Betting Big Against the Government
Posted on Jul 26, 2011
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.
Flickr / zoonabar (CC-BY-SA)