Wall Street unwittingly created one of the catalysts for the collapse of Bear Stearns, Lehman Brothers and American International Group by backing new bankruptcy rules that were aimed at insulating banks from the failure of a big client, lawyers and bankers say.
2005 changes made clear that certain derivatives and financial
transactions were exempt from provisions in the bankruptcy code that
freeze a failed company’s assets until a court decides how to apportion
them among creditors.
However, experts say the new rules might have accelerated the demise
of Bear, Lehman and AIG by removing legal obstacles for banks and hedge
funds that wanted to close positions and demand extra collateral from
the three companies.
“The changes were introduced to promote the
orderly unwinding of transactions but they ended up speeding up the
bankruptcy process,” said William Goldman, a partner at DLA Piper, the
law firm. “They wanted to protect the likes of Lehman and Bear Stearns
from the domino effect that would have ensued had a counterparty gone
under. They never thought the ones to go under would have been Lehman