Financial Arson: News not Paranoid Fantasy

I have long been interested in the possible use of naked credit default swaps to profit from deliberately driving a firm bankrupt (see here, here, and here). My idea was that this was like arson of a building insured for more than it is worth.

I was not the only one who had this idea. It is no longer a proposed fraud. It is actually committed and caught doing it fraud.

at The Atlantic, Matthew O’Brien discusses reporting by Stephanie Ruhle, Mary Childs & and Julie Miecamp at Bloomberg

1. Buy CDS on a bond, and then bribe the borrower to temporarily default. This is like taking out insurance on your neighbor’s car and bribing him to get in an accident. You get the insurance, and then you kick some money back to him to upgrade his car.

Sound far-fetched? It’s not. It’s essentially what a unit of the Blackstone Group did with the Spanish gaming operator, Codere SA. First, Blackstone bought insurance on Codere‚Äôs bonds, so it stood to make a nice bit of money if Codere missed an interest payment. But how do you make a company miss an interest payment? Well, Blackstone took over one of Codere’s revolving loans, as a hostage, and told the gaming company: “We’ll force you to pay back this entire revolving loan unless you kindly miss the next interest payment on your bonds.” It was a clever ransom. And guess what? The clever ransom worked. The interest payment came late. Blackstone made $15.6 million from its CDS. And as for Codere, they turned out fine, too. Blackstone agreed to restructure its bonds, and reward the company for good behavior with another $48 million loan.

OK I admit I didn’t figure out the part about losing nothing from the default because it is just a late payment. That’s why they make the big bucks. Also I didn’t do it, so I don’t risk jail time. But somehow I don’t think anyone will go to jail over this one either.