Tuesday, May 12, 2009

Who owns credit default swaps on GM? And who's on the hook?

Mortgage-backed securities and their derivatives were supposed to spread risk but ended up impeding mortgage restructurings as ownership of each mortgage split into anonymous fragments.

Credit default swaps were designed to offset lenders' risk but now may impede restructurings outside of bankruptcy, as some CDS holders have more to gain from the CDS payout triggered by default than they have to lose from default on bonds they hold . The FT's Henny Sender explains that holders of credit default swaps on General Motors' debt may derail the restructuring plan now on the table:

...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....

“Chrysler looks like a simple two-car funeral compared to the traffic jam of assets and liabilities and contracts at GM,” said the credit research boutique CreditSights.

Question: aren't something like 80% of credit default swaps held by "naked" buyers that hold no debt - that is, by those who are speculating rather than insuring? Sender reports that investors hold $34bn in CDS on GM's debt and would receive net payments of $2.4bn if GM defaults. How much of that is owned by bondholders, 10% of whom can derail the restructuring?

Question 2: who underwrote the bulk of that $34 billion in CDS? When GM teetered on the brink of bankruptcy last December, some warned that bankruptcy could trigger a financial chain reaction - specifically, via CDS. Could this be another chapter in the AIG crisis?

Postscript: Companies have already been pushed into bankruptcy by CDS holders. The Deal had this on 4/27:
Money Morning newsletter author Martin Hutchinson argued that swaps were catalysts for the bankruptcies of AbitibiBowater Inc. and General Growth Properties Inc.

AbitibiBowater could not persuade enough of its bondholders to exchange a portion of its $6.2 billion in debt and went into bankruptcy. General Growth, with $27.3 billion of debt, also filed for bankruptcy after bondholders refused to approve a restructuring. Subsequently, the value of a major tranche of General Growth bonds was determined by auction to be worth 71% of par, allowing investors to receive $710,000 for each $1 million in CDSs. "A nice reward for voting 'no' to a restructuring," Hutchinson wrote

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