Reply to thread

No, it was due to the lack of federal regulation. The policy change was the enactment of safe harbor provisions of Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 that exempt derivative contracts from bankruptcy. This, together with the prior repeal of the provisions of Glass-Steagall, enabled banks and their parent holding companies to trade in derivatives (viz. mortgage-backed securities) on the financial markets with immunity. It was the sale of these securitized mortgages, and subsequent default on the repurchase agreements, that triggered the bank failures, the stock market crash, and subsequent recession. President Bush had no choice but to take over the failed banks, and move to stabilize the financial markets to prevent catastrophic economic collapse; however by then it was too late as the damage to the economy had been done. The fallout was unprecedented, the bailout unresolved, and the legal issues, for the most part, unsatisfactory. There are a few cases that have held the flip clauses in a collateralized debt obligation to be an invalid ipso facto clause that are unenforceable despite the safe harbor provisions of the Bankruptcy Code; however the consensus of opinion is that these decisions will not stand up on appeal. See Lehman Bros. Special Fin. Inc. v. BNY Corporate Tr. Servs. Ltd. (In re Lehman Bros. Holdings Inc.) 422 B.R. 407 (Bankr. S.D.N.Y. 2010); and Lehman Bros. Special Fin. Servs. Ltd. v. Ballyrock ABS CDO 2007-1 Ltd. (In re Lehman Bros. Holdings Inc.) 452 B.R. 31 (Bankr. S.D.N.Y. 2011). This is why the safe harbor provisions for derivative contracts should be repealed, and trading in these high-risk securities by bank entities disallowed. Dodd-Frank (which the banks say goes too far) doesn’t go far enough as it fails to address the derivatives problem effectively; and it will be up to Congress to enact remedial legislation to curb this undisclosed speculation (i.e., "shadow banking"), or, as I said in my previous posts, what happened before will surely happen again.


Back
Top