July 16, 2020

Greek Talks Stumble Over Interest Rates

LONDON — Talks between Greece and its private-sector creditors over restructuring its debt hit a snag over the weekend over how much of an interest rate the new bonds would pay.

While considerable progress has been made, Greece’s financial backers — Germany and the International Monetary Fund — have been unyielding in their insistence that the longer term bonds that would replace the current securities must carry yields in the low 3 percent range, officials involved in the negotiations said on Sunday.

Bankers and government officials say they still expect a deal to get done; Greece and its private-sector creditors on Friday appeared close to a deal that would bring the yield to below 4 percent. But the continuing disagreement over the interest rate is a reminder of just how complex and politically sensitive it is to restructure the debt of a euro zone economy.

Greece’s private creditors, who hold about 206 billion euros in Greek bonds, are resisting accepting a lower rate. They argue that they are already faced with a 50 percent loss on their existing bonds and that the lower rate would increase the hit they would take.

It would also make it more difficult to describe the deal as voluntary. A coercive deal, bankers warned, could lead to a technical default and the triggering of credit-default swaps, or insurance, an outcome that all sides were trying to avoid.

The bonds’ rate “is the only issue,” said a senior official directly involved in the negotiations. “We have to accommodate the needs of the Greek economy.”

Talks broke off over the weekend when Charles H. Dallara, the managing director of the Institute of International Finance, a bankers group that is representing private-sector bondholders, left Athens. In a statement, a spokesman for the I.I.F. said that Mr. Dallara had a previously planned personal engagement in Paris and that progress was being made with regard to securing an agreement.

During an interview broadcast Sunday on the Greek television Antenna, Mr. Dallara emphasized that creditors were insisting on 3.8 percent to 4 percent. “This is certainly the maximum offer that is consistent with the voluntary debt exchange,” he said. “It is largely in the hands of the official sector to choose the path — a voluntary debt exchange or a default.”

With the Greek economy forecast to shrink by 6 percent this year and 3 percent next year, the ultimate goal of Greece lowering debt to 120 percent of gross domestic product by 2020 is seeming more and more unrealistic. With G.D.P. plummeting, the I.M.F. is insisting that Greece’s debt load — currently 160 percent of GDP — be reduced more quickly and that the private sector pay its fair share.

Bankers say that the fund has been demanding a coupon rate of below 3.5 percent for bonds maturing by 2014. Over subsequent years, the rate would escalate to 4 percent and above as the economy improved.

A majority of the funds the I.M.F. has disbursed so far has been paid out to Greece’s bondholders as opposed to helping Greece itself. Of the close to 20 billion euros that the fund has so far disbursed, two-thirds has gone to pay back bondholders — an increasing number of whom have been hedge funds betting that this trend will continue.

A debt restructuring agreement is a precondition for Greece to receive its next installment of aid from Europe and the I.M.F., 30 billion euros that the country needs to stave off bankruptcy. European Union finance ministers were to resume talks Monday on solutions to the region’s debt crisis.

To be sure, getting Greece and its bankers to agree on a deal to restructure 200 billion euros in debt was never going to be easy, given the many different constituencies involved. And bankers say there are a number of other important technical issues that also must be ironed out, from what kind of collateral would be used to back the new bonds to how long their maturities would be.

Also holding up discussions was the question of what to do about the European Central Bank’s 55 billion euros in Greek bonds. The E.C.B.’s refusal to take a loss has been regularly cited by investors as unfair, and many have said that they will sue Greece if they have to take a loss while the E.C.B. does not.

To get around this, official are now discussing the possibility that Europe’s rescue fund might lend money to Greece to allow it to buy the bonds back from the E.C.B. at the price the central bank paid for them — thought to be about 75 cents on the euro.

The E.C.B. would then not have to take a loss on these holdings. By selling them back to Greece, it would remove itself as an obstacle to a broad restructuring agreement.

