To be honest there were countries that defaulted on their sovereign bonds in their home fully controlled currency. Russia did this in the late 90s and took down LTCM, which was collecting premiums for insuring something that they thought is too illogical to ever occur. Well, it did occur.
The reason why this is illogical is that there is very little distinction between "the dollar" and US sovereign debt. It applies to all countries in a similar situation, for example "the Yen" and Japanese Government Bonds. It doesn't quite apply to odd cases like, IDK, Spanish sovereign debt in EUR and "the Euro" since the Spanish government does not control all forms of the issuance of the currency of the bond.
What they were doing is identifying pairs of securities whose values had diverged and they believed would eventually converge. They would short the more expensive one and buy the cheap one. When they converged they would sell the no longer cheap one, use the money to close out the no longer expensive one, and collect a profit.
However usually the reason why one was more expensive is that it had a more liquid market. So people could safely invest in it with money that they might need back quickly. This shouldn't matter if you planned to buy and hold though..at least in theory.
But in the wake of the Russian default, liquidity became more valued. So people sought to get rid of illiquid securities and buy liquid ones. This meant that LTCM had shorted things that were rising in value, and bought things that were falling in value. So they had a loss. And as the shorts got higher, they wound up having to sell assets at a loss to cover their shorts. And now the temporary losses became very real ones, and drove them bankrupt.
However, infamously, their investments made money in the end. They just weren't able to last long enough to benefit from it.
> I don't believe that LTCM was insuring anything.
While most of their strategy was convergence arbitrage, if I recall from the book, they thought of selling short equity options as a form of selling insurance.
People buy these options to insure against some event and they expected more buyers than sellers, so LTCM figured they would profitably be the provider of it. Well-structured insurance is always a loss to the buyer (they take in more than they pay out).
Insurance works because people, companies, shareholders etc are risk-averse and thus value paying a little for reducing variance a lot. That’s not a loss to the buyer. NPV isn’t the only measure of value.
Been a while since I read the book as well, but wasn’t part of the narrative that their backstop as insurance enabled traders to take bigger and bigger bets, because they were hedged with LTCM?
I don't think any trader at a broker/dealer would think that, but it's possible people on the buyside thought that. There are plenty of funds who have a strat of just allocating say 95% of their holdings to the Russell or something and then putting the remaining 5% into some high-vol bets (like putting them into LTCM or whatever). They don't see it as a hedge exactly, but it means that they hardly need to work at all and when these pay off they say "look this is alpha" and when they don't they say "look, your error vs the Russell is less than 5%". Some funds (eg big pensions) have enough AUM that this risky piece is a very significant amount of money.
I was working in the city shortly after LTCM failed and one of the interesting things I heard is that several large European institutions were using LTCM for overnight treasury. So at cob in Europe they would sweep funds into LTCM and then move them out the next morning for trading. If that was actually the case it would have caused massive fluctuations in their assets during the day which would be extremely hard to manage.
How has that got anyhing whatsoever to do with the thread or indeed TFA? Did you perhaps post this in the wrong thread or something? This literally is a thread about finance in response to an article about US credit default swaps.
The fact that we don't talk about any of the great tragedies that have happened throughout history is due to a policy of trying to keep conversations on topic.
That paper explicitly states this is not the result of "capitalist raping", and it's sad to see such nonsense injected into a paper explicitly stating the opposite. Did you read it or just see a tweet?
"In sum, according to the dysfunctional culture approach, self-destructive health behaviour - in the case of the post-socialist mortality crisis primarily referring to hazardous drinking - is not a result of the radical economic policies adopted during the transition from socialism to capitalism but of a dysfunctional, anomie-laden culture inherited from the socialist past whose effect was made worse by low alcohol prices during the transition"
In short, socialism had for so long ruined the economy that the country imploded, and the transition to a better working capitalism brought about deaths as a result of the wider destruction that caused the implosion.
Deindustrialization is the opposite of capitalism.
> It doesn't quite apply to odd cases like, IDK, Spanish sovereign debt in EUR and "the Euro" since the Spanish government does not control all forms of the issuance of the currency of the bond.
While that's true, Spain could go the tax route and say "gimme more euros this year" or sell off assets it owns. I guess a printer is faster (if they feel like it) but medium-term, developed countries have lots of tools to pay down debts (if they feel like it).
For some reason, people are more comfortable with inflation as a tax than taxes.
Well, I would assume apropos of my one economics class that the reason the average person doesn't care too much about inflation is that he has more debt than assets. If you ask me whether I want to pay a lot of taxes on my income or whether I want a big slice of my house to be free in inflation-adjusted dollars, here we would be, assuming I had no assets and most of my income went to my home loan.
> the average person doesn't care too much about inflation is that he has more debt than assets
What the average person forgets is that some people (and businesses) have wayyyyyy more debt, so when it gets diluted, they're a net loser on average.
Kinda like getting a $1000 stimmy cheque while large capital owners gets their equity saved by government bailout money. Everybody wins something, but winning last place isn't a win when no real wealth was created.
