BusinessBusiness RecoveryDerivatives surge threatens to increase bankruptcies

Derivatives surge threatens to increase bankruptcies

Creditors keen to push companies into bankruptcy because of derivatives boom

Companies are becoming more eager to push troubled companies into bankruptcy
rather than rescue them because of an increase in the use of derivatives, new
research has claimed.

According to the FT a study by University of Texas academics Henry
Hu and Bernard Black found that debt-holders such as banks and hedge funds stood
to gain more from failing companies than ones that survived because of
derivatives.

‘Investors now accumulate positions in a company by targeting layers of debt
or multiple layers of debt. Where their interests lie are less predictable,
especially if they also hold credit default swaps. Their financial interests may
be best served by forcing a default if they are on the right side of a CDS
position,’ said Michael Reilly from financial restructuring experts Bingham
McCutchen.

The study warns that the breakdown in the relationship between lenders and
borrowers threatens the stability of the economy during a credit crunch.

‘Spread across the economy, the “freezing” of debtor-creditor relationships
can increase systemic financial risk,’ the research says.

Further reading:

Corporate insolvencies rise signals economic
woe

Bankruptcies down in 2007, but set to
rise

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