Country Default Risk Continues Its Rise

Mar. 5.09 | About: iShares MSCI (ACWI)

Below we highlight sovereign debt default risk as measured by credit default swap prices. The list below is sorted by year to date percentage change, and as shown, Japan's default risk is up the most in 2009, although it remains on the low side when compared to other countries. The United States' default risk is up 41% year to date. All CDS prices, with the exception of the US, are priced in US dollars, while US CDS prices are quoted in Euros. Sovereign debt insurance makes you wonder, especially for the big countries that are probably "too big to fail." If the US defaults, will anyone that sells the insurance contracts really be able to pay off the claims?

Lots of traders out there don't use CDS as an actual hedge for bonds they own, but instead they buy them simply because they think default risk will rise so they can sell the CDS at a higher price. Traders could care less if the firms writing the contracts can pay off the insurance as long as they're not the last ones holding the bag when the music stops. And those that do buy something like a US sovereign debt CDS as a hedge do it in order to meet compliance and risk regulations, not because they think it will pay off. As these examples and the mess with the Lehman bankruptcy and the AIG bailout illustrate, the whole CDS game is pretty messed up.