Wednesday, April 01, 2009
How bailing out AIG dooms General Motors
Anybody out there want to disagree with this?
GM (GM) has 58 days to negotiate to convince bondholders to take a major haircut or debt-for-equity swap. But it doesn't sound like it's going to happen.
Why not?
Because the bondholders don't seem interested in taking the ridiculous haircut that would be necessary for GM to be viable.
Why won't they take this haircut? Because many of the same bondholders presumably own credit default swaps on GM debt with AIG. And the US government has already made clear that it will cover those CDS's at 100 cents on the dollar. In other words, if GM goes bankrupt (defaults), the bondholders may be assured of getting all their money back!
The only question is the "presumably" qualification. The odds are that many GM bonds are hedged with AIG credit default swaps, but as far as I know there is no proof. Even if they are, it would not impeach the actual point of the AIG program (which is to avoid much larger losses at the counterparties), but it certainly counts as an unintended adverse consequence that, once again, neither the Bush nor Obama financial regulators saw until it was too late.
3 Comments:
By 
Rob, at
Wed Apr 01, 08:21:00 PM:
Couple of points:
1) Make sure to check out the comments thread to the business insider post. A couple of us have taken issue with Denninger's underlying premise, which I believe is false.
2) Some (although not all) of this perverse incentive is similar to the moral hazard you encounter whenever insurance products are involved.
3) I would love to know what % of GM bonds are hedged. My guess is that it is a lot lower than this writer believes, but I can't substantiate that intuition.
4) Even absent all possibility of CDS recovery, I think I could make an argument that a bond holder would still prefer bankruptcy to giving concessions now. They just have to believe that their claims would do better vs the UAW's claims in court rather than in a political process (not much of a stretch). Also they could believe that the long term economic value of the firm could be higher through a bankruptcy - since it would allow for the reworking of all contracts - leading to a bigger pie to be split, long term, among the different claimants.
By Purple Avenger, at
Wed Apr 01, 09:01:00 PM:
Since Obama is just makinshituponthefly wholesale, it should be no problem to have congress pass a quickie throwing the bond holders under the bus by nullifying the AIG CDS's.
By 
, at
Wed Apr 01, 10:22:00 PM:
I agree with Rob. I doubt that many of the GM bonds are hedged with CDS. And even less likely that AIG is the counterparty to those hedges.
