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I spent the majority of my Wednesday spreading my bearish positions further around the European banks (the balance was catering to my beautiful, yet demanding 2 year old daughter). Let me give you a glimpse into some of the reasons why. First a glance at the home page of yields...

1.    U.S. Stocks Plunge Most Since Market Crash of 1987 on Recession Concerns- Sounds like a market crashing to me.

VIX Index of U.S. Options `Exploding' Amid Growing Concerns About Economy- Hey doesn't this hypervolatility almost always precede a major market crash?

Bernanke Says Fed May Take New Role in Trying to Curb Asset-Price Bubbles - Which contradicts the story below. If you want to prick asset bubbles, you can start by not letting them form, such as in allowing banks to conceal the losses of assets on their books - in essence inflating those asset values. 

SEC Clears U.S. Banks to Postpone Writedowns on Value of Some Securities-  And so it begins, the obfuscation of true market values of assets held on bank's books. They can't fool me though. Now, preferred stock is to be called debt. When is debt to be called preferred stock. When are we going to be notified if or when the assets a bank is holding and paid for with leverage have dropped in value by 70%. Doesn't that make the bank worth less. Maybe not, after all stock is really debt, right?

S&P May Downgrade $280.1 Billion of Alt-A Mortgage Debt Amid Delinquencies - But it doesn't really matter because if you read the article above, banks don't have to write it down now. You know, if I run into the middle of the highway, as long as I close my eyes so I can't see the cars I'll be just fine.

Bush Says U.S. Taxpayers Will Get Back `Most' of Money Under Bank Rescue- Of course they will. Bush and his cronies have ever been the bastion of credibility (Reggie Middleton says, "Don't believe Paulson": S&L 2.0 - bank failure redux, Is Paulson to be trusted, or is this Bush Administration Shock and Awe, 2.0? and Reggie Middleton asks, "Do you guys know who you're messin' with?").  Just look at bullet point one above: all of those levered equity securities bought at the top of the stock bull run from 2003 to 2007 will generate tons of return for tax payer as they overpay to buy them up.

What does all this have to do with my buying of the European banks bear positions? Well, most are still much, much too optimistic about the financial sectors prospects here. The Monday rally was an opportunity to go shopping, and shopping I did, for price and value diverged even farther. While I won't divulge what I bought, I will share a little anecdotal research (more empirical research on this may be available to professional level subscribers next week). Before we go on, if you haven't read Interesting Lehman email, it is must reading to fully grasp the weight of the rest of this article.

The Lehman collapse has yet to be felt 

The final number of enrolled bidders for Lehman's debt auction, according to ISDA, was 358, among them the biggest debt and derivatives dealers in the business. The final CDS settlement is 8.625%. of each dollar protected. Keep this percentage in mind as I go through a list of companies that allegedly have "de minimus exposure" or have had their positions "substantially netted out". I use quotes because: a) these were the actual words quoted by company reps, b)this is bullsh1t, the losses are real and someone has to take them so I ask "How was this exposure netted out?", and c) the recovery rate is close to zero, "de minimus" indeed. Keep in mind the percentage quoted and realize that Lehman was the 10th largest writer of CDS in the WORLD!

This smattering is not even scraping the surface of what will take place next week. A rough estimation, this is about 20% or less of the total creditors outstanding exposure on the hook.

Note and update:

We looked into exposure of Citibank and The Bank of New York Mellon Corporation to Lehman’s debt and securities. Upon deeper analysis and search, we observed that the exposure of these companies to Lehman is that of administrative nature only and doesn’t represent any loss due to possibility of non-payment of debt money by Lehman.

This was also recently clarified by Citibank in response to Chapter 11 bankruptcy filing by Lehman disclosing exposure to the failed investment firm.

Following was the clarification by Citibank:

Chapter 11 bankruptcy filing does not represent exposure to the failed investment firm. "Citibank N.A. is listed in the Lehman Brothers bankruptcy filing as an indenture trustee for bond debt of approximately $138 billion under Lehman Brothers Holdings Inc. Senior Notes," Citigroup said in a statement. "Citi wishes to clarify that our role in this issue is administrative in nature and does not represent exposure for Citi to Lehman. Any assertions to the contrary are false."

