Thursday, October 16, 2008

Complexity in the ruins of Lehman

Lehman was too connected to be allowed to fail. Now a bankruptcy court is trying to sort through 1.5 million derivatives trades with 8000 counterparties...

WSJ: Lehman Brothers Holdings Inc.'s legal and financial advisers said Thursday they plan to hire about 200 professionals to help settle the more than 1 million derivatives trades the investment bank entered into before it collapsed last month.

Lehman attorney Harvey Miller said at a court hearing that advisers are working around the clock to understand Lehman's transactions in the wake of the "chaos" that resulted from its Sept. 15 bankruptcy filing, the largest ever in U.S. history.

Much of their work will focus on wading through about 1.5 million derivatives trades involving 8,000 counterparties. Lehman's chief restructuring officer Bryan Marsal of turnaround firm Alvarez & Marsal said about 210 financial professionals will be hired to unwind those trades.

Mr. Miller credited Mr. Marsal for his work so far, saying he has "brought order to this chaos." Alvarez & Marsal has 144 employees working on the Lehman matter along with 165 Lehman employees still working at the bank.

...Mr. Miller told Judge Peck he expects it will take 45 to 60 days before Lehman can answer numerous inquiries from creditors.


Anonymous said...

I'm wondering how much market spread-out cratering will the final tally of the Lehman insured debt exert, when counterparties discover that their CDS claims on default debt are worthless, especially when many of these CDS buyers may be smaller banks.

I understand that buyers are crossing their fingers, not really sure if Lehman still holds their counterpart CDS obligation or passed it along.

Anonymous said...

This is somewhat off-topic, but in the still roiling wake of this whole debacle it might be useful to consider the relevance of Robert D. Austin's Measuring and Managing Performance in Organizations (referenced in a new article by Joel Spolsky). It would seem that the U.S. and world economy has fallen victim to some wildly dysfunctional incentive systems, which is what this book is about. Of course, it is hardly original to point out that the problem begins at the top echelons of American business.

Also see this post from Brad DeLong (and the comments).

Anonymous said...

Care to comment?

Steve Hsu said...

I think bad incentive structures where a huge component in the crisis. Corporate governance in general is a huge problem -- CEOs who are chummy with the board do not really answer to shareholders.

One of the reasons bubbles are so dangerous is that almost no one can afford to bet against them -- time it badly and you will get killed. Even the strongest can only sit them out (e.g., Buffet) and wait until the pop. That includes the risk managers at banks.

Dave: I read the post you linked to and agree with it, but the writer doesn't even mention additional derivatives-related effects from Lehman's collapse. The UK-specific aspect of it I can't really comment on.

Anonymous said...

Lehman CDS auction update:
Lehman CDS auction fears allayed
(The Independent, U.K.)

The Depository Trust and Clearing Corporation, which runs a voluntary scheme where market participants can register their CDS positions and cancel out offsetting trades without having to exchange cash.

“The payment calculations so far performed by the DTCC trade information warehouse relating to the Lehman Brothers bankruptcy indicate that the net funds transfers from net sellers of protection to net buyers of protection are expected to be in the $6bn range,” the DTCC said.

An earlier estimate by the International Swaps and Derivatives Association suggested the net losses by sellers of credit default swaps might be just $8bn.

It will be unclear until the trades are finally settled on 20 and 21 October if any individual players have suffered losses that they cannot cover, but analysts said that many will already have been required by their trading partners to post higher collateral as it became clear Lehman was going bankrupt.

Today is 22 October; anybody have a post-mortem?

Anonymous said...

From the New York Times:
Tracking Firm Says Bets Placed on Lehman Have Been Quietly Settled

The company, Depository Trust & Clearing Corporation, processes large numbers of investment transactions. It said that only $5.2 billion had to change hands for all the traders to close out their positions, a much smaller amount than had been predicted a week ago.


The lack of information is thought to have fueled the general panic in mid-September, when Lehman Brothers went bankrupt and the American International Group came to the brink of collapse before being rescued by the Federal Reserve.

As if to underscore the opacity of the market, American International said this week that it had to pay only $6.2 million to settle all of its credit-default swaps on Lehman’s debt. The amount was much smaller than had been expected, given A.I.G.’s big presence in the market for credit-default swaps, and given that A.I.G. required an emergency line of credit worth $85 billion from the Fed.

Steve Hsu said...

1) The CDS bets that were settled 10/21 are only on contracts that *reference* Lehman as a bond issuer.

2) Stress on AIG could have been great even if the netted amount was only $6 billion. We don't know what their specific exposure was leading up to the auction and netted settlements.

3) The contracts referenced in the post above are those in which Lehman was a direct counterparty. Those contracts are mired in bankruptcy court and include *all* derivatives transaction that Lehman entered into before its collapse.

Anonymous said...

More in the "hey, it ain't that bad, folks" CDS vein:

Why the CDS Market Didn't Fail
Felix Salmon,
(via "CDS Silliness" on NPR's Planet Money blog)

As you suggest, this may just be breathing easy while in the eye of a hurricane.

Also, a debate between Salmon and John Carney over the question, "Should Lehman Have Been Rescued?". Carney is essentially channeling Anna Schwartz.

Blog Archive