Editor’s Note: It is true that with this form of corporate debt insurance, bondholders do actually have less of a reason to not want to restructure a corporation’s debt and might actually like to see them fail so they can recoup losses from the counter-party that took this risk from them.
Personally, I am on the fence if this is productive or counter-productive? Either way, in a market system their are winners and losers and that is what brings balance to our system. If we did not have this type of debt insurance, we might have less participation in the bond markets or more due diligence when making these types of investments. I am not sure if there is anything wrong with that so at this moment I would just say they do need to be regulated and standardized so we know what types of risks our companies are taking on.
News (Reuters):
Companies at risk of failure may be more likely to succumb to bankruptcy than in previous downturns because bondholders who also own credit default swap protection could be less amenable to debt restructurings, Moody’s Investors Service said on Monday.
A global recession is crimping the earnings of companies at the same time as their access to capital markets is also being curtailed, forcing some to launch distressed debt exchanges as a means of reducing their obligations and avoiding bankruptcy.
Unlike previous downturns, when bondholders were faced with the choice of taking a hit outside of bankruptcy or risking even greater losses if the company filed, credit default swaps allow investors to recoup their investment even in bankruptcy.
“Bondholders with CDS protection have financial incentives to be less accommodating in their workout negotiations with issuers than those without CDS protection,” Moody’s said in a report.
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