Wednesday, July 27, 2011

What Triggers a U.S. Treasury CDS "Credit Event" (Credit Default Swaps)

5Y US Treasury CDS (Bloomberg)
As you already know, the U.S. faces the risk of running out of cash to pay bills on August 3 if Congress doesn't raise the debt ceiling. As noted by Christian Post's math, there will be enough money in August to cover interest payments on the debt to prevent a default, but $21 billion will be left unpaid.

It gets more interesting. There are currently $4.8 billion (net) U.S. Treasury Credit Default Swaps outstanding that insure against a "credit event", or missed interest payments on Treasury bonds. If the U.S. Government decided not to pay interest on its debt next month, it would trigger the "credit event" and holders of Treasury CDS would be made whole by the sellers at par (Treasury bond). 5Y Treasury CDS is currently trading at 58 bps in euros and trending higher. It spiked to 99 bps in February 2009. I remember doing a post on Treasury CDS in September 2008 when S&P said "pressure is building on the pristine "AAA" rating of the United States after a federal bailout of American International Group Inc". There are $9.3 trillion Treasury bonds held by private investors, so the CDS number is tiny.

David Geen, General Counsel at the International Swaps & Derivatives Association (ISDA), explained what would trigger a "credit event" for Treasury CDS. Watch the Bloomberg interview after the jump ("ISDA Says Missed Payment Would Trigger U.S. Debt Swaps").

"There doesn't seem to be a lot of fear reflected in the pricing, as it hasn't been reflected in the Treasurys itself. If Treasurys are still trading at par or close to par that means that the CDS settlement, if there was a credit event and there was an auction, then the settlement would not be at large amounts and therefore protection holders are not going to receive large payouts if anything."

More on Treasury CDS and debt ceiling updates:
  • U.S. has 3 days grace before CDS triggered: ISDA (Reuters)
  • Step Aside UniCredit And Italy: The US Is Number One... In Monthly Spike Of Default Bets (Zero Hedge)
  • Betting $4.8 billion on a U.S. default (CNN Money)
  • S&P warns against prioritizing debt payments: report (Reuters)
  • Is default deadline truly Aug 2? Analysts say no (Reuters)
  • U.S. Downgrade May Cost $100B a Year: JPMorgan (Bloomberg)
  • U.S. likely to lose top rating: economists (Reuters)
  • Treasuries Decline as Obama Threatens to Veto House Speaker’s Debt Plan (Bloomberg)
  • Treasuries Fall, Gold Gains on U.S. Debt Rift (Bloomberg)


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