By on May 12, 2009

Credit Default Swaps (CDS) are a fairly complicated financial instrument. The bottom line: a significant number of GM debt holders stand to make more money if GM defaults and enters Chapter 11 than if it doesn’t. “According to the Depository Trust & Clearing Corporation, investors hold $34bn in CDS on GM,” the Financial Times reports. “Once off-setting positions are considered, the DTCC estimates CDS holders would make a net profit of $2.4bn if GM were to default.” That’s net profit. Reuters puts the total pay off at $4 billion. But don’t worry about the CDS payees; the Bank of America says “any payments are unlikely to cause widespread losses.” Easy for them to to say. The feds gave the Bank of America a $20 billion bailout in January and $118 billion worth of guarantees against bad assets. Anyway, CDS are not THE reason why GM’s debt holders won’t agree to restructure the ailing American automaker outside of bankruptcy. Some may actually believe that a liquidation offers a better chance of recouping their money. But CDS are not exactly at the bottom of the causation pile, either. Especially as the Treasury’s out-of-court debt-for-equity offer requires a 90 percent conversion rate. Say goodnight, Dick.

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22 Comments on “Credit Default Swaps Sink GM...”


  • avatar
    Kevin

    In the category of “who’d be crazy enough to buy GM stock” I’ll add, who’d be crazy enough to write a CDS on GM bonds? If chronically ill people can be uninsurable for health and life insurance, surely GM debt should be uninsurable?

  • avatar
    BDB

    How the hell are credit default swaps even legal? The more I read about them the worse they look.

  • avatar
    yankinwaoz

    who’d be crazy enough to write a CDS on GM bonds?

    The same people who were crazy enough to write liar-loan mortgages. You sell it, take your cut, and any future problems become that of the last guy dumb enough to hold the contract.

    If your income depends on sales commissions and not on the quality of what you are selling, then there are literally millions of incentives to sell such junk.

  • avatar
    nocaster

    In the category of “who’d be crazy enough to buy GM stock” I’ll add, who’d be crazy enough to write a CDS on GM bonds? If chronically ill people can be uninsurable for health and life insurance, surely GM debt should be uninsurable?

    I’m just guessing here, but I’m assuming the American Taxpayer via the bailed out AIG.

  • avatar
    Pig_Iron

    This is no Laugh-In matter.

  • avatar
    tedward

    So if I buy homeowner’s insurance and burn it down I get investigated and probably charged with arson. If I “buy” a publicly traded company, get my investment insured (in effect) and then facilitate the companies’ dissolution it’s a brilliant investment strategy that everyone else wishes they thought of first.

  • avatar
    tedward

    Oh yeah, fraud. I’d be charged with insurance fraud as well.

  • avatar
    Martin Schwoerer

    Here come de’ judge!

  • avatar
    Mullholland

    Definition:”last guy dumb enough to hold the contract”=U.S taxpayer.

  • avatar
    50merc

    And somehow this all winds up in the Government’s lap. The American taxpayer’s refrain: “Sock it to me!”

  • avatar
    Hippo

    tedward,

    Better. You don’t have to own the underlying asset to buy CDS. LOL.

  • avatar
    tedward

    Hippo
    “Better. You don’t have to own the underlying asset to buy CDS. LOL.”

    I have a lot less of a problem with that. It’s when the owner of a CDS is also invested in the company, and/or actively tries to push a company into default, that I have an issue. Even if I were, short of setting fire to the house myself, to take steps making it extra vulnerable to fire, in public, damn skippy the insurance company would find a way out of that claim. In short, who was the idiot that accepted a bet placed by a player on the court?

  • avatar
    agenthex

    Better. You don’t have to own the underlying asset to buy CDS. LOL.

    Even better, you don’t have to have any reserves to sell them.


    In short, who was the idiot that accepted a bet placed by a player on the court?

    Who cares when you don’t have to pay out?

  • avatar
    wsn

    tedward :
    May 12th, 2009 at 1:46 pm

    I have a lot less of a problem with that. It’s when the owner of a CDS is also invested in the company, and/or actively tries to push a company into default, that I have an issue.

    —————————————–

    Wrong. No one can push a sound business into default.

    Tell me, who bought CDS of Toyota bonds and is pushing for Toyota’s default?

    No one.

    The companies go into default because of poor management.

    Investors who correctly recognized poor management and bet against it deserve to profit. It’s not unlike that you see Chrysler doomed and choose not to buy a Chrysler car (bet against it).

  • avatar
    agenthex

    Investors who correctly recognized poor management and bet against it deserve to profit.

    Case in point.

  • avatar
    Hippo

    Who cares when you don’t have to pay out?

    We should because .gov has been paying out.

  • avatar
    Hippo

    I have a lot less of a problem with that.

    Consider that someone like GS that owns decision making of .gov may buy CDS without owning the bonds, and you see the fraud potential.
    They don’t even have to follow rule of law like bondholders.

  • avatar
    agenthex

    We should because .gov has been paying out.

    Sorry a bit of confusion as the “you” was referencing the gambler.

  • avatar
    stuki

    Wonder how much of this CDS ‘profiteering’ only became an issue after senior bond holders saw the kind of haircuts they were supposed to take outside CH11 at Chrysler.

    If all you ever did was buy enough protection to put a floor under your losses at 50%, in the expectation that the only way your bonds would be worth less than that is if the company went under; and are then suddenly asked to take 70+% losses outside of CH11, a CDS payout triggering event could well become the most profitable resolution available. That does not automatically make you someone who have been angling to destroy GM all along.

  • avatar
    tedward

    wsn

    I’d guess no one as Toyota isn’t considered a likely prospect for defaulting on a loan.

  • avatar
    agenthex

    That does not automatically make you someone who have been angling to destroy GM all along.

    Sure, it’s not always the case, some fires only look like arson, but allowing this scenario to be profitable is kind of a problem in a system that fundamentally encourages it.

  • avatar
    PeteMoran

    Investors who correctly recognized poor management and bet against it deserve to profit.

    Everyone is a gambler??????

    Is there no constructive/expansive direct investment anymore?

    INVESTMENT in the true sense of the word; Look at what the company does, look at their offering, does it have a market?, can they make a profit?, will I get a return?

    Back to basics for all those financial wizards….

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