USA Credit Risk Now Worse Than 2011

Tyler Durden's picture

Understanding the complexities of the sovereign CDS market is tricky... so we are constantly bemused by the mainstream media's constant comment on it as if they have a clue. The fact is that the USA CDS market is indicating a higher risk of imminent technical default now than in 2011. As we explained in painful detail previously, you cannot compare a 71bps (+8 today) 1Y USA CDS spread to a 1200bps JCPenney CDS spread - they are apples and unicorns. Having got that off our chest, the fact that the cost of 1Y protection is at 2011 extremes (implying around a 6.5% probaility fo default) and has been higher (inverted) relative to 5Y now for 3 weeks is a clear indication that investor anxiety is very high this time (just look at T-Bills!).


The absolute level (given the lower levels of interest rates and EUR forwards) and the inversion (size and period) make this far more "risky" a period than in 2011...


and the net notional (think open interest) has exploded...


And in order to help a few people out, here is Barclays with a primer on USA CDS...

FAQs on USA Sovereign CDS


The current stalemate over raising the debt ceiling has renewed interest in USA sovereign CDS. While still at low absolute levels, spreads have been moving wider, particularly at the front end, with 1y CDS going from 24bp on September 19 to 70bp (mid) on October 9. Although we believe the probability of a technical default is very low, we think it is important for investors to understand the basics of the USA sovereign CDS contract in the event that CDS were to trigger. To that end, we provide a brief list of FAQs on USA sovereign CDS.


What type of contract is USA sovereign CDS?
USA CDS is a Standard Western European Sovereign (SWES) contract. It is denominated in euros. For more details on SWES, please refer to the latest physical settlement matrix on the ISDA website.

How much USA CDS is outstanding?
Using DTCC data, as of October 4, 2013, the net notional outstanding of USA CDS was $3.63bn. Investors can monitor the data using the CDNO function on Bloomberg.

Are there any restrictions on buying USA CDS?
The European Commission (EC) ban on naked CDS shorts applies only to the member states of the European Union, so the EC ban would not affect an investor’s ability to buy USA CDS.

What credit events are applicable to USA CDS?
Under SWES, there are three potential credit events: Failure to Pay, Repudiation/Moratorium, and Restructuring. Most of the focus currently appears to be on the Failure to Pay trigger. A Failure to Pay only refers to a failure to make payments on debt (i.e., borrowed money) obligations, not on payments in general (for example, to vendors, employees, etc.).

What would happen if one or more rating agencies determined that the US was in default?
Actions by the rating agencies are not considered a credit event for the purposes of CDS. The determination of whether a credit event had occurred would be made by the Americas ISDA Determinations Committee (DC).

How much debt is due to mature in the period surrounding the October 17 debt ceiling deadline?
$120bn of debt is scheduled to mature on October 17. Another $93bn is scheduled to mature on October 24. The Treasury is expected to roll over the debt. However, as the Bipartisan Policy Center recently noted, “One risk is that buyers of government debt will be less likely to participate in Treasury auctions and, for those that continue to participate, more likely to demand higher interest rates, increasing the cost of servicing the existing debt”[1].

When is the first significant interest payment due following the October 17 debt ceiling deadline?
According to our rates strategists, the first real test from a coupon payment standpoint will be the $6bn in interest payments due October 31. Please see pages 2-3 of Global Macro Daily, October 2, for more details.

Is there a grace period for US Treasury interest payments?
US Treasuries do not have a specified grace period. However, there is a 3 business day grace period for Failure to Pay specified in the ISDA definitions, which would apply.

What is deliverable into USA CDS?
The ultimate determination as to what is deliverable would be made by the DC. However, based on our interpretation of the ISDA definitions, we believe US Treasury bills, notes, and bonds would be deliverable into USA CDS. We also believe the current cheapest-to-deliver (CTD) bonds among US Treasuries are the 2.75s of 8/15/42 (ISIN US912810QX90) and the 2.75s of 11/15/42 (ISIN US912810QY73), which closed on October 8 at $82.90 and $82.77, respectively. However, this is not a legal opinion, and clients should do their own due diligence. In addition, the final settlement price for USA CDS following a Failure to Pay event is determined through the ISDA auction process, which will reference a portfolio of deliverables, not just the cheapest to deliver obligation.

