links for 2008-09-14
A Trifecta!

Ken Houghton on the Failure of Lehman Brothers

He wries:

Angry Bear: Roubini's not wrong, but...: There's a brilliant moment in Janet Tavakoli's Credit Derivatives and Synthetic Structures:

[B]efore the fall 1997 [Korean banking] crisis, I took a call from a trader at a securities firm....The trader told me that several Korean banks were willing to offer credit default protection on other Korean names. In order to bolster up their own credit perception, they were willing to post 30 to 40 percent of the notional amount with G7...collateral....The trader then went on to tell me that Commercial Bank of Korea would sell credit default protection on bonds issued by the Commercial Bank of Korea.

"That's very interesting," I countered, "but the credit default option is worthless."

"But people are doing it," persisted the trader.

"That's because they don't know what they're doing," I affirmed. "The correlation between Commercial Bank of Korea and itself is 100 percent. I would pay nothing for that credit protection. It is worthless for this purpose."

The trader mustered his best grammar, chilliest tone, and most authoritative voice: "There are those who would disagree with you." (p. 85)

Several months later, those people were, presumably, downsized. Eleven years after that, no one in the market today would make the mistake of not considering the risk of the guarantor as well as the guaranteed.

LEH will file bankruptcy, but the market has largely priced that into its current market valuations. There will be failures, and there will be many stories about the suffering of former LEH employees, and the occasional counterparty without another option close at hand. But its failure would not have a contagion effect, and any Fed support should be not to save the firm itself but, in the manner of the SBA's efforts in NYC seven years ago, small loans to ensure that as few of those counterparties whose businesses are impaired by the LEH bankruptcy are unable to find other sources of capital...