ViewsPaper: October 3, 2008

Is Credit Default Swap Litigation the Next Big Thing?

Robin Sparkman

It seems that hardly a day goes by anymore without someone predicting with utmost confidence that boom times for litigators are just over the horizon.

Thursday's prognostication, courtesy of a media lunch hosted Wednesday by Paul, Hastings, Janofsky & Walker: It's going to be all about the credit swaps.

Robert Claassen, chair of the firm's derivatives group, and Keith Miller, chair of the credit crisis group, told reporters that the banking industry's implosion means that banks with a piece of the $43 trillion market in these unregulated instruments are likely to sue to recoup their losses. And who are they going to sue? Other banks.

A credit default swap, for those of you who aren't versed in the obscurities of sophisticated financial instruments -- a group that until yesterday included us -- is a credit derivative contract in which the buyer makes regular payments to the seller in exchange for the right to a payoff if there is a default or "credit event". Basically, these are insurance contracts, which were widely sold as a hedge against declines in the markets for complex securities.

But if credit default swap litigation takes off, big Wall Street firms could end up on the outside looking in.

The problem is conflicts.

As we've written before, banks don't generally like to sue other banks, and they particularly don't like the law firms that get in the middle of such disputes.

Miller speculates that firms outside of New York that don't ordinarily represent the big banks will have real entree here, just as they have in signing up the hedge fund clients that are already active plaintiffs against banks.

That might be good news for firms like Quinn Emanuel Urquhart Oliver & Hedges, but then, Quinn Emanuel's already been in the credit default swap game long enough to lose the bellwether case in the field.

On the other hand, we don't expect to hear much from the winner of that case, either. It was Merrill Lynch, represented by Skadden, Arps, Slate, Meagher & Flom.


Judge Naidu’s Comments on this Article that appeared in Legal News:

Do you see how big this "mess" is? Look at the third paragraph: US$ 43 trillion is involved, and these represent an unregulated market. It means the government looks the other way. These are the villains who finance the political campaigns. Both Republican and Democrat parties, after all, these are the people who run Congress. A handshake here, a nod there, hugs all around, LOTS of speeches, debates, backslapping, parties, trips, keynote speeches. IT IS ALL ABOUT BIG BUSINESS.

Bottom Line: All is well. The deposit and credit multiplier works. The unregulated market is worth at least 43 trillion dollars and everyone found on the wrong side of the fence will be punished – that is, no prison time, but just pay a hefty fine, usually 150 million dollars each. A tiny drop in the bucket.

Look at the fourth paragraph in this article where the writer of the article tries to describe and define a "credit default swap". What he fails to say is that there are many parties involved – a number of banks, a number of insurers, a large number of buyers and sellers, and a large number of attorneys, and a vast number of investors. The game is played in such a way that all semblance of order is replaced by controlled chaos.

That is, until the bubble bursts. Here is an illustration: The price is determined at $20.00 for a certain instrument of value. Everyone comes in thinking that buying it at $5.00 will bring a fortune. It is sold for $7.00. More people now come to buy again. Next, it is sold for $10.00. More people made money, and now more are coming in to buy since lots of people made money. Now, it is sold for $13.50 and ALL SYSTEMS STOP. Nobody allowed to buy except some key insiders. They now gobble up ALL the shares. They announce a sale at $16.00. The whole world comes in to buy. MORE money comes in. More money by newcomers sell at $19.00. MORE people and more money comes in. Now, everybody liquidates. The damn thing was only worth $2.00 to start with, not $5.00. The government steps in and bails them out. This whole play is scripted as a credit default swap with complex contracts and mind-boggling clauses which nobody understands.

Law firms simply love this sort of mess and problems. Billable hours will be aplenty. Lots of attorneys will be involved if they were not already involved right from the beginning. Courts will be happy as they will have full dockets and lots of filing fees are welcome. Lots of money will be spent xeroxing. Lots of expert witnesses will be involved. Lots of reporting to do by the media. Lots of travel time. Lots of money will go into the "economy". Lots of new business.

BIG BUSINESS AS USUAL... And then, some fool will write about how efficient law enforcement was and how quickly they brought the crooks to justice. And then, another fool from another influential media will do an in-depth study, throw in some graphs, and write another story hoping a Pulitzer will come by. Hollywood is bound to make a movie about this epic event.

The whole system is warped and crooked. Notice how quiet the OCC, SEC and IRS been during this whole drama? All this money is needed to keep the war effort going in Iraq. It costs a billion dollars a day. And then, there is Afghanistan. War is good. War creates money and jobs. See now why Russia attacked Georgia? Our leaders are experts in finding any excuse for starting another war. If Bush 43 remains in power, Iran would be next. Iran is smart enough to stoke the pot. War is good because oil is aplenty in the Middle East. Read all about how ARAMCO first started in Saudi Arabia and how the West stoked the fires of rebellion in the Middle East. Noam Chomsky has written some great books like "Failed States", "Imperial Ambitions" that tell a great story. And then read "The Dance of Legislation" by Eric Redman who describes the sinister spirit of the legislative process in Washington.

Be blessed and informed.

Judge Naidu


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