Are inflation-linked bonds deliverable?
Deliverability of inflation-linked bonds is complicated by the “Not Contingent” deliverability requirement, basically meaning that the principal of a bond cannot by reduced in any other way than by payment. Depending on the specific fact pattern, this could prevent a bond from being deliverable altogether or make it deliverable only for the nominal, “non-inflated” principal.

Are STRIPs deliverable?
Based on previous pre-ISDA DC decisions, we believe it is unlikely that STRIPs (IOs/POs) would be deliverable, as “components of bonds” have historically not been considered to be direct, deliverable obligations of the reference entity. As an example, when Fannie Mae and Freddie Mac defaulted in 2008, their stripped, principal-only obligations were deemed to be not deliverable. But again, this is not a legal opinion.

Is there any other debt that would be deliverable?
In addition to US Treasuries, debt obligations of US government agencies that benefit from a “Qualifying Guarantee” (QG) would be deliverable, as per the ISDA definitions. The QG requirement is generally very restrictive, excluding any guarantee that is not evidenced by a written instrument or that is capable of being released in any other way than by payment. Entities that carry (implicit or explicit) guarantees but do not satisfy the strict QG requirements would not be deliverable obligations. With that in mind, entities such as Fannie Mae and Freddie Mac, which benefit from implicit guarantees, are unlikely to be deliverable.

How does the CDS auction process work?
Please see CDS Auction and Settlement Dynamics for more information on the CDS auction process.

When would the exchange rate for the CDS auction be fixed?
The DC has discretion in deciding when the FX rate is taken. That said, it usually picks the mid-level rate published by Reuters at 4pm the day before the auction. The day for picking the FX rate forms part of the Auction Settlement Terms (AST), published ahead of the auction. Despite USA CDS being denominated in EUR, given that the pool of deliverables would be dominated by USD, we find it likely that any auction would be held in USD. We saw this for the case of the credit event for The Hellenic Republic, where the auction was held in EUR, despite the majority of CDS trades being denominated in USD.

What factors could affect the final settlement price on CDS?
One consideration for investors who just buy USA CDS protection (and do not own the cheapest to deliver obligation) is what might happen to the CDS payoff in the event that rates rally sharply prior to the CDS auction. It is worth remembering that rates rallied sharply following the downgrade of the USA sovereign rating by S&P in August 2011. If a technical default triggered a similar reaction (i.e., a flight to quality), recovery could be higher, in which case the CDS payoff would be lower than expected. In addition, even without a rally in rates, the fact that the auction process references a portfolio of deliverables, not just the cheapest to deliver obligation, could also make the overall payoff lower than expected for those who do not own the cheapest to deliver.

We would imagine that the pool of deliverables could be very large, with many bonds included that are not well understood by the auction participants. This could make them bias their prices in the auction down, so as to compensate for the uncertainty of risking delivery of a “worse-than-expected CTD” bond.

Another consideration for investors who own CDS protection only and do not hedge the currency risk is the potential effect of a sharp rise in the US dollar vs. the euro. Since the naked short position in USA CDS is denominated in EUR, any decline in the EUR/USD exchange rate would lower the eventual payoff in USD terms.


Please do not comment on default risk or CDS until you have read this...

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Renewable Life's picture

Really, I don't see anyone on Wall Street looking nervous at all!

Cult_of_Reason's picture

Obama wants US default, so he can blame the economic collapse on republicans and regain control of the house.

Obama: "This time's different. I think they should be concerned."

Spastica Rex's picture

If so, risky move.

I really doub it - these guys don't get where they are by taking risks.

Cult_of_Reason's picture

It worked for Obama and Dems before.

It's all George Bush's fault becomes It's all Republican's and Tea Party's fault.

Dems are desperate. They cannot get anything through the congress. The left-wing is pissed at Obama over "immigration reform"  (aka expansion of democratic voting base via amnesty for millions of illigals).

Skateboarder's picture

Good article. Banning only EU states from naked CDS leaves pretty much the rest of the world to openly bet. And credit agency ratings have no influence, so even the likes of silencing Egan Jones doesn't mean shit here. CDS are like mothafuckin grenades.

onewayticket2's picture

Sure, it's risky....but either way, he wins.  if it collapses, he gets to blame republicans.  if the republicans cave, he gets to claim victory. 

either way, our kids lose.

knukles's picture

But then the prez could declare and "emergency" a la the 7 regions, usurping state powers, military....
Y'all know the drill

john39's picture

not sure is this is accurate, but rumor is that only Eric Cantor in the house can call (in the house) to end the shut down:

twh99's picture

It's a BS story.  No truth at all to it.

