Gerry Canavan

the smartest kid on earth

Posts Tagged ‘credit default swaps

Thirteen Ways of Looking at a Sovereign Debt Crisis

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…at the Atlantic. #13 in particular is the one that’s got my hair on fire, in no small part because it gives us #7, 8, and 9 as a bonus.

‘Riskless Return’

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Ezra Klein on my broken record: If the federal government’s borrowing costs rise, so will everyone else’s. Mortgages rates will jump, car loans will be harder to come by, universities won’t be able to float bonds, cities won’t be able to fund themselves.

Treasuries are supposed to set the rate of “riskless return” — the price of loaning someone money and knowing, with perfect certainty, that they’ll pay you back, with interest. So when lenders decide how much to charge, they start with the riskless rate and then add to it to cover the risk that you won’t pay them back, and the inconvenience of having to wait for you to pay them back.

It’s a practice called benchmarking, and it’s everywhere: in your mortgage, your credit card, your car payments, the loan you took out to hire three new employees at your business. It’s even common internationally. The fact that Brazilian loans tie themselves to the American government’s debt just shows the high esteem in which the world holds us.

But if the rate on 10-year Treasuries rises, it means rates rise for everything else, too. That’s why economists consider the Federal Reserve’s power to affect interest rates — a power it has virtually exhausted during this crisis — so potent: if you can move the basic interest rate, you can move the whole economy.

End of the World Blues

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So what happens if the U.S.’s bond rating does get downgraded? Some 7,000 top-rated munis would be automatically downgraded if the U.S. government lost its AAA rating. In addition the credit ratings of a host of state and local governments, housing bond programs, higher education and non-profit institutions, and other entities dependent on the federal government would be reviewed, Bloomberg reports. 

And it could get much worse than that. There are huge swaths of the global economy that are predicated on the idea that the U.S. government will absolutely never default. Additionally, there’s no telling what sorts of CDS-style time-bombs and investment-product doomsday machines are out there waiting to be triggered if the U.S. were to be downgraded as a result of all this political posturing. Recall that the stock market crash of 2008 was triggered in large part by the downgrading of a single firm’s credit rating. The U.S. is orders of magnitude more important to the world economy than AIG.

In short, the Republicans have completely lost their minds.

Towards a Grand Unified Theory of Apocalypse

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