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Home Publications Blogs Beat the Press Credit Default Swaps Do Not Insure U.S. Debt

Credit Default Swaps Do Not Insure U.S. Debt

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Sunday, 24 July 2011 21:21

Suppose an insurer in New York sold insurance against a nuclear bomb being dropped on the city. Is this insurance against nuclear war?

As a practical matter, only a fool would think that this covered his financial bases. If there were actually a nuclear bomb dropped on New York, this New York based insurer would almost certainly be destroyed along with whatever it had insured.

This is the same deal as with credit default swaps on U.S. debt. If it turns out that the United States defaults on its debt (meaning a true default,  where bonds are not paid, not a technical default where there is a brief delay in payment), then it is very questionable whether any financial institution issuing the CDS will be around to pay it off. That is the case not only with U.S.-based financial institutions. Even banks in Europe and Asia would be badly shaken by a default on U.S. debt.

Therefore the NYT is misleading its readers in a chart accompanying this article that presents the price of CDS on U.S. debt as a measure of the price of buying insurance against default. Since this is not real insurance, this can more accurately be viewed as the price of a bet on some sort of default event that could allow someone to get into court with a claim. If a holder of CDS can get through the door on arguing for a claim, the issuer may pay them to just go away.  

Comments (3)Add Comment
Betta Buy Dis CDS Just So Nuttin Happens if Sumpin Do Happen
written by izzatzo, July 25, 2011 8:45
Since this is not real insurance, this can more accurately be viewed as the price of a bet on some sort of default event that could allow someone to get into court with a claim.


USA debt has attained the same status of USA patents and requires a concurrent degree of mafia extortion protective insurance just to make sure nuttin happens to your business.
...
written by skeptonomist, July 25, 2011 10:30
In the worst days of the credit crisis 2008-2009 interest rates on US Treasuries actually went down while the price of insuring them went up. Currently treasuries are basically holding steady (down slightly this morning despite discouraging news on credit-ceiling talks) while the price of insurance has gone up. Dean's lawsuit scenario seems pretty far-fetched to me, but how about speculators buying CDS's on the expectation that some people will be spooked - perhaps on the basis of rising CDS prices - and cause a temporary bubble in CDS price? Anyway, CDS's are subject to speculative pressures in different ways than real credit markets and as Dean says can certainly not be taken as general indicators of lack of confidence in bond issuers.
...
written by Charles Ganter, July 25, 2011 1:52
What is ‘this’ article? I don’t see the article referred to by name, and I don’t detect a link by mouse over. I only comment because this is the second time it’s happened in three days. I don’t know what NYT article you’re talking about.

Happened also with your blog
“The NYT is Wrong: Official Do Not Say that Medicaire….”

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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