Renewable Life's picture

Ya that's why stocks are 200 points off their all time highs, and bond yields are still at 100 year historical lows!! What will this panic look like, when it hits????

gjp's picture

"The determination of whether a credit event had occurred would be made by the Americas ISDA Determinations Committee (DC): i.e. never, rally on, it's all good

Renewable Life's picture

You might be right, but theres gonna have to be "blood in the streets" as they say, before this conditioned bunch of Pavlov's dogs, start to get jumpy!

It's been 2008 since any of these guys actually had a risk of losing money, big daddy has always been there and always will, is their mentality!

knukles's picture

Credibility my friends.  All about credibility. And what good role models we have.  Crony capitalism deluxe, a well established free shit army, intrusive secret domestic police agencies, a propagandized press...
And then....

All the shit in the White House Garden is rotting.  Because the people who take care of it have been...

...told not to pick the shit...

read that again...

...told to not pick the shit...

Credibility Trap Anyone?

It's a clusterfuck!
Let alone the budget and debt ceiling negotiations...
Let alone the Fed monetization...
Let alone the Ongoing Criminal Activities of the Bankers...
Let alone the....


RSloane's picture

All of that is very true. Yet we have been assured that we are not a banana republic.

Bearwagon's picture

That's right. You are a measly banana republic, at best. (Not to say it's any better here at my place.)

knukles's picture

To be a banana republic you got to export bananas.
We export democracy, freedom and all that good shit.
So we're a "good shit" republic

With which I'm sure the Free Shit Army would agree.... maybe... but then again there's always room for MOAR jello. 

Cosmicserpent's picture

We export weapons of mass financial destruction.  We give you our worthless paper and you give us cheap shit for the masses and real tangible assets for the 1%.  No, really, we INSIST. 

Now we default, but we keep all your shit world!  BWAHHAHAHA! Send in the drones!

War is coming baby!

RSloane's picture

Hah! the US is the 7th largest banana exporter in the world, and growing. There is no stopping us now.

Millivanilli's picture

Just watched a clip with Pelosi. If I took a shit that look liked her, I'd head straight to the emergency room.  

What I thought was most poignant was the quip that 401k plans are at risk.  Yeah, they are at risk because they are a ponzi scheme supported currently by the fed. When they pull the plug everyone stuck in these instruments will get fucked.  She went on to say that all forms of loans were going to be advesely affected, eg student loans, car loans, home loans, etc. JUST LIKE A TYPICAL BANKSTER PUPPET.  That fucking WHORE sold us out the first day she took office- eons ago.


In regard to CDS risk. HAH.  That shit doesn't mean a fucking thing if none of the counter parties can pay out.  REmember when they canceled "voluntarily" greek cds contracts.  All a big game and the people of the world are the punching bag.


The truth is we are in the event horizon of the EXPONENTIAL FUNCTION ON DEBT.  WATCH OUT, BITCHEZ...

knukles's picture

we have already transited said event horizon

Chupacabra-322's picture

That & she's a War Criminal. She was briefed on the Bush/Cheany Regime on the Torture programs & did nothing.

The Criminal Policy is supported by the duopoly.

Illegal Wars
Assassination Lists.
No Habeus Corpus
Patriot Act
John Warner Defense Act
Illegal Spying
False Flags.
Arming Terror Organizations
CIA drug running
Fast & Furious

TeamDepends's picture

We're on an express elevator to Hell, goin' down!

Fogey's picture

hey yo! there is no show in da town!

Chupacabra-322's picture


Only one thing to do—hang onto to your butts. We have no idea of the enormous storm about to hit this country...and soon. Meanwhile the man in the White House is poised to feel the glory of a birdie on 18th hole.

TeamDepends's picture

“What do you mean, ‘They cut the power’?”

JJ McApe's picture

politicians have no spine, they will agree on something very soon when they start to panic.

but thanks GS for the warnings. nice try though

DoChenRollingBearing's picture

All of this makes me think about Going Galt and/or leaving...

