It’s Friday, March 14, and hedge fund adviser Tim Backshall is trying to stave off panic…
Bear Stearns Cos. shares have plunged 50 percent since trading began today, and his fund manager clients, some of whom have their cash and other accounts at Bear, worry that the bank is on the verge of bankruptcy. They’re unsure whether they should protect their assets by purchasing credit-default swaps, a type of insurance that’s supposed to pay them face value if Bear’s debt goes under.
Backshall, 37, tells them there are two rubs: The price of the swaps is skyrocketing by the minute, and the banks selling the insurance are also at risk of collapsing. If Bear goes down, he tells them, it may take other banks with it.
"There’s always the danger the bank selling you the protection on Bear will fail," Backshall says. If that were to happen, his clients could spend millions of dollars for worthless insurance.
Investors can’t tell whether the people selling the swaps – – known as counterparties — have the money to honor their promises, Backshall says between phone calls.
"It’s clearly a combination of absolute fear and investors really not knowing," he says.
Of course, the nightmare counterparty-default scenario didn’t happen in the case of Bear Stearns. Instead, it happened with Lehman Brothers. And the repercussions from that — well, let’s ask Tim Backshall.
Tuesday is the final day credit default swaps on Lehman’s debt can be paid out.
"It seems like a non-event," said Tim Backshall, chief strategist at Credit Derivatives Research in Walnut Creek, California.
No panic? No "absolute fear"? Guess not.