4 ms·

> Blackstone came along with what it pitched as a better deal, but with an unusual provision: Hovnanian had to agree to do it in a way that would trigger credit

> Blackstone came along with what it pitched as a better deal, but with an unusual provision: Hovnanian had to agree to do it in a way that would trigger credit-default swaps, which are essentially side bets on whether the builder meets all of its debt obligations. That would lead to quick gains for GSO because it had been buying short-dated insurance contracts. If this is true, it should be illegal (and probably is). CDS is a derivative, and derivative traders are generally not permitted to manipulate the underliers of their products. It would be like buying stock on a particular expiry date to push a much larger, cash-settled digital option into the money. Expect a flurry of legal action if things go according to plan for GSO.

whatok 9y ago
Not going to comment on the legality of this but this isn't the first time BX has done this and nothing happened previously. See [0]. I actually don't necessarily have a problem with this as the underlying company theoretically should see a real benefit from this. [0] https://www.bloomberg.com/view/articles/2013-12-05/blackstone-made-money-on-credit-default-swaps-with-this-one-weird-trick https://www.bloomberg.com/view/articles/2013-12-05/blackston...
- totalZero 9y ago
  In the Hovnian case, there have been some indications that there will be legal action if the triggering goes through. https://www.bloomberg.com/news/articles/2017-11-15/a-high-stakes-hedge-fund-battle-erupts-over-hovnanian-debt-deal https://www.bloomberg.com/news/articles/2017-11-15/a-high-st... https://www.wsj.com/articles/home-builder-accused-of-default-swap-scheme-with-blackstone-unit-1512168887 https://www.wsj.com/articles/home-builder-accused-of-default... Even if an individual trader buys stock in a company to manipulate a derivative and your price impact is beneficial for the shareholders, twenty executives, and a hundred pension funds, FINRA will not give you a free pass when they investigate him. No idea how complicated it gets at the institutional level, but I can't imagine there is a very strong argument for allowing manipulation to occur in this instance. Even if the company gets a cash injection, all of the counterparties who sold protection via CDS will get housed. I don't know who those counterparties are, but it's easy to imagine that they are trading with money from many sources, including university endowments, pension funds, insurance companies, and so forth. So where do you draw the line between beneficial manipulation and detrimental manipulation?
  - whatok 9y ago
    I've read the Solus letter and like I said earlier, no comment on legality as that's not my domain. Just wanted to point out previous BX case.
  - valuearb 9y ago
    So now CDS sellers are too big to fail? I imagine Hovnanian and Blackstone are owned by pension funds, etc, too.
    - totalZero 9y ago
      > So now CDS sellers are too big to fail? Not sure how you came to this conclusion. The point is that you can't argue "this is good for the company/shareholders/lender" if you're selectively choosing the winners without mentioning the losers. It's not compelling, especially not to regulators. The issue is that if you allow manipulation of derivatives, then the markets become totally useless and they reward only the large players who have the resources to make large trades and deals that custom-fit the triggers to their own payoff profiles. Many of the counterparties in the derivatives market trade against the banks where they do business, in effect meaning that banks would be manipulating their own customers if you allow certain manipulative tactics. And like it or not, it's an established fact that manipulation in the derivs market is, broadly speaking, illegal.
      - valuearb 9y ago
        Derivatives are legalized gambling. And this wasn’t manipulation, just two parties doing their fiduciary duties.
        totalZero 9y ago
        > Derivatives are legalized gambling. I don't agree with you. There is a different utility to commodity futures, for example, than to bets on horse races or blackjack games. Derivatives allow tailored hedging of real-world risks. The regulatory stipulations are different, especially for dealers, and there is a far larger opportunity for people with predictive skills in the derivatives market. > And this wasn’t manipulation, just two parties doing their fiduciary duties. By this logic, any profit from market manipulation would be justified because it generates a return for investors. Yet the reason these behaviors are prohibited is because they make the market worse for everyone, arguably including the long-run returns of those very same investors. "Is it beneficial to my investors" is a very poor test to answer the question, "is it manipulation?".
DenisM 9y ago
A company that accepts this sort of a deal is basically trading its reputation for cash. Their CDS in the future will be more expensive, affecting their contract negotiation position. but they are willing to take that future hit for the present ability to survive. I don't see it as obviously wrong, unless the CDS contract itself stipulates otherwise (e.g. multiple damages in case of "voluntary" trigger) or there being a statutory requirement to this effect.
- runeks 9y ago
  Excuse my ignorance on the subject, but isn’t the CDS issued and traded by third parties unrelated to the company it pertains to? I don’t see how the company in question has any moral obligation to not take this deal, nor do I see why it would affect future CDSs, which will almost certainly add a clause that prevents this from happening.
  - whatok 9y ago
    CDS are traded in standard contracts and it would require a lot committee-ish type work to get things changed along with the fact that I'm not even sure how you would define this type of trade in a clear way. Really doesn't happen overnight [0] As far as the issuer goes, issuers get a reputation for fucking over creditors and that makes it hard for them to tap markets in the future (except in these yield hungry days..). People really don't forget about this kind of stuff. [0] https://corpgov.law.harvard.edu/2014/08/24/new-isda-2014-credit-derivatives-definitions/ https://corpgov.law.harvard.edu/2014/08/24/new-isda-2014-cre...
  - totalZero 9y ago
    Liquidity in the CDS market can help creditors hedge their debt to the company in question, so -- setting aside the moral question -- doing something erratic with the derivative market on their own credit would likely hurt their ability to borrow in the future. Creditors would be less confident about hedging, and would offer credit with less favorable terms to compensate.

