The Lehman news is widening CDS spreads in the Credit Default Swap Market. I looked at the Liquid 50 Investment Grade Credit Default Swap Index Future chart at cbot.com which is priced in spread. The underlying CDS are driving the problems of this financial disaster because all of these big banks originated swaps to protect from defaults on debt securities. When a big bank like Lehman or Bear become insolvent and have CDS (counterparty) obligations on their balance sheet, they might not be able to pay par value when there's a default. What if Lehman re-insured a credit default swap with Bear Stearns? Well, the tax payers have it now.
It's crazy because these banks were investing in sub-prime real estate securities and at the same time protecting other firms making the same investments. Also book value means nothing whatsoever on Lehman's balance sheet due to their illiquid toxic debt investments. As Lehman stands today at $0.22 on the market, they're most recent quarter book value per share is $34.88. Nothing was marked-to-market until the actual bankruptcy aka a big fat 0. Here is the chart of the Credit Default Swap Index from the CBOT. It's an investment grade index, not high yield. As you can see in the chart, we're still not at the March 2008 high of 420bps when Bear Stearns was sold but it did break above the June 2008 highs. The index should be watched closely because if things get worse it could retest the Bear Stearns high. However if spreads start to narrow and spreads fail to make new highs, the credit crisis could be at it's peak. Let's just hope enough people don't listen to Professor Roubini at NYU and create a run on the retail banks. Then it would truly be a great depression and not just a structured finance depression. I think after all of this we need to bring back the gold standard. We'll see how the other big I-banks and Insurance companies come out of this...
Here's a chart of the of ABX 2006-2 AAA asset backed securities index via CDS from markit.com, which quickly turned sour as you can see. It's priced like a bond. When these indexes were first originated they were priced at par or 100. Since the securities in the index were downgraded after 2006 origination, prices plummeted and cost of protection spiked. Hedge fund manager John Paulson made billions of dollars in 2007 shorting this index. The index bounced off of the 68 resistance to the downside and could be headed toward the 61 support level.
The next chart from markit.com is the 2006 CMBX AAA tranche, or AAA rated commercial mortgage backed securities index originated in 2006 priced in spread via CDS. You can see that spreads widened recently and broke out of a downtrend. It could retest old highs.
Chart sources: markit.com, cbot.com
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