WHO PROTECTS THE PROTECTORS?
"We" now know a lot about those settling Credit Default Swap protection on Lehman brothers.
We also know that the buyer of default protection assumes exposure to *both* the (a) issuer of the protection and (b) the target of the protection.
What we do not know, and what I have not seen published, is what the impact of the Lehman failure was on those who owned derivative "protection" that Lehman sold.
I'm not sure if those swap contracts show up in a bankruptcy filing, or, if they do, whether it is at a sufficient level of detail to develop an analytical perspective.
WHAT SHOULD ISDA DO?
Now, for the people who had default contract on (not by) Lehman, ISDA provides a fancy auction process, complete with superior netting of trades and determination of net open interest, so that settlement is ... highly manageable.
But what about those others, those who had protection from Lehman, who suddenly find themselves scrambling, in one way or another, because they are "unprotected"?
I'll leave that as an open question, pending further research.
Depending on the amount of the protection relied on, losing your hedge or your rating-enhancement can be a significant dislocation.
Update, from the Lehman filing, 19 September:
Derivative Contracts
The Registrant and its affiliates are parties to a large number of swaps, options, forwards and other derivative contracts with a variety of counterparties. These derivatives are governed by approximately 7,000 master agreements. The filing of the Voluntary Petition constituted an event of default and automatic early termination under certain of these master agreements and, in other instances, constituted an event of default allowing the applicable counterparties to terminate the agreements. The accelerated obligations under these agreements are expected to be material, but the Registrant is unable to specify their amount at this time.
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