As we watch the water rise toward the top of the government default levees, I am amazed that the market townfolk aren’t panicking, putting their most portable valuables into and on top of their cars and getting out of town. Maybe they have so much flood insurance that they would actually want the levees to break.
The least likely reason that big market players aren’t heading for the hills is that they think Washington will just increase the debt limit to cover spending they’ve already approved. After all, that two-sentence, no drama option is only used most of the time, and would have already been used last April or May to avoid the cost and disruption of playing the extension games Treasury had played these last few months.
I do notice how frequently these days I hear the offering levels of CDS (Credit Default Swaps) for US Treasuries. In other words, lots of people (institutional, corporate “people” as defined by the Supremes) have been buying insurance. Cheap insurance.
It makes me wonder who is writing that insurance. After all, the most famous recent new fortunes were made by people that paid pennies (often fractions of pennies, like 15 basis points per annum) to collect dollars when AAA mortgage bonds defaulted. Not to mention the $360 billion paid out to CDS holders the day Fannie Mae CDS settled. That was more money lost in one day than the entire two years’ worth of subprime mortgage credit losses in 2007 and 2008. The best part was that the winners had paid out about $15,000 for a year of insurance that paid $1 million when insolvency was declared.
We still don’t have any disclosure of CDS exposures, nor any requirement that providers of those insurance policies set aside capital to reserve for the risk that they have to pay off. Those parts of “regulatory reform” went into the trash bin even before Dodd/Frank got a vote.
So it leaves me wondering. If the current game ends with yet another credit default triggering event, this time for the US Treasury, then who wrote the insurance policies? Will the banking system freeze up again when the market realizes that JPM or DB or BAC might actually be bankrupt, but nobody knows?
PS Today, the price of that insurance is way up, but still under one penny per dollar of coverage.