Will CDSs Push GM into Chapter 11?

By Dirk van Dijk

Yesterday's Financial Times had this tidbit:

Hedge funds and other investors stand to make billions of dollars on credit insurance contracts if GM declares bankruptcy, a prospect that is complicating efforts to persuade creditors to agree to a restructuring plan for the automaker, analysts say.

Holders of $27 billion in GM bonds have until June 1 to decide whether to swap their debt for a 10 per cent equity stake in the company as part of an offer that would give the US government 50 per cent of the shares, a United Auto Workers union healthcare fund 39 per cent and existing shareholders 1 per cent.

However, analysts say the chances the proposal will be accepted have been diminished by the large number of credit default swap (CDS) contracts written on GM's debt.

Holders of such swaps would be paid in the event of a default -- but would lose money if they agreed to restructure GM's debt. For investors who own bonds and CDS, this could create an incentive to favour a bankruptcy filing."

In other words, these unregulated insurance contracts have made it so General Motors Corp. (GM) is worth more dead than alive to the bondholders. A bankruptcy filing will have enormous costs, and the thought that it can be a quick and easy prepackaged deal is, frankly, absurd. It will be a long protracted battle, and while it goes on, the carcass of GM will rot. Consumers will be unsure if the parts will be available for the car down the road, and will decide that maybe it is better to buy a Ford (F) or a Toyota (TM), instead.

The bondholders complain, with some justification, that the UAW is getting too sweet a deal since it will be receiving 39% of the firm for giving up $10 billion in health care liabilities, while the bond holders are giving up $27 billion in face value of debt and getting only 10%. However, the UAW has also made many other concessions already in its basic contract, including getting rid of the jobs bank, and dramatically lowering wages for current workers.

Not all the bondholders have CDS protection on the bonds, but only 10% of the debt has to not agree to cause the company to have to file. There are probably more than 10% of the bondholders who have the CDS protection and which would profit from GM going under. If the CDSs were written by American International Group (AIG), it would be the taxpayers who ultimately pick up the tab.

So here we have a case where credit default swaps were being used in the most legitimate way -- they are actually serving a real insurance function. They are actually being held by people who have a real insurable interest (the equivalent of having a life insurance policy on your spouse) as opposed to a rank speculation (taking out a life insurance policy on a stranger you know is in the nursing home) and still they look like they are going to cause major economic damage to the country.

Tell me again why we allow these things to exist, let alone exist totally unregulated? Oh yeah, the banking lobby did a good job back in 2000, that's why.

Comments

[greedy bond...:]

1. It's not clear that all or even the majority of CDS are owned by Bondholders
2. How much per month does the CURRENT union worker make? MAny of the "concessions" are for futrue workers
3. you don't even mention the disproportionate government stake and their "control" of this company. 50% ownership for less stak thatn the bondholders who get 10%?
4. A reasonable offer to bondholders months ago could have prevented this mess....now the people of the US will fund this monster through BK (another 10-20 billion)
5 Chrysler bondholders could have been assuaged with a couple billion more.....now the governement is funding them 7 billion through BK.....no other conclusion than it was designed to favor unions and tear down capitalism.
6. GM Bond intrest was only 2 billion a year on revenues of over 100 billion...intrest payments ARE NOT THE PROBLEM at GM. INfact they could have issued new bonds to replace the old bonds that just paid intrest for next 20 year s and never paid the principle and that would have been acceptabel to all parties. but that didn't happen either.

things that make you go hmmmm?

May 13 06:33 AM

[Rational Human:]

The point on CDS is interesting but one must dispute the argument that a Chapter 11 filing is somehow massively more expensive to the taxpayer than a Govt. led, UAW directed repackaging and bailout

May 13 06:36 AM

[babyray:]

I dont understand how you reward the hedge fund managers and the greedy Wall Street bankers who performed the credit default swaps that got our country into this economic mess in the first place and not the lunch pale blue collar worker that built this great country of ours with his hands. Even after the Union worker has opened up his contract twice in the last 4 years for numerous give backs and bondholders refuse to take a haircut!!!!