“Both sides know that a deal has to get done,” said a banker who asked not to be identified because he was closely involved in the talks. “But they have to dance this dance to get there.”

Separately, the German magazine Der Spiegel reported that Italian Prime Minister Mario Monti was pushing for an increase in the European bailout fund to 1 trillion euros. That would be more than double the amount that the European Financial Stability Facility is authorized to lend to troubled euro zone countries.

A German government official, who was not authorized to be quoted by name, said Sunday that Germany had received no formal request from Italy to increase the fund. In any case, he said, Germany would be opposed to an increase now.

Germany’s position remains that the way to reduce borrowing costs is for euro zone countries to take steps to reduce debt and remove impediments to economic growth. Recent declines in borrowing costs for Spain and Italy show this is the most effective policy, the German official said.

“We don’t see the need for additional funds,” he said. “It’s not the way to reduce financing costs. You need to do the reforms.”

A spokeswoman for the Italian government had no official comment on the Spiegel report. Mr. Monti has been on record in recent weeks calling on Europe to increase the “firewall” of bailout money available to lend to vulnerable economies.

Jack Ewing contributed reporting from Berlin. Niki Kitsantonis and Rachel Donadio contributed from Athens.

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On Religion: Gemach Offers Loans Without Profit in Jewish Tradition

As he grew into his teens, Hirshy came to learn that his father operated a traditional Jewish free-loan program called a gemach. The visitors, many of them teachers in local religious schools, struggling to raise their families on small and irregular salaries, had been coming to borrow money at no interest and with no public exposure.

Now 39 years old and serving as the rabbi of a Chabad center near Atlanta, Rabbi Minkowicz has done something he never expected: open a gemach that deals primarily with non-Orthodox Jews in a prosperous stretch of suburbia. The reason, quite simply, is the prolonged downturn in the American economy, which has driven up the number of Jews identified by one poverty expert as the “middle-class needy.”

The same phenomenon has appeared in Jewish communities across the country, albeit most often in those with existing Orthodox populations already familiar with the gemach system. This institution, rooted in biblical and Talmudic teachings and whose name is a contraction of the Hebrew words for “bestowal of kindness” (“gemilut chasadim”), is now meeting needs created by such resolutely modern causes as subprime mortgages, outsourcing and credit default swaps.

“I honestly never thought, in my realm here, to start a gemach,” Rabbi Minkowicz said in a recent interview. “I thought people wouldn’t understand it. It’d be a foreign concept. They hadn’t grown up that way. But definitely, definitely, definitely the economy now is the worst. The 13 years I’ve been here, I’ve never seen people go from a regular life to rags. I’ve seen that up-front and personal.”

It is difficult to determine the exact dimensions of the economy’s impact on the Jewish population in general and on the surge in the use of gemachs specifically. The loan programs, often financed and run by families, operate on the basis of anonymity. Governmental statistics on poverty, unemployment, foreclosure and other such measures of the continuing malaise are not broken down by religion, as they are by race.

Still, the evidence points to an economic toll on Jews — not severe enough in most cases to plunge them into homelessness and destitution, or to qualify them for food stamps and Medicaid, but deep enough to destabilize what had been securely middle-class lives. Since the stock market collapse in late 2008 pushed the nation into recession, the demand for food and clothes from Jewish social service agencies and charities has risen by roughly 40 percent, according to their administrators.

“This area of the middle-class needy has just exploded,” said William E. Rapfogel, the chief executive of the Metropolitan Council on Jewish Poverty, which covers the New York area. “We’ve seen people who were making $75,000, even $200,000, lose a substantial portion of income. When they lose a job, they get another, but it’s a job for less. They’re so over-leveraged in their homes, they can’t get out. If they sold, they wouldn’t take out a nickel.”

