (as is rumored), can they really pay off possibly tens of billions? And if they don’t, will the Fed bail them out or will they go under? If they were to go under, you would see a whole new set of CDS come due. Lending is already ground to a standstill. If for whatever reason CDS do not pay, I would shudder to think what would happen. As I write this, the TED spread is now 457 basis points, an all time high.
Of course, these are all hypothetical questions. I’m watching and waiting.
