Monday, March 1, 2010

Walking away from OTC derivative contracts

Posted on the Institutional Risk Analyst:

When you recall that the Fed has been and continues to be the chief cheerleader in Washington for OTC derivatives, the implications for the global economy are truly mind boggling.

Needless to say, the City of Los Angeles is not very happy with the folks at BK nor with the other large, OTC derivative dealer banks that are the chief recipients of the Fed's largess. In fact, Los Angeles is thinking about moving billions of dollars in municipal deposits as well as nearly $30 billion in pension assets away from the largest banks in order to redress the perceived wrongdoing by BK and other large banks. You can probably guess that the City of Los Angeles will be using The IRA Bank Monitor's Bank Stress Index to help them select high-quality, smaller banks to receive this new business windfall.

But at IRA we believe that it is better to get even than to get mad, especially when there are billions of dollars in public funds at stake. This is why we have begun to assist public sector agencies in negotiating the repudiation of OTC derivatives positions that are causing unanticipated losses to customers like the City of Los Angeles. The message to the OTC derivatives dealers is simple: Take back the deceptive, unfair and misleading OTC contract or else the public sector client will pursues any and all options. Remember that defrauding a state agency is a felony in most jurisdictions.

The fact is that with proper legal advice and support, it is possible for both public and private sector clients to force the OTC derivatives dealer banks to take back their "sacred" gaming contracts. If you know what buttons to push and which lawyer to have under retainer, it is possible to force the OTC derivative dealer bank to tear up the agreement and slither away. We know this to be true because we have helped two private sector institutions in New York achieve such a result in the past month.

If your state or public sector agency or fund has been duped into entering into a OTC derivative contract that you believe was unfair and deceptive, we want to talk to you. We'll be glad to offer you our assistance in negotiating the termination of the OTC contract with your friendly OTC dealer bank. We'll even suggest some very good lawyers here in New York and around the US who do not have conflicts with the OTC derivatives dealer community.

You don't think that repudiating an OTC derivative contract is possible? Think again. Ponder the fact that the 2004 "Interagency Statement on Sound Practices Concerning Complex Structured Finance Activities" was not focused on protecting the customers from the predatory behavior of the OTC derivatives dealers, but instead on protecting the large banks from the negative reputational effects of trafficking in these gaming contracts.

When enough large, public customers of JPM, Deutsche Bank (DB), Goldman Sachs (GS) and other OTC dealers say "Foxtrot Oscar" to their tormentors, the proverbial house of cards will collapse around the ears of the Federal Reserve Board. All it takes is a few large cities, states and public pension funds in the US and around the world to be willing to challenge the large OTC dealers and say that enough is enough.

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