Screwing Bondholders: Ending Bondage

The biased legal system lets bondholders make extortionate demands against workers, poor countries, ….  President-elect Clinton learned how bond markets can even intimidate the government from exercising reasonable policies.  So, with a bit of schadenfreude, I am glad to learn that Blackstone has the right to screw bondolders. Why should Blackstone have more rights than ordinary people?  Why can’t we organize to put some limits on the untrammeled power of financial markets, including that of Blackstone?

Here is the story:

Denning, Liam. 2010. “Blackstone Might Rewire Dynegy’s Balance Sheet.” Wall Street Journal (16 August).

http://online.wsj.com/article/SB10001424052748704868604575433722961359484.html?mod=WSJ_Markets_section_Heard

“It isn’t often a 62% premium offers reason for grumbling. Blackstone Group‘s takeover offer for Dynegy effectively gives it two-thirds of the company’s generation capacity plus cash for no money down. That is because NRG Energy has simultaneously agreed to buy about a third of Dynegy’s megawatts for $1.36 billion, or about $800 million more than the price tag for Dynegy’s equity.”

“Why didn’t Dynegy sell the assets to NRG and keep the money itself? Probably because it did this a year ago for no discernible gain. In August 2009, Dynegy sold about a quarter of its capacity to LS Power to boost liquidity. That didn’t stop the stock dropping from about $10 then to less than $3 before Blackstone showed up.

If shareholders are miffed, it is Dynegy’s bondholders that have real reason to worry. Should Blackstone decide to dividend the entire proceeds of the NRG deal back to itself, Dynegy will be left carrying its existing debt load on a smaller stream of profits. That would raise the company’s already high credit risk. But then Blackstone, sitting on a potential $800 million instant profit and with no other shareholders to protect, need not worry too much about that.”

“Alternatively, Blackstone could use some of that profit to buy in some of those bonds. Doing so would reduce Dynegy’s debt burden and, possibly, its cash interest costs, potentially boosting Blackstone’s return when it sells the company down the road.  This likely would only make sense, however, if Blackstone bought the bonds below even today’s market values of between 60 and 80 cents on the dollar. Shareholders might wish they got a higher premium. Bondholders may end up scrambling to limit their losses.”

2 comments so far

  1. Stephan on

    Michael,

    I disagree. There’s no such thing as vigilant bond holders blackmailing a sovereign government. Bond holders can only exert pressure on sovereign issuers if the bond is denominated in (i) a foreign currency (i.e. Baltic) or (ii) in currency pegged to a reference foreign currency or basket (i.e Eurozone) or (iii)in currency convertible to gold … This 3 monetary arrangements pose a solvency risk.

    Now the US government is the monopoly issuer of its FIAT currency US$ which floats on foreign exchange markets and is non-convertible. By definition the US government can always meet it’s interest and principal payments except Congress chooses for some political reason not to so. Sophisticated bond market participants know this and that’s why they like treasuries.

    But of course they take advantage of a stupid/ignorant administration which is hostage of some incompetent or ideologue economists and ask for higher yields. Fair enough. I think a reasonable number of academic scholars knows this but because of their anti-government bias either ignore or simply lie about that fact. And then there also complete idiots like Laurence Kotlikoff.

    It’s useless to argue about bonds per se. Bonds are simply a tool to drain nominal demand from the private sector in exchange for an interest-bearing risk-free financial asset. There’s no economic rule to issue bonds 1:1 for government spending. And the proper tool for government to further public purpose is fiscal policy provided the government has an idea public purpose.

    Which the Obama administration has not. End of story.

  2. mperelman on

    I am thinking of the people who buy up higher discounted bonds, then demand full payment. The courts generally comply.


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