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Betting Big Against the Government

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Posted on Jul 26, 2011
Flickr / zoonabar (CC-BY-SA)

On Wall Street, a small number of investors are betting $4.8 billion that the U.S. government will fail to raise the debt ceiling in the next week and, subsequently, will default on its $14 trillion debt.

Those investors bought credit default swaps against the U.S. government, meaning that in the event a default occurs, which is seeming more and more likely by the day, financial firms will be obligated to pay out.

However, experts believe it would be some time before such payments could actually be made, noting that certain criteria must be met before declaring an official “credit event.”  —BF


A credit default swap, or CDS, is basically an insurance contract against a default, and in this case, $4.8 billion is quite meager in comparison to what those on the other side of the bet are putting down.

Private investors—including everyone from individual consumers to hedge funds to the Chinese government—currently hold $9.3 trillion (with a T!) in Treasury bonds, and they’re counting on Uncle Sam paying up when those contracts mature.

But if they’re wrong to count on the “full faith and credit of the U.S. government” and the U.S. stops paying bondholders principal and interest, Treasury investors could lose some of those funds.

In contrast, the small group of CDS investors could demand payment from the investment banks that sold them their “insurance” contracts.

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By SarcastiCanuck, July 27, 2011 at 1:42 pm Link to this comment
(Unregistered commenter)

Holy shit,isn’t that one of the seven signs of the coming apocalypse….Are these guys by chance tea baggers bringing doom and then profiting from it?...

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By Marian Griffith, July 27, 2011 at 12:28 pm Link to this comment
(Unregistered commenter)

The economy is not going to collapse in a Y2K style meltdown come tuesday. A last second deal will be brokered, or not, or Obama will use his discretionary powers. Even in the case a deal not being reached some payments will be postponed, people will be sent on administrative leave without pay for a while. The tea party will feel vindicated that the world does not end and become even more intransigent. The rest of the republican party will continue to focus media attention on this issue while setting up a frame for the next elections focussing on the subject of unemployment that concerns far more Americans, and the democrats are left to wonder how they got outmanouvred yet again.

The real economic damage has already been done, but it is more subtle and will take longer to set in. Already the rest of the world is no longer absolutely certain that the USA will repay its debts, a certainty that let the country borrow immense amounts of money against unrealistically low interest rates. Over the next months, as treasury bonds mature and must be paid back one should pay close attention to what the Chinese are doing with that money. Are they reinvesting it in new bonds, and at what interest rate? Or are they moving part or all of that money to other economies?
The first is not good news, as it means that the deficit will grow without more money coming into the country, making it harder to balance the budget. However, the more of the second happens the worse news it is, as it means that the Chinese (who hold some 2 trillion worth of bonds) are beginning to doubt that the American economy is able to survive in its current form and are hedging their bets. Considering that the yearly deficit approaches half that money (i.e. the government needs to borrow that much each year) China pulling out is going to cause lots of troubles real fast. Europe is not going to pick up the slack seeing that they have their own similar problems and the rest of the world combined can not cover for China.
Should worst come to worst and it becomes clear that China -is- pulling out of dollars (something they will try to hide to the best of their abilities) then hyperinflation is a real likelihood. 14 (or by that time 16) trillion dollar coming home to roost without economic production to support that amount of money is going to lead to a price explosion if not carefully managed (and who trusts any political party with that after the show they have been putting on so far).
Already the rest of the world is feeling the result of over a trillion dollar worth of ‘quantitative easing’ (another word for inflating yourself out of debt) which was promptly moved out of the country, multiplied by fractional reserve banking to exceed the GDP of all but the largest economies in the world and used to speculate against those. It certainly was not used what the voodoonomics predicted would happen (increase national consumption and thus bolster the economy).
If the rest of the world no longer trust dollars (i.e. the promise of the american government to support their value) then all that 14 trillion can no longer float out of the country and instead must find a place in the USA economy.
But .. none of that is going to happen this august, nor next year (if the economic crisis every 5 year cycle holds the whole house of cards will collapse somewhen the second half of 2013). Makes you wonder if you should -want- to win the next presidential election…

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By SoTexGuy, July 27, 2011 at 11:43 am Link to this comment

If, as was suggested by one savvy commenter, a default is sought by financiers
holding US debt in order to increase their returns.. one thing good possibly to
come out of such an embarrassment could be bringing our empire home. We
couldn’t afford to keep it going.

There would be those opposed to such a move.. and would do most anything to
keep the status quo of armed-earth going.. Like maybe another 9/11?

What a cheery idea!

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By TDoff, July 27, 2011 at 6:25 am Link to this comment

Those betting against the US and buying CDS’s are certainly not risking their own money, they are undoubtedly investing some of their unused ‘Bail Out’ funds.

Which completes the amusing economic circle-jerk the US in which the US is currently involved: Supplying free money to the wealthiest amongst us which will assure our financial collapse.

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By SteveL, July 26, 2011 at 8:55 pm Link to this comment

Bad news and good news.  Clinton, Sen. Charles E. Grassley of Iowa, the top Republican on the Senate Judiciary Committee and others have told Obama to use the 14th amendment to end the debt crisis but when you have no balls this is impossible.  The good news, is that the courts are just as gutless when it comes to something this major and would never overrule it.

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By old nj guy, July 26, 2011 at 7:18 pm Link to this comment
(Unregistered commenter)

Total Corporate Collusion:

Banks that got bailed-out are the ones artificially forcing US debt down grades to increase their return on covering US loans. 

A lot like bailing out the mortgage bankers that then still foreclose on homeowners, and get good, marketable housing at pennies on the dollar.  This, all after taking in major monthly mortgage payments from desparate homeowners trying to keep their homes. 

Finally, folks cash in their pittance 401K’s to cover Credit Card debt, also the result of trying to keep their homes from foreclosure.

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By rbrooks, July 26, 2011 at 5:45 pm Link to this comment
(Unregistered commenter)

Wonder if it’s the same “small number of investors” who bet against the airlines and corporations that were going to get hit on 9/11. It will be interesting, won’t it, to see whether they are right? And even more interesting to find out who they are - especially if they are right….

But hey, these financial hit men have no worries. Their names are as safe with the Obama administration as the 9/11 “investors’” identities were with Bush.

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