Markets Signal US Default Likely

This dangerous game that the US congress and the White House are playing just got very real.  How real?  The Credit Default Swap market just gave a strong signal that a US Government default is likely.

Today's curve (red) is 'inverted' compared to all previous curves. This usually signals that the issuer (the US Government in this case) is about to default. Source: Bloomberg.

The figure tells the story: the red curve (today, Tuesday July 26) is ‘inverted’ as compared to all previous curves (in other colors).  When this happens to a company, it’s a signal that the company is likely to default on its loans.  In this case, it applies to the US Government.  In other words, market participants are putting their money on a higher probability of default.

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Stress Testing the United States

A curious thing happened on the way to August 2… Last week, professional money managers started asking us to perform Stress Tests on the US Government.  Gulp.

My company provides a variety of different risk management services for professional investors.  Among them is a ‘Stress Test’ for Money Market Mutual Funds in which we simulate a number of different simultaneous market downturns to show the fund’s managers what impact these hypothetical events would have on their ability to continue to provide liquidity at $1.00/share.  Typically, we simulate three simultaneously ‘bad’ things happening: interest rates rising (so bonds lose value), credit spreads widening (so bonds lose value) and fund investors increasingly redeeming shares (so the fund has to sell bonds – potentially at a loss – to have the cash to pay back investors, a vicious downward spiral).  For most of our clients, we perform these stresses monthly.

Last week, we got calls from several clients asking us to run these stresses in the middle of the month because they’re concerned with the US not raising the debt ceiling.  The fact that professional money managers are paying us to perform a stress test on the US Government should ring alarm bells. Let me describe what they’re worried about:

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This Isn’t Rocket Science…

My firm’s been growing quite a bit recently and there are plenty of new faces around the office.  In one of the ‘getting to know you’ water-cooler type conversations (which never happen anywhere near the actual water cooler), someone asked me why I went into risk management and why I didn’t stay in nuclear physics.  “Well, this isn’t rocket science” I told him.  “It’s much harder than rocket science.”  He thought I was being sarcastic.  Here’s a summary of the explanation I gave:

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Who Defaults First: Greece or the US?

When I saw the BBC headline I thought to myself: “get with it, the US is not going to default.  This is just a game of political chicken.”  For the past several months, whenever this topic has come up, I’ve been thinking that this is an example of great showmanship by the Republicans who are going to teach President Obama a very painful and expensive lesson in using leverage when you have it.  I even read this CNN article earlier today, which summed up my take on the whole thing rather nicely.  And then I started to consider the possibility of the US Congress and the White House failing to reach an agreement.

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