2023-05-07 13:17:34
The exchange rate of the swaps used as insurance against US government bankruptcy shot above the 2008 level. While last year at this time it was possible to bet on the fall of the United States at a cost of 0.15%, you currently have to pay 1.49% per year for the same insurance – experts say that it is better to be safe than sorry.
How can you take out insurance against state bankruptcy?
A CDS (Credit Default Swap) is a financial instrument used to protect investors against the risk of credit default. This can also be concluded in the case of corporate bonds or government bonds, so anyone who wants to achieve a completely risk-free return on a bond can cover their risk with CDS.
In the past six months, the cost of insuring the $31.4 trillion U.S. national debt against default has increased tenfold. In particular, a huge jump occurred in March: the price of 1-year US credit default swaps (CDS) jumped from $57 to the current level of $151. In December, the same CDS stood at only $15.
CDSs also have a maturity similar to bonds, i.e. you can buy a 1-year CDS, when you bet that the state bankruptcy will occur within 1 year, or a 5-year CDS, if you want the same event over a 5-year time horizon cover. 5-year credit default swaps have not yet surpassed 2008 levels, but at $63 they are not far from their February 2009 peak of $86.
The biggest risk comes from the commercial banking sector
Three American banks collapsed in March, followed by another $200 billion bank, First Republic, in April. Some of the remaining financial institutions are still under extreme pressure, the sector’s shares fell sharply on Thursday, and in the event of new bankruptcies, the American government would have to reach into its pockets, because the local deposit insurance fund, the Federal Deposit Insurance Corporation (FDIC), would only be able to do so from budgetary resources to satisfy the demands of depositors. This is particularly problematic because in 2008 the national debt of the United States was approximately 40% of GDP, while it is currently well over 100%, so the budget has much less room for maneuver.
Crisis management and the budget generate a lot of debate in the legislature. Republicans are understandably unhappy with Biden’s lax fiscal policy, so they’ve done everything they can to stop further borrowing. Behind the scenes, negotiations are certainly going on regarding lending, but the Biden administration denies that it has officially communicated with the opposition.
High politics does not seem to take the debt ceiling problem seriously enough, favoring immediate stimulus measures over tight financial controls. This can cause a serious problem during a systemic banking crisis, since the domino effect caused by bank runs can cause such financial damage to the deposit insurance fund (and ultimately to the budget) that it overwhelms all other momentary problems.
According to the markets, lending to the US government is riskier than a well-managed company
The peculiar situation arose in the USA that government securities are no longer necessarily the lowest-risk investments. Not only have CDS prices shot up, but the short-term debt level of the US government is higher than that of the better companies in the market. Just to illustrate the pros and cons of the situation with an extreme example: Apple has relatively little exposure in the banking sector, so the company’s profitability would not be shaken by a spillover banking crisis, but at the same time it cannot print money or levy special taxes on other industry players. All things considered, the well-performing companies in the US economy are in a much more comfortable position than the US government and can issue bonds with much lower risk.
It is not known whether it is a momentary anomaly or a paradigm shift, but it is certain that for decades US government bonds were considered the main benchmark for risk-free returns, but now it seems that epidemic management, which has been axed both from an economic and regulatory point of view, is paying the bill. In recent years, the US debt has grown much faster than the economy. The United States pays 5% interest per year on short-term debt, which alone is $1.5 trillion spent on interest alone, not counting the actual principal. The magnitude of the expenditure is well illustrated by the fact that this amount is about as much as the United States spends on the military and Social Security combined in one year.
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