Lehman CDS Payout On October 21: One of the most expensive payouts in the history of this market.

What is Credit Default Swap?

Suppose you are Citi Bank & bought bonds worth Rs 100 Cr from Lehman, now your bond value might go up or down so you have take an insurance from Barclays by paying say just Rs 10 Lakhs. In fact you are securing safety of your Rs 100Cr bond by paying just Rs 10 Lakhs. There are some people who do short selling of these bonds, like selling bonds without buying it and they also get these bonds insured, they are called naked CDS.

And just like in case of Nifty future trading & Nifty Spot market volume if you compare, you will see futures are traded 5-6 times more in volume compare to volume of spot market. So, in this case too naked CDS will be worth 5-6 times or more compare to spot CDS.

On Oct 10th payout was done done for those who were holding bonds, and the payout amount was $138bn. On Oct 21st payout for naked CDS will be done which is expected to be 5-6 times more than spot CDS, hence it might be $400-600bn who knows? Since Lehman is bankrupt hence those guys who insured these naked bonds need to pay such a hugh amount. We expect 2-3 big banks who insured these naked CDS to go bankrupt on Oct 21st, Watch Out!!!

In theory, a CDS is a contract in which a bondholder buys insurance — known as protection — against that bond defaulting. In practice, however, CDSs have become hugely popular among investors trading on the likelihood of a bond default without holding the underlying bond. The market has proved particularly popular with hedge funds, in part because it offers an opportunity to "short sell" bonds.

Idiots who made money by selling insurance on Lehman bonds will learn a lesson on Oct 21st. These idiots were betting that Lehman will be rescued like Bears! $400 billion in CDS’s — just take a look at the bond debt issued by Lehman on its bankruptcy schedules, it was $138 billion, so you know there are some naked CDS’s out there. $60 trillions CDS are outstanding 90% held by people not owning the underlying bonds with no regulation or exchange……………regulation …………what regulation?
Who will get impacted most or might go belly up?

Derivatives specialists insist it is impossible to predict which investors will be hit hardest by the losses on Lehman CDSs, which are spread far and wide, as Lehman was one of the most actively traded credit default swaps. Barclays and Royal Bank of Scotland are likely to be prominent among those required to pay out on Lehman CDSs. Meanwhile, counterparties failing to meet their CDS obligations to the two banks could lead to significant writedowns. Against this, tangible shareholders' equity bases of £20bn to £30bn seem like cloth tents in a hurricane.

On the heels of similar auction processes for Fannie Mae, Freddie Mac and Washington Mutual late last month, on Oct 10th auction for CDS of Lehman were done for the bond holder and on Oct 21st payout will be done for naked bond holders. For now, traders in the equity market are concerned about the prospects for the settlement, adding that its uncertainty is casting a dark cloud over the most likely holders of the debt — big banks such as Morgan Stanley, Goldman Sachs and J.P. Morgan Chase.
This Lehman credit default swaps settlement auction will likely be one of the most expensive payouts in the history of that market, something the government is certainly keeping an eye on.