[dorlomin]

And now for the complicated and scary stuff. Today is the beginning of "auction season", when the International Swaps and Derivatives Association starts a series of auctions to settle who pays what to whom on a plethora of credit derivative contracts relating to businesses that have gone into default.

It's settlement time on those humungous insurance policies for corporate debt, called credit default swaps, which I've mentioned to you as being another potentially lethal flaw in the financial economy.

In the coming three weeks, payouts of hundreds of billions of dollars may be made - or at least demanded - to cover losses arising from the defaults on the debt of Fannie Mae, Freddie Mac, Lehman and Washington Mutual.

Sandy Chen, the analyst at Panmure who's been a smart predictor of credit-crunch accidents, estimates that payments on Lehman's battered bonds could be as much as $350bn.

Now the problem here is that for every beneficiary of these payments, there's an underwriter - those who provided the CDS insurance - which has to find the cash. And, as I've pointed out, this was a largely unregulated market, so the great fear in markets is that some underwriters have insufficient capital and will simply collapse when the claims are made.

That in turn would hurt financial institutions expecting to be paid out on their CDS contracts and damage others with separate exposure to the collapsed businesses. The shock to the system could be very severe.

To compound the current anxiety about all this, the CDS market is so opaque that it's impossible to know right now who is holding the radioactive baby.

Link

This 'bailout' is not even going to touch the sides.

[seahorse2]

Work or not work, this is exactly what the bailout is intended to do, which is buy these bad assets of Lehman and Wamu who are now in bankruptcy. If left unsold, this will cause a major crash for many players who insured these bad debts against default (insurance policies called CDS). So, how to prevent all this? Have the buyer of last resort, the US taxpayer, buy all this toxic stuff not sitting in a bankruptcy dumpster. The $700 bn is probably enough to buy these bad debts from Lehman and Wamu and the PTB have kept the FDIC off the hook too.