Arturo Cifuentes says that it’s not just the bankers and the ratings agencies who bollixed up the alphabet soup of debt products which are now imploding. It’s the lawyers, too:
More than 100 collateralised debt obligations (CDOs) and structured investment vehicles (SIVs) have already entered the murky post-event of default (EOD) state. This number will grow in the coming weeks.
Unfortunately, the legal documents that govern these transactions are so poorly written – full of ambiguities, inconsistencies, “circular references” and worse, contradictions – that many investors, trustees and respective legal advisors do not know how to interpret them.
For instance, in a number of cases it is not clear whether the assets should be sold (liquidation) or let to run off (acceleration). Moreover, even the rules to distribute the money post-EOD (who gets what) are unclear.
In essence, we have gone from bad models to bad writing.
Paul Krugman says the magneto is broken:
The defective alternator is the financial system. We replaced the old, bank-centered system with a high-tech gizmo that was supposed to be more efficient — but it relied on fancy computer chips to function, and it turns out that there were some fatal errors in the programming.
Anybody know a good mechanic?
He’s right, the fancy quant stuff broke – but so did the very unfancy legal boilerplate. The Great Moderation, it turns out, bred a Great Complacency, which reached even into the ranks of top-tier law firms. The resulting legal headache probably won’t have systemic consequences, but it will still be very painful and very expensive to deal with.