whatok 9y ago

Not going to comment on the legality of this but this isn't the first time BX has done this and nothing happened previously. See [0]. I actually don't necessarily have a problem with this as the underlying company theoretically should see a real benefit from this. [0] https://www.bloomberg.com/view/articles/2013-12-05/blackstone-made-money-on-credit-default-swaps-with-this-one-weird-trick https://www.bloomberg.com/view/articles/2013-12-05/blackston...

totalZero 9y ago
In the Hovnian case, there have been some indications that there will be legal action if the triggering goes through. https://www.bloomberg.com/news/articles/2017-11-15/a-high-stakes-hedge-fund-battle-erupts-over-hovnanian-debt-deal https://www.bloomberg.com/news/articles/2017-11-15/a-high-st... https://www.wsj.com/articles/home-builder-accused-of-default-swap-scheme-with-blackstone-unit-1512168887 https://www.wsj.com/articles/home-builder-accused-of-default... Even if an individual trader buys stock in a company to manipulate a derivative and your price impact is beneficial for the shareholders, twenty executives, and a hundred pension funds, FINRA will not give you a free pass when they investigate him. No idea how complicated it gets at the institutional level, but I can't imagine there is a very strong argument for allowing manipulation to occur in this instance. Even if the company gets a cash injection, all of the counterparties who sold protection via CDS will get housed. I don't know who those counterparties are, but it's easy to imagine that they are trading with money from many sources, including university endowments, pension funds, insurance companies, and so forth. So where do you draw the line between beneficial manipulation and detrimental manipulation?
- whatok 9y ago
  I've read the Solus letter and like I said earlier, no comment on legality as that's not my domain. Just wanted to point out previous BX case.
- valuearb 9y ago
  So now CDS sellers are too big to fail? I imagine Hovnanian and Blackstone are owned by pension funds, etc, too.
  - totalZero 9y ago
    > So now CDS sellers are too big to fail? Not sure how you came to this conclusion. The point is that you can't argue "this is good for the company/shareholders/lender" if you're selectively choosing the winners without mentioning the losers. It's not compelling, especially not to regulators. The issue is that if you allow manipulation of derivatives, then the markets become totally useless and they reward only the large players who have the resources to make large trades and deals that custom-fit the triggers to their own payoff profiles. Many of the counterparties in the derivatives market trade against the banks where they do business, in effect meaning that banks would be manipulating their own customers if you allow certain manipulative tactics. And like it or not, it's an established fact that manipulation in the derivs market is, broadly speaking, illegal.
    - valuearb 9y ago
      Derivatives are legalized gambling. And this wasn’t manipulation, just two parties doing their fiduciary duties.
      - totalZero 9y ago
        > Derivatives are legalized gambling. I don't agree with you. There is a different utility to commodity futures, for example, than to bets on horse races or blackjack games. Derivatives allow tailored hedging of real-world risks. The regulatory stipulations are different, especially for dealers, and there is a far larger opportunity for people with predictive skills in the derivatives market. > And this wasn’t manipulation, just two parties doing their fiduciary duties. By this logic, any profit from market manipulation would be justified because it generates a return for investors. Yet the reason these behaviors are prohibited is because they make the market worse for everyone, arguably including the long-run returns of those very same investors. "Is it beneficial to my investors" is a very poor test to answer the question, "is it manipulation?".

DenisM 9y ago

A company that accepts this sort of a deal is basically trading its reputation for cash. Their CDS in the future will be more expensive, affecting their contract negotiation position. but they are willing to take that future hit for the present ability to survive. I don't see it as obviously wrong, unless the CDS contract itself stipulates otherwise (e.g. multiple damages in case of "voluntary" trigger) or there being a statutory requirement to this effect.

runeks 9y ago
Excuse my ignorance on the subject, but isn’t the CDS issued and traded by third parties unrelated to the company it pertains to? I don’t see how the company in question has any moral obligation to not take this deal, nor do I see why it would affect future CDSs, which will almost certainly add a clause that prevents this from happening.
- whatok 9y ago
  CDS are traded in standard contracts and it would require a lot committee-ish type work to get things changed along with the fact that I'm not even sure how you would define this type of trade in a clear way. Really doesn't happen overnight [0] As far as the issuer goes, issuers get a reputation for fucking over creditors and that makes it hard for them to tap markets in the future (except in these yield hungry days..). People really don't forget about this kind of stuff. [0] https://corpgov.law.harvard.edu/2014/08/24/new-isda-2014-credit-derivatives-definitions/ https://corpgov.law.harvard.edu/2014/08/24/new-isda-2014-cre...
- totalZero 9y ago
  Liquidity in the CDS market can help creditors hedge their debt to the company in question, so -- setting aside the moral question -- doing something erratic with the derivative market on their own credit would likely hurt their ability to borrow in the future. Creditors would be less confident about hedging, and would offer credit with less favorable terms to compensate.