In the recent Fannie Mae and Freddie Mac CDS auction the net position was bid – there were more buyers than sellers – which led to the perverse result that the final price for subordinated paper was higher than that for senior. In Lehman’s case there are US$138 billion senior bonds and US$17 billion subordinated bonds outstanding (but many of these are non-deliverable under the ISDA protocol) and CDS exposure widely reported as being around US$400 billion. Lehman bonds were trading in the mid-teens prior to the auction which would indicate that protection sellers face a significant payout. However, these positions are collateralized and the extraordinary trading session on Sunday 14th September (the day before the bankruptcy was announced) allowed those with exposure to Lehman to net off their positions. The initial results of the auction revealed a net open interest of US$4.92 billion to sell and an inside market midpoint 9.75. The final price of the auction was 8.625%. This means that protection sellers have to pay out 91.375c on the dollar.
But no matter how efficient the ISDA auction protocol system is, it was never designed to deal with a succession of defaults on this scale.