On Staten Island, the borough of New York most akin to a suburb, Rabbi Moshe Meir Weiss of the Agudas Yisroel synagogue has seen that situation. In the past, Jews in his community used gemachs primarily to borrow items they needed for only a limited time: a wedding dress, rubber bins for moving furniture, a wig to cover hair lost to chemotherapy, even breast milk for a nursing child. Over the last several years, however, the gemachs have increasingly dispensed cash loans and groceries.

“People have been so taken by shock,” Rabbi Weiss said. “Picture yourself, God forbid, having to take a can of tuna from someone. It’s almost like the soup lines of the Great Depression.”

The gemach system, however, offers two tangible differences. First, as a matter of religious teaching and longstanding custom, a gemach makes no profit on its loans. Second, the tradition of confidentiality, rooted in Judaic commentaries about giving and receiving charity, allows a supplicant to save face.

“When it’s within your own group, it’s less embarrassing,” Rabbi Weiss said. “You feel your compadre understands and is doing it out of love.”

In suburban Atlanta, Rabbi Minkowicz had similar thoughts in mind last August, when a congregant approached him with an idealistic but unformed proposal. The man had seen the toll that corporate layoffs and the cratered housing market had taken on the local Jewish community. He and his wife, both professionals in public-sector jobs, had saved $5,000 to do something about it. Their question was what.

At that point, Rabbi Minkowicz explained about gemach, a word the donor had never heard. What impressed the man immediately, in this era of celebrity charities and naming rights, was the quality of humility. A borrower would not be subjected to a credit check or required to put up collateral, only to have another member of the Jewish community co-sign. The donor could remain unknown.

“I could help people without seeming like I’m showing off,” the man said. Indeed, he spoke for this column only on the promise that his identity not be revealed.

By now, four months later, the resulting gemach has made two loans of about $1,000 apiece, with a third imminent. As those borrowers repay the gemach, at the rate of roughly $100 a month, Rabbi Minkowicz can in turn recycle the money to others who need it.

All of which puts him in mind of those knocks on the door in Brooklyn decades ago, and of the decorous way his father answered. “I’ve tried to use the same model I saw,” Rabbi Minkowicz put it. “You help the people who are struggling. And you try to preserve their dignity.”

E-mail: sgf1@columbia.edu

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DealBook: Italian Bond Dispute Illustrates Obstacles to Triggering C.D.S.

Seat Pagine Gialle is the publisher of the Italian yellow pages directories.Chris Warde-Jones/Bloomberg NewsSeat Pagine Gialle is the publisher of the Italian yellow pages directories.

The publisher of the Italian yellow pages directories, Seat Pagine Gialle, has missed a payment on its bonds and announced a tentative agreement to cancel the bonds and issue shares in the company instead. But that agreement may collapse because of a disagreement over how much stock will be issued.

That sounds like a prime example of how bondholders could have protected themselves by buying credit-default swaps, which are supposed to assure that investors will not suffer if a creditor defaults.

But it may not be.

At a meeting Monday, a committee of the International Swaps and Derivatives Association, the trade group that administers the credit-default swap, was unable to decide whether a “credit event” had taken place. So the decision was delayed until a group of three independent experts could be appointed to consider the issue.

All this may soon be moot if the company does not manage to make the bond payment by Wednesday. In the meantime, however, it serves to emphasize how difficult it can be to determine whether a credit event has taken place. If it has, procedures go into place to determine how large the losses are and require those who issued the credit-default swaps to pay that amount to the purchasers.

Under the association’s rules, in some cases there is no event if investors “voluntarily” agree to exchanges that in reality cost them money, a fact that has made it seem likely that credit-default swaps on Greek debt will not be activated if a European plan to encourage banks to exchange their bonds for bonds worth half as much goes through. Since that exchange would not be mandatory, the swaps would not be activated if interest payments continue on the bonds that are not swapped.

Yellow page directories have lost business everywhere, and Seat has tried to expand its Internet business. But it reported a loss of 33.2 million euros for the first nine months of this year, and on Oct. 28 it said it would delay an interest payment of 52 million euros, or about $69 million, for a month.

