Monday, June 11, 2018

Still 'Risk-Free'? Insurance on Treasuries Jumps

The first thing you're taught in B-school is that the prevailing Treasury rate--most likely on the 10-year note--establishes the 'risk-free' rate of return. Now, imagine the entity issuing all these Treasuries being on the hook for all the risks previously borne by various financial institutions (plus airlines, automakers, and I don't know what else). Also imagine that the institutions in question had declared over a trillion in losses, with several more yet to be disclosed. I am of course not telling you a FEDtime story but the fate of the entity known as 'The United States of America'.

It seems investors are bidding up default premia on probably the world's largest banana republic. Just as all sorts of subprime-related riffraff were rated AAA before the crisis hit, so is Treasury riffraff still being given the blessing of rather clueless rating agencies. Ooh Sammy, you're the greatest [smooching sounds all around]; you should manage everything--like Hugo! As I've mentioned before, America's rating will probably never be lowered despite its relentless Summers-style jihad on fiscal sanity. Others, however, probably know better as the costs of insuring against American default are ballooning at a rapid clip. From MarketWatch:
The cost of buying protection against the risk that the United States will default on its mounting debt has surged in the past months, outpacing the rise in corporate-credit costs, now that the government has absorbed more private-sector debt. The spreads on credit-default swaps for U.S. government debt jumped to 97 basis points Tuesday, nearly seven times higher than a year ago and 60% higher than the end of last year, to a level roughly in line with those of France, according to data supplied by Markit. The spreads also hit a record last week.

In contrast, an index that tracks the cost of buying credit protection against defaults on North American companies with investment-grade ratings -- the Markit CDX.NA.IG index -- has not even doubled in the past year. The index, which includes CDS on blue-chip companies like Altria Group and Bristol-Meyers Squibb Co. has risen 30% this year.

Higher spreads on credit-defaults swaps indicate sellers have raised the price of guaranteeing protection because they perceive the likelihood of a default as higher. A spread of 97 means it would cost about $97,000 to buy protection on $10 million in U.S. government debt.

The rise in U.S. sovereign CDS spreads reflects the increasingly active role the United States has played in debt markets, according to Bank of America Securities analysts. In the past year, it's absorbed the toxic assets that led to Bear Stearns' collapse; taken mortgage-backed and asset-backed securities as collateral for loans; and bought commercial paper and agency debt, among other moves.

"Having effectively guaranteed the short-term markets, that risks shifts to the government," wrote Bank of America Securities-Merrill Lynch analysts led by Jeffrey Rosenberg, in a note issued early Tuesday. The rising costs to buy credit protection undermine hopes that credit markets are improving -- a turnaround that could set up the U.S. economy and stock market for revival...
As the US nationalizes ever-greater swathes of what used to be known as the 'private sector' (remember that?) its risk premia should increase accordingly. And we haven't even talked about surefire dollar devaluation yet. God Bless America, for it will require divine intervention soon.

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