Debt-for-Equity Swaps
In a debt-for-equity swap, a
company's creditors generally agree to cancel some or all of the debt in
exchange for equity in the company.
Debt for equity deals often occur when
large companies run into serious financial trouble, and often result in
these companies being taken over by their principal creditors. This is
because both the debt and the remaining assets in these companies are so
large that there is no advantage for the creditors to drive the company into
bankruptcy. Instead the creditors prefer to take control of the business as
a going concern. As a consequence, the original shareholders' stake in the
company is generally significantly diluted in these deals and may be
entirely eliminated, as is typical in a Chapter 11 bankruptcy.
Debt-for-equity swaps and the subprime mortgage crisis
Further information: Subprime mortgage
crisis solutions debate
Debt-for-equity swaps have also been
discussed as a way of dealing with sub-prime mortgages. A householder unable
to service his debt on a $180k mortgage for example, may by agreement with
his bank have the value of the mortgage reduced (say to $135k or 90% of the
house's current value), in return for which the bank will receive 50% of the
amount by which any resale value, when the house is resold, exceeds $135k.
Bondholder
haircuts
A debt-for-equity swap may also be called a
"bondholder haircut." Bondholder haircuts at large banks were advocated as a
potential solution for the subprime mortgage crisis by prominent economists:
Economist Joseph Stiglitz testified that
bank bailouts "...are really bailouts not of the enterprises but of the
shareholders and especially bondholders. There is no reason that American
taxpayers should be doing this." He wrote that reducing bank debt levels by
converting debt into equity will increase confidence in the financial
system. He believes that addressing bank solvency in this way would help
address credit market liquidity issues.
Economist Jeffrey Sachs has also argued for
bondholder haircuts: "The cheaper and more equitable way would be to make
shareholders and bank bondholders take the hit rather than the taxpayer. The
Fed and other bank regulators would insist that bad loans be written down on
the books. Bondholders would take haircuts, but these losses are already
priced into deeply discounted bond prices."
If the key issue is bank solvency,
converting debt to equity via bondholder haircuts presents an elegant
solution to the problem. Not only is debt reduced along with interest
payments, but equity is simultaneously increased. Investors can then have
more confidence that the bank (and financial system more broadly) is
solvent, helping unfreeze credit markets. Taxpayers do not have to
contribute dollars and the government may be able to just provide guarantees
in the short-term to further support confidence in the recapitalized
institution.
For example, one of the largest U.S. banks
owed its bondholders $267 billion per its 2008 annual report. A 20% haircut
would reduce this debt by about $54 billion, creating an equal amount of
equity in the process, thereby recapitalizing the bank significantly.
Informal
Debt Repayment Agreements
Most defendants who cannot pay the
enforcement officer in full at once enter into negotiations with the officer
to pay by installments. This process is informal but cheaper and quicker
than an application to the court.
Payment by this method relies on the
co-operation of the creditor and the enforcement officer. It is therefore
important not to offer more than you can afford or to fall behind with the
payments you agree. If you do fall behind with the payments and the
enforcement officer has seized goods, they may remove them to the sale room
for auction.
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