Last week, it said it had reached a tentative agreement with a majority of creditors, but that disputes remained with its senior debtholders over how much equity would go to the holders of 1.3 billion euros in bonds. It said that if a final deal were reached and accepted by bondholders, it would make the interest payment by Wednesday.

The swaps association’s committee for Europe — the same one that would determine whether a Greek default occurs — met three times over the last two weeks and delayed a decision. On Monday, eight of the 15 members voted there was a credit event, but the other seven voted that there was not. Since support of 12 members is needed, the proposal failed.

Six of the 10 members that came from banks that make markets in swaps voted that there had been an event, but only two of the five members that come from institutions that invest in swaps agreed. The association said no one would discuss reasons for their votes.

If the tentative deal falls apart and the interest payment is missed, there would be no doubt that a credit event had taken place. But since Seat Pagine Gialle is trying to get a voluntary agreement for a swap of the bonds for stock, it may be possible that there would be no credit event at all, even though it will be clear that bondholders have suffered a major loss.

With a new doubt regarding whether the swaps would be activated, the price of credit-default swaps on the company dipped a bit on Monday, but remained high. Markit, a market information firm, said the cost of buying a swap on 10 million euros of bonds was 7.25 million euros on Monday, down from 7.95 million euros on Friday.

Article source: http://dealbook.nytimes.com/2011/11/28/italian-bond-dispute-illustrates-obstacles-to-triggering-c-d-s/?partner=rss&emc=rss

Fair Game: Credit Default Swaps as a Scare Tactic in Greece

Leading the charge is BNP Paribas, the big French bank, which has been hired by the Greek government to help persuade investors to accept a deal that would cut the value of their investments in half.

On paper, this restructuring would be voluntary. Bond holders would exchange their old Greek bonds, at a 50 percent loss, for new ones that would mature in 30 years. Painful, yes. But in theory, such a move would help Greece get a handle on its debt, and that would be good for everyone.

Behind the scenes, however, BNP officials seem to be twisting some arms. A big point of contention is — surprise! — derivatives.

Investors who own Greek debt and have bought insurance on it, in the form of credit default swaps, wonder why they should accept the offer that’s on the table. If Greece stops paying after the restructuring, those swaps are supposed to cover their losses, much the way homeowners’ insurance would cover a fire.

The International Swaps and Derivatives Association agrees. The group, which represents the industry and is largely controlled by big banks, says anyone who doesn’t like the offer can walk away. “If a payment is missed, trigger the C.D.S. and be made whole,” the group said on its Web site.

BNP and its client, Greece, want to corral as many investors as they can. The more bond holders they persuade, the more that Greece would benefit — and the more the bank would collect in fees.

So it is perhaps unsurprising that some recent meetings have taken on a forceful tone, according to three portfolio managers who attended three different sessions with BNP Paribas. The investors spoke on condition of anonymity because they feared retaliation by the bank.

Contrary to what the I.S.D.A. says, the BNP Paribas bankers have been telling bond holders that their credit insurance may not pay off down the road, because after the restructuring is completed, the terms of the old debt might be changed, these money managers said.

Normally, investors would shrug off such an argument.

But the warnings from BNP Paribas carried weight, the money managers said, because of one of the officials who was making them. She is Belle Yang, a BNP specialist who also happens to serve on a powerful I.S.D.A. committee. The panel, the “determinations committee” for Europe, decides what constitutes a “credit event” in Greece or elsewhere on the Continent.

This is the committee that will likely rule that the Greek deal would not constitute a default. That is because the restructuring would be “voluntary.” Some investors who were counting on their credit insurance would be out of luck.

In the meetings, the investors said, Ms. Yang identified herself as a member of the committee. That itself was unusual, because the names of I.S.D.A. committee members are normally kept confidential. The association doesn’t disclose them, and lists only panel members’ employers — 15 large global banks and financial services firms. Those institutions include Bank of America, BNP Paribas, Goldman Sachs, BlackRock and Pimco.

