The truth about Blackstone and Codere

By Felix Salmon
December 6, 2013
a single Bloomberg article from October.

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I’ve always felt that the Daily Show should do more financial stuff, and there’s no doubt that Wednesday’s piece on Blackstone was funny. But it was also extremely credulous about a single Bloomberg article from October.

Jon Stewart — a man who, according to the NYT, might be “the most trusted man in America” — said that the Bloomberg piece was “unbelievable story” of how Blackstone engaged in “incredibly egregious behavior” which “should be illegal” — strong words, which elicited smart reactions from both Matt Levine and Dan Primack.

In a sign of the degree to which Bloomberg is implicitly trusted, however, all concerned — Bloomberg View, the Daily Show, Fortune — take at face value the core assertion made by Bloomberg News: that Blackstone made a profit of “from 11.4 million euros to as much as 13.7 million” on its Codere trade.

The article attributes those numbers simply to “data compiled by Bloomberg”, but in fact it’s quite easy to see where they came from. Blackstone, according to Bloomberg, “held 25 million to 30 million euros” of credit default swaps on Codere. It then forced Codere into a technical default (repaying a loan two days late) — which triggered those swaps and forced a payout at 45.5 cents on the dollar. Therefore, the amount that Blackstone received on its CDS position was somewhere between €11.375 million and €13.65 million.

But that number is gross revenue, not profit. The profit on Blackstone’s CDS position can be looked at as being the difference between that payout, on the one hand, and the amount that it spent buying the CDS in the first place, on the other. (Although in fact, as we’ll see, it’s more complicated than that.) Unless we have some idea of Blackstone’s cost basis on this trade, we have no idea what its profit was. Bloomberg, however, seems to simply assume that Blackstone’s cost basis for the CDS was zero — that it managed to accumulate all that insurance without paying anything for it whatsoever.

To be sure, Blackstone are smart operators, and I don’t doubt that they’re making a profit on this trade. But we really have no idea how big that profit was.

And in any case the whole thing was part of a much bigger trade, which has yet to be unwound. Primack explains that “in the first half of 2013, Blackstone affiliate GSO Capital Partners purchased debt and credit default swaps in Codere” — in other words, it entered into a basis trade, where it bought debt in a troubled company and also bought insurance on that debt. But Codere was already a deeply troubled company in the first half of 2013, which means that Blackstone would have had to pay some nontrivial amount of money to buy its CDS position in the first place.

So before we take Levine’s lead and admire the “majestic beauty” of the Blackstone deal, let’s wait and see just how profitable it was. We’re not going to know that for a while, since Blackstone is now a major creditor of Codere, which is (still) at very high risk of defaulting on its debt: when the original Bloomberg article was published in October, Codere’s bonds were trading at a mere 53 cents on the dollar.

The way that Blackstone made some unknown amount of money on the CDS leg of its trade, then, was to take a huge direct exposure to Codere on the other side of its trade. It’s still entirely plausible that Blackstone’s current exposure to Codere could be written down sharply, and could even end up being bigger than the profits on its CDS trade.

Two other points are worth making, here. The first is, as Primack points out, that absent new money from Blackstone, Codere was pretty certain to default in any event. As a result, Blackstone can credibly be painted as the white knight here — as the company which managed to find a way to funnel money from the CDS market back into Codere, thereby avoiding a bankruptcy filing. That’s certainly Blackstone’s view: spokesman Pete Rose says that the trade saved jobs at Codere, as well as lots of money for Codere’s supplier-creditors.

What’s more, it’s worth stopping to ask who Blackstone bought the CDS from, in the first place. Not many people are in the business of writing single-name CDS on a troubled company like Codere, and the people who do engage in such transactions tend to be highly sophisticated investors — and indeed are probably engaging in some kind of relative-value trade of their own.

Add it all up, and I really don’t think that what Blackstone did was particularly egregious; there’s certainly no reason to believe that it should be illegal. The Daily Show basically accuses Blackstone of setting fire to Codere so that it could collect the insurance proceeds — but in fact Blackstone’s actions were a large part of the reason why Codere managed to survive. Far from being a pile of ashes, Codere now has a real chance of avoiding liquidation. For a piece of clever financial engineering, that’s an uncommonly positive societal outcome.

