Bloomberg has a fantastic article today about how Lehman’s decaying corpse is suing a bunch of former clients, many of them wee and sympathetic nonprofits, who hosed Lehman when they terminated swaps in September 2008. Some of these lawsuits turn on disputes over when those clients, or their consultants, should have valued the swaps for termination purposes, and I was looking forward to reading Bloomberg’s account of which of those customers used the SWPM <go> function on their terminals and on what dates, but for some reason that wasn’t mentioned.

The basic story is that clients had trades with Lehman that were in-the-money to Lehman, and when Lehman went bankrupt the clients terminated the trades and wired Lehman termination payments that Lehman now rather belatedly finds inadequate. You could understand why the clients would want to get out of these trades: for one thing, the trades had moved against the clients (thus being in-the-money to Lehman) and seemed likely to move further against them1; for another, if the trades did move back in the clients’ favor, what were the odds that a freshly bankrupted Lehman would pay the clients what they were owed?

Is Lehman right that the clients underpaid? Oh, I mean, of course. I don’t have the details of the trades but you can reason this out from first principles. Here:

  • It’s September 15, 2008, and Lehman has just filed for bankruptcy.
  • You owe Lehman some money.
  • How much you owe them is a somewhat subjective matter that depends on what termination date you pick, what model you use, whom you ask for a quote, etc.
  • You know, with some certainty, that everyone at Lehman who knows anything about your trade, and also everyone who doesn’t, has bigger things to worry about, like stealing office supplies on their way out the door.
  • You can basically write them a check and enclose a note saying “here’s what we think we owe you,” and see if they write back.
  • How big is the check?

Read more »

  • 02 May 2013 at 12:09 PM

Lehman’s Bankruptcy Worked Out Well For Intel, Anyway

One possible reaction to Apple’s gigantic tax-optimized share repurchase program is to think that spending a lot of time fiddling with how to optimize your share repurchase program might mean you’re out of better ideas. You can ponder whether this Intel share repurchase trade described in a Lehman Brothers bankruptcy lawsuit filed yesterday supplies any evidence on that question. Intel decided to buy back $1bn of its stock in August and September of 2008, and rather than just buy it in the market it entered into a pretty fiddly forward contract with Lehman like so:1

  • Intel gives Lehman $1bn on August 29.
  • Lehman hands the $1bn back to Intel for safekeeping – it’s Lehman’s money, but Intel keeps it as collateral.
  • On September 29, Lehman gives Intel some shares, based on the average price of Intel stock from August 29 to September 26.2
  • The dollar amount of shares Intel buys is $1bn, if the average price is $21 or below, or $250mm, if the average price is $25 or above, or some amount linearly in between if the average price is between $21 and $25:

  • If the dollar amount Intel buys is less than $1 billion, Lehman gives back the extra money.
  • So in other words as the stock price goes up Intel buys fewer shares, and vice versa, which is kind of wrong-way for them3 but right-way for Lehman.
  • In exchange for that risk Lehman agrees to give them a discount of 10.6 cents per share.4
  • The number of shares Intel buys is equal to the dollar amount divided by the average price minus 10.6 cents:

Read more »

If Congress won’t act to curb derivatives speculation (and fund his own agency) with a transaction fee, Bart Chilton will. Read more »

“Bucket shop” has become a general-purpose Wall Street insult – “don’t work at Blackstone, it’s a total bucket shop” – but it’s actually a particular thing, “[a]n establishment, nominally for the transaction of a stock exchange business, or business of similar character, but really for the registration of bets, or wagers, usually for small amounts, on the rise or fall of the prices of stocks, grain, oil, etc., there being no transfer or delivery of the stock or commodities nominally dealt in.”1 The “bucket” bit comes, I think, from the notion that your long order and someone else’s short order would be thrown into a bucket together, netting them out with the shop as a bookie, rather than being forwarded to the stock exchange.

These are illegal now in all sorts of ways, and when they existed in the olden days they seem to have been pretty shady, but I’ve always thought that as a concept they get sort of a bum rap. What’s wrong with giving people synthetic exposure to equities, particularly exposure with low initial margin requirements and limited recourse?

Anyway Risk has this truly delightful article today about synthetic prime brokerage: Read more »

  • 26 Mar 2013 at 5:42 PM

ISDAt Wrong?

The European Union will be very cross if it finds out that the International Swaps and Derivatives Association conspired with its members to keep out would-be members. Read more »

  • 22 Mar 2013 at 1:20 PM

Everybody Wins With Bespoke Synthetic CDOs

Bloomberg this week had an article about how bespoke synthetic CDOs are coming back in vogue, and various people have fretted about that, because synthetic CDOs are scary, financial crisis, etc. And, sure, it’s certainly possible that the next financial crisis will be exactly like the last, only with more Cyprus.1 But today let’s talk about something tangentially related.

If you require banks to have capital based on risk-weighted assets, and if capital is expensive (at least for bankers), then you’ll have banks who want to lower the risk weights of their assets. There are many ways to do this, including buying safer assets, selling riskier assets, monkeying with models, etc., but one popular way is to buy credit protection against risky assets. The reason that this is popular is because of regulatory discontinuities: if you have $100 worth of stuff with a 200% risk weight, then you have $200 of risk-weighted assets, but if you buy protection against the riskiest $10 of it then you might go from $200 of risk-weighted assets all the way to $6.30, because the safest $90 of it might have only a 7% risk weight.

That’s a big jump. If your aim is to have capital equal to 12% of your risk-weighted assets, then your capital requirements go from $24 to like 75 cents. If your cost of capital is 10%, then that jump saves you $2.32 a year. So you could pay, say, $2 a year to the protection provider and still be up a few cents, versus not buying credit protection – plus, of course, you’ve got credit protection (meaning that you get more money back if there are defaults). And if you pay $2 a year for five years to protect $10 worth of risk, then the protection provider should do that trade all day long: he’s getting paid $10 to take $10 of risk. At worst – if 10% of your stuff, or for that matter all of your stuff, defaults – he breaks even. It’s free money.

That’s oversimplified (time value, counterparty risk, whatever), but it’s kind of a thing. To some extent that thinking underlies things like the glorious Credit Suisse PAF2 trade, where Credit Suisse basically wrote credit protection to itself because doing so saved it so much on risk-weighted assets. But the folks on the Basel Committee on Banking Supervision don’t particularly like it, and so they released a document today yelling at banks about it. Read more »

  • 12 Mar 2013 at 10:42 AM

Derivative Of Derided Derivatives In The Works

So credit-default swaps have a pretty bad rap in the wake of that whole financial crisis. And people apparently aren’t interested in trading things that some parts of the general public (otherwise known retail investors) blame for the aforementioned unpleasantness without actually understanding anything about CDS.

The IntercontinentalExchange has an idea to change all of that: Sell them that which they do not understand. Read more »

You may not believe this, but a few weeks ago I spoke to a business school class about the financial industry, and a student asked me “what would you say to someone who’s considering a career at an investment bank?” Somehow it did not occur to me to congratulate her on her humanitarian impulses. Instead, I suggested that there are two possible futures for the big banks. In one, the various efforts to “make banking boring” – more onerous capital and liquidity regulation, clearing and futurization of derivatives, bans on prop trading, calls to break up big banks, and so forth – would create amazing opportunities for people with the intelligence, motivation, and shall we say aesthetic sensibilities to find new ways to accomplish their non-boring goals within a shifting framework. Just like changes in the tax code create work for smart tax lawyers, so changes in banking regulation and structure create opportunities for smart bankers to steal a march on their competitors.1

In the other possible future, banking would be boring.2 Today is a dark day: Read more »