One of the money managers who attended the meetings said Ms. Yang’s presence seemed to raise a conflict. Ms. Yang works for BNP, which stands to profit from the restructuring. She is also on the I.S.D.A. panel, which will determine if credit default swaps pay off.

One of the money managers said he pointed out Ms. Yang’s dual role at a meeting.

“You’re on the determinations committee, your firm is earning a big fee and trying to scare me into tendering my bonds,” he said he told her. He said Ms. Yang replied: “No, I’m just trying to help tell you what could go wrong.”

A BNP Paribas spokeswoman declined to comment.

According to one of the money managers, Ms. Yang told the investors that one potential hitch would be if Greece were to change the terms of its old bonds. Ninety percent of those bonds are governed by Greek law, so the government could, in theory, redenominate an issue, say, from $1 billion par value to $100 million. This would require holders to deliver far more bonds to receive the amount of insurance they thought they were owed.

Responding to an e-mail request, Ms. Yang declined to comment, citing “our policy not to comment on matters to do with the I.S.D.A. Determinations Committee.”

It is interesting that an I.S.D.A. committee member would argue that credit default swaps may not pay out. The organization is already facing criticism over its expected ruling that the Greek restructuring is voluntary.

The I.S.D.A. wields enormous power in the derivatives market. Since 2009, it has required that all contracts struck with its members adhere to rulings by its committees on credit events. Before then, counterparties could take disputes to arbitration or court.

The money managers with whom I spoke said BNP Paribas seemed to be motivated either by its desire to generate fees from the exchange or, perhaps, by worries about its own exposure to Greece. They wondered, for instance, if BNP Paribas has written a lot of insurance on Greek debt. If so, getting people to unwind such swaps now would be less costly for BNP than having the insurance pay off.

If investors think debt terms can be changed by fiat, they will flee the market. Ditto if they find that their insurance can be made worthless. Indeed, some of the volatility in European debt recently may be attributed to investor fears about these issues. The discussions with BNP Paribas confirm the view of some investors that credit default swaps are not insurance at all, but rather instruments that big banks use to benefit themselves. The secrecy of who serves on I.S.D.A. committees feeds this fear, as does the fact that these panels are both judge and jury.

“Market forces like to think of market pricing as having symmetry,” said David Kotok, founder of Cumberland Advisors, a money management firm in Sarasota, Fla. “But a system which requires decisions by parties who have vested interests on one side is asymmetric. A surprise rule change or an interpretation which was understood by some and misunderstood by others also defeats symmetry. In the case of credit default swaps, both elements apply.”

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G.A.O. Says New York Fed Failed to Push A.I.G. Concessions

The report, by the Government Accountability Office, says that New York Fed officials have offered inconsistent explanations for their decision to pay other financial companies the full amounts they were owed by A.I.G., and that some of the explanations were contradicted by other evidence.

The report also asserts that the decision to pay the full amounts, rather than seeking concessions as the government later did in other cases, disregarded the expectations of senior Fed officials in Washington and the expressed willingness of some of the companies to accept smaller payments.

In one case, when a company offered to accept a smaller amount of money, officials at the New York Fed responded that they had decided to pay the full amount of the debt, the report said.

The agency’s report revisits a controversial chapter in the history of the financial crisis: the government’s decision to sink tens of billions of dollars into A.I.G., the world’s largest insurance company, which was running out of money to cover its vast and losing bets on the health of the housing market. Much of that money was then paid to other companies to honor their outstanding contracts with A.I.G.

The basic conclusion echoes the findings of previous federal investigations. The rescue mission succeeded, but efforts to minimize the costs and risks borne by taxpayers were insufficient. But the new report also raises concerns about the explanations subsequently offered by New York Fed officials.

For example, the G.A.O. says that officials at first told its investigators that they had initiated discussions about possible concessions with most of the 16 companies that stood on the other side of insurance-like contracts, called credit-default swaps, with A.I.G.

