Would the US Really Default?

I for one thought that a US default was outside the range of realistic possibility.  For the last half a century, the United States has been the icon of economic strength and stability.  But it appears that the at least some people think it's a real possibility in the next year.

The chart above shows the price of a 1-year credit default swap on US Treasury Bills.  For those of you who don't understand credit default swaps, a quick primer:

A credit default swap is a an agreement between two parties, typically large institutions.  Retail investors can't (yet) participate in the CDS market.  The agreement is set so that at the end of the period if the underlying debt issuer has defaulted (declared bankruptcy or otherwise defaulted on their debt payments), then the buyer of the swap gets paid $100.  If there is no default, then the swap agreement comes to an end worthless.  At the beginning of the contract, the buyer of the swap pays an agreed upon amount to enter the transaction.  In many ways is is like "insurance" for a bond holder.  If the bond defaults, the CDS is a mechanism to make them whole again.  However, it's not bond specific, so it's not an exact hedge.  This chart says that a CDS on US Government Debt is currently trading at 32bps.  Which is 0.32% or 32 cents for a $100 bond.  While that may not sound like a lot -- we can see that is almost 200% higher than it was last week.

It's important to keep this in perspective.  A 1-year CDS for Greece are currently trading over at 22.37%.  So we aren't even in the same magnitude of numbers.  But that indicates to me that 25% or so what a country might be trading at if it's...insolvent, running a massive deficit, and has only a few months of cash left.  I'm a little surprised it's not higher than that.  The country is on the brink of default!  It must be the tenuous EU and ECB backing that keeps the price of Greek CDSs relatively low.

Regarding the US CDS rate, I wouldn't panic about this move from 10 bps to 32 bps.  However, it is interesting to see SOME possibility of US default being priced into the market.  I suspect that this is mostly an attempt to price in the political risk of the US Congress not raising the debt limit before August.  I honestly can't imagine the havoc in the capital markets if the debt ceiling isn't lifed and the US actually enters a default situation.  I just can't imagine it.  It would be chaos. I'm sure between now and then there will be plenty of people who are smarter than me will paint some pictures in the financial and popular press.  I would expect that the images will be vivid enough to get congress to raise the debt cap.  In either case, I would expect that the US CDS probably get more expensive in coming months with or without a raise in the debt ceiling.

MONKEY BUSINESS:

Holding: AGQ ($159.70)