When the Markets Get It Wrong: US Government Debt (Of Human Bond & Greek Gifts)

American Shareholders ^ | 6/9/10 | Jeremy Weltmer

[Andrea19]

...Basically, a credit default swap offers a way to insure a debt (whether it be a corporate bond, a mortgage, or a government note) so that if the borrower cannot repay the loan, the creditor has limited his risk. They function as a sort of contract; the buyer pays upfront for the insurance against the risk, and if the debtor does default, the lender calls in the policy and only loses what he paid for the contract.

So, credit default swap pricing shows the raw pulse of the market: one can quantify the cost of risk on any government bond. So, today, insuring $10 million of US government debt for 5 years costs about $43,000 whereas insuring $10 million of Greek debt for the same time period costs about $730,000. CDS pricing shows clearly that the market values Greek government debt at about 17 times as risky as US debt, which sounds encouraging to Americans.

But, as 2008 showcases, sometimes the market can underestimate risk. Of the major world economies presently embroiled in a debt crisis (France, Germany, Greece, Ireland, Portugal, Spain, the UK, and the US), US sovereign debt is presently priced as the safest, closely followed by Germany. Yet when looking at the big picture, the US situation has much more in common with the Greek than the German...

[Andrea19]

It's the end of the world as we know it; do you feel fine?

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