The decision by many an Asian distributor to stop using Lehman Brothers as an issuer has proven both prophetic and prudent, even though many of the distributors believed the US Federal Reserve would come to the rescue if the worst was to happen. But the worst did come to pass and the Fed, contrary to most people’s expectations and against the Bear Stearns precedent, refused to guarantee a portion of the US investment bank’s losses.
You can almost hear the heavy exhales of distributors’ relief, especially when the prospect of continuing to use Lehman was enticing to say the least. Lehman’s CDS rate skyrocketed to over 400bp a few months ago, which meant the products they issued would have far better terms than other issuers with lower CDS spreads. The temptation was there: better products for your customers coupled with the expectation that hell would freeze over before letting Lehman go bust seems a reasonable rationale to carry on buying the bank’s products.
Perhaps their prudence should be applauded, however, many of these distributors did sell products issued by Lehman prior to discontinuing the relationship. It remains to be seen whether these products, capital guaranteed or not, will give a return (the latest valuation of Lehman’s securities is 60 cents on the dollar) or another investment bank will purchase the products at a significant discount. S&P today downgraded Lehman’s credit rating to selective default, meaning ‘payments may not be made on some financial obligations’. Confidence-inspiring indeed.
Perhaps the one good thing to come of all of this is that investors who purchased Lehman Minibonds, credit-linked products with CDOs forming the underlying collateral of which possessed mark-to-market values of around 30%, have been put out of their misery, the final nail has been hammered home.
