With three weeks to go before General Motors bondholders must decide whether to accept a government offer to settle their claims in an out-of-court restructuring, the chances that G.M. will be forced to file for the mother of all Chapter 11 bankruptcies are better than ever. And if you feel inclined to blame the ever-popular credit default swap (CDS) as the villain, go right ahead.
According to the Depository Trust & Clearing Corporation, investors hold $34 billion in CDS on GM. Once off-setting positions are considered, the DTCC estimates CDS holders would make a net profit of $2.4 billion if GM were to default.
Let's restate that: The bondholders (that own CDs) stand to do better if they force G.M. to declare bankruptcy. It's a no-brainer: Suffer huge losses by agreeing to the government's offer, or cash in by collecting insurance payments in the event of a G.M. default. But not surprisingly, the bondholders are denying any such nefarious culpability. According to the New York Times' Michael J. de la Merced, the bondholders "are seeking only to be treated fairly in a restructuring of the company." In their opinion, the government's deal, which would give the bondholders a puny 10 percent stake in the new G.M., is "designed to fail." So it's the government that's forcing bankruptcy.
From the FT:
"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 mom and pop mutual funds who will oppose this deal."
How much of this is real and how much is just the swagger of a couple of bull moose preparing to lock antlers? If the Chrysler saga offers us a model, then we should recall that as the government-set deadline got closer, the two sides haggled their way near to an agreement, before hedge fund intransigence ended up scuttling a final accommodation. But that didn't work out so well for the hedge funds.
G.M. CEO Fritz Henderson said on Monday that there were no plans to "sweeten" the deal offered by the government, but isn't that exactly what you would say if you were attempting to stare down your opponent in a game of Texas hold 'em? The Obama administration has already demonstrated that it is prepared to take one of the Big Three into bankruptcy court. Why not G.M.?
But if the White House strengthened its bargaining position by its Chrysler strategy, that doesn't change the fact that the G.M. bondholders are in a far stronger position. They've bought their insurance, they are far more numerous and diverse than in the case of Chrysler, and a resolution in bankruptcy court for G.M. will undoubtedly be far messier and difficult to achieve.
So both sides have more ammunition to play with. And, not uncoincidentally, the stakes are far higher. GM, despite all its woes, is still a major economic player whose survival is critical to the economic health of, at the very least, the American Midwest. If the government ends up in protracted litigation with the bondholders, everyone ends up suffering.
The next three weeks tell the tale: Of all the brewing narratives involving the new administration and its handling of the economy, G.M.'s restructuring is the drama on the hot burner. It seems inevitable that someone is going to get their hands scalded. But who?
UPDATE: A correspondent has convinced me that I misunderstood the implications of the CDs data.
If you net out the longs and the shorts, the NET exposure of the CDS market to GM is 2.4bn. In other words, when you net out all the positions registered with the DTC, the total amount of insurance written on GM is 2.5 billion.
There is 27 billion in debt, so in aggregate, the bondholders most certainly would NOT make money if the company files and bonds are worth zero. ...
So, in other words, those bondholders who own CDs stand to make some money in the event of a default, but the majority of bondholders would still lose out.
So the "smoking gun" you cite is not a gun at all, it's really just noise that affects maybe 10 percent -20 percent of the bonds outstanding. If GM were to get an exchange offer where a significant majority of the bondholders were willing to take a deal (say two/thirds), then the argument that the marginal 10-20 percent hedged by the CDS market ended up making negotiations more difficult might hold water -- but we're absolutely nowhere near that stage.