Lehman CDS Net Settlement Only $6B: What Does It Mean?

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 |  Includes: LEHMQ, XLF
by: Bo Peng

The whole world financial market has been in cryogenesis for weeks due to the known unknown of Lehman (OTC:LEHMQ) CDS settlement on 10/21. But Saturday DTCC came out with a bombshell revelation: The settlement will net to a measly $6B.

Well, according to "calculations so far performed by the DTCC", that is. Anybody care to hint how far this "so far" is? 10%? 50%? 90%?

Secondly, the overall net is meaingless. Let's say A owes B $600B and B owes C $540B. The net is $6B. A still fails, which may trigger another round of CDS settlement. Let's say that one nets to precisely $0. Are we supposed to be suckers again and take comfort on that?

Thirdly, the settlement on 10/21 includes virtually all credit derivatives involving Lehman -- CMCDS, fixed recovery CDS, Nth to Default, CDX, CDO.

There're many other reasons why the DTCC announcement cannot be taken at the face value. But the above are the most important ones and I'll stop here.

The important thing is for the government and the market not to be fooled into a false sense of complacency by this press release. The logjam in worldwide financial markets for the past few weeks is because of the Lehman CDS settlement. Banks know how much they're liable for. But they don't know how much others are, including their hedge fund clients.

Unless government forces disclosure on Lehman settlement exposure, we can only assume the worst -- another bank or two going down and propagating the chain reaction. The opacity has been the single most important reason why the inter-bank market has seized up and hedge funds have been forced to liquidate by the double whammy of prime brokerage margin calls and investor withdrawal.

Government must take the pending storm seriously and force all financial institutes to disclose their net liability or windfall on 10/21. For those with huge liability and whose failures are likely to cause chain reaction, the government must provide immediate backing -- buy preferred stock or force debt-to-equity conversion -- so that it's clear to everyone that the chain reaction will be stopped.

The CDS settlement is a zero-sum game. However big the total payout may be, somebody else will get exactly equally big windfall. So there's no reason for the world to go down on 10/21. However, if left unforced, narrow self-interest, greed, and distrust will make people choose certain demise. We need full disclosure, now.

At a time opacity is causing and fanning panic and distrust, the DTCC press release is not helpful. It merely adds smoke to the scene.

Stock position: None.