Tomorrow is the deadline for settlement of insurance on Lehman debt. There are insurance contracts worth about $400 billion outstanding. With Lehman debt worth less than a dime on the dollar, the potentional liability for those who sold insurance is around $360 billion. Much of this exposure is hedged, the experts say. But the truth is that no one really knows.
The Times of London explains the conflicting opinions.
Fears are mounting that billions of dollars of insurance will go unpaid and that dozens of financial groups will go under because of Lehman’s demise.
Groups such as the Deposit Trust and Clearing Corporation (DTCC) argue that many insurers have hedged their exposure effectively and estimate that the “net settlement”, after hedging, will amount to only about $6 billion.
Robert Pickel, chief executive of the International Swaps and Derivatives Association, said: “People have been monitoring these positions on a daily basis and have been hedging against their exposure. I don’t think at this point there’s any unexpected loss or unexpected payment.”
However, Hugh Johnson, head of Johnson Illington, an American fund manager, said: “I hope the $6 billion estimate is correct — that would be a real gift — but I don’t believe anybody really has a good handle on the size of the net settlement. I have heard a range of $2 billion to $300 billion and have no idea what it is.” Mr Johnson said that “significant net settlement figures” could require further government intervention and may force down financial shares as investors fret about exposure to CDS contracts.
Part of the problem, experts say, is that the underwriters sold the policies on and nobody really knows who will be on the hook for the Lehman debt, by how much or whether they will be able to pay up.
Any large hits are likely to leak out soon. About 350 banks and investors are thought to have taken on CDS contracts, of which hedge funds hold about a third. Some institutions have already declared their exposure. These include Freddie Mac and Swedbank, with $1.2 billion apiece, and State Street, with $1 billion. Of greater interest will be the exposure of the hedge funds and whether they can pay.
In another era, we would have been certain that much of the exposure was hedged. But the depth of financial irresponsibility we’ve seen from sophisticated investment banks has wiped out that confidence. So we’re going to ask you. After hedging, how large will the net settlement of Lehman CDOs be?
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