Treasury Credit Swaps Soar to Record on New $800 Billion Pledge

[ASusilovic]

Nov. 26 (Bloomberg) -- The cost of hedging against losses on U.S. Treasuries surged to an all-time high after the Federal Reserve’s new $800 billion effort to combat the financial crisis raised concern about how the ballooning debt will be funded.

Benchmark 10-year credit-default swaps on U.S. government bonds jumped six basis points to 56, according to CMA Datavision prices at 12:20 p.m. in London. The contracts have risen from below two basis points at the start of the credit crisis in July 2007.

“There is a lot more money to be spent and it is not clear how it is going to be financed,” said Tim Brunne, a Munich-based credit strategist at UniCredit SpA. “Credit spreads don’t reflect expectation of default, just the uncertainty over the enormous cost to the government.”

The Fed’s new plan to kick-start markets for loans to students, car buyers, credit-card borrowers and small businesses means it will be taking on credit risk by buying debt. The central bank pledged to purchase as much as $500 billion in mortgage-backed securities as well as up to $100 billion in direct debt of Fannie Mae and Freddie Mac, the world’s two largest mortgage buyers, and Federal Home Loan Banks.

“They are loading their balance sheet with credit risk,” Brunne said in a phone interview. “Where does all the money come from?”

http://www.bloomberg.com/apps/news?pid=20601009&sid=aWA3UOD97dcc&refer=bond

Hum...anybody any idea where the money is coming from ?

 

[ProfitTakgFool]

Out of thin air. All the Fed has to do is "pledge" money. It doesn't even have to run the printing press to back it with a piece of paper. The Fed's pledges are backed by the public's faith in the pledge. That will only go on for so long. The Fed will eventually collapse but it will just get replaced with another central bank, most likely and international one. In another 100 years that one will collapse.

Quote from ASusilovic:

Hum...anybody any idea where the money is coming from ?

 

[dumb_mother]

how would one go about shorting the US's credit worthiness through these spreads? what product / symbol / exchange? thanks ~ i think this will easily jump to 2-3% in the next couple of years and there should be some decent money to be made jumping on now

 

[Susannah]

dumb mother, they're just hedging against the bond becoming worthless, so shorting one of the treasury bonds is betting that they are right.

 

[dumb_mother]

i feel like more downside risk in that though- maybe i'm wrong though.

 

[Daal]

plenty of trees in the US. and we all know that as a long there are trees US cant default

 

[ammo]

Quote from Daal:

plenty of trees in the US. and we all know that as a long there are trees US cant default

trees to make paper to print on,if we print enough and it devalues extremely,doesnt that devalue everyone elses currency so it all eventually evens out,after a depression of course? Is this a race to get rich by raiding the U.S. so the smartest people have the money and will be able to rebuild and control everything,not that they don't already,its just that if we are going down,and we are,those that already know it ,won't suffer and will profit the most. They just learned that those cd swap guarantees were worthless,what moron would be buying into them now. Baaaa baaaa

 

[Random.Capital]

In all seriousness, what is the point in spending money hedging against a Treasury default? If the US defaults, it's global mayhem, and you're looking at perhaps 80% of the G20 defaulting on their own sovereign debt.

There won't be a counterparty left alive to pay off on the policy...

 

[btud]

Quote from Random.Capital:

In all seriousness, what is the point in spending money hedging against a Treasury default? If the US defaults, it's global mayhem, and you're looking at perhaps 80% of the G20 defaulting on their own sovereign debt.

There won't be a counterparty left alive to pay off on the policy...

I tend to agree with that. This is almost similar with what happend with the CDS on subprime dept. The same banks that held subprime debt were buying CDS's to "hedge", so they all could say they were safe. But those selling CDS's were banks themselves, who themselves held subprime debt. In theory, if the number of banks in the system was infinite, the risk would really be spread out by this. But in practice we have a small number of huge banks trading these instruments, which is a major flaw. A single bank going bankrupt could drag down the whole web. The relationships became circular. Bank A buys insurance against default from bank B. Bank B buys insurance from bank C. Bank C buys insurance back from bank A. They all think they're hedged. But they ignore the "systemic risk". There is no quantitative model out there to rigurously asses the "systemic risk". The truth is you may let AIG go down, but no one knows what can happen, so the government cannot take this kind of risk and bails out everything.

Same thing is true whne sovereign debt is involved. If US would default, everything would go down. By the way, I think this will never happen. US will prefer to bring US$ value down to 0 rather than default. But anyway, these treasury CDS do not seem to make any sens. You can trade the treasuries directly,its a much more liquid market.