Hu/Gross on the "Empty Creditor"

Daniel Gross showcases some interesting work by Harold Hu on what Hu calls "the empty creditor": the creditor who has no incentive to settle because he is all hedged up--indeed, who might prefer that the debtor go broke, so that he will then have the right to call on the insurer.

As Gross shows, this is not your mother's distressed-debt market:

One key economic assumption is that people act to preserve their economic interests. Those who have lent money to troubled companies, for example, generally prefer the company remain solvent; otherwise, they can't get paid back. Similarly, lenders to troubled firms frequently favor swift, out-of-court restructuring deals, in which they swap debt for stock, instead of pushing companies into Chapter 11 bankruptcy.

He's right up to a point, although I think he glosses over the fact that the old-fashioned model of creditor-as-stakeholder is long gone. Years ago, you might have struggled to save the business. Lately, who knows? Some roll-up artist might have taken out the equity. And meanwhile most of the debt might have spilled into the hands of arbitrageurs who bought it for pennies on the dollar, and who operate on an entirely different set of motivations from those of the original creditors. I mean, if you buy the debt for 20 cents on the dollar and get a payout at 25, you're ahead of the game right?

So the emergency of credit insurance may be just one more chapter in a longer story. Which makes me wonder about the next step. Gross doesn't mention it and I haven't read Hu's stuff on this issue--but what about the insurers? Where are they? If they are going to bear the loss, don't they have a stake to step in and play the kind of role that old fashioned creditors used to pay?