Of all the craziness and silliness in the financial market, which is plentiful, the most entertaining thing must be CDS on US sovereign debt.
I'm always against irresponsible fiscal policies, especially the bailouts and stimuli since '08. The current and future US public debt levels are a recipe for future disaster. I won't argue with you even if you want to go more apocalyptic.
But US Treasuries will never suffer a technical default.
Why? Not to sound too chauvinistic, let's assume for a moment that there will be someone left standing to pay for the recovery in the event of US government default. But the US government will NEVER EVER default, because all US government debt is in USD, and they can always print more. The currency's value may be zero, but they can always pay back your generous loan. And this argument has nothing to do with the peculiarities of the US. It applies to any sovereign with its debt primarily denominated in its own currency.
If I borrow money from you with a promise of paying you back with my handwritten IOU, would you actually stay up at night worrying that I would not fulfill my promise, while I am an honorable gentleman and all? You may very well stay up at night, but the reason should be something else.
This much is obvious. A more intriguing question is: Who are the clowns buying it?
As an anchor point, DTCC data show the latest net notional of CDS on US is $2.4B, on par with that on Finland. In terms of percentage of debt outstanding, this is tiny, but still, the net premium is a cool $12MM at today's rate (~50 bps). At the height of panic in '08, when a lot of CDS on US were traded, the premium went above 100 bps. WTF?
Nobody smart/capable enough to gain entry into the CDS market and trading her own money would buy it, of course. So it must be someone playing with others' money, and most likely in order to show how diligently she hedges her risk, with a model and some VAR numbers to show for it. Most likely some public fund manager, because any private investor with any say in such a humorous affair would surely question such mind-boggling stupidity.
Whoever it may be, if you find someone buying CDS on US, for any reason, for any premium greater than zero, fire her.
Author's Disclosure: None