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Old 23rd October 2008, 07:41 PM
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Talking Bets Placed on Lehman Have Been Quietly Settled

October 23, 2008
Tracking Firm Says Bets Placed on Lehman Have Been Quietly Settled

Hundreds of traders who placed bets on Lehman Brothers’ creditworthiness before it went bankrupt have settled their positions “without incident,” according to a company that tracks derivatives contracts.

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 settlement process had been seen as a major test of the market for credit-default swaps, and whether it could handle the unprecedented stress of a big Wall Street firm going bankrupt. The overall system appears to have borne the shock successfully, although individual firms might have taken painful losses they have not yet disclosed.

At the same time, the contrast between this week’s orderly settlement process and last month’s financial turmoil, which also involved credit-default swaps, raised anew policy questions over the market for credit derivatives and its failure to limit systemic risk. Because the swaps are private contracts between two parties, there is still almost no information in the public domain over who holds which positions, or who might be left teetering the next time there is a major default.

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.

A spokesman for A.I.G., Nicholas J. Ashooh, said that the company had needed the big loan from the Fed because of its high level of exposure in other areas, but not on its derivatives trades on Lehman’s debt. He said that A.I.G. had written many derivatives contracts on Lehman’s debt, but because they took opposing trading positions they almost completely canceled each other out during the settlement process.

“Lehman was not the source of our problem,” Mr. Ashooh said. “Our issue really preceded that. We were already having problems when Lehman went under.”

He said most of A.I.G.’s problems with the credit derivatives involved swaps that covered the financial strength of complex debt securities linked to the housing market.

Credit-default swaps are similar to insurance, providing coverage to investors who hold a company’s bonds or other fixed-income instruments. In the event of a default, the one who sold the protection has to pay the one who bought it.

In Lehman Brothers’ case, Depository Trust & Clearing calculated the amount of payments each trader would pay or receive, based on the price of Lehman Brothers’ bonds, which was set in a special auction on Oct. 10.
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