What, exactly, is a "predatory" or "manipulative" hedge fund? Is it hedge fund that is acting illegal? Then fine - there are plenty of those. Is it one that offends your moral or ethical view? I'm sure there are those as well. But why in the world is CDS special? I mean, options allow equity holders to "shape" their exposure and change their behavior. What's difference between a major shareholder who has hedged all of his exposures via puts and a major creditor who has hedged all of his notional position with a CDS? Hell, the equity guy has far more rights than the creditors. Why aren't you crying bloody murder about that? I do, however, agree with the economist's general positions that there ought to be disclosure rules associated with major creditors and their CDS exposure. But this is a not a fundamental objection to CDS itself. (The deepcapture thing is a piece of opinionated, sensationalist, and mostly ignorant sloppy journalism).
The difference is that equity holders are generally not called to the table in bankruptcy proceedings. And more than just disclosure is needed, you have to remove the financial conflict of interest or you could always abolish bankruptcy laws. And tell me why deep capture is 'opinionated, sensationalist, and mostly ignorant sloppy journalism.' Because I find that comment to be 'opinionated, sensationalist, and mostly ignorant sloppy.' Deep Capture is simply doing what media should be doing - investigative journalism. 90% of what they state is solidly backed by linked facts and the other 10% is written alongside warnings that it is 'speculative' and based on the low likelihood of a confluence of suspicious and independent events ocurring.
Equity holders are generally not called to a bankruptcy proceeding? This is certainly not the case. In fact, equity holders are the ones who file for bankruptcy protection and are the main participant of a negotiation (though I'm not a lawyer, as someone with a large CDS book and a bond book, I have a very good idea of how bankruptcy workouts work). In the American (versus British) legal tradition, equity holders have outsized powers in a bankruptcy preceding. They can (and do, and often get it) petition the court to cram down (that's the actual legal term) all sorts of restructuring deals against bond holder interest. (I'm going to leave the deep capture thing out of this discussion. It has nothing to do with the matter at hand. I can't change your opinion on it; nor can you change mine. It's not productive)
And in case you want to use willful ignorance as a defense, here's corporate finance 101 for you, (1) When a company fails to pay either interest or principal (or violate a covenant of the debt), he is in default. (2) When a company is in default, the default posture is that company head toward liquidation and the creditors are satisfied in the priority of their debts (3) At this point, the company's equity holder may elect to file for bankruptcy protection (4) Once filed, there's an automatic "stay" that prevents any creditors from claiming a company's asset. (5) The equity holders and creditors engage under the judge's supervision a negotiation trying to settle the claims without liquidating all the assets. (6) Good faith applies. If either party acts in bad faith, the judge has broad power to impose his will. (7) If successful, the debt holder usually gets some cash + equity in exchange for reliqinishing their original debt claim. The company emerges. (8) If failed, and the judge decline from craming a settlement down the debt holder's throat, the company goes into liquidation. The equity holder is the initiator of bankruptcy action and the major player. I would further argue that if having CDS means bond holders are less likely to concede to equity holders' restructuring plans, all the power to them. That is their economic and legal right; Bankruptcy proceedings are fundamental unfair (but necessary from the perspective of preserving efficiency) from the point of view of debt holders, who may end up getting less than their contract allows for. * this triggers a CDS event for CDS holders. CDS holders are not entitled to be heard in this process (unless they are also bond holders)
Generally, equity holders are wiped out in the event of bankruptcy as bond-holders are owed first... -- http://www.businessweek.com/magazine/content/09_25/b4136063169698.htm "To file for bankruptcy, a company is supposed to be insolvent, with debts exceeding assets. Since debtholders must be paid back before existing shareholders see a penny, typically equity owners are wiped out." -- And usually, if equity isn't wiped, it's because there is massive new equity issued to recapitalize the firm and the old equity-holders become excessively diluted anyways. -- Bond holders wield the power in bankruptcy court, as so they should. If they didn't, bond yields would have to drastically increase. Thus, allowing bond holders to hold CDS as well is in violation of the spirit of bankruptcy laws, no doubt about it.
I think a lot (maybe most?) people who are short, whether it's by cds or just short the stock, want to see the company fail. Kind of goes with the territory.
WTF? This is absolutely not the case. I am a regular reader of the "Journal of Bankruptcy Law and Practice", the law industry's standard journal on this, and just about every article ever published will tell you otherwise. I don't think you understand your own business week quote. A company goes into bankruptcy when the creditors can enforce a claim (that often wipes out the equity holder if enforced) so that they are protected. That's why it's called bankruptcy protection. Look, rant all you want about CDS, but this is not a matter of opinion. This is the factual reality of bankruptcy law and proceedings. Equity holders are the primary instigators of bankruptcy and have a major, controlling voice in the proceeding. I'm not sure why you refuse to understand how bankruptcies work... You are not just being opinionated, which is fine, but being willful ignorant about a fairly well known process in corporate finance & law.
I don't think you understand what I'm saying. The very fact that most companies that go into bankruptcy protection are insolvent belies the fact that equity holders end up being wiped out or lose almost all of their money. Just because equityholders TECHNICALLY initiate preceedings to get scraps when they are going to get nada does not imply that equityholders have power to dictate terms in bankruptcy. Naturally, debt holders are given preferential treatment as they should. When debt holders are also CDS holders, there is incentive for these debt holders to force the collapse and liquidation of the firm that has filed for bankruptcy. This opportunistic and predatory drive to maximize the debt holder's immediate profit and reduce risk is exactly why bankruptcy protection was created in the first place. IS THIS REALLY THAT HARD TO GET?
Is it really hard to get that bond holders are NOT given preferential treatment in a bankruptcy proceeding? That the exact opposite is true? And moreover, if you are willing to concede (hopefully you'll concede to a matter that is factually and legally true) that equity holders have a place in the bankruptcy proceeding table, then why do you have beef with CDS for debt holders but not equity puts for equity holders?
Well, I never really considered current equity holders as having a major say in any bankruptcy preceeding outcome and so I never gave the equity-put relationship much thought. But if the majority equity stake desired bankruptcy, why would they ever initiate bankruptcy protection in the first place..? I can't exactly envision this situation occurring. And if they somehow manipulated markets to depress the share price and/or bring about a default event, this is fraud. The same way it is fraud when a CDS / Bond Holder motions to have the firm liquidated, even if it has likely potential to remain a going concern. That being said, I will concede that if the judge is qualified enough, he/she may strike down the bond holder's motion to liquidate. Of course, it shouldn't be assumed that judges possess the kind of economic expertise to determine this.