Correct me if I am wrong, but I don't understand this logic. I am not a corp CDS expert, so I can only extrapolate from sov CDS (maybe sjfan can weigh in here). If I am long protection and wish to get paid, why is it that I would seek the company to fail and prevent an orderly and well-done Ch. 11? Isn't the set of credit events that trigger the CDS relatively diverse and wouldn't necessarily call for the company to fail? Personally, once proper CDS margining and central clearing is implemented, I really don't see what makes these contracts worse than any other financial derivative.
Only when there is no counter party risk. Otherwise, left to its own devices, the market will balance itself out just fine.
I have no problem with bankruptcy. But I have no idea what you are talking about. If you want to hold up a bankruptcy proceeding, you only need to buy bonds or stocks in some size; CDS protection sellers, though replicate the exposure of a bond, doesn't get a seat at the table. This is exactly the same as equity option holders don't get to vote in shareholder meetings. Second, if anything, CDS buyers have incentive to push companies into bankruptcy. If they use the legal devices avaliable to them, then they are no different from any of the distressed debt players around for decades (in fact, some are). There is a problem if a bank's CDS trader pressure its investment banking division to cut off source of funding for a company he bought protection on so he can get paid on the default; but, this is a violation of a unbelieveable volume of regulations on a lot of side. If it has ever happened (and every default these days is highly scrutinized) , I have ever got a hint of it. Finally, it's worth pointing out that CDS default-settlement event is run in parallel to the bankruptcy proceeding; In fact, that fact that it settles quickly is a major attraction for using them.
CDS settlement on default is parallel; It runs its own process and doesn't depend on the outcome of the bankruptcy proceeding. I'm not sure what the whole "CDS is the devil" business is about. It's just another derivative, nothing more complicated or different than equity options; And while optons are villifed once in awhile, CDS is get the shaft these days. We don't think there's any problem with equity investors holding option hedges.
I don't know either, although, clearly, there are a few technical issues that need to be addressed, such as proper collateralization, etc... Just because there are idiots that misuse a product doesn't mean that the product itself is to blame and must be outlawed. In my view, all the CDS rants are completely misdirected.
Indeed - and I'm not even so sure I can come up with an example of an idiot misusing the product; counterparty risk that took down AIG in their CDS and CDO trades (mainly CDO trade) exist in any form of margined trades; Tighter margin requirements (I for one agree that the days that AAA counterparties can write risk without posting collaterals should rightfully be over) and better clearing arrangements should alleviate a lot of those potential problems. Call me biased, I'm certain PragmaticIdealist is barking up the wrong tree on this issue.
You're basically saying that lenders should have a toughter time getting their $ back, beacase they should be subject to social benefits for other stakeholders. If those are the rules, then so be it, but interest rates will rise. Regarding "well done bankruptcies:" Things like the 363 sale process upset me, especially when the government rams them through like they did recently with the former GM and Chrysler (now Fiat/government/union motors). 363 should be outlawed way beofre CDS's.
http://www.economist.com/businessfinance/displaystory.cfm?story_id=13871164 "Credit-default swaps are pitting firms against their own creditors SIX FLAGS, an American theme-park operator, filed for Chapter 11 bankruptcy protection on June 13th, bringing its long ride to reduce debt obligations to an abrupt halt. The surprise was that bondholders, not the tepid credit markets, stymied the restructuring effort. Bankruptcy codes assume that creditors always attempt to keep solvent firms out of bankruptcy. Six Flags and others are finding that financial innovation has undermined that premise. ... Pragmatic lenders who hedged their economic exposure through credit-default swaps (CDSs), a type of insurance against default, can often make higher returns from CDS payouts than from out-of-court restructuring plans. In the case of Six Flags, fingers are pointing at a Fidelity mutual fund for turning down an offer that would have granted unsecured creditors an 85% equity stake. Mike Simonton, an analyst at Fitch, a ratings agency, calculates that uninsured bondholders will receive less than 10% of the equity now that Six Flags has filed for protection. Some investors take an even more predatory approach. By purchasing a material amount of a firmâs debt in conjunction with a disproportionately large number of CDS contracts, rapacious lenders (mostly hedge funds) can render bankruptcy more attractive than solvency."
As much I love the Economist, I find this a little sensationalist. It's a big "so what". Creditors (or other stakesholders) disagree with a course of a bankruptcy work out? That's neither new nor surprising. Keep in mind, in most chapter 11 cases, the cram-down provisions of the law make equity holders very powerful in relation to the bond holders; So priorities get shifted all the time. Moreover, I don't find it particularly unreasonable that a bond creditor, who otherwise is entitled to assets, don't want to take equity. The last paragraph is an unsubstaniated assertion. Who are these "lenders"? Who are these predatory funds?
Try reading the rest of the article. Also, if you are naive enough to think there are no predatory and manipulative hedge funds out there, this conversation is over. Read www.deepcapture.com 15 part segment on how hedge funds manipulated the markets for a single prostrate treatment research firm and then get back to me.