Whoops! Something from Left Field

Daniel Gross writing on Slate magazine raises something unexpected (at least for me): the CDSs (Credit Default Swaps) which let companies bet on each other has created a "market" in which debtors are happy to let companies go bankrupt rather than negotiate:

One key economic assumption is that people act to preserve their economic interests. Those who have lent money to troubled companies, for example, generally prefer the company remain solvent; otherwise, they can't get paid back. Similarly, lenders to troubled firms frequently favor swift, out-of-court restructuring deals, in which they swap debt for stock, instead of pushing companies into Chapter 11 bankruptcy. That's because companies in Chapter 11 can languish there for years and waste scarce company assets on huge fees to lawyers, consultants, and accountants.

But if a lender or creditor believes it can profit more from a complete failure—i.e., if it has an insurance policy that pays off only in the event of utter devastation—that creditor might be more inclined to push a company toward bankruptcy. And thanks to the financial innovations of recent years—the rampant use of hedging and credit-default swaps, the ability of investors to purchase insurance on debt—that's exactly what seems to be happening. Creditors are acting to protect their economic self-interest by encouraging companies to destroy themselves.

The article goes on to discuss specifics. It is well worth reading the whole article to understand this new phenomenono.