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Comments
10 comments so far

MY GOD! No wonder there are no comments. The sign up process is a nightmare, lol. Not to mention being forced to sign up for some newsletter. Back to this articles point. I agree with most of your assertions that insurance does cost something and so you can’t take the whole payout at face value (yet they did for obvious tv effect). On the other hand, I think you do not have a good moral compass. Example: I make a bet that a fighter will lose and then pay him to take a dive, that’s cheating. It doesn’t matter if the fighter has cancer and his family is starving. Yes, it is nice of you to pay that person to do a service. Especially when it will help him care for himself and his family (or workers). We are not talking about that. We’re talking about cheating on a bet. About insurance fraud in essence. The other guy may have been a regular person as it was with mortgage backed securities. These things have to stop. No one gets to say, we’re a “white knight” because we helped saved this company when they’re also cheating. No one gets to say while I give my wife a good life so that makes me a good husband, but I also kill people. Yes, being good to the company was a great thing and may have even saved it, but that doesn’t mean you get to cheat. Excuse my examples, they’re egregious to try and get the point across to someone it seems will defend these shady deals to the ends of the earth.

Posted by fjosidjf12321 | Report as abusive

All very true, but in the market of public opinion Blackstone was guilty the second their name was mentioned, and no amount of explanation will exonerate them. So kudos to Jon Stewart and the Daily Show for playing to the masses

Posted by CDN_Rebel | Report as abusive

This might be the best article you’ve written in 2013 Felix… and as usual you’ve written some great ones.

Posted by y2kurtus1 | Report as abusive

The forced technical default is interesting, could blackstone have worked out a deal to avoid the technical default? Like waiving some covenant, or extend payment period, etc. or re-structure the debt in exchange for a coupon bump… I don’t know the details of the indenture, did Blackstone make a good faith effort to avoid default? Did blackstone push the technical default knowing the firm would be better off with a default? I have no opinion till I know more about the details.

Posted by jznyc | Report as abusive

We can argue as to the societal benefits and costs of the Blackstone-Cordere deal, and certainly their profit was less than the CDS payout (when not considering the interest that they were charging to Cordere).

But if you were to buy insurance on your neighbor’s house, and burn it down to collect the payout, it would be insurance fraud, and but for the fact that a CDS is not technically “Insurance”, the CDS transaction is insurance fraud.

Technically legal, which is the real problem, but clearly an example of how Wall Street makes its rents through regulatory arbitrage.

Posted by Matthew_Saroff | Report as abusive

They paid those dudes to default. Hard to make that anything but sleazy.

Posted by Eericsonjr | Report as abusive

Good points by Felix.

To the extent that events like this are a problem, it seems like a classic example of something that should be resolved contractually between private parties. As Felix correctly points out, both buyers and sellers of CDS are sophisticated institutions. So, for that matter, are companies issuing debt in large enough amounts that someone will write CDS on them. Changes to the ISDA form for CDS contracts, or language in a corporate credit agreement or bond indenture, could therefore address these issue in couple of ways – specifically, either limiting the circumstances in which CDS pay out or limiting the voting rights of a creditor who is hedged by CDS.

Posted by realist50 | Report as abusive

Of course it is more complicated than what we saw on the daily show. That’s true of just about everything we get from any media.

Whoever sold them that CDS should have had terms that would outlaw tricks like that. Normaly insurance has rules that prevent gaming the system.
Outfits like blackstone make their money by finding the creases and taking advantage of them, so it shouldn’t be surprising. Hopefully this is all part of some complex play that will fall to pieces and end in tears for blackstone, but they have never been looking for my respect.

Posted by whyascreenname | Report as abusive

Could you please turn off the auto-play function for the video that accompanies this post. It is hugely annoying to have the audio come suddenly blasting out of my computer whenever I visit your blog.

Posted by MarkInCA | Report as abusive

Every contract, in the US at least, includes an implied covenant of good faith and fair dealing. Blackstone’s actions as described appear to violate that covenant. Moreover, I wouldn’t be surprised if a motivated prosecutor could find a criminal violation here. It’s disturbing that the article focused on the amount of profit Blackstone made, and not the allegation that the company created the default it collected on. If that is business as usual in the derivative markets, something has to change. Get your moral compass fixed, Felix! Then ask the counter-party how it feels about paying off after Blackstone’s manipulation.

Posted by NYCEsq | Report as abusive
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