Credit Default Swaps on US Treasury bonds are currently trading at 16 basis points, up from 1.6 basis points when this was written.
As commenters at the above blog observe, “I’m trying to imagine a scenario where a Treasury bond defaults, but a CDS contract promising payments in the event of that default is still worth something” and “So if you went long the underling Treasuries in July, and went short by buying the CDS, you would have made gobs of money being both long and short the same asset. My mind is blown.”
There turn out to be a lot of scenarios. You point out one way:
The United States is a democracy; if enough people vote for representatives who decide not to pay off the bonds, they won’t get paid. Do you want to look at recent history, let alone ancient history, and tell me this is impossible?
This is exactly the scenario unfolding now with the Republican brinkmanship on the debt ceiling. No new debt = default. From Forbes “What a US Default, Downgrade Might Look Like” (emphasis added):
“If Congress fails to increase the debt limit, the government would have to stop, limit, or delay payments on a broad range of legal obligations, including Social Security and Medicare benefits, military salaries, and interest on the national debt, which is paid to big, market maker banks like J.P. Morgan Chase, Citibank, and others, not to mention the government of China, which is the largest holder of US government bonds overseas. Defaulting on those obligations, including coupon payments to bond holders, would cause severe hardship for the US economy. It would erode the historic legacy of the US as the safe harbor within the global financial system.”
Credit Default Swaps on US Treasury bonds are currently trading at 16 basis points, up from 1.6 basis points when this was written.
As commenters at the above blog observe, “I’m trying to imagine a scenario where a Treasury bond defaults, but a CDS contract promising payments in the event of that default is still worth something” and “So if you went long the underling Treasuries in July, and went short by buying the CDS, you would have made gobs of money being both long and short the same asset. My mind is blown.”
There turn out to be a lot of scenarios. You point out one way:
This is exactly the scenario unfolding now with the Republican brinkmanship on the debt ceiling. No new debt = default. From Forbes “What a US Default, Downgrade Might Look Like” (emphasis added):