The thing you missed is that although inflation makes the nominal of the debt less valuable in real terms the associated cost of living increase means the cost of servicing the debt can go up both in real and nominal terms. You have less left over from your paycheck to pay the interest and the interest rates go up.
For most Americans, the biggest debt we have is our mortgage and 90% of mortgages in the US are fixed for the entire duration of the loan so nominal cost stays the same and the real cost goes down.
Aah interesting. Here in the UK most “fixed rate mortgages” are actually only fixed for a few years. Fixed for the full term does exist but is definitely less common.
>For some reason, people are more comfortable with inflation as a tax than taxes.
Because everything doesn't inflate at the same rate at the same time. That means the average person has some theoretical room to reconfigure their spending to minimize the impact of inflation. Ordinary people have no legal options to minimize the impact of higher taxes. That requires expensive CPAs and lawyers.
This is an extremely relevant Matt Levine piece. He gives an example of long-dated treasuries trading at 83 cents on the dollar. Today long-dated treasuries issued during COVID are trading well into the 50ies.
That's not because of their credit risk but because they pay little to no coupon and get discounted through the interest rates. In particular imagine a treasury bond that will pay $100 in 10 years, you wouldn't pay $100 for that, would you? You'd instead put that $100 in a savings account (t-bills).
The true credit risk on US Treasuries is indeed an abstract and mysterious creature. Nobody knows what would such a "default" mean in practice, what paper would get paid up and what paper would not get paid. Would commercial bank deposits at the Fed get paid? And if not, then what does it even mean to "pay in dollars"? Like how do you achieve "paying someone X dollars", do you deliver printed currency?
Yes, they're trading well under par because they're very long duration bonds and interest rates have moved against them, not because of credit risk. What Levine points out in the linked piece is that per the terms of these CDSes if the US technically defaults you can use the CDS to accelerate repayment of these very long duration bonds and get par back immediately rather than having to wait 30 years to collect. There's little to do with credit risk per se and everything to do with the interaction of the CDS contract and the current low valuation of certain debt instruments.
OMG, you made me read his article, and only then realized how ludicrous the "cheapest-to-deliver option" is. I had no idea you can send the CDS issuer any bond! Of course this is just an option for the scenario of "the congress got into a massive fist-fight and couldn't press the `yes` button on their voting machines for three weeks straight". What a hilarious piece of financial engineering.
> OMG, you made me read his article, and only then realized how ludicrous the "cheapest-to-deliver option" is.
It’s not really ludicrous, the US Treasury isn’t selling bonds of every duration every single day. You need some kind of framework to outline which Treasuries are acceptable to settle derivative contracts like futures/options/CDSes since Treasuries are not directly fungible like equity shares or commodities.
This is only true for those who are not impacted, in this case, by a government shutdown.
For example, suppose you’re running a company that has won a government contract and you receive scheduled payments from them. You use the payments to pay your suppliers and employees. If you don’t pay your suppliers and employees on time it causes all kinds of problems.
If the government looks like they might delay their next payment to you, you can “buy insurance” so that you can still make the payments. Is this gambling? Maybe? But if you don’t gamble there are real consequences, so “not playing” is still “gambling”.
> ... and get par back immediately rather than having to wait 30 years to collect
In a parallel universe the US has entered a short technical default just slightly before SVB's collapse, which allowed them (if CDS insured) to collect all MBS at par value.
I'm guessing also that as the ex-date for a possible US default approaches (I think it hasn't been announced yet), the demand for older cheap bonds/notes would rise
> That's not because of their credit risk but because they pay little to no coupon and get discounted through the interest rates. In particular imagine a treasury bond that will pay $100 in 10 years, you wouldn't pay $100 for that, would you? You'd instead put that $100 in a savings account (t-bills).
Long treasuries (>1 year) are issued at very close to par and do pay coupons. A treasury that is trading at 50-something cents on the dollar has lost a lot of value (because it has a lower coupon rate than newer treasuries).
Yeah the particular one I was looking at was 912810SP4, a 30 year treasury with a 1.375% coupon. It was issued in August 2020 at a price of $99.24 for $100 of par, and it now trades just under $59.
The way I understand the article: Insurance not likely to pay in case of small short cured default and in a major default the counterparty is at risk. So buying it as insurance makes no sense. But..
.. there are special rules which trigger even in a short default allowing a fair bit of money to be made turning the CDS into a sensible bet on a short duration US default.
The theory and the practice of CDS’ have always been wildly different.
In theory, a CDS is “insurance” if a bond issuer defaults.
In reality, CDS’ are used to go in and out of positions on companies because contracts are too difficult and expensive to cancel. The end result is big firms end up with huge, complicated CDS positions all over the place for 5-10 years until the contracts cancel.
A CDS on the United States is another stupid end result just like CDO2 vehicles were.
The CDS market is just so incredibly flawed when markets are stressed.