Then, according to the report, the officials said they had contacted eight companies before abandoning the effort. Even then, the report said, only four of those companies confirmed that they had been contacted by the Fed.

The New York Fed declined to comment on the specific account of the negotiations. Officials of the bank, including Timothy F. Geithner, then the president of the New York Fed and now the Treasury secretary, have testified that they needed to act quickly to prevent greater damage to the financial system, and that they chose the approach that was most likely to succeed and easiest to enact.

The bank said in a statement Monday that it had “put together an effective lending program that minimized disruption to the economy from A.I.G. while safeguarding the taxpayer interest.”

Representative Elijah E. Cummings, Democrat of Maryland and the ranking member of the House Oversight Committee, said the report highlighted the importance of the financial legislation passed last year.

“This report reinforces the need to implement provisions in Dodd-Frank that will prohibit the use of taxpayer dollars to artificially prop up or benefit one firm,” said Mr. Cummings, who with Representative Spencer Bachus, Republican of Alabama and the chairman of the House Financial Services Committee, requested the report as a final word on the controversy.

The Federal Reserve Board of Governors voted in September 2008 to let the New York Fed lend up to $85 billion to A.I.G. as part of a deal that placed the company under federal control. The bailout was expanded several times, ultimately expanding to more than $180 billion. And roughly a quarter of that money was used to pay 16 companies that had bought credit-default swaps from A.I.G. — a roll call of the most prominent names on Wall Street, including Deutsche Bank and Goldman Sachs.

Federal Reserve officials in Washington expected that the New York Fed would negotiate discounts with those companies since, without the government’s intervention, they might have received far less.

An analysis commissioned by the New York Fed recommended concessions around $1.1 billion to $6.4 billion. But according to the New York Fed, when it asked companies if they were willing to accept voluntary discounts, only one company said yes, conditional on everyone else doing it, too.

New York Fed officials told the G.A.O. that they had little leverage to secure concessions from the companies. Moreover, they concluded that A.I.G.’s inability to secure concessions in earlier negotiations suggested that the banks were unwilling to compromise. And they were constrained by a decision to apply the same repayment terms to all of the counterparties.

The G.A.O. report questions the basis of the Fed’s insistence on equal treatment, noting that there were significant differences in the quality of the assets covered under the insurance agreements, and therefore the potential losses for each company were quite different. An analysis found that under extreme conditions, the losses would vary from 75 percent of the original value down to 1 percent.

The differences, the study concluded, “might have offered an opportunity to lower the amount” that the government sank into the rescue. Fed officials told the G.A.O. that negotiating with each company individually was impossible given the pressure to act.

The report also questions the Fed’s assertion that it could not wrest concessions from French banks — who held some of the largest contracts — because French law banned them from accepting discounts unless A.I.G. had filed for bankruptcy. A French official told the G.A.O. that there was no such prohibition, although such a decision might have raised legal concerns.

The Fed’s actions contrast with the agreement that European governments, led by Chancellor Angela Markel of Germany, secured from some of the same institutions in October to accept discounts of up to 50 percent on their holdings of Greek debt.

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DealBook: When a Bankruptcy ‘Event’ Doesn’t Mean Bankruptcy

A subsidiary of Energy Future Holdings operates a natural gas plant in Dallas. Aurelius Capital said the Texas power company is in default on a loan.Matt Nager/Bloomberg NewsA subsidiary of Energy Future Holdings operates a natural gas plant in Dallas. Aurelius Capital said the Texas power company is in default on a loan.

In finance and law, bankruptcy is understood to mean a process for resolving financial distress, like those under the United States Bankruptcy Code or the Companies’ Creditors Arrangement Act in Canada. State law assignments for the benefit of creditors could also been seen as a bankruptcy process under this definition.

In common parlance, bankruptcy is often used more casually, to mean something like broke or insolvent.

Which version, then, would you expect would apply to a bankruptcy trigger in a credit default swaps contract?

