Another problem with Derivatives: It can kill an innocent company too

In the previous post, we talked about AIG and how their pursuit for smaller profit (CDS- credit Default Swap) got them into troubles. (Sorry, the AIG did not get into troubles; we all got into troubles as our Government had to bail them out with our money). That was the result of derivative contracts which shifted risks from risk-averse to risk seekers like AIG for a small amount.

Now what I am going to tell you is the effect of derivatives on innocent players. Yesterday two companies declared bankruptcies- AbitibiBowater, a newsprint producer, and General Growth Properties, a mall owner. Usually when companies (bond issuers) are in trouble, they renegotiate their debt terms with their lenders. Lenders also respond. Instead of losing all money, they let go some of it and often the company restructures and this little or big sacrifice by bond holders/lenders helps the company, its employees, suppliers, stock holders, customers etc. Many bankruptcies are avoided this way and such companies get another chance.
Now welcome to the new world of derivatives and CDS! The lender has bought 'bond insurace' from companies like AIG so they care less if the company survives or goes under. They have the insurance to get full value back!!! I read somewhere that for these two companies- AbitibiBowater and General Growth Properties- they were pushed in bankruptcy because some of the their biggest lenders were less interested in these companies' future because they had the insurance. So for them, the best thing was to care less and get full value from their CDS partners (bond insurers). So the lenders just did not respond to SOS by these two companies and their reluctance in my opinion played a key role in pushing them into bankruptcies. In normal world- world withour derivatives, they may have survived, or maybe not, who knows.
This is just one perspective on how the rules of the game are shifting now.