Citigroup and Bank of New York Mellon are trustees to $138 billion of Lehman Brothers' bonds, the biggest on the list of unsecured creditors, according to a petition filed in New York bankruptcy court on Monday. Banks are trying to calm employees and clients in the wake of Lehman's bankruptcy filing Monday

We have, therefore, separately collated information on names and exposure of entities in the US having exposure to Lehman. We are going to share this list with you in a couple of hours. The list contains entity-wise details of total exposure, estimated loss (in absolute amount and as % of equity). This required a lot of manual efforts since a ready list was not available from any source.

We shall be highlighting and sharing name of 5-6 companies having potential exposure to Lehman, which have not witnessed significant fall in their valuation in last 3 months. The guiding factor will be (among others)

·        Highest exposure as% of their respective equity

·        Share price above $15

·        Not significant fall in share price in last 3 months.

This report will be available to the professional subscribers when released.


Lehman CDS exposure (millions)





 BNP Paribas






 Deutsche Bank






 UBS* net exp. substantially closed out?



 Societe Generale



 Credit Agircole



 Credit Suisse




Exposure of some life insurance companies

Primus Financial CDS exposure


Washington Mutual

$16.1 mn

Lehman Brothers

$80 mn

Fannie Mae and Freddie Mac

$215 mn


FPIC Insurance Group Inc


Lehman Brothers

$4.1 mn


$2.1 mn

WaMu senior debt

$2.1 mn

Morgan Stanley

$2.5 mn


Zenith National Insurance


Number of companies, including AIG (both fixed income and equity), plus fixed-income investments in Citigroup, Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley and Wachovia

$100.7 mn



  Below, that is a "B" not an "M", as in Billions!

Lists of debtors- Largest unsecured claims



Bond Debt

$138 billion

The Bank of New York Mellon Corporation, as indenture trustee under the Lehman Brothers Holdings Inc. Subordinated Debt

Bond Debt

$12 billion







The Bank of New York Mellon Corporation, as indenture trustee under the Lehman Brothers Holdings Inc. Junior Subordinated Debt

Bond Debt

$5 billion








Bank Loan

$460 mn

Mizuho Corporate Bank,

Bank Loan

$289 mn

Citibank N.A. Hong Kong Branch

Bank Loan

$275 mn

BNP Paribas

Bank Loan

$250 mn

Shinsei Bank Ltd.

Bank Loan

$231 mn

UFJ Bank Limited

Bank Loan

$185 mn

Sumitomo Mitsubishi Banking Corp

Bank Loan

$177 mn



Bank Leumi (Israel's largest bank)


WAMU Debentures

$27 mn


$23 mn

Here is a primer on the CDS risk that I am alluding to (from previous posts). The rampant credit and counterparty risk is literally out of control. I think there is hundreds of billions of dollars of worthless paper sitting on derivative, loan and bond trading desks around the globe. Even if I am wrong, most of these banks make decent shorts via the macro argument anyway. 

And back to the basic problem

The CDS insurance contract created primarily to transfer credit risk from bond investors to other parties may be insurance companies or hedge funds to protect against the default risk. However, as depicted in the chart below, the financial institutions may sell and resell the insurance contracts among themselves creating the ‘entanglement of credit risk’. This also makes it difficult to identify who bears the ultimate risk. This reselling of insurance contacts to another party has created a near untraceable credit risk web among the market participants.


Source: The New York Times


The growth in CDS market in the last few years has outstripped that of the US equity and bond markets

The credit derivatives market has grown at a remarkable pace as reflected from the tremendous increase in total notional amount outstanding over the last few years. The total notional amount of credit derivatives as of June 2007 increased to US$42.6 trillion, an increase of 109% over the US$20.4 trillion reported in June 2006. This has been driven by both the rise in single name CDS and the multi name CDS instruments. The significant rise in the multi name CDS (traded indices) has notably surpassed the growth in single name CDS. Single name CDS’ total notional amount outstanding has increased from US$7.31 trillion in June 2005 to US$24.2 trillion in June 2007 while the multi name CDS has grown from US$2.9 trillion in June 2005 to US$18.3 trillion in June 2007.



Source: Thomson Research