A second instance is related to Lehman Brothers and its role as a counterparty in myriad bilaterally settled over-the-counter (OTC) derivatives transactions. Lehman’s default and the doubts it raised about the viability of the few remaining investment dealers struck at the heart of both the funding and the OTC derivatives market.
The strains broadened to a general evaporation of market liquidity and a retrenchment from risk. In both cases, a basic problem was counterparty risk associated with financial contracts that are cleared and settled bilaterally.