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GM’s major bondholders are asking for a 58 percent stake in a reconstituted General Motors, but there are a number of challenges facing any debt-swap to relieve GM’s crushing $28b debt load. First of all, the Freep reports that some $2.7 billion worth of GM debt is covered by credit-default swaps. Since this means that ten percent of GM’s bondholders stand to receive face value for their bonds, the odds that 90 percent of GM’s creditors will take up any haircut offer seem slim. Add a bunch of angry, populist small bondholders to the equation, and you have yet another obstacle to the restructuring goal.
11 Comments on “Why GM’s Debt Swap Won’t Work...”
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And the credit default swaps were written by? AIG? We know how that worked out.
“Social Security isn’t enough,” she said. “I hope we’ll at least get something. I don’t want to be one of those ladies packing groceries at the store.”
I can’t help but think of that scene in Titanic: “Do you want to see me working as a seamstress? Is that what you want?”
In other words, I’m sympathetic to the bondholders here, but I imagine a woman who works at a grocery store might not be.
Fun Fact! A lot of CDS’s were written by Hedge Funds as they were considered easy money and a great way to juice returns – essentially they were writing insurance policies against the bonds going bad. Lot’s of cash coming in to the fund upfront, and calculating the corresponding liability was (is) left to interpretation.
What puts us into a Bonus Situation is that you don’t need to own GM Bonds to go out and buy a Credit Default Swap. This is where the mischief starts… Just call a hedge fund (or any Wall St Company) tell them you want to buy a CDS for a series of Bonds – and they will sell it to you.
Now, this does not affect the situation at GM very much but it will make for interesting reading at WSJ.com as the actual claims against purchased Credit Default insurance far exceeds the previously mentioned $2.7 Bln.
@MikeInCanada
Buying a CDS on bonds you don’t own sounds sort of like buying a life insurance policy on someone else.
The financial folks are too smart by half. And now they are paying for it. And apparently the whole CDS market is un-regulated and very opaque.
AIG (and its new masters aka the government) should have not paid out in full on their CDS. They should have offered 10 cents on the dollar.
@tced2:
On what legal grounds can they do that?
Re tced2 :
That is exactly what has made CDS’s and other derivatives exponentially disruptive. Note, I did not say they were inherently bad though. Companies need a way to hedge risk, and CDS’s are legitimate financial tools.
Not all CDS’s are (were) speculative.
As for paying out 10 cents on the dollar and the resulting lawsuits (which AIG, hedge fund, investment bank would be sure to lose – it’s called a contract) would result in the first to file getting 100% return, wiping out the issuer and everyone else getting squat. The knock on effect would be a disaster as companies that thought they hedged their liabilities find themselves exposed.
Well I’m not a lawyer, but I play one on the blogs.
The term is called “bankrupt”.
AIG wrote CDS that obligated them to pay out far more than they even imagined in their reserves. I don’t think there are any regulations for “standards” of reserves for CDS. For example, when you buy auto insurance, your state has regulations stating the reserves that the insurance company must have to cover the face amount of the coverage.
Our government (Paulson et al) determined that it would be destructive to let AIG default on paying these CDS on defaulting mortgages. Government ($180B?) to the rescue.
In normal circumstances, an insurance company that couldn’t pay its claims would go bankrupt. The bankruptcy court would divvy up the assets (and most claimants would collect a portion of their claim). I don’t know if 10 cents on the dollar would have covered it – that was just an example – 10 cents on the dollar would have meant that the government (you and me) would have spent $18B instead of $180B to bail out AIG. Maybe AIG would have $18B in reserves down in the basement and government money wouldn’t have been needed at all.
We learned later that many of the CDS claimants were CitBank etc. Basket cases in themselves. I never expected to see Tillie living in Podunk as one the direct CDS claimants. This was a financial tool that was for sophisticated financial companies but it backfired in a big way for AIG.
Those independent bond holders may be the last true capitalists in America.
CDS’s are legitimate financial tools.
That’s true. However it was the lack of regulation (of them and also the instruments that they were used on) that made them explode in popularity.
It’s quite telling that this kind of money follows a lawless enviro like when credit derivatives were some of the last to lack transparency.
I sympathize with their plight…
But,
If GM’s debt haircut is going to hurt them as much as they would have us believe, they did not diversify their assets, or they’re lying about how un-diversified they are.