You might be surprised.

Section 4.2 of the 2003 International Swaps and Derivatives Association’s credit derivatives definition lists seven categories that could set off a bankruptcy credit event and thus a payout from a protection seller. There is also an eighth category that picks up any event that is analogous to the first seven. The precise language is set forth in the document below.

Take a close look at Part (b) of Section 4.2, which provides that

Bankruptcy means a Reference Entity . . . becomes insolvent or is unable to pay its debtors or fails or admits in writing in a judicial, regulatory or administrative proceeding or filing its inability generally to pay its debts as they come due.

Not exactly polished English grammar, but corporate lawyers are rarely rewarded for that.

Now, one credit default swap protection buyer wants to argue that the phrase “becomes insolvent” means that a bankruptcy credit event involves bankruptcy in the colloquial sense of the work.

The issue involves Aurelius Capital Management, no novices in the world of distressed debt world, which, one can surmise, holds lots of credit default swaps that reference the Texas Competitive Electric Holdings Company.

The Texas Competitive Electric Holdings Company is not a public company, but a subsidiary of two reporting companies. And in a recent registration statement, one of those parent companies said this as part of its discussion of the “risk factors” associated with the registration:

Analyses of TCEH’s business indicate that the principal amount of its outstanding debt exceeds its enterprise value.

Aurelius Capital has asked the International Swaps and Derivatives Association committee that considers these matters to rule that the “becomes insolvent” language in part (b) means insolvency in a balance sheet sense of the word, and that, among other things, the above registration statement language constitutes an admission that the Texas Competitive Electric Holdings Company is insolvent on that basis.

In short, Aurelius Capital wants to say there has been a bankruptcy credit event, without any actual bankruptcy or similar proceeding.

This could have major implications for the broader market for credit default swaps. Among other things, it would seem that if this interpretation is adopted, any company with negative shareholder equity on its books has also triggered the credit default swap contracts that reference it.

That includes a lot of companies, including some that have reasonably good share prices, which presumably reflect the possibility of a brighter future. For example, AMR, parent company of American Airlines, reported assets of $25 billion and liabilities of $29 billion on its 2010 10-K filing.

Has it also triggered a bankruptcy credit event? If so, how do we explain current credit default swap prices, taken from Bloomberg, which show price of about $2,400?

If there has been a credit event, the credit default swap prices should equal the payout on the credit default swap because the buyer would essentially be buying the right to the payout. Of course, one doubts there would be any sellers in such a situation.

Other major companies with negative book equity — based on their most recent 10K as reported on Bloomberg Law — include Ford, Clorox, Cablevision Systems, Lorillard and Moody’s (irony noted).

If all of these have experienced credit events, the credit default swap market is in for some major dislocation.

This is but one reason why Aurelius Capital’s argument can’t be right, no matter how clever and seemingly plausible it is in the abstract. More generally, their proffered reading of Part (b) really makes no sense in the broader context of Section 4.2, which is entirely focused on bankruptcy in the legal and financial sense of the word.

Rather, it seems to me that Part (b) is really trying to capture something like the criteria that would support filing an involuntary bankruptcy petition under Section 303(h) of the Bankruptcy Code. That makes Part (b) consistent with the other elements of Section 4.2.

The drafting is awkward, but does it make any sense to generate a credit default swap based on a financial condition that is not tied to any actual default? Clearly there is no hedging reason for such a thing, and even on the speculative side it seems unlikely that such a provision would be buried deep within the definition of bankruptcy.

All of this is no doubt behind the International Swaps and Derivatives Association’s decision on Thursday that no bankruptcy credit event had occurred.

Here’s betting that the International Swaps and Derivatives Association amends this provision in the next round of credit default swap definitions.

International Swaps and Derivatives Association’s credit events definitions

Stephen J. Lubben is the Daniel J. Moore Professor of Law at Seton Hall Law School and an expert on bankruptcy.

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