The week in turmoil

This past week ill be remembered as one of the most dramatic weeks in financial history because of the unprecendented intervention by the U.S. Government and central banks from around the world. The events are likely too many to list, but you can check out a summary of the week's events at the Wall Street Journal: http://online.wsj.com/public/page/wall-street-in-crisis.html

In a nutshell, the Federal government, along with the Fed, has provided stop-gap measures to help stem the bleeding on Wall Street and to prevent further damage to the economy. There are many "bad players" in this mess and it is not clear how many will bear full or partial cost of their bad decisions. In a free market, these bad players would bear the full cost, but politics and the fear of trickle-down damage to the economy has prevented a free-market solution to the problems.

Lehman's Woes

Lehman Brothers is struggling this year, not just with their real estate investments, but with other firms' confidence in the firm. Check out the Wall Street Journal's coverage of Lehman's challenges: http://online.wsj.com/article/SB122109572989621863.html?mod=hps_us_whats_news

Also, check out how the stock has fared this past year: Ticker = LEH

Why do we care that the ABX may be wrong?

ABX is an index of prices of subprime securities, primarily determined by credit-default swaps (that is, agreements in which one party pays another to bear the credit risk of a security). An article in the Wall Street Journal indicates that this index may result in overstated losses on sub-prime investments: http://online.wsj.com/article/SB122020948016886713.html?mod=hps_us_whats_news .

What is ABX's relation to losses? In the absence of a readily available market value to use to value securities, companies with illiquid investments must now use an index to value these investments if one is available. The index that is prescribed for subprime-backed securities is the ABX index, maintained by BIS. The requirement of using this index went in to effect this past year -- hence, all the losses reported by Citigroup, Bear Stearns, etc.