(MarketWatch) The creation of a "car czar" to oversee the federal bailout of Detroit's car makers might trigger what's known as an event in the vast market for credit-default swaps, prompting holders of General Motors Corp. and Ford Motor Co. credit protection to demand payments from their counterparties, analysts said.
Such an event is also likely if a federal bailout falls flat and either company files for bankruptcy, as many investors fear.
On Wednesday, Congressional Democrats and the White House reached a deal to give $15 billion in loans to the struggling GM , Ford and Chrysler LLC.
The agreement would create a presidentially appointed "car czar" who would have the power to dole out loans - and could force the companies into bankruptcy if they didn't cut deals with labor unions, creditors and other businesses, said the Associated Press. See full story on auto maker bailout.
It's this appointment of a government administrator to oversee auto makers' large expenditures and asset sales that has raised the possibility of a bankruptcy event for credit default swaps, said Banc of America Securities analyst Glen Taksler.
He noted that the International Swaps and Derivatives Association, the trade association that acts as a standard-setter for credit derivatives trading, says one trigger for a bankruptcy credit event is the appointment of an administrator, trustee or similar official to oversee all or most of an entity's assets.
But it's unclear whether the potential car czar's powers would correspond with the ISDA definition. The authority to review and prohibit certain transactions, or what's been discussed in one piece of draft legislation, is different from having control over assets, Taksler noted.
"The result may depend on the exact wording of a potential bailout package," he wrote in a report made public late Tuesday.
"We find arguments both for and against an autos czar triggering CDS," he said, adding: "The actual process is likely to be determined through ISDA."
If the auto maker bailout does amount to a credit event, it would create another shock in the $50 trillion market for credit default swaps. Risk premiums have been ballooned since the bankruptcy of Lehman Bros. and the near collapse of American International Group in September.
Lehman's failure - the largest U.S. bankruptcy ever - met the usual definitions of a credit event, where sellers of credit protection were forced to pay holders of this protection in the wake of its bankruptcy. Roughly $5.2 billion was transferred from sellers of protection on Lehman debt to buyers of that insurance, netted for offsetting positions.
A wave of such events in September, including Washington Mutual Inc.'s failure, government takeovers of Fannie Mae and Freddie Mac, had raised concerns that the CDS market could crack under the weight of so many contracts settling in such a short time.
Risk of bankruptcy has sent credit spreads on auto makers' debt to deeply distressed levels.
According to Markit, credit default swaps on GM debt traded at 9,837 basis points late Wednesday. These spreads means that a buyer of protection on $10 million in GM debt would pay $9.84 million to the CDS seller. At the beginning of September, a buyer would have paid $2.53 million to protect against the same amount of debt.
"Sellers of protection are demanding these punitive prices due to the uncertainty surrounding GM and the high probability it will file for Chapter 11 if a rescue package isn't agreed," said Gavan Nolan, vice president in credit research at Markit.