re:financial engineering at its best https://www.bloomberg.com/news/arti...e-next-company-with-head-scratching-cds-trade
Well this is a complicated one. From a business ethics point of view, the hedge funds is DEFINITELY guilty of manipulation. I mean if we are not allowed to blow up all of the INTEL's chip manufacturing plants after shorting its stock then ESL shouldn't be allowed to short Sear's credit derivatives on one hand and then give Sears the funds for it to buy up their debts. But from a business point of view, if this albeit self-serving attempt helps Sears to do a bit of limited restructuring keeps Sears opens its doors a bit longer, is it really all that bad? I mean Sears employs a lot of people and if getting rid of a bit of its debt would help them stay afloat longer and maybe help them to turn their business around from their current obsolete business model, wouldn't that be a good thing? Isn't helping a business stay open more preferable to shorting them to the ground? After all, this isn't the MBS industry where everybody involved from the banks to the crediting agencies were all committing fraud, this is just a retail store whose business model is not working very well anymore. Is the Big Short really a better idea this time here?
Totally different examples. What esl did when it financed sears was legal (separate from the cds part). Blowing up plants is illegal regardless of the motivation. A more apt comparison is citron research who goes on twitter raids (which are legal) after shorting the stock.
Agreed your example is better but the idea is the same. Holding an investment in one hand and then manipulating circumstances legally or illegally to make the investment increase in value with the other hand should be illegal; this is no different from insider trading.
No. It’s completely different. Taking your idea to a further extreme example: warren buffet could not ever buy a stock because after it becomes public that he owns a stock, the stock rallies and he profits. Further, its not irrational for a company to buy back its cheapest debt. After all that company can buy more debt back. If the company did something irrational for the benefit of esl, I think there would be a stronger case that there was manipulation. This esl situation definitely smells dirty; but that doesn’t make it wrong.
I never said Sears did anything wrong; of course they are free to buy back their debt any time. But the way that ESL sold credit derivatives on Sears' debt on one hand and then help Sears to buy back their debt so the value of those credit derivatives drop in value is definitely manipulation and is wrong. They directly caused the losses suffered by all those who bought the credit derivatives on Sears. If ESL really wanted to help Sears, it shouldn't have sold the credit derivatives in the first place. The conflict of interest is clearly there.
It feels shady but is it any different than warren buffet buying convertible preferreds in Goldman and then issuing a statement that he invested in Goldman? So many shorts got burned by that. I am not a lawyer but if esl compelled sears to buy back the debt, that might be a problem; but if sears did it on their own accord (wink wink) then there wouldn’t be a problem.
There is still a difference between what Buffett did and what ESL did. What Buffett did was not a direct manipulation that would result in a DIRECT and guaranteed impact on the investment that he holds. His announcement does not go into the direct calculation of the share price nor does it result in any guaranteed direction or magnitude of the change of the price in any way. The share price of Goldman is still at the end determined by what everybody thinks. He can say and announce all he wants but if nobody gives a crap, the stock is not going to go anywhere. The shares only went up because people are crowd-following sheep and that's not something that Buffett can control. What ESL is doing is different. First ESL is the largest shareholder of Sears (and Buffett is not that of a Goldman btw) so the compelling factor is quite obvious. Second what ESL did results in a change on the value of the credit derivatives because the calculation of the value of the credit derivatives is based on the value of the lowest priced debt of the company of which the credit derivatives is issued calculated by a math formula. Whenever you have something that's determined by math and you manipulate one of the factors that go into that math, you are manipulating because the impact is direct and guaranteed. The article is very clear on how value of credit derivatives are determined: "A company’s lowest-priced debt is typically used to determine payouts on credit derivatives ", "A buyer of credit derivatives profits from the difference between the face value of a company’s debt and its cheapest bonds, so eliminating low-priced debt decreases the potential payouts for the buyer and gives a higher return to the seller" so you can see if a company's cheapest bonds are being bought out then that automatically pushes the price of the cheapest bonds up and this is what is happening, again stated in the article, "Many of what had been Sears’ cheapest bonds are now surging. Some $43 million of 7.5 coupon bonds due in 2027 have rocketed more than 36 cents on the dollar since April, to around 74 cents on the dollar, a level not seen since 2015.", so if you have an investment in this case the credit derivatives that has its value calculated according to a formula: face value of the bond - market value of the cheapest debt" and the market value of the cheapest debt is going up, then it's obvious the credit derivatives value will be guaranteed to drop and whoever sold that credit derivatives, in this case, ESL would benefit and whoever bought the credit derivatives would be screwed and there is nothing you can do about it cuz it's math.
Further to my point a company has only two obligations: the stock holders and the bond holders. Credit derivatives are side bets; the company owes them nothing. It’s completely rational for a compsny to roll its weakest bonds into higher quality financing; whatever the effects are to non-stakeholders that the company has no obligation to. By your rationale a company shouldn’t engage in stock buybacks because they hurt short sellers.
Ok I have been writing three posts about this now. My problem is not with Sears. Sears can do whatever it wants. It's with ESL that I have problems with. Companies answer to its shareholders but that doesn't mean shareholders like ESL get to engage in non-arms' length transactions from which they are the exclusive beneficiary using someone else's money. You want to help out a company, fine, do it on your dime, don't do it with someone else's money. ESL is essentially using those credit derivative buyers' money to finance Sears' buyout of those cheapest debts. And everybody is a shareholder of Sears. What about the other shareholders of Sears? Why is it they are not able to profit from these "higher quality financing"? How about ESL let the rest of the shareholders of Sears share in the profit that they are getting from these credit derivative sales?