Diving Deeper in the Financial Mess: Lehman and Bankruptcy Laws

Well, it appears that while Lehman technically filed for chapter 11 reorg, because of changes to the laws the effect is much closer to that of a Chapter 7 liquidation, particularly with the 2005 changes to the bankruptcy laws.

The bullet points:

• The holding company has filed for BK, but , its subsidiaries, "its brokerage-dealer subsidiaries, asset management unit, and investment management division", continue to function."
• Lehman will try to sell off the good bits.
• Under normal BK procedures, there is a stay on collecting debts, but, "most financial contracts — including securities contracts, swaps, repurchase agreements, commodities contracts, and forward trades — are unaffected by automatic stays."
• By declaring bankruptcies, it means the creditors can file to collect immediately.

So have this problem:

Now comes the downside potential. The risk is that lots of these commercial counterparties will choose to terminate their financial contracts with Lehman — say, for instance, credit default swaps — all at once, and then try to rehedge themselves all at once, causing the market to seize up.

But the market is already seized up.

The US financial system is in a pit of ugly, and no know knows which way is out.