Wednesday, October 22, 2008

Lehman's Credit Default Swaps Roll Up

The story on settling Lehman Brother's credit default swaps changed from yesterday to today. The contracts pay the holder face value for the underlying securities or the cash equivalent should a company fail to repay its debt. Purchasers of "insurance" on Lehman's debt were owed $365 billion based on the final price of the Wall Street firm's bonds.

Tuesday's story said "the liquidation of forward open commitments involving Lehman Brothers had completed, with no loss allocations imposed on its mortgage-backed securities division member firms."

Today's news release from the Depository Trust & Clearing Corporation (DTCC) offered a different story:

At the time of the bankruptcy of Lehman Brothers Inc., approximately $72 billion in credit default swaps written on Lehman Brothers were registered in the Warehouse.

For Lehman Brothers Holdings Inc. the calculated amounts netted in the Warehouse on a bilateral basis amounted to approximately $21 billion. The $5.2 billion net funds transfer represents the net of these nets.

How did $365 billion in credit bets settle out to a mere $5.2 billion? Swap holders were supposed to make up 91 cents on the dollar of bad bonds. How did they end up paying only a penny and half? Did Uncle Sam jump in and cover a large chunk of the obligation? Or did holders walk away from their jackpot to avoid Andrew Cuomo driven criminal prosecution?