Morgan Stanley, Goldman to be Nationalized?

There are so many bad things happening that it is hard to keep track. Here are two of the worst:

1) Lehman’s debt sold at auction on Friday for below 9 cents on the dollar; meaning the owners of the CDS contracts that insure these securities will have to pay more that 91 cents on the dollar to fulfill their obligations. There is speculation that the figure to do so might run as high as $400 billion. Somebody owes a lot of money that they probably don’t have. (This defines the credit crunch in a nutshell.)

2) In a related story, Morgan Stanley and Goldman Sachs both appear to be on the ropes. From CNBC:

“I don’t wish to spread alarm on the line people but the big issue confronting the market is I’m afraid the health and sustainability of Morgan Stanley and Goldman Sachs” Hugh Hendry, Partner and CIO at Eclectica, told CNBC early Friday. “It is unimaginable that they can be allowed to go, I suspect that they will be nationalized at some point today or over the weekend,” he add.

Not much else to say, is there?

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5 Responses to Morgan Stanley, Goldman to be Nationalized?

  1. bcs says:

    Lehman’s debt sold at auction on Friday for below 9 cents on the dollar; meaning the owners of the CDS contracts that insure these securities will have to pay more that 91 cents on the dollar to fulfill their obligations.

    Does it? My understanding is that CDS insurers have to pay the sums defaulted, not the sums the securities can command on the aftermarket.

  2. nahnopenotquite says:

    The CDS contract seller must pay the face value of the debt security. If you sold Lehman a CDS contract on a bond whose value was $10 and is now 9 cents, you owe $9.01. These contracts on Lehman debt are due to be settled on Oct 21. On that day, we’ll see who is exposed.

  3. bcs says:

    The CDS contract seller must pay the face value of the debt security.

    Yes, but under what circumstances? My understanding is that the seller must pay the buyer in the event of a default by the reference entity – In this case, by the subprime borrower.

    Now this default may already have happened, in which case a liability to the CDS seller of the amount of the default will already have crystalised, or it may be expected to happen within the near future.

    But a mere transfer of the debt to another party won’t give rise to a CDS liability.

    At least, I don’t think it will.

  4. bcs says:

    OK, I get it now. The auction wasn’t an auction by Lehmen of its mortgage assets, but an auction by investors in Lehmen of the latter’s stock.

    Lehmen here is the reference entity, and it is already in default by reason of bankruptcy.

    The CDC’s are now effectively put options.

    I think.

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