Monday, October 26, 2009

No mystery in Goldman's claims against the Lehman estate

NY Post: ... during a Goldman earnings conference call on Sept. 16, 2008, a day after Lehman filed for bankruptcy, Viniar during Goldman's earnings conference call downplayed its exposure to both Lehman and American International Group, the insurance giant that back then was on the verge of collapsing

Despite telling Wall Street that its credit exposure to Lehman was, in the words of Goldman CFO David Viniar, "immaterial," the gold-plated bank late last month filed one of the largest and most senior claims against the bankrupt Wall Street firm.

That has raised the hackles of some Lehman creditors, who are noting the disconnect between Goldman's public statements and its actions.

"How can you say this on one hand, while making these claims on the other?" asked one creditor, who described the inconsistencies as "suspicious."

There is actually nothing "suspicious" about this. Goldman's exposure to Lehman included a large position in Credit Default Swaps on Lehman, which nearly neutralized their overall Lehman risk. That's why the conference call "downplayed" Goldman's exposure in September of 08. The CDS had settled last year, paying Goldman the amount equal to par less the implied recovery at the time. The recovery amount was determined by the auction on Lehman bonds, a standard procedure in the land of CDS settlement. Now Goldman will try to recover the remainder of their exposure.

For simplicity assume $100 of Lehman exposure hedged with $100 CDS. As Lehman failed, the recovery was say 10 cents on the dollar, or $10. That means Goldman gets $90 in cash on the CDS settlement and has $10 left to recover from Lehman bankruptcy (to get their full $100 back). They now put in a claim against the estate.

Goldman's exposure to Lehman however wasn't just in Lehman bonds that could be easily sold - and the CDS wasn't a perfect offset as in the example above. The exposure included things like the OTC derivatives replacement cost, repo replacement cost, and possibly senior financing. Depending on the amount they recover, Goldman may end up getting back more than their original $100 exposure. No mysteries here, just the mechanics of counterparty risk management.
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