By Mike Gallagher, Albuquerque Journal | July 1, 2021
The state of New Mexico filed a class action lawsuit against some of the largest financial institutions in the country alleging a 15-year pattern of manipulating the market for complex financial instruments called credit default swaps.
The lawsuit was filed Wednesday on behalf of the New Mexico State Investment Council by the Attorney General’s Office and Kirby McInerney LLP, a New York law firm, in New Mexico federal court.
The lawsuit does not specify how much the alleged market manipulation cost the SIC over a 15-year period starting in 2005 and asks for the court to determine damages.
But the lawsuit claims that the SIC suffered losses from trading at artificial prices caused by a conspiracy to manipulate the auction price of the complex financial instruments in violation of the Sherman Anti-Trust Act.
It appears to be the first lawsuit in the nation making these allegations, according to the Attorney General’s Office.
The SIC oversees and invests more than $30 billion in permanent endowments for the state as well as investments for 23 other state agencies.
New Mexico Attorney General Hector Balderas said, “New Mexican families should not be harmed by Wall Street greed, and we will enforce the rule of law against anyone who exploits our state.”
The lawsuit alleges that Bank of America/Merrill Lynch, Barclays Bank, Citi Corp., Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan, Morgan Stanley, their affiliated companies, and others participated in the alleged scheme.
Those companies will have weeks to respond to the allegations in court filings once they have been served with the lawsuit. Court records don’t show that anyone has been served as of Thursday.
The lawsuit involves the market for credit default swaps, which are a form of financial insurance.
The seller of the swap promises to pay compensation to the buyer for losses the buyer sustains if the underlying investment, like a corporate bond issue, fails.
In exchange for the promise of compensation from the seller, the buyer makes premium payments to the seller over the life of the swap contract.
Payment on a credit default swap is triggered when the issuer of the bond files for bankruptcy or fails to make an interest payment on the bond.
Unlike a typical insurance policy, the buyer of the credit default swap does not have to own the underlying bonds. The investor not owning the underlying bonds is making a bet that the underlying investment will fail.
According to the lawsuit, the price of a credit default swap is supposed to be set through an auction, but it alleges that the auction system was set up by the banks and rigged.
The lawsuit alleges that the banks communicated prior to the auctions and used inside information not available to the buyers to set benchmarks on the prices prior to the auction.
The result, the lawsuit claims, was that the auctions were not competitive, allowing the banks to make billions of dollars at the expense of investors like the SIC, according to the lawsuit.
Institutional investors, like the State Investment Council, pension funds, and others invest in credit default swaps directly or indirectly through investments in hedge funds or other financial firms.
Prior to the Great Recession in 2008, the market for the credit default swaps was nearly $40 trillion a year.
It now ranges between $5 trillion and $8 trillion a year, according to the lawsuit.