Trading of Credit Default Swaps on U.S. Debt Doubles

May 27, 2011

Trading of credit default swaps (CDS) insuring U.S. treasuries has doubled in the last year in response to fears over our inability to deal with our debt and deficit problems in addition to fears about lawmakers not raising the statutory debt ceiling to avoid a U.S. default.

Credit default swaps act as an insurance policy against a default on a loan. Just like other types of insurance, the purchaser of a credit default swap makes a series of payments to the insurer, and in exchange receives a payout if the borrower defaults on the (now insured) debt or loan. In the case of U.S. Treasuries, those who hold our debt may choose to purchase credit default swaps as a protection against a potential U.S. default this summer or down the road.

Increased trading suggests a higher level of fear over U.S. default on its debt obligations. As of May 20, 819 contracts insuring $4 billion in U.S. debt were outstanding, up from 449 insuring $2 billion of U.S. debt last year, according to Depository Trust & Clearing Corp (DTCC). Average daily trading just jumped to $490 million last week from $10 million the week prior, putting the U.S. at fourth most traded among those tracked by DTCC -- up from 633rd!

This is certainly an unsettling sign for the U.S. Our creditors will not lend to us indefinitely, and appear to be waking up to our unsustainable fiscal path and our rapidly approaching August deadline when Treasury estimates we'll hit our debt limit.

We need to responsibly raise the debt ceiling and put our debt on a downward path.