Badly Written Contracts
Naked Captialism has a post about badly written contracts which probably means that a great many of these derivative things are unenforceable.
The post says that the CDOs are so poorly written, how to handle a default isn't clear. In the past month or two there was an example of one of these things where one company paid about $100k to insure $10 million and they lost in a legal battle for essentially a technical wording reason. They paid insurance that could never be collected on the debt they thought they were insuring with the way the contract was written.
I have had past experience reading many legal documents and contrasting them for what you would think they said and what they actually say and whether they are enforceable. I got this experience when I was working to get smoking out of public places in BC. I got all the existing by-laws that I could find at the time, and there were 30-40 municipalities that had some kind of by-law at the time, usually the you-can-smoke-in-this-half-of-the-room and damn the laws of physics.
I systematically broke these by-laws down and contrasted individual points onto a grid. I had about 40 different columns. I did this exercise in the 80s and it was one of my most important learning experiences and an enormous contributor to what gives me an edge in everything I read and analyse. It was as much work as I put into a semester of university.
I read the link about these "badly written" deals and my immediately thoughts are that of course they are badly written. They've hardly come under any kind of public test what-so-ever because defaults have been exceptionally low.
Further, those issuing contracts are probably going to have enormous advantage in putting in clauses that until you have a problem you would fail to appreciate how it limits the contract. I guess I've also had to deal with a "sucker" contract and the next one I wrote up was tight and specific. And guess what, the other guy completely failed to see or interpret my limiting clauses.
These derivatives are toast for yet another reason.