Comments on: The US default-risk meme

By: niveditas

niveditas — Sat, 27 Mar 2010 18:16:00 +0000

Greycap, the swap settles off of 3m libor, so the payoff incorporates 3m bank credit risk, independently of any counterparty risk in the swap. Besides, interest rate swaps between dealers are margined and have very little counterparty risk.
And if you add the funding angle (you can borrow against treasuries at below libor rates) the effective spread between the treasury rate and the swap rate is even greater than the quoted one.

By: Greycap

Greycap — Thu, 25 Mar 2010 17:28:42 +0000

1. US treasury rates are usually below the risk-free rate. The liquidity premium you pay is higher than whatever default premium you receive. In the typical IR environment of the last 25 years, swap rates are not as far above risk-free (arithmetically) than treasuries are below.

2. In any case, have you bothered to compare swap spreads with with sub-debt bond spreads from the same issuer? A true anomaly would be if the swap spread were not lower than the bond spread. The reason is that (absent disguised loan tricks) the credit risk of the bond is much greater because of the exposure to principal. With the swap, half the time the other side has exposure to you.

3. It follows that you really want to compare bank vs government credit (still a pointless exercise in my opinion), you have to compare like for like: swap vs swap or bond vs bond. (CDS vs CDS won’t work because the terms aren’t comparable e.g. EUR payoff from EUR bank in the case of the sovereign.)

Bond Girl has some speculation on the technical mechanics of putting on an arb but no matter how you do it, you will founder on this problem of credit risk.

By: high_al

high_al — Thu, 25 Mar 2010 14:28:51 +0000

History has shown that not too many revolutionary governments honor the previous government’s debts.

(This is the only way I could come up with a plausible default risk for the US.)

By: dewey2999

dewey2999 — Thu, 25 Mar 2010 12:38:58 +0000

Bloomberg articles tend to be written by 25 year old Ivy Leaguers who couldn’t find work in an investment bank, and tend to remain somewhat bitter about that fact. As regards their journalism, the gap between level of expertise and breadth of readership is surpassed only by The Economist.

By: Uncle_Billy

Uncle_Billy — Thu, 25 Mar 2010 04:05:16 +0000

Let’s ask some of the characters in Michael Lewis’ book, and Michael Lewis himself. They are the ones that can see the shapes in the mist. And there’s always that Bill Gross character. See if he’ll take your call.

By: Sprizouse

Sprizouse — Thu, 25 Mar 2010 02:26:57 +0000

Is the swap-spread meme assuming that the rate differences between equal maturity swaps treasuries reflects ONLY default risk? Shouldn’t we also calculate any embedded options?

After all, what about prepayment risk? Treasuries are callable aren’t they?