It seems very arcane, but the reason that the markets have been so spooked, according to one line of thinking is that the pricing the Lehman's CDS' happens this afternoon. The protocol and the timing are given here in this Reuters article. I wrote about this yesterday as well.
In theory, the amount lost by one actor in the CDS passes to the other, so the overall effect on the market should be relatively neutral. Except, if the amount that you have to transfer is sufficiently large, then potentially the counterparty cannot make it, and to give an idea here, we seem to be talking about 85% or so of about 400 billion dollars having to move in settlement. (No one actually knows because trades are party to party, and so there is no control, documentation, or reporting of any kind of official statistics.)
Supposing that then means that 340 odd billion dollars have to move, it is not inconceivable that some of the weaker actors are simply not good for the amount, and will default, either directly as a result of the payment, or soon after as a result of their financial wounds.
If that happens, then the description by Warren Buffet of derivatives as weapons of financial mass destruction will well deserved.
The general public do not understand that this is in the offing, and how will anyone be able to explain it to them?
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