The Joy Of Credit Default Swaps: Why GM's Bondholders Are Praying For Bankruptcy

There’s one small hitch in GM’s plan to avoid bankruptcy by swapping debt for equity: Why should bondholders take pennies on the dollar when they can get 100 cents if the company goes bust? 

Answer?  They shouldn’t.

Of course, the government’s involved now, which means contract law could be thrown out the window.  So if we owned GM CDSs, we might consider taking, say, 90 cents.

The FT: Hedge funds and other investors stand to make billions of dollars on credit insurance contracts if GM de clares bankruptcy, a prospect that is complicating efforts to persuade creditors to agree to a restructuring plan for the automaker, analysts say.

Holders of $27bn in GM bonds have until June 1 to decide whether to swap their debt for a 10 per cent equity stake in the company as part of an offer that would give the US government 50 per cent of the shares, a United Auto Workers union healthcare fund 39 per cent and existing shareholders 1 per cent…

According to the Depository Trust & Clearing Corporation, investors hold $34bn in CDS on GM. Once off-setting positions are considered, the DTCC estimates CDS holders would make a net profit of $2.4bn if GM were to default.

The opposition of 10 per cent of bondholders is enough to derail the proposal, which has already triggered protests from investors who argue it unfairly rewards the UAW at the expense of bondholders.

“You have every incentive not to agree,” said one bondholder, a large credit hedge fund. “You would be locking in a loss if you did. It isn’t only the ‘shark’ capital; it will be the mum and pop mutual funds who will oppose this deal. “

Ah, yes, but don’t forget about Mr. Rattner.

And who’s on the other side of those swaps, anyway?  Is Mr. Geithner going to cover the losses?

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