May 13 09:37 AM

[slowdown:]

2. The same as a non UAW worker at Toyota. Wages were never the issue.


On May 13 06:33 AM greedy bondholder wrote:

> 1. It's not clear that all or even the majority of CDS are owned
> by Bondholders
> 2. How much per month does the CURRENT union worker make? MAny of
> the "concessions" are for futrue workers
> 3. you don't even mention the disproportionate government stake and
> their "control" of this company. 50% ownership for less stak thatn
> the bondholders who get 10%?
> 4. A reasonable offer to bondholders months ago could have prevented
> this mess....now the people of the US will fund this monster through
> BK (another 10-20 billion)
> 5 Chrysler bondholders could have been assuaged with a couple billion
> more.....now the governement is funding them 7 billion through BK.....no
> other conclusion than it was designed to favor unions and tear down
> capitalism.
> 6. GM Bond intrest was only 2 billion a year on revenues of over
> 100 billion...intrest payments ARE NOT THE PROBLEM at GM. INfact
> they could have issued new bonds to replace the old bonds that just
> paid intrest for next 20 year s and never paid the principle and
> that would have been acceptabel to all parties. but that didn't happen
> either.
>
> things that make you go hmmmm?

May 13 12:24 PM

[Sad for now:]

"Even after the Union worker has opened up his contract twice in the last 4 years for numerous give backs and bondholders refuse to take a haircut!!!!

Yeah, those dirty speculators who lend money to corporate America and actually expect repayments. What a bunch of thieving Capitalists!

With actions like this the Bond market that funds businesses is going to become extremely moribund.

May 13 12:33 PM

[Tomas04:]

The concessions are for current wages. Everything they gave up impacts them right upon ratification. Also how is $2 billion a year not a problem? That's more than triple what Toyota pays.


On May 13 06:33 AM greedy bondholder wrote:

> 1. It's not clear that all or even the majority of CDS are owned
> by Bondholders
> 2. How much per month does the CURRENT union worker make? MAny of
> the "concessions" are for futrue workers
> 3. you don't even mention the disproportionate government stake and
> their "control" of this company. 50% ownership for less stak thatn
> the bondholders who get 10%?
> 4. A reasonable offer to bondholders months ago could have prevented
> this mess....now the people of the US will fund this monster through
> BK (another 10-20 billion)
> 5 Chrysler bondholders could have been assuaged with a couple billion
> more.....now the governement is funding them 7 billion through BK.....no
> other conclusion than it was designed to favor unions and tear down
> capitalism.
> 6. GM Bond intrest was only 2 billion a year on revenues of over
> 100 billion...intrest payments ARE NOT THE PROBLEM at GM. INfact
> they could have issued new bonds to replace the old bonds that just
> paid intrest for next 20 year s and never paid the principle and
> that would have been acceptabel to all parties. but that didn't happen
> either.
>
> things that make you go hmmmm?

May 13 01:19 PM

[dfalter:]

GM posted 75 billion losses over the last 7 quarters.

Over the same time period, they paid about 4.5-5 billion in interest.

So without any interest expenses, they would have only made about 70 billion losses.. Evidently the vast majority of losses are coming from somewhere entirely different... namely the fact that GM was/is producing and selling cars at a loss.

May 13 02:04 PM

[AndrewDover:]

The extremely low percentage (Rumor single digit) of GM unsecured bondholders that accepted the offer hurts the CDS theory. There was little data behind it anyhow.

Also, the CDS theory fails to account for the GM bondholder's counter offer which would have not triggered the CDS.

A more likely scenario is that most of CDS were held by non-bondholders, including stockholders, speculators, and suppliers.

The simple theory is that GM bondholders thought that the GM offer was worse than bankruptcy.

May 27 01:18 PM