What’s Good For Counter Parties Is …

Not good for anyone else.

The winding up of the ill-fated Lehman operations has run afoul of counter-party greed. More to the point it has run afoul of the hopeless inability of the dumb lawyers and bankers who constructed the apparently never ending Russian doll like constructions in which they hid those toxic assets to think clearly. Beyond their bonuses that is.

The problem is this: some of those labyrinthine and senseless structures touch down in foreign countries, where … gasp … they have actual laws and stuff. That might be different from ours. Oh the horror!

You think I’m being funny?

Then think about this.

The dimwits who advised the dimwits at Lehman ended up creating a chain of legal entities that stretches clear around the globe. At every point one of those entities touches planet earth – down from the parallel universe that exists in the attorney’s and investment banker’s minds – there are things called investors. These investors, it turns out, didn’t want to be ripped off so that the aforesaid attorneys and bankers could pay themselves big bonuses, they thought they were going to get a return on their investment.

When the music stopped and Lehman folded a whole host of bankruptcy lawyers went to work all over the world in an attempt to preserve value for their clients, some of whom weren’t aggrieved and bailed out bankers, but were real investors. People with cash at stake.

This has set off an international furore as each set of bankruptcy laws clashes with the next.

What fun.

But it has huge implications.

The latest fight centers around an investment vehicle called ‘Dante’ – presumably an oblique reference to the layers of hell that attorneys and bankers inhabit – whose investors have been ably represented in an English court. The judge concluded, not unnaturally, that they were entitled to compensation from whatever proceeds were available as Dante was wound up. This finding is in complete accord with English law.

It also happens to be completely at odds with what would have happened in a US court.

Here the bank counter-parties would rank ahead of the investors – they have a prior claim under US bankruptcy law. Since paying off the counter-parties would use up all the cash available in the defunct Dante, the investors would get zilch.

Its the American way: protect the bankers and let the investors swim as best they can.

Apparently the English judge knew full well the mess he was walking into -American lawyers like to think that their law applies everywhere and those other people’s laws are simply quaint impediments to be swept aside – so he put a stay on his decision pending appeal.

So now the American lawyers can save the poor counter-parties.

The problem is now this: if this case goes the way the bankers want it too, and American law prevails, the counter-parties will be paid and the investors will be hung out to dry. So who will want to invest in a similar US entity?

This case could spell the end of American bank ability to package and sell all sorts of investment vehicles. Practically any of the exotic securitized assets would fall into the same bucket as Dante. A precedent that protects the banks, rather than the source of the cash, vastly increases the risk associated with investing in a US domiciled investment vehicle.

While this may seem arcane and merely a problem for the future, it actually has huge current implications also: all those existing investment structures sitting on bank balance sheets will get a whole lot riskier too. That makes them worth a lot less to investors. That means their value will drop sharply.

And that, ladies and gentlemen, implies a write-off. Yes: we have discovered a potential new source of bank balance sheet weakness.

The banks are hoist upon their own petard.

By enforcing their rights as counter-parties, they undermine the value of their own balance sheets.

You just can’t make this stuff up. Banks really are that stupid.

The saving grace is that our doughty bankers will most likely have long retired, along with their bonuses, by the time the court challenge is resolved. Which only goes to show the depth of the brotherly love the legal profession has for the bankers. They have such a symbiotic relationship: both make money off the other’s folly.

Sweet.