Lehman default swaps still pending, DTCC says

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Lehman default swaps still pending, DTCC says

By Laura Mandaro, MarketWatch

Last update: 7:31 p.m. EDT Oct. 21, 2008

This update corrects and clarifies that final settlement is still pending.

NEW YORK (MarketWatch) -- An industry clearing organization said late Tuesday that it was still awaiting final results from the settlement of Lehman Brothers' credit-default swaps, a massive financial transfer that would add significant support to a recovery in the credit markets.

The Depository Trust & Clearing Corp. will issue a statement when the settlement is completed, according to spokeswoman Melanie Best. She declined to comment on timing.

Payments under these derivatives contracts have to be made by the close of business Tuesday.

The International Swaps and Derivatives Association, the group that represents swaps dealers, issued a statement just before 6 p.m. Eastern noting the "success" of the Lehman settlement.

"Today's settlement demonstrates that the industry infrastructure for [credit-default swaps] clearly works," said Robert Pickel, chief executive of the ISDA.

The exchange between the buyers and sellers of credit-default swaps, a type of derivative contract that pays out when a company reneges on its debt, spooked markets Tuesday. Some investors worriedsellers would be unable to come up with the cash to pay their counterparties, and these no-shows would usher in a new round of bank or fund failures.

This type of domino effect turned what started as a U.S. housing-market collapse into a global credit crisis.

"Settlement of Lehman's CDS is what has the market on the nervous side," said Peter Cardillo, chief market economist at Avalon Partners, said earlier Tuesday about the credit-default swaps.

The major U.S. stock indexes briefly scaled back declines late in the session after reports that counterparties had closed the swaps settlement without a hitch. See Market Snapshot.

Global interest rates spiked and lending contracted after Lehman Brothers (LEHMQ:LEHMQ 0.05, -0.01, -11.1%) declared bankruptcy in mid-September, a failure that risked taking some of the firm's numerous trading partners down with it.

The bankruptcy also triggered a relatively rare event in the $50 trillion market for credit-default swaps: the requirement that holders of protection on Lehman debt get paid by the sellers of these swaps.

An Oct. 10 auction determined terms of the payout. Buyers of protection against a Lehman default were slated to receive 91.375 cents for every dollar of Lehman debt they held. See full story.

The overall size of the payout was expected to be as much as $400 billion. But if the counterparties' offsetting trades are taken into account, the Depository Trust and Clearing Corp. has forecast that sellers of the protection may only have to cough up about $6 billion.

The credit-default swap settlement comes as stressed credit markets showed some early signs of recovery.

The cost of short-term borrowing continued its recent fall Tuesday.

The London interbank offered rate, or Libor, for three-month dollar loans fell to 3.83375% from 4.05875% the previous day. The decline follows a sharp drop of about 35 basis points, or 0.35 of a percentage point, on Monday. See Libor story.

Still, there are more companies at risk of default and more debt outstanding than in several years, and credit-default swaps may cause continued headaches for credit markets, said John Atkins, a fixed-income analyst at IDEAGlobal.

Going forward, "workouts can be much more convoluted," he added. "This doesn't mean things can't go wrong."

Laura Mandaro is a reporter for MarketWatch in San Francisco.

http://www.marketwatch.com/news/story/lehmans-massive-credit-default-swaps/story.aspx?guid=70FEEA73-AAF6-4555-A10E-EE434BFC983E
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