Unlike a lot of names that were long in real estate derivatives, LEH had deep exposure to the commercial market, which is much lumpier than the residential market. When you own a position in a $1 billion issue of CMBS you have a much narrower exposure to risk than for a $1 billion issue of RMBS and a much, much narrower exposure than to some of the RMBS derivatives that became essentially vehicles for opposing views about how long the real estate bubble would last and if there was enough time to get in and out before it popped.
The net is that the market to which LEH was most exposed was the market for which there was the thinnest opportunity for CDS. LEH’s problem was not necessarily the credit risk in its portfolio (although it’s likely there were some losses simply due to recessionary effects) so much as its market risk. As the financial panic set in (a disease to which the markets are depressingly liable due to the herd mentality of the flesh and blood people that the market consists of), financial assets other than what were regarded as the safest of sovereign debt became highly illiquid.
In the context of CMBS, and ABS, in general, “illiquid” is a term of art meaning that the dealer who sold them stops making a market and, therefore, stops giving pro forma quotations to mark against. Since there is no longer any supposedly “objective” market indicator with which to game the accounting rules, the only ploy that passes the laugh test for GAAP purposes is to mark down a security that would otherwise be quoted at a premium to prevailing prices to one that must be discounted.
The dominos continue. Leverage is great when the winds blow in your favor, but fatal when they don’t unless you have the capital to support it. LEH didn’t, wouldn’t seek refuge in the arms of someone who did when it had the chance, and ignored the plain message that Hank Paulson did not consider it too big to fail.
Sad story, it is true. But if you look at banks and dealers from before the Great Meltdown in terms of their histories, a large number of them were amalgams created from the picked bones of once famous predecessors. That’s why they clothe themselves in marketing vestments of classical facades and timeless integrity.
They create great wealth, for their executives and commissioned staff, not so much for their stockholders or creditors.