Tony Crescenzi
Chief Bond Market Strategist
Miller Tabak + Co

A Bloomberg story mentioned that Lehman bonds were trading around an average of 13 cents on the dollar yesterday, indicating that sellers of credit protection against Lehman bonds would have to pay 87 cents on the dollar when Lehman credit defaults settle. This morning it was said that the initial value from an auction-setting process was put at 9.75 cents on the dollar, indicating that those that sold protection against Lehman bonds might have to pay more than they initially thought. We won't know exactly how much until the final settlement value for Lehman credit default swaps is made known at 2 p.m.

News that the settlement price might be lower than the 13 cents Lehman bonds have been trading at may have rattled the financial markets today. The theory being that if the sellers of insurance of Lehman bonds had to make a larger payment to protection buyers than previously thought, this might force the protection sellers to liquidate assets (of all kinds and in all asset classes) to raise money for the final settlement.

The negative reaction is symptomatic of the heightened state of anxiety in the financial markets, which are focused more on the fact that protection sellers may have to pay an extra penny or two or three rather than on the fact that protection sellers are already prepared to pay 87 cents on the dollar.

In the Bloomberg story, BNP Paribas is quoted as saying that protection sellers may have to divvy out $220 billion to settle their credit default swaps. If the payment is going to be 90 cents on the dollar instead of 87 cents, that's about 3% more, or about $6 billion. Again, the market is focused much more on the fact that $6 billion MORE must be paid rather than on the more important fact (in terms of dollars to be raised) that protection sellers already anticipated and likely took action to be prepared to make $220 billion of payments to protection buyers. Keep in mind that the extra few billion to be paid will wind up in the hands of lucky buyers, making it a zero-sum game in reality.

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Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market." Crescenzi is a contributor to RealMoney.com."

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