Unless you can collect the protection in Swiss Franc, we find it difficult to get our head around credit default swaps on U.S. Treasuries. Surely, if you find yourself actually needing the protection, the last thing you want is U.S. Dollars. And in addition, if you find yourself in a position to expect payment from your counterparty, how likely are you to get paid? And finally, why in the world would the U.S. choose to default, rather than just turn on the printing presses?
First, default, at least domestic default, is much more common than you might think. Reinhart and Rogoff’s The Forgotten History of Domestic Debt is an interesting place to start if the topic compels you.
Second, what constitutes a default isn’t at all clear when you see credit default swap prices thrown about. To the extent the OTC market is a substantial portion, it is difficult to know exactly what constitutes a default.
Third, use of the “no-arbitrage” model to price credit default swap spreads can be misleading, particularly in times of financial crisis. (Sound familiar?)
All this is a gentle way of bracing you for the rumor fact that spreads on credit default swaps on U.S. Treasuries have blown out to triple digits today.
Uh oh.
Now if only we could find a reliable counterparty to write us some CDS contracts denominated in gold.
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Your last paragraph answers the question.
CDS on treasuries is like playing pass the hot potato. You just hold them long enough to sell them to someone else. No one actually plans on being caught holding them when things get better and spreads tighten (or–on the flip-side–if the government implodes).
Its getting pretty bloody around here. Today is not good.
T-bonds are up today. Rumors are a dime a dozen these days.
“WE’RE THE ONES WE’VE BEEN WAITING FOR!”
Yes we can.
I wish I had a dozen dimes.
Kenny Boi
What happens to BAC common stock if BAC gets nationalized?
@7: Seriously? Where were you during the FNM/FRE fiasco?
In FULL nationalization/conservatorship, equity investors GET WIPED OUT.
@7 – First, if u’ve been holding BAC shares this long, shame on you. Second, if they are, I’d recommend hope + prayer.
@7 here. I was, uh, um, just asking the question for a, uh, friend.
@7/10, No, it was a test. To see if other people knew.
To your second points, on many of the contracts, the failure of congress to raise the legislated debt ceiling when needed constitutes a default. If that happens, surely the world will go on and you will have a chance at collecting.
@10 – oh in that case, if you get a boner every time you see shower with the guys afetr sports, chance are that you are indeed gay
Oh, Saskia’s on CNBC again. I’d bark like a dog for her, I’d buy Citi equity, I’d do just about anything for that British minx
12:
That’s interesting. I hadn’t heard that. How exactly is “when needed” defined in the language?
Is it simply the fact of exceeding the statutory debt limit? Is there a de minimus exception?
12,15- Yeah so there is a credit event. And then the CDS auction settles at what, 99.9 cents on the dollar?
EP,
What on earth are you thinking? Don’t buy them, write a bunch of them and bolt the country. Call it an “enforcement arb”
Is there not a healthy treasury CDS market in which ratings agency downgrades trigger payment?
Like buying insurance on the Titanic from John Jacob Astor IV
@17
Exactly.
@15 Sorry, can’t help you there – don’t work in that market myself. Just asked some friends who do the same question EP is asking a few weeks ago.
COuple of points:
-It isn’t a rumor. DB was bidding 100bps for EUR25mio size today. Fuh real.
-The contract is quanto’d into EUR. i.e. USD (local) debt is reference asset and deliverable, but the contract is sized in EUR. When a default happen, buyer delivers X EUR (at that date’s fx rate) of USD debt.
-@12, 15, 16. You might get a credit event if Congress doesn’t raise the debt ceiling and as a result payments are delayed for some short period of time. IN that case, the auction will definitely clear at high price, but not necessarily as high as you think, 16. At the time of default, there might be low-coupon treasuries out there trading at a low dollar price for reasons that have nothing to do with credit risk. Given low volume of contracts outstanding, these “CTD” will influence where auction clears.
Adding on to 22, it was bad enough determining which FNMA and FHLMC bonds were deliverable into CDS contracts – but in the case of the US gov’t, there are plenty of long-dated zero coupon bonds that could potentially be deliverable into CDS, and these bond prices are just a function of interest rates – so you could potentially find bonds that or only worth 50 cents or so just by virtue of their maturities (i.e. there would be no debt acceleration like you would normally find with a typical corporate). This is ignoring any bizarre structured products which could potentially be deliverable as well.
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