Insurance Cost Against US Default Hits Record

The cost of buying insurance against a default by the U.S. rose to a record on Wednesday, in a sign of growing unease that gridlock in Washington over raising the federal debt ceiling may result in the Treasury failing to pay interest to bondholders.


The market for buying and selling insurance on the creditworthiness of the U.S. is thinly traded, denominated in euros and dominated by European and UK banks in London. But trading in so-called credit default swaps has picked up as the threat of a default has grown.

In a CDS, a buyer of protection is compensated by the seller should there be a default or missed payment, known as a “credit event”.

“The U.S. CDS market is much less liquid than other sovereign markets as up until recently no one thought the chance of a U.S. credit event was very high,” said Ira Jersey, strategist at Credit Suisse. “The market is getting nervous over the risk of a default.”

Premiums for one-year U.S. sovereign CDS rose sharply this week and traded at about 90 basis points in London on Wednesday, overtaking the previous high set in March 2009.

In a sign of greater concern of a near-term default, U.S. one-year CDS was trading higher than premiums for the more liquid five-year sector, at about 65bp, for the first time.

Otis Casey, director of credit research at Markit, said: “Typically you see an inversion of the short end in [issuers] that are fairly well distressed.”

The net size of the U.S. CDS market, or actual market exposure, is $4.9 billion. The U.S. has risen above Greece’s $4.6 billion in net exposure but is below the UK’s net size of $12.3 billion, according to data at the Depository Trust and Clearing Corp.

Analysts said that, given the cost of buying protection for one year and the risk of the Treasury missing a debt payment in the next month, there is potentially a massive pay-out for investors under that scenario. ......

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