This is the story of YRC , a trucking company with 55,000 employees and revenues of about $9 billion.
YRC got in trouble in 2008, like many, especially the "too big to fail" financial institutions, when the credit market collapsed and they couldn't refinance their debt. They asked their bondholders to swap their debt for equity. In other words, in exchange for being lenders, they'd become owners.
This is common to prevent reorganization (bankruptcy). The business was basically strong. The process of convincing bondholders to forgive about $500 million of debt was long and arduous. But YRC managed to convince most of them. Except $40-50 million worth. YRC couldn't even locate the owners of those bonds. YRC and its advisers were puzzled. Why would a bondholder force them into bankruptcy? Then they'd get nothing.
Enter credit default swaps. Ordinary people (that is, people that have regular lives and no time or patience for arcane jargon designed to obscure), don't run across the concept much. So let me explain.
With CDSs, you can take out insurance that the target will fail, in this case YRC. You can make a lot of money that way. You don't even have to own stock in the company. It's like betting that your neighbor's house will burn down. Maybe your house benefits from not having a smoking pile of bricks next door (helps preserve property values) but you can make lots more burning your neighbor's house down. Who cares if the family's inside?
CDSs are not transparent. In fact, they're opaque. They're not traded on an exchange, prices aren't public and you don't know who holds them or how much. Often they're simply the result of a phone call between two parties.
It turned out that the $40-50 million was held by the NY hedge fund Brigade Capital. Brigade literally held the fate of YRC and its 55,000 employees and $9 billion in revenue in its hands. To some people, you're worth more dead than alive.
Wall Street vs. Main Street: If it weren't for the intervention of the Teamsters and finally, Pennsylvania state treasurer Rob McCord, who invested state pension funds in Brigade, YRC would have been destroyed so the Brigade Capital hedge fund managers could compete as to who could buy a bigger European castle. Ironically, the Pennsylvania pension fund probably held some money from YRC.
Keep your eye on the Financial Reform bill making its way through Congress. I guarantee transparently that CDSs will emerge intact, unregulated, ready to wreak more havoc on Main Street.