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Hedge fund refuses to say whether it has credit default swaps that would benefit from an Illinois default

Tuesday, Aug 13, 2019

* Remember this story?

John Tillman, the CEO of conservative think tank Illinois Policy Institute, and Warlander Asset Management’s Eric Cole, a protege of Appaloosa Management’s David Tepper, are teaming up in an effort to invalidate a whopping $14.3 billion of Illinois debt on the grounds that the state’s pension bond sale in 2003 and securities issued in 2017 to pay a backlog of unpaid bills were in fact deficit-financing transactions prohibited by the constitution.

We’ve been through the constitutional arguments of this case time and again. It’s been called a “crank lawsuit,” “absurd,” “ridiculous” and a “policy paper masquerading as a complaint.”

* There was also this little tidbit buried in some of the coverage

Warlander owns $25 million Illinois general-obligation bonds issued in 2001, 2014, 2017 and 2018. Those bonds would be more secure if the firm succeeded in having the other securities invalidated, since there would be more money available to service the debt.

But is that all this is about for Warlander?

* AllianceBernstein and Nuveen have filed an Amicus Brief in the debt service case. In that brief is this allegation

Warlander is not an Illinois taxpayer – its Complaint asserts a disclosed interest in the litigation that has no economic basis and admits a “separate financial interest in the litigation” that is not disclosed at all. On information and belief, that “separate financial interest” is credit default swaps Warlander purchased that will pay off if this action causes Illinois to default on any of its G.O. Bonds.

A simple question from the bench will resolve the question raised by Warlander’s own Complaint. In any event, the Petition should not be granted until the answer is provided so that the Court can determine whether the Petition is filed not to vindicate the interests of Illinois taxpayers but to allow an out-of-state hedge fund to create a default and profit from its swaps. […]

A credit default swap is a contract similar to an insurance policy on a bond. If the bond defaults, the buyer can collect from the institution that sold the swap. The swap-buyer does not have to own any bonds when it buys its swaps; it can buy the bonds later – even after a default craters the price of the bonds – and tender the bonds to the swap-seller for 100% payment on its swap contract.

Permitting activist investors to litigate against the validity of widely held municipal bonds based on their credit default swap bets could introduce a significant destabilizing force into the municipal markets and harm investors and government entities alike. […]

If public officers “for their own protection” refuse to pay principal and interest on
the challenged bonds until Petitioners’ lawsuit is finally adjudicated, the result will be catastrophic – the bonds will default, Illinois will immediately lose its credit rating and the trading price of the challenged bonds will drop sharply. If Warlander holds swaps, it can then buy G.O. Bonds at bargain basement prices and tender them to the swap-seller at 100 cents – realizing an enormous profit from the catastrophic default it has manufactured. […]

As of the date of that report, credit default swaps on Illinois G.O. Bonds exceeded $300 million. […]

On information and belief, Warlander has bought credit default swaps well in excess of its nominal $25 million in G.O. Bonds. If swaps are Warlander’s undisclosed “separate financial interest in the litigation,” then Warlander stands to reap an extraordinary profit from the mere pendency of this litigation. [Emphasis added.]

* I asked Warlander and the Illinois Policy Institute for a response. A spokesperson said he would not be providing comment beyond a new motion to block the Amicus Brief

The proposed brief speculates at length about the nature of Warlander’s “financial interest.” There is nothing improper about an investment firm having a financial interest in litigation—this is simply what investors do. Importantly, the existence of Warlander’s financial interest has been disclosed from the outset. Further inquiry into that interest is not relevant, has no bearing on any issues relevant to Mr. Tillman’s Petition, and stands entirely separate from the constitutional violations alleged.

The next hearing is Thursday.

- Posted by Rich Miller        

  1. - TopHatMonocle - Tuesday, Aug 13, 19 @ 11:59 am:

    If you want to learn more about hedge funds engineering a default like this to make money, read this article from Matt Levine with Bloomberg:

    It’s plain as day that this is what Warlander was attempting, or at least hoping for.

  2. - Da Big Bad Wolf - Tuesday, Aug 13, 19 @ 12:01 pm:

    “We’re fighting for Illinois. We just also want to make a nifty profit too.”

    “Oh and some, oops, most Illinoisans will be collateral damage. Freedom isn’t free. You’re welcome”

  3. - Dirty Red - Tuesday, Aug 13, 19 @ 12:06 pm:

    If they were an underwriter, they would have to report their swaps to GOMB.

  4. - Anyone Remember - Tuesday, Aug 13, 19 @ 12:17 pm:

    Dirty Red -
    Does GOMB retain that data, make it available, or can it be filed in the circular file?

  5. - Huh? - Tuesday, Aug 13, 19 @ 12:30 pm:

    IPI and WAM are trying to invalidate bond sales from 2003 and 2017. If by a leap of the legal imagination, these bond sales were ruled invalid, couldn’t the judge make a ruling that the WAM holdings from 2001, 2014, 2017 and 2018 were also invalid?

  6. - Rich Miller - Tuesday, Aug 13, 19 @ 12:32 pm:

    ===couldn’t the judge make a ruling that the WAM holdings from 2001, 2014, 2017 and 2018 were also invalid? ===

    If they have credit-default swaps, that wouldn’t really matter. Read the link posted in comments above for how this works.

  7. - Sue - Tuesday, Aug 13, 19 @ 12:32 pm:

    Kind of foolish to give any concern to these fools

  8. - Abracadabra - Tuesday, Aug 13, 19 @ 12:45 pm:

    Don’t these financial shenanigans give an incentive to states , counties and municipalities to pay down debt?

  9. - @misterjayem - Tuesday, Aug 13, 19 @ 2:36 pm:

    If you were able to buy a restaurant (bonds) for $10,000 and then insure it (credit default swaps) for $1,000,000, no one would be terribly surprised if your restaurant burned down (default).

    But no one would believe that you had the interests of your customers and employees at heart when you actively piled greasy rags and greasy rags near the restaurant’s furnace (this lawsuit).

    – MrJM

  10. - Da Big Bad Wolf - Tuesday, Aug 13, 19 @ 3:05 pm:

    Mr. JM that is much more clear than the Bloomberg article. Thanks.

  11. - Anyone Remember - Tuesday, Aug 13, 19 @ 5:36 pm:

    @misterjayem -
    Well, wasn’t Tillman’s “partner in crime” (Gov. Carhartt) accused of having the same approach to Illinois?

  12. - Ok - Tuesday, Aug 13, 19 @ 5:46 pm:

    I wonder if WAR has made c3 contributions to IPI. AG might want to know that, too.

  13. - Not a Billionaire - Tuesday, Aug 13, 19 @ 7:35 pm:

    I would sure like to know who his 3 clients are too.

  14. - PublicServant - Wednesday, Aug 14, 19 @ 6:16 am:

    John Shillman at it again?

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