Excerpt: Why Should Derivatives Players Get the Upper Hand?

“The point is that we have two sets of bankruptcy rules—one for derivatives counterparties and one for everyone else—and having two sets of rules here is unwise. One set limits creditors’ seizures from the bankrupt firm. The second set exempts seizures and accords extra priorities to creditors holding financial contracts called ‘derivatives’ or ‘repurchase agreements.’ It is no surprise that sophisticated finance players seek this favored framework because it protects them. By doing so, the super-prioritized counterparties’ incentive to ration their dealings with financially weak debtors declines [because it’s the United States that bears the risk of a major financial failure].

“These negative incentives can perniciously affect the debtor itself, its other creditors, and, ultimately, the economy. Better for Congress to re-do most of the special treatment, repealing some and cutting back others. Doing so would reduce the possibility of another AIG-Bear-Lehman melt-down.”

From “The Derivatives Players’ Payment Priorities as Financial Crisis Accelerator,” forthcoming in the Stanford Law Review

Read the entire manuscript.

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