Raghu writes: >> Thats is one argument. Although I am not sure what you mean by "very >> attenuated": derivatives simply could not have existed without moral >> hazard. Did anyone really think they were buying real insurance by >> buying CDSes from some itty-bitty hedge fund?
A little more trivia from the Lehman bankruptcy case. To generalize, if you were a run of the mill hedge fund, trader, etc. and wanted to engage in derivative transactions with Lehman (whether a default swap, interest rate swap, power trade, etc.), Lehman required the party to post collateral to secure the party's potential obligations to Lehman in recognition that there was risk that a counter-party might default on a payment obligation. On the other hand, where Lehman required collateral from a counter-party, Lehman was not required to post matching collateral -- after all it was Lehman Brothers, one of the largest investment banks in the world, so who would think Lehman might default? To really make things fun, the derivative agreements permitted Lehman to "rehypothecate" the collateral, meaning Lehman was not required to segregate the collateral (such as a US Treasury Note), but could take the collateral and pledge it to a third party to secure a different Lehman trade, which in turn provided Lehman with another source of leverage. In the ordinary world, no big deal, because if a counter-party closed out its trades and was entitled to its collateral back, Lehman could easily return substitute collateral. However, now that Lehman is insolvent, where the collateral is and who is entitled to a specific piece of collateral is absolutely critical and is going to take years and significant litigation to figure out. It means that a party that transacted with Lehman and posted say, $25 million in collateral, and has closed out its trades and is owed say, $25 million on the trades, is not only out the $25 million on the trades, but may also be out the $25 mill! ion in collateral. Crazy stuff. David Shemano _______________________________________________ pen-l mailing list [email protected] https://lists.csuchico.edu/mailman/listinfo/pen-l