Gold, fishez.  Peru, putaz.


"Haole" and "KirkNC2071" drop me a line at gmail (w/ my moniker) or hushmail me at rodajesyoro.  I will be in Peru for a little while but will be checking my mail every other day or so.

Bearwagon's picture

Only gold, lastly? What became of your 100 Cr 6 ?! You already got plenty? ;-)

thismarketisrigged's picture

am i the only one who wants a default and another lehman right now?


i want this entire system wiped out now, please default

NOTaREALmerican's picture

Re:  You're not the only one.

Right now, listening to somebody talking to others about shopping for a car last night.  It was so crowded, they couldn't find a sales person.   They bought a Lexus something-or-other.

The economy must be really improving, they all agreed.   

Fogey's picture

They use the value of the land they live on to take out debt and consume. Just adds to the downside.

MetalFillBoy's picture

And do you really think that would change anything???  

Think about it....fine, burn this bitch to the ground.  

Then what??  

From the ashes, we start a new.  

And guess what emerges?  A group called TPTB.  

You think this new TPTB will be act more in your best interest?  Nope.

They will act just like the previous TPTB.  "What is mine, is mine.  What is yours is going to be mine too!"

"What has been will be again, what has been done will be done again; there is nothing new under the sun."



bagehot99's picture

Attitudes could be adjusted, if things were set up so that those in power who abused their position went to prison for thirty years. No parole.

And job numero uno is to wipe out the fuckers who are already there: Can't start a new party without kicking out all the guests who fucked up the last one.

The Abstraction of Justice's picture

I really *HATE* having to sell my silver each month to pay the rent. So yeah, roll on the end of the world. Let's have the big fight so I can get my katana out and cave a few scumbags heads.


If the world does not end on the 17th I would be really well chuffed and thankful is some rich stock broker type Zerohedger help fund this Indiegogo campaign, of which I am the CEO.

Ham-bone's picture

We have all been trained to not worry about this stuff - we know a "default" is no more possible after Oct 17 than it was before (ie, plenty of tax revenue ($200B mo) to pay the $30 billion in monthly would be a political decision, not an inability to pay)

Plus, think about most events that allow far greater power or galvanization of the populace to allow a government to take an action that would have previously been unthinkable...perhaps this is another "engineered" event coming??? (ie, strip the house of it's constitutional powers via a "temporary" ability of the Fed to print to "save" the people??? or something of that nature?...

Nixon "temporarily" closed the gold window in '71 (that's 43yrs of temporary closure)...

NOTaREALmerican's picture

Re: Nixon "temporarily" closed the gold window in '71 (that's 43yrs of temporary closure)...


beegle's picture

WTF ! talk about US default as soon as tonight and people arent buying gold ?! 

NOTaREALmerican's picture

Re:  talk about US default as soon as tonight and people arent buying gold

Most people think that should the US default, the money in their pocket won't turn from green to red, so there's no point worrying about anything.

The money stays green, the ATM's dispense green,  the restaurants take green, the gladiator games stay green, the porn stays green.

All systems green.  


Cosmicserpent's picture

Uhhh. You can't put gold on an EBT card, and the credit markets are about to lock up tighter than a fishes asshole, so no home equity loans.  Most 401k's don't allow purchase of physical, so PEOPLE do not have the ability to purchase more than a miniscule fraction of available gold.

TPTB will force gold down to herd everyone into bonds. GOLD IS GOING DOWN BABY!!!

CheapBastard's picture

Who cares anymore? It's all based on Fed/Banker pumping and Spin.

Fogey's picture

Better change your technique because you may face the shaolin!!!!!!


Fogey's picture

 they are apples and unicorns

born out of storm

you are standing there naked

noticing that life are bit hectic

get into debt to get cash

soon you will know someone owns your azzzzzzzzz

Bearwagon's picture

Please do not think about default risk or CDS, even if you have read this article, unless you won't mind everything going black for quite a time ...

yogibear's picture

LOL, default now or later. 

The US cannot pay all it's obligations anyway. 


China and middle easterners, how does it feel to be bag holders?

We buy your stuff with  IOUs calls US treasury notes. Foolls. 

MFLTucson's picture

Gold shopuld have gone through the roof if this were true?  Or are these gangsters able to manipulate the paper price with the worthless dollar indefinately?