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Who’s Caught Holding Lehman Bag?

There’s chatter that an aftershock could rock Wall Street this week. But this kind of ripple has nothing to do with geology.

Instead investors are bracing for a fresh set of shockwaves triggered by the credit default swap market.

First Lehman Brothers’ CDS worth hundreds of billions come due on Tuesday. (As you might know, a CDS essentially acts like an insurance policy against defaults on corporate bonds or loans.)

Also there’s word that Federal prosecutors and New York's attorney general are joining forces to see if the CDS market was manipulated illegally. The investigation will focus on all of the large financial firms including banks and hedge funds that made use of the credit-default swaps.

Lehman Woes

Dylan Ratigan says settling the Lehman credit default swaps could be the equivalent of a hurricane coming. The cash settlement turns out to be about 9 cents on the dollar. That means if you sold insurance on Lehman default as of Tuesday you own 91 cents for every dollar of risk you assumed, according to Ratigan.

However, others say speculation about an aftershock might be a bit overblown including analysts at Citigroup and Barclays Capital who call market fears about the October 21 date, overstated.

"This is more of a slow process, and people (already) have had to come up with the money long before the settlement date," said Michael Hampden-Turner, a Citigroup credit strategist.

Karen Finerman agrees. She says, "if anyone wasn't able to make good wouldn't we know that already? Wouldn't the market have seen some kind of desperation? Then, after thinking about her own comment she adds, "Perhaps we did."

There are, however, serious concerns about select hedge funds. A lot of hedge funds were the ones selling this insurance, reminds Ratigan.

In the current environment, "the stresses that hedge funds are facing because of volatility are unprecedented," Puneet Sharma, a credit strategist at Barclays Capital Sharma adds. "The number of margin calls from the commodity, equity, credit, volatility and other positions are going to be enormous." For some investors, Tuesday's payment "could be the final straw," he says.

It will probably cost the market $400 billion and what happens on Tuesday is very important because we will recognize losses and that’s very important for the market going forward, adds Joe Terranova.

Official Probe

Meanwhile, on a related note, Federal prosecutors and New York's attorney general said Monday they had taken the unusual step of joining forces to probe the multi-trillion-dollar credit-default swap market.

The probe will focus in part on finding out whether the credit-default market, which is estimated to be worth tens of trillions of dollars, was manipulated, according to a state official.

"Our concern is that areas of misconduct that we used to see in the major markets moved to the credit default market because of that market's opaqueness and lack of regulatory oversight," the official said.

The investigation will focus on all of the large financial firms including banks and hedge funds that made use of the credit-default swaps.

Tuesday could be interesting.


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Trader disclosure: On Oct.20, 2008, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s Fast Money were owned by the Fast Money trader; Finerman Owns (GS), (MRK), (JNJ); Finerman's Firm Owns (MSFT); Finerman's Firm Is Short (IYR), (IJR), (MDY), (SPY), (USO), (BBT), (COF), (IWM); Finerman's Firm Owns (OIH) Puts; Finerman's Firm Owns (NKE) Calls; Seymour Owns (AAPL); Seymour Owns (CCJ); Seymour Owns (MER); Seygem Asset Management Owns (FXI), (VIP); Najarian Owns (AAPL) And Is Short (AAPL) Calls; Najarian Owns (ADM) And (ADM) Call Spread; Najarian Owns (EMC) And Is Short (EMC) Calls; Najarian Owns (FCX) And Is Short (FCX) Calls; Najarian Owns (MS) And Is Short (MS) Calls; Najarian Owns (MSFT) Calls And Is Short (MSFT) Puts; Najarian Owns (SNDK) And Is Short (SNDK) Calls; Najarian Owns (BNI); Najarian Owns (TSO) Calls And Is Short (TSO) Puts; Terranova Owns (AAPL), (EXM), (FCX), (FTO), (MA), (NOV), (POT), (X), (VLO); Terranova Owns Dec. Crude Oil; Terranova Owns Dec. Gold;

Terranova Is Co-Portfolio Manager Of The Virtus Diversifier PHOLIO; Virtus Diversifier PHOLIO Owns (IGE), (DBC), (DBV;

Terranova Is Chief Alternatives Strategist Of Virtus Investment Partners, Ltd.; Virtus Investment Partners Owns More Than 1% Of (ABD), (ARE), (BIG), (CNW), (OFC), (DLM), (DRH), (DLR), (EPR), (EXR), (FL), (SLB), (LNET), (MAC), (DBC), (DBV), (SKT), (UA), (BLV), (VV), (CLB), (GWX), (IGE), (FSMXX); Virtus Investment Partners Owns Seagate Tax Refund Rights; Virtus Investment Partners Owns Seagate Technology Tax Refund Rights; Virtus Investment Partners Owns More Than 1% Of Shares Of Incitec Pivot Ltd.; Virtus Investment Partners Owns More Than 1% Of Shares Of Essex Property Trust Inc.

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