Balkinization  

Tuesday, July 12, 2011

Intrade's latest

Sandy Levinson

I note for the record that Intrade's latest prediction re Congress's passing a debt limit increase by midnight on August 31 is only 75% likelihood. This is down a full six points from yesterday's 81%. It is also interesting that the date is August 31, which presumably takes into account the possibility of a default in early August that would so roil that markets that even Republicans would come to their senses. Still, it seems fair to say that the actual markets are still refusing to take the possibility of default very seriously, though that seems less true in Europe re the possiblity of Greek and now Italian default. (Perhaps one difference is that European default is a reflection of truly deep and fundamental economic problems, whereas the American controversy is about the capture of the Republican Party by anti-tax fanatics.)

I made a bet back in April in which a friend of mine offered me 100-1 odds (i.e., his $100 against my dollar) against a default. So the obvious question is what any readers would be willing to offer me for an assignment of my bet. Since it might violate federal law actually to use the Internet for such purposes, I'll take your offers only as a theoretical exercise and not an "actual offer" that would enable me to respond with an "actual acceptance" and exchange of funds. We certainly wouldn't want to turn Balkinization into a betting operation :)

Comments:

well, first you have to define "default." Do you mean the standard ISDA definition pertaining to CDS?

the odds of an actual isda -defined default are still pretty low:

http://www.npr.org/2011/07/08/137679211/got-government-default-jitters

You really cannot price a default by the U.S. govt. because the impact is unknowable. Most pension funds and collateral agreements require AAA securities, currently in Treasuries- What happens if the entire world tried to rebalance and sell when moodys or S&P downgrade U.S. to D? Whose gonna buy? It's like selling hurricane or other catstrophe insurance - its impossible to get data and the impact is impossible to quantify.

they sell CDS ... but um, if the U.S. defaults, the collateral underpinning these agreements is U.S. Treasuries, likely, so um, how are you going to get paid exactly when the banks fail? Whose gonna bail out the failed banks?
 

Sandy:

You can't offload your sucker bet that easily.
 

Obama is upping the ante by not only threatening default, but also cutting off SS, disability and veterans checks.

http://www.cbsnews.com/8301-503544_162-20078789-503544.html

Human shield political negotiating.
 

My Treasury ETF (TLT) keeps going up, so the market must not be too worried about default. Still, in theory, I would take your position as a hedge. But only in theory, because I don't want anyone accusing me, like Eric Cantor, of profiting off catastrophe.
 

It's amazing how conservatives want to remove Obama's ability to pay the nation's bills, and simultaneously blame Obama for failing to pay those bills. Yes, Bart, if Congress fails to raise the debt limit, a lot of government obligations will have to go unpaid. Some of those obligations are very important and should be paid, but there will not be enough money to pay all of them. Are you under the impression that Obama could make up the shortfall simply by defunding ACORN and Planned Parenthood?

Of course Bart had no concerns when Bush claimed that the troops in Iraq would run out of ammunition if Democrats failed to pass a funding bill. That was much different, and not "human shield negotiating" in the least!
 

Your bet isn't exactly like a CDS, because in a CDS you'd have to pay the $1 either way (or in other words you'd only win $99 rather than $100). Also the standard CDS contracts have a yearly price and an experation of five years.

Nonetheless it is close enough to give you an idea of a fair price.

For a CDS contract that would pay out $100 if the U.S. government defaulted anytime in the next five years you'd have to pay an annualized $0.51 per year. If your bet were to expire on August 31, than using a simple linear pricing model, your position should be worth around $0.07.
 

Of course our yodeler had no concerns with the costs of the Iraq war because of Bush/Cheney's assurances that such costs would be repaid from Iraq oil revenues and would not add to deficits initially resulting from Bush/Cheney tax cuts for the wealthy pre-9/11, although Bush/Cheney viewed tax cuts as not increasing the deficit (although when reality set in, the adult - Dick Cheney - said deficits don't matter). No wonder our yodeler has hated Obama beginning with 1/20/09.
 

Perhaps mls could explain:

"My Treasury ETF (TLT) keeps going up, so the market must not be too worried about default. "

how this would apply to the stock market equities.
 

Steve M said...

Yes, Bart, if Congress fails to raise the debt limit, a lot of government obligations will have to go unpaid. Some of those obligations are very important and should be paid, but there will not be enough money to pay all of them.

We have more than enough to pay for the necessities - interest on the debt, the military, domestic criminal justice, emergency Medicare and Medicaid and checks to the elderly and disabled. The rest we could live without until our political class realizes that the people are serious about placing them on an allowance.

You will notice that our President is not prioritizing, but rather immediately threatening our most vulnerable in order to stop even marginal spending cuts. The GOP demand for a $2.5 trillion cut over ten years amounts to $250 billion a year or less than 14% of the deficit and less than 7% of the budget. And most of this is backloaded. This is barely a good start and hardly radical.
 

The Executive branch is to execute the laws resulting from initiation by Congress. If Congress fails to provide the funding for such execution, perhaps Congress should designate the prioritization of which laws are to be executed with such limited funding, if Congress has this same concern that our yodeler has:

"You will notice that our President is not prioritizing, but rather immediately threatening our most vulnerable in order to stop even marginal spending cuts."

But that might conflict with separation of powers.
 

Forget the word default for a moment. The Federal government is collecting around 15% of GDP in taxes, the lowest since about 1950 when the GOP discovered it loved to spend on the military, and it is spending about 25% of GDP. Which is why deficit spending is about 10% of GDP, obviously.

Without that borrowing the GDP would shrink a good portion of that 10%. Setting aside what gets defaulted on, the debt or whoever stops getting checks from the Treasury, without more new borrowing we will enter recession within weeks. We might be in one now as a matter of fact. Which is stunning in its own right as deficit spending is no longer stimulative in the conventional sense which means spurring growth. Rather that spending is an existential necessity to prevent recession, or worse.

This dilemma has been baked into the cake for exactly 3 years. To be clear 'dilemma' means having no good choice. Oddly the word has come to mean just a hard choice but this raising the debt limit is not just that, a hard choice. For either choice is bad. The only thing if favor of raising it and why it will be raised is that it delays a reckoning. What reckoning? The one where the Treasury can't borrow the money it needs and the Fed has to print it.
 

TLT is up again today, but one would think that tomorrow will be a different story.
 

And it was. Down 1.43% today.

Don't you appreciate the market updates?
 

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You really can not the price of a default by the U.S. Government. because the impact is unknown. Most pension funds and guarantee contracts require AAA titles currently in Treasury-What if the world has tried to balance and sell when Moody's or S & P downgrades U.S. D? What will you buy? It's like selling a hurricane or other insurance catstrophe - it is impossible to obtain the data and the impact is impossible to quantify.

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