Lehman CDS Auction Tomorrow - Big Day

Major litmus test for the market tomorrow. Will be one of our first real looks into the black box that is the CDS market. What are you guys expecting? Any predictions as far as $ value? Any ideas as to which companies (presumably insurance companies) will prove to be the largest CDS sellers? How do you think the stock/credit markets react? I personally have no idea what to expect, but I have a bad feeling about it. For whatever reason, despite the fact that people are starting to appreciate the size of the CDS market, I still feel that these upcoming auctions have gone shockingly under the radar. I think the general public may be in for a rude awakening tomorrow. What is also interesting is that given the opacity of the CDS market, it is very possible that tomorrow’s auction (and consequently, future auctions like WaMu’s on the 23rd) is not being priced in to the market nearly enough. If the results are as bad as I suspect they might be, it could be a historically bad day for the Dow. In the case of a bad auction (bad = huge dollar values), I wouldn’t be shocked to see the Dow tank 800-1,000, and that wouldn’t even suggest capitulation to me, it would just represent the market adjusting to incorporate the grim reality that is the CDS market.

Why don’t they just call CDS a “default insurance”? I think this name makes more sense.

Couldn’t edit my original post, but for those interested, Big Picture just posted a blog on the subject, pretty informative: http://bigpicture.typepad.com/comments/2008/10/lehman-cds-unwi.html#more

ymc Wrote: ------------------------------------------------------- > Why don’t they just call CDS a “default > insurance”? I think this name makes more sense. If they use the term “insurance” they have to post collateral. So its a “swap.”

Wouldn’t they fall under regulation if they used the word “insurance” as well?

ymc Wrote: ------------------------------------------------------- > Why don’t they just call CDS a “default > insurance”? I think this name makes more sense. According to 60 Minutes if they use the term “insurance” firms that trade these products would have additional requirements.

there is no “insurance” business like quality to the CDS. there is no actuary actually crunching thru years of data to calculate the reserves that need to be set aside for meeting the eventuality of a default. the risk management is practically full of crapola

Aspiring - what are you concerned about actually? Are you concerned that someone won’t be able to pay, like maybe JPM?

I’m a bit confused how this auction is going to work tomorrow. Are the firms which hold LEH CDS going to settle all of their outstanding positions? If so how does an auction come into play? Shouldn’t the buyers of this protection simply collect the gains as LEH is now bk?

Here’s a good primer on CDS auction: http://markit.com/information/affiliations/fixings/auctions/current/credit_event_auction_primer.pdf Yep - everyone will at least know what they owe tomorrow.

In a nutshell, yeah. My understanding of this market–and correct me if I’m wrong–is that the CDS sellers have put aside hardly any money in preparation for these payouts. I feel like virtually anything could happen tomorrow and I wouldn’t be surprised (e.g. a big CDS seller defaulting, the gov. stepping in to bail out a seller who clearly can’t make good on their payments, etc.). I am expecting to see some huge dollar amounts tossed around that these CDS sellers simply are not ready for. Edit: Joey, couldn’t really gauge the tone of your post–are you suggesting that there really is nothing to be concerned about? Or are you suggesting perhaps that the inability of someone to pay is not in fact the biggest concern with regards to the CDS market? If so, then what is?

Actually, the tone of my post was really “I dunno, either”. This is new ground, I think. I’ve heard all kinds of conflicting opinions from “tons of cash locked up waiting for worst case” to “little cash and people are going to throw in the towel if its bad”. I think the dollar amounts of a few hundred billion, which is absolutely something to be concerned about.

And WaMu on the 23rd! I’m buying bottled water, tinned food and viagra and heading to the hills with my wife and a shotgun.