Financial Syphilis

The day’s reports are that both Barclay’s and Bank of Amercia have walked away from deals for Lehman. In related news, "A rare emergency trading session has been opened Sunday afternoon between Wall Street dealers who have carried out transactions with Lehman Brothers that may be put at risk if the investment bank files for bankruptcy, the International Swaps and Derivatives Association said.

U.S. regulators and bankers were making last-ditch efforts on Sunday to prevent toxic assets from ailing Lehman Brothers spilling into global markets and rupturing investor faith in the international financial system. A rare emergency trading session has been opened Sunday afternoon between Wall Street dealers who have carried out transactions with Lehman Brothers that may be put at risk if the investment bank files for bankruptcy, the International Swaps and Derivatives Association said.
U.S. regulators and bankers were making last-ditch efforts on Sunday to prevent toxic assets from ailing Lehman Brothers spilling into global markets and rupturing investor faith in the international financial system."
I’m afraid that the "U.S. regulators" trying to paper this crisis over are, just as they were with Fannie and Freddie, much too little and way too late. The only company I know of that actually has real-world experience at settling derivatives is Berkshire Hathaway, which inherited $8 billion of derivatives when it bought General RE in 1998. Berkshire spent years working through that portfolio back when conditions were ideal for settlement. Here are comments of Berkshire Vice Chairman Charlie Munger on the experience:
"One thing about accounting, the liabilities are always 100% good. It’s the assets you have to worry about…When Berkshire bought General Re a few years back, it had a derivatives book…Gen Re needed a derivatives book like I needed a case of syphilis. When we went to sell these derivatives, we discovered that we couldn’t get the prices that they were supposedly worth…They were Good-until-reached-for assets…"
One of the paradoxes of the derivative markets is that both sides to a zero-sum trade booked profits. Someone is clearly wrong, or just plain lying. That’s one reason why the banks and insurance companies buried so many holdings in Level 3. Level 3 is, "Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement." It is the fear of having to establish observable values for these obligations that has, thus far, pushed the government and financial industry to quietly settle every crisis. Now, though, it looks like under the weight of mortgage and derivatives losses — combined with the political uproar over Fannie, Freddie and Bear —the banking cartel is breaking up as each rat tries to swim to safety.