Four Ways to Help Us Out of the Crisis

Although Korea Development Bank walked away from purchasing a stake in Lehman for various reasons, the rapid erosion in financial preferred shares didn't help instill confidence in the prospective buyer.

Solution: Treasury should reinstate the dividends on Fannie and Freddie preferred shares and emphasize a renewed commitment to keeping the preferred asset class viable. The increased cost to taxpayers (roughly $644 million quarterly) is paltry compared with the hundreds of billions we're currently debating about in Congress, and it paves the way for private capital to re-enter the marketplace. This is ultimately what is needed to sustain any recovery.

Problem No. 2: Lehman's bankruptcy has severely eroded confidence between counterparties.

While it was arguably OK to draw the line and appease the "moral hazard" hawks by letting Lehman go, it was a disastrous mistake to not guarantee Lehman counterparty risk -- especially when Barclays was allowed to feast on its carcass. We have not even begun to see the shoes that are about to drop here, as Lehman was a very pervasive counterparty to innumerable sell-side/buy-side accounts.

While the face amount of credit default swap contracts has never been released, as of May 31, Lehman's net derivative position was $47 billon, cash collateral was $45.6 billion, and cross-product and counterparty netting was $43.3 billion. Keep in mind that the face amount of the derivative portfolio could be orders of magnitude greater than its net value. As a result of the bankruptcy, any over-the-counter trades done with Lehman have now been terminated.

To make things immeasurably worse, any associated profits from these trades have to be treated as senior unsecured claims in bankruptcy court. (By the way, Lehman's senior unsecured bonds are now trading at 15 cents on the dollar. This means that if I hypothetically had $1 million of profit in any over-the-counter trade I had on with Lehman, $850,000 of that "profit" just evaporated, and it would remain to be seen when I'd even get the remaining $150,000 back.