Lehman derivatives auction described as 'smooth'Value of Lehman bonds set at 8.625 cents on dollar; contracts to settle Oct. 21An auction to work out the value of Lehman Brothers bonds for the huge credit derivatives market went smoothly Friday, according to the International Swaps and Derivatives Association, which helps oversee the market.
The auction set the value of the debt of the bankrupt brokerage firm at
8.625 cents on the dollar, said Markit and Creditex, the administrators of the auction.
Earlier action in the auction suggested Lehman bonds might be worth almost 10 cents on the dollar. The final result means sellers of protection in the credit-default-swap market may have to pay out more than expected to settle the contracts.
Credit-default swaps are a common type of derivative contract that pay out in the event of default. The market has grown quickly, with the notional amount of contracts outstanding surging past $50 trillion in recent years.
The collapse of Lehman, the largest bankruptcy in U.S. history, along with the failures of Fannie Mae, Freddie Mac and Washington Mutual, have sparked concern that the CDS market could crack under the weight of so many contracts settling in such a short time.
There are often more CDS contracts than actual bonds to which they're linked. That means when a big default happens, an auction is held to work out the value at which traders can settle the contracts in cash.
Similar auctions earlier this week to set the price of Fannie and Freddie debt were "messy," undermining confidence in the process, according to CreditSights, an independent fixed-income research firm.
However, the Lehman auction Friday went "smoothly" and "efficiently," according to Robert Pickel, chief executive of the ISDA, which represents major dealers in the CDS market.
Traders and other CDS market participants marked the fair value of their exposures and posted more collateral as Lehman's troubles increased, Pickel explained. This discipline means that sellers of protection should not have trouble paying to settle the contracts related to Lehman, he added.
The result of the Lehman auction means sellers of CDS protection on the firm will need to pay 91.375 cents on the dollar to their counterparties.
Roughly $400 billion will be paid out on Lehman CDS, but, once all positive and negative positions are "netted" out, about 2% of that money will actually change hands, Pickel estimated. Payments are due on Oct. 21 to settle Lehman CDS in cash, he said.