Ignore America’s Debt Ceiling Doomsday Headlines

by Dan Burrows | October 3, 2013 1:38 pm

debt ceilingIf a debt ceiling debacle happens, it really will be doomsday.

But it won’t happen.

The U.S. government is going to run out of money sometime in the middle of the month if Congress doesn’t raise the debt ceiling. That means the U.S. is at serious risk of defaulting on its debt, because it won’t have the cash to make interest payments on Treasury bills, notes and bonds.

Sovereign defaults are always bad news, but this would be another order of magnitude.

Heck, it’s hard to imagine anything much worse.

U.S. Treasury debt is the bedrock — the ultimate benchmark and reference rate — for the world’s entire financial system. It’s widely held to be the closest thing there is to a “risk-free” asset. After all, the Treasury has a printing press and a huge tax base. How could it ever fail to make good on its obligations?

Indeed, the Treasury Department released a report Thursday outlining the “catastrophic” consequences of a failure to raise the debt ceiling:

“The United States has never defaulted on its obligations, and the U. S. dollar and Treasury securities are at the center of the international financial system. A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.”

Of course, with Wall Street being Wall Street, someone is trying to figure out a way to profit should everything go to hell.

Bearish Bets as the Debt Ceiling Deadline Looms

Some institutional investors are buying securities that will pay off if the government defaults, CNNMoney reports[1].

You might remember these things — credit default swaps (CDS) — from the financial crisis. It’s like buying an insurance policy on your neighbor’s house in hopes that it burns to the ground. CDS are what caused American International Group (AIG[2]) to implode and become a ward of the state. Ring a bell?

Never mind that these bets are worth nothing. As Matt Levine at Bloomberg sums it up[3]:

“(A) CDS on the U.S. government, in either of the two most plausible U.S.-government-default scenarios — brief technical default or zombie apocalypse — is worth zero.”

That’s because a technical default means bondholders get paid — just a little bit late. And in an honest-to-goodness default, there will be no one left to pay you for betting right.

It’s like trying to collect on homeowner’s insurance after a nuclear attack that takes out your house, and also your insurer.

No, this is not a deep or serious market, as Levine notes. Perhaps more importantly, these crackpots aren’t even particularly on edge.

Yes, the number of CDS contracts — currently 866 worth about $3.4 billion — is going up as we get closer to the debt ceiling deadline, but it’s still far below the roughly 1,300 contracts posted the last time we flirted with default in 2011, CNNMoney reports.

Even better: Take a look through the data from the Depository Trust and Clearing Corporation[4], and you’ll see that this market has even bigger worries that are also pretty weird.

For example, there are more than 2,000 contracts betting on a default from Australia. Or, get this: There are more than 4,000 contracts with an insured value of $13.1 billion betting on a default coming from Germany.


Sure, the Germans are locked into using the euro … but do you really think that bastion of Prussian rectitude is going to blow off its debts?

So forget about what the CDS market is saying — and all the other scaremongers, too. The U.S. is not going to default, if for only one reason:

If the Treasury runs out of money — which it will if Congress doesn’t raise the debt ceiling — Social Security payments will stop.

Thus, keeping the debt ceiling where it is would be political suicide for whichever party gets the blame (cough, Republicans, if the polls are to be believed).

The folks in Congress might be crazy and even stupid, but they ain’t that stupid.

As Warren Buffett recently said on CNBC: “We will go right up to the point of extreme idiocy, but we won’t cross it.”

That sounds about right.

The opinions contained in this column are solely those of the writer.

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  1. CNNMoney reports: http://money.cnn.com/2013/10/03/news/economy/investors-bet-us-default-cds/
  2. AIG: http://studio-5.financialcontent.com/investplace/quote?Symbol=AIG
  3. sums it up: http://www.bloomberg.com/news/2013-09-26/why-would-anyone-buy-credit-default-swaps-on-the-u-s-.html
  4. data from the Depository Trust and Clearing Corporation: http://www.dtcc.com/products/derivserv/data_table_i.php?tbid=6

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