But there are legitimate reasons to worry about the growth o the CDS markets, regulatory arbitrage first among them. And now here's another possible reason: they may be making it harder for firms to restructure short of bankruptcy:
This week, mall operator General Growth Partners (GGP) and newsprint maker AbitibiBowater both filed for bankruptcy, after failing to persuade bondholders to restructure voluntarily.
Now lawyers involved in these bankruptcy proceedings tell the Financial Times that the credit default swaps are the problem -- mainly, bondholders who have purchased CDS on this debt have little incentive to negotiate or play ball, since the CDS, if the counterparty honors the agreement, makes them whole.
. . .
If it is AIG [on the other end of the swap contracts], it means our bailout is pushing companies into bankruptcy that might otherwise be able to restructure.Note that this has been alleged before, though previously with GM's ongoing failure to get its bondholders to exchange debt for equity. Now those involved in actual bankruptcies are citing it as a problem.
This is very troubling. We know from mutliple economic studies that systems that are too creditor-friendly have lower rates of entrepreneurship and innovation. We all have a vested interest in forcing creditors to the table short of liquidation (though to be fair, in this particular case, my sense is that the bankruptcy is expected to result in a reorganization, not a liquidation). Perhaps swap contracts should allow the issuers to get involved in these negotiations, the way insurance companies sit at the table during lawsuits.
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