Matt Levine, Columnist

Hedge Funds Fight Over Sears Swaps

Also insider trading, merchant cash advance and farting Teslas.

December 20, 2018 at 4:40 PM UTC

Matt Levine is a Bloomberg Opinion columnist. A former investment banker at Goldman Sachs, he was a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz; a clerk for the U.S. Court of Appeals for the 3rd Circuit; and an editor of Dealbreaker.

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When Sears Holdings Inc. filed for bankruptcy, that triggered payouts on credit default swaps linked to its debt. The way that CDS pays out is that, some time after the default, the International Swaps and Derivatives Association holds a special auction for the relevant debt, and the price of the debt in that auction sets the payout on CDS. The idea is that even in bankruptcy, holders of the debt will get some recovery, and the auction price is an estimate of that recovery value. And CDS is essentially insurance against default, so it should pay the par value of the debt minus the recovery in default; if the debt is valued at 25 cents on the dollar in the auction, then CDS should pay out 75 cents on the dollar.