The impact of a default far outweighs the economic impact of just the debt and equity a company has issued. When you write derivatives to take exposure and have more people betting, you magnify the impact of a default.
– Gregg Berman, Co-Head Risk, RiskMetrics
Citi credit strategist Michael Hampden-Turner recently estimated that $400 billion in credit default swaps has been written on Lehman Brother’s debt. Tomorrow (Fri) these contracts are going to be settled. With Lehman debt selling for 10-11 cents on the dollar, the writers of these CDS look like they’ll be on the hook for about $360 billion. This could potentially push some financial institution over the edge and could be one of the factors that resulted in today’s afternoon crash.