Country Default Risk Rises Across the Board

On November 7th, we highlighted the cost to insure against government default through sovereign CDS prices for 38 countries. Since then, default risk has risen for all but two of these countries (Lebanon and Argentina). Below we provide the current credit default swap prices for these countries, along with where they were trading one month ago and at the start of the year. As shown, Argentina, Venezuela, and Iceland have the highest default risk, with Russia not far behind. Germany, Japan, and France all have lower default risk than the US at the moment. It now costs $60 per year to insure against US default for the next five years. While this may not seem high, it was at $8 earlier in the year, and $36 one month ago.

Ireland, Austria, Greece, and the UK have seen default risk rise the most over the last month. All have risen close to or more than 100%. US default risk has risen the 8th most at 68%.

Comments

[cochie:]

How can this be ? no one would pay $4,400 to insure $10,000...
I obviously don't understand this subject....is there anywhere I could read a explanation? Who buys this ?

2008 Dec 04 04:04 PM

[Chris B:]

Perhaps if the interest rate was high enough you might. What if you bought the $10k bond from its unfortunate owner for $5k? Making it a $8400 total investment that is sure to pay out $10k one way or another in 5 years might seem worthwhile to some. Of course, then there's counterparty risk, but that's another subject.

2008 Dec 04 04:39 PM

[Dividend Gr...:]

Cochie,

Argentina's bonds are pretty likely to default, so I wouldn't be surprised if someone paid 4400 in order to get $10,000 back.. I think that Argentine bonds trade well below par right now..

2008 Dec 04 04:40 PM

[maelstrom:]

bar chart resembles south american continent..does that help? ha ..just an obseration..CDS= risky business today..fiat money

2008 Dec 04 04:41 PM

[Alex Trias:]

The confusion over the high cost of CDS relative to the underlying debt is this: the folks who buy this stuff aren't insuring ANYTHING. They're trading CDD in the way traders trade any asset: buy it if it's going up, and sell it if it's going down.

That the price of CDS has no relation to fundamentals is not important. When you think about CDS, think about how folks trade oil futures. There's always some reason people put forward for why the price of oil is going up - demand from China, whatever - and can continue going up forever. Now we are getting the same story from the CDS traders - every country in the world is borrowing too much, so they are all going bankrupt.

Obviously, though, fundamentals tend to return to any market with explosive force. When do we know when fundamentals in the CDS market are completely out of whack? You will know this once the yeild on US treasuries is falling down to zero (which means bond investors are so convinced of the US government's ability to repay, they will accept low or negative interest) and the cost of insuring US government debt is spiking higher (which, if things were working in the CDS market based on fundamentals as opposed to technical trading momentum, should drive interest rates HIGHER rather than lower).

It will not go unobserved we are seeing precisely this happening right now.

If interested, I've written some articles on the subject, and have argued that CDS spreads are in a bubble.

2008 Dec 04 05:09 PM

[SugarDaddy:]

Its just one giant complex Casino !!

2008 Dec 04 05:40 PM

[doubleguns:]

What is the witch said, bubble, bubble toil and trouble. Something like that. Now CDS spreads are in a bubble? How about the bonds themselves?

A whole lot of bubbleing going on and the feds want the housing bubble to come back! Go figure, they think they know what they are doing.

Best beware of anything the feds touch. Auto industry is next.

2008 Dec 04 05:59 PM

[Reinko:]

As usual with the Bespoke guys, basic stuff is missing:

These are mostly five year long contracts with a minimum value of 10 million in government bonds to protect.

When the USA comes in at 60 this means 60 pips or a likelihood of 0.60% a year for the USA to default (during the next five years).

So the seller of this CDS stuff thinks it takes about 1/0.0060 = one in every 167 years for the USA to default (given the present conditions).

Of course the sellers of this kind of CDS use other 'more advanced' mathematical models to come to their pricing. Yet any idiot can see: the USA CDS is very very cheap & you don't have to own 10 million in US bonds to buy such a five year contract.

2008 Dec 04 06:36 PM

[Reinko:]

On the second graph:

It if funny to observe Iceland hanging just in the middle of the UK and the USA.

Again: at bargain prices like this you are crazy not to buy such a cheap CDS contract on the UK or the USA.

2008 Dec 04 06:43 PM

[markettaker:]

This is a great visual of how much in debt each country is. In addition there are some other visuals of where the bailout money is going.

Check it out here...

How Big Are The Bailouts???

www.gotoguy.com/?p=604

2008 Dec 04 07:39 PM

[Jackson Cash:]

So, how long until the US is like Ireland and red hot!?

2008 Dec 04 07:40 PM

[Big-P:]

Watch WFC boys. Big blow-up coming there. Also avoid any bottom fishing tomorrow because i'm taking the Futures down big-time tomorrow and Monday.
Big-P
wallstreetprick.com

2008 Dec 05 01:10 AM

[Big-P:]

Reinko, you seem like a smart guy (swimming in a sea of knuckleheads as far as this post goes) so I'm wondering what the benefit is of coming to a site like this? How does this gum-flapping help anybody make any money?


On Dec 04 06:36 PM Reinko wrote:

> As usual with the Bespoke guys, basic stuff is missing:
>
> These are mostly five year long contracts with a minimum value of
> 10 million in government bonds to protect.
>
> When the USA comes in at 60 this means 60 pips or a likelihood of
> 0.60% a year for the USA to default (during the next five years).

>
>
> So the seller of this CDS stuff thinks it takes about 1/0.0060 =
> one in every 167 years for the USA to default (given the present
> conditions).
>
> Of course the sellers of this kind of CDS use other 'more advanced'
> mathematical models to come to their pricing. Yet any idiot can see:
> the USA CDS is very very cheap & you don't have to own 10 million
> in US bonds to buy such a five year contract.

2008 Dec 05 02:42 AM