Bankruptcy

CREDIT DERIVATIVES AND THE WORLDWIDE FINANCIAL CRISIS

By J. Michael McBride

Last night, I attended a seminar presented by the Turnaround Management Association of Dallas/Fort Worth concerning credit derivatives and their role in the current financial crisis facing the U.S. economy, and by extension the economies of the rest of the world. The seminar was moderated by Michael Farquhar of Winstead, P.C., and was the best synopsis and explanation of this complex situation I have heard.

The presentation ran over an hour past its intended stopping point, because the audience, comprised of financial and legal professionals, was intently interested and universally shocked by what they were hearing. The questions and observations of the audience members made it apparent that even to this group of seasoned professionals, gaining an understanding of the immensity and seriousness of this situation was difficult and frightening.

Mr. Farquhar stated, for instance, that there are credit derivatives totaling approximately $62,000,000,000,000.00 (that’s TRILLION) floating around out there, which dwarfs the gross domestic product of the entire world. While he feels that the course being taken by the government could be effective, if managed properly, the $700,000,000,000.00 bail-out package is a minuscule finger in a huge dike. His view is that the worse-case scenario is a one-day melt-down of the economy that would equal the seven-year savings and loan crisis that took place in the late 1980s and early 1990s. If such a thing happened, no one can predict what the outcome would be for the U.S. and world economies.

Adding to the uncertainty is the naming of Neel Kashkari as Interim Assistant Secretary of the Treasury for Financial Stability and Assistant Secretary of the Treasury for International Economics and Development. That impressive title means that the 35-year-old Kashkari will be the person in charge of disbursing the $700 billion bail-out package. His description of himself as “a free-market Republican” makes one wonder if he is the appropriate person to inspire confidence in an economy destabilized by an unregulated market in risky debt instruments.

Mr. Farquhar strongly recommended a book written by Janet M. Tavakoli – “Credit Derivatives and Synthetic Structures” – for an explanation of what these instruments are and to gain an understand of what has led to this crisis. I ordered my copy this morning. In January 2008, Ms. Tavakoli was called the “Cassandra of Credit Derivatives” by Business Week Magazine, but since she also predicted the thrift collapse 20 years ago, I’m more than a bit interested to hear what she has to say about our current crisis.

Link to the article on Janet M. Tavakoli:
http://www.businessweek.com/bwdaily/dnflash/content/jan2008/db20080128_934507.htm

Kathleen

Full post as published by Texas Lawyer Blog on October 10, 2008 (boomark / email).