Credit-Default Swaps May Produce Another Bear Stearns

Looking ahead, the final phase of this unraveling is likely to implicate the giant market in credit-default swaps. Those swaps are essentially contracts that allow sophisticated investors to bet on whether a company, a government entity, or even a securitized package of loans will default on its debt obligations. And they can place these bets whether they own the underlying security or not.

Because these contracts trade on unregulated derivatives markets, nobody knows who holds the losing side of the bets. But it’s a good guess that if defaults rise even to historically normal levels, a big hit will be taken by highly leveraged hedge funds, some of which may be unable to pay off on their bets and simply collapse. That, in turn, would trigger even further losses by banks and other investors that, unlike pure speculators, rely on those instruments to insure against default.

The credit-default swap has become so central to modern global finance that its size — the amount insured, in effect — is estimated at $43 trillion. If the losing side is unable to make good on even a fraction of a percent of those contracts, it could set in motion a financial chain reaction that could easily rival the subprime debacle.


NEW YORK, Sept 9 (Reuters) - The cost of protecting Lehman Brothers' (LEH.N: Quote, Profile, Research, Stock Buzz) debt with credit default swaps rose by 125 basis points on Tuesday as concerns that it may be unable to raise needed capital battered its shares.

Five-year credit default swaps on Lehman Brothers traded at 450 basis points, or $450,000 a year to protect $10 million of debt, 125 basis points wider than Monday, according to data from Phoenix Partners Group. For details click on [ID:nL9561695] (Reporting by Dena Aubin)


NEW YORK (AP) -- Lehman Brothers Holdings Inc. shares plunged to a new low Tuesday on a report that talks with state-owned Korea Development Bank ended without any deal for a badly needed capital injection.