TimButler

Lehman's CDS Mess: Who's on the Hook?

In my post above, I noted one error. In paragraph 6, first line, strike "banks" and insert "governments" instead. So, as corrected, that paragraph, should read as:

"While European, Asian and American governments have stepped up to be commited to their respective large banks, if the CDS exposure is concentrated, the scale of the CDS settlement payout's impact on a bank's capital base could be mind numbing."

Tim Butler

Lehman's CDS Mess: Who's on the Hook?

I think Mr. Bo Peng's article is one of the very best, and most insightful articles I have ever read on Seeking Alpha. It goes to the heart of where we are in the global financial crisis.

The Lehman CDS settlement on Oct 21st will be one of the biggest coming out events ever witnessed because of the scale of the numbers. Mr. Peng cites $100-$400 billion, while I think I saw the New York Times estimate the range at as much as $400-$600 billiion in an article at the end of last week.

Think of these numbers -- $100-$600 billion on a single company's default (i.e., Lehman) relative to the US industry wide $750 billion rescue plan, or the Treasury backing of AIG to the tune of $85 billion.

Yes, this single company CDS settlement on Oct 21st of $100-$600 billion is part of the $56-$58 trillion estimate of the global CDS market currently outstanding. Happily, Lehman is the only super scale level bankruptcy thus far.

AIG and hedge funds seem to be the prime suspects for having to face the Oct 21 Lehman CDS settlement pay-out. Who else will take a big hit, we do not know. To further illustrate why Oct 21st becomes so important, just suppose the Lehman CDS exposure is concentrated in a single additional firm such as Bear Stearns, now inside JPM, or an RBS or DB?

While European, Asian and American banks have stepped up to be commited to their respective large banks, if the CDS exposure is concentrated, the scale of the CDS settlement payout's impact on a bank's capital base could be mind numbing.

No wonder interbank lending has virtually ground to a halt. No wonder LIBOR, as the best barometer, is nearly 5%. No wonder, as Mr. Peng explains so well, the banks were calling hedge fund debt last week, which in turn was a significant contributor to the scale of last week's equity market rout.

In a nutshell, US housing price declines over the last two years, are the source of subprime mortgage problems, and in turn, mortgage back securities problems, which with asset liability gap mis-management and an inherent degree of high leverage, led to large bank losses and capital problems.

But the big kahouna looming in 2008 has been the CDS settlement risk faced by CDS issuers in the event of a large scale bankruptcy (i.e., Lehman), and that day of reckoning comes on Oct 21, as pointed out and explained so well by Mr. Peng.

As a credibility check on Mr. Peng's article, I checked the "Oct 21" web link at the outset of his article, which leads to the ISDA web site. To see the Oct 21 date, one has to click on "Lehman Brothers" at the top of the ISDA page, then click on the link next to "Protocol", and then click on "Plain English Summary".

We're not out of the woods yet (as of today, Oct 13). Hopefully, the concentration of Lehman CDS issuer risk will not be too great. We will find out in little more than a week.

Comparing This Past Week to the '87 Crash

Bespoke Investment Group's charts are virtually always insightful and fact based -- this one is another good example.

It would be nice to see the Dow Stocks in a table with current P/E, P/Bk, P/Sales, and P/Cash Flow, along with a last line entry showing the Dow's long run average for these benchmarks.

As for Chris E's comment above -- beware -- and be wary:
1. I do not believe that the $400b in CDS's (Credit Default Swap) have been paid, which are the contract obligations due on the Lehman debt default auction which was completed at the end of last week.
2. Chris E's website is non-operational.

Tim Butler

AIG and the Lunacy of GAAP Reporting

This is a superbly written, insightful commentary about AIG.

FASB mark-to-market accounting rules do their level best to give an accurate picture of a balance sheet at a point in time, namely today. However, the equity value of a company is a function of all of it's future cash flows, discounted to today's present value. The distinction between the two numbers can be, and usually is, large.

Notwithstanding Robert Merton's argument suggesting that capital market stock prices accurately reflect all the information available about the value of a stock today, I concur with the author of this Seeking Alpha article, in suggesting that Wall Street today is paying too much attention to today's mark-to-market book equity, along with the risk of 1 to 2 year sustained EPS losses, rather than focusing on longer run cash flow generation from AIG.

Of course it's a matter of opinion, I just happen to think that Hank Greenberg, Warren Buffet and Robert Willumstad might well agree.

Disclosure -- As of Friday, August 25th, I'm long AIG too. I'm trying to make up for buying AIG Jan 60 '08 Calls at $10 in September '07!

Timing is everything, and differing views is what makes a market. I've placed my bet, and I like to think of it as an investment, though I'll be the first to admit that it certainly does have a speculative component.

WaMu: Intensification of Stealth Buying

Superb, insightful article. Interesting contrast with today's other WM piece on the resumption of short selling in the wings.

I do hope WM has fully come clean, and surprises to the upside in October. Nous veron, as the French say.

With the strong retail franchise and deposit base, and book value at ~$15.35 per share, there is a lot of upside if WM is really clean, relatively speaking of course.

Thanks for sharing your hard work and insight in this forum.

Sadly, Seeking Alpha has become 90% junk or regurgitated crap, whereas your piece is rich, substantive, insightful, and clearly opinionated, which I think is always a good thing.

On-Demand Software Update: SuccessFactors Files For IPO, Acquisition Target for Salesforce.com?

Why is Seeking Alpha doing straight PR pieces directly from the company issuer?