Credit Default Swaps Could Force General Motors Bankruptcy
By Andy Miofsky, Illinois Bankruptcy Attorney on May 28, 2009 in Chapter 11 Bankruptcy
GM Investors holding credit default swaps [CDS] may get a better return on their investment if GM files what would be history’s 4th largest bankruptcy. A credit default swap is a derivative contract between two parties where one party pays the other party a fee and receives a payoff if the specified investment fails. It is a loosely structured form of insurance, unburdened by accounting restrictions that are common in a regulated insurance industry. General Motors proposed issuing equity shares of stock in exchange for debt foregiveness. Bondholders carrying that debt rejected the offer. Some bondholders who purchased credit default swap contracts stand to collect more money by cashing in the CDS claim if GM defaults on its obligations. CDS hedged bondholders with little faith that a restructured GM will be profitable in the near term could recover a larger portion of their investment by collecting on the default contract. Think about that - an investor makes more money if a company fails than if it sheds unmanageable debt. In this case the investor is actually a creditor who purchased corporate bonds, thus making a loan to the company. Still, the investment succeeds when the CDS is exercised upon GM’s failure to repay the debt.
Sorry, comments for this entry are closed at this time.