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>   On Wed, Nov 26, 2008 at 11:31 PM, Scott wrote:
>   FYI. More insanity. Love it when the guy asks where the money comes
>   from. What are your thoughts on selling CDS on Tsy’s?

I’d sell it!

I also suggested the Fed sell it.

They seemed to like the idea, but no action so far.

Treasury Credit Swaps Soar to Record on New $800 Billion Pledge

By Michael Shanahan and Abigail Moses

Nov. 26 (Bloomberg) — The cost of hedging against losses on U.S. Treasuries surged to an all-time high after the Federal Reserve’s new $800 billion effort to combat the financial crisis raised concern about how the ballooning debt will be funded.

Benchmark 10-year credit-default swaps on U.S. government bonds jumped six basis points to 56, according to CMA Datavision prices at 12:20 p.m. in London. The contracts have risen from below two basis points at the start of the credit crisis in July 2007.

“There is a lot more money to be spent and it is not clear how it is going to be financed,” said Tim Brunne, a Munich-based credit strategist at UniCredit SpA. “Credit spreads don’t reflect expectation of default, just the uncertainty over the enormous cost to the government.”

The Fed’s new plan to kick-start markets for loans to students, car buyers, credit-card borrowers and small businesses means it will be taking on credit risk by buying debt. The central bank pledged to purchase as much as $500 billion in mortgage-backed securities as well as up to $100 billion in direct debt of Fannie Mae and Freddie Mac, the world’s two largest mortgage buyers, and Federal Home Loan Banks.

“They are loading their balance sheet with credit risk,” Brunne said in a phone interview. “Where does all the money come from?”

Five-Year Contracts

The cost of five-year contracts on Treasuries rose 3 basis points to 50.5, after earlier trading as high as 52, CMA prices show. That’s higher than the debt of Finland, Germany and Norway, according to data compiled by Bloomberg.


9 Responses

  1. Who sells and how do you sell these things? Are there any requirements or can anybody do this? I want to take advantage of the stupid people too.

  2. Warren,

    US Treasuries yields seem to have decoupled from the stock market, moving relentlessly lower even as stocks have soared over the past week. Has the Treasury market been captured by the mortgage traders trying to maintain a matched book with respect to their convexity/duration exposure? Is there a way to know when this situation might exhaust itself?


  3. I think that it is a cash flood at the top of the system chasing safety. Some banks have plenty of cash, don’t want to lend as they might not get it back, so buy 10yrs at 3% and don’t get delivered. At least they tried, right?

  4. Actually the trade here is to buy the U.S. CDS. Unless the govt comes in and sell as per your suggestion Warren, these will soar to much greater levels. Do not mis understand me – these CDS must eventually go to zero at expiration. I just think the trade is to buy them now and sell them short at much higher levels.

    Why? A four part answer.

    1. Paul Krugman is widely regarded as the expert on liquidity traps. In “the return of depression economics” he gives a possible solution to pushing on a string: The govt must spend and inflate in a reckless manner that convinces traders that they have either lost or have given up the battle with inflation. The critical point is the belief of market participants must change from thinking the fed/govt is fighting inflation to one where the mandate is either unknown or something else. I bet Larry S. had Tim G. read that book this weekend, he is just finishing now. The top people in the Obama administration are extremely familiar with this argument and it is going to be implemented.

    2. The debate has shifted to what caused the end of the great depression:
    a. and the conclusion by almost everyone was the massive govt spending of WWII.
    b. and what level of debt/gdp ratio does this imply for todays crisis.

    3. There is a growing consensus that the proper level of Keynesian stimulus was not attempted by FDR until the war forced him too. I know you didn’t like that recent article in the NYT, but I think thats what the author was attempting to prove. Brad DeLong is a much better writer and far more specific on this topic. Brad DeLong’s chart of GDP to deficits in the great depression is extremely compelling, where the output starts to fall when FDR attempts to balance the budget

    4. Obama has repeatedly said he will solve this crisis. He is a guy who does stuff right and will listen to his economic team. Plus, I think he genuinely wants to create a green economy and lots of jobs. His advisors will advise him to err on the side of too much rather than too little, and that is exactly what he will do.

    So the conclusion is to buy these CDS now as a trade, sell them about a year after the economy starts to get back on track.

  5. Jcm,

    Keynesian deficits are not structural deficits and I haven’t seen a politician yet that doesn’t like to spend 2X as much as they said they would.

  6. Mick, good points and agreed.

    The better risk adjusted trade might be to buy stocks than to sell US cds?

    My first choice for a cds trade is to sell the UK and buy germany, take out maybe 65 cents

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