The debt ceiling functions primarily to give negotiation leverage to the minority party. The problem is, if the threat of not raising the ceiling is executed on then it hurts both parties. Even the possibility that the debt ceiling will not be raised is collectively hurting us. This credit default swap is one signal of the negative impact these debt ceilings negotiations have. We really need a reform on the way the US handles debt, one that provides more predictability.
A no-nonsense solution would be to make raising the debt ceiling part of the annual budget or any bill that that has an impact on the budget. Another potential solution would be to make increases on the debt ceiling automatic based on a percentage of GDP, or over time. Another solution would be to reduce the national debt. We have options, and it almost doesn't matter what we choose because our current path is too volatile.
The most straightforward option would be to just get rid of it. It has not made any sense since the 1970s when Congress gained direct control over the budget. The actual thing that the debt ceiling does is stop the Treasury from issuing debt to pay for things Congress has already decided to pay for. It's bonkers.
Also, it's not just "the minority party". Ever single debt ceiling crisis since 1995 when the Gephart Rule was repealed has been instigated by the Republican Party.
Yep. When congress (or any government) passes bills with spending implications, following through with the associated payments should be automatic/mechanical, not relitigation of the issue. To pretend the central bank/treasury is anything but the check writer for government spending is just fiction.
Pretending that major economies are going to pay back their debt in anything close to money with similar purchasing power is also fiction. At this point, let's repeal the personal income tax (to free the people) and print currency instead of the game of loaning it into existence. The debt ceiling charade is a distraction which causes economic disruption.
Inflation would be a train wreck and the dollar could then be used as toilet paper. Most other nations would move to using other currencies since holding on the depreciating dollar would be a liability on top the liability it is already is proving to be. (sanctions happy freezing ,etc)
Taxes can control inflation the problem with MMT is they naively think democratically elected governments can raise taxes without losing government to someone who promises not to.
> The actual thing that the debt ceiling does is stop the Treasury from issuing debt to pay for things Congress has already decided to pay for. It's bonkers.
Great summary. That's why, if there's going to be something like a debt ceiling, it has to be part of the budget process, not a separate part of the debt-repayment process. You don't boycott paying your credit card bill. You stop putting more purchases on it.
Granted, the one step follows the other. But Congress is manifestly unable to backpropagate consequences by one step.
So if we're going to have a guardrail, it has to be in the right place. Yet somehow this middle way is never considered. Instead it's just "debt bad" or "debt ceiling bad". People always with the dumb binaries and false dichotomies.
"The actual thing that the debt ceiling does is stop the Treasury from issuing debt to pay for things Congress has already decided to pay for."
It's unlikely it does that. If it came to a court the judge would have to decide which of Congress's instructions take precedence or how to reconcile them. That falls into territory of implied repeal and reinterpretation of the Federal Reserve Act.
If the Democrats had any backbone, they would instruct the Fed to pay what Congress has authorised and if the Fed said 'no', take them to court to force an interpretative judgement to settle the matter. (which I call the 'empty chest' problem).
Which would almost certainly involve reading section 15(1) of the Federal Reserve Act using the same 'futurity' that the courts have used in appropriation bills.
(ie the deposits it talks about are past, present and future deposits).
That would imply a balancing amount held at the Fed, and the debt ceiling stops the Treasury refinancing that balance into bonds.
Both the spending and the debt ceiling requirements of Congress are then satisfied - and the tool is neutered.
Even more straightforward option - get rid of the debt ceiling by requiring the federal government to run a balanced budget. States are required to run a balanced sheet (with a few caveats), the feds should have to follow the same rules.
You cannot simultaneously a) be the largest reserve currency in the world, b) be the backstop for all those states that require balanced budgets and can't pay for emergencies, c) have the largest military in the world, and d) require a federal level balanced budget.
Nationstate finances are not the same thing as personal finances or corporate finances. Trying to paint them the same is misleading at best and actively harmful at worst.
Agreed, my opinion is simply that (d) should be prioritized and the others would reasonably be on the chopping block when we have to cut trillions in deficit spending.
It's worth noting that I wasn't comparing nation-state finances to personal finances at all. I was only comparing US federal finances to US state finances.
> The actual thing that the debt ceiling does is stop the Treasury from issuing debt to pay for things Congress has already decided to pay for.
Maybe we should revisit those decisions. Even individuals revisit decisions, it is insane that we don't revisit certain decisions.
Even if we agree to pay for things, is the government at peak efficiency? There is so much wastage at every level in the govt. Rather than blame Republicans, maybe ask why Democrats are against a more efficient govt (that can still be large and fund their pet programs).
> Maybe we should revisit those decisions. Even individuals revisit decisions, it is insane that we don't revisit certain decisions.
Isn't that what the annual budget process is about? Why do we need a separate process to allow for the borrowing to make the payments for the things that were individually authorized (often with renewals every so often) and then collectively authorized in the budget?
If you don't think the programs are efficient enough as it is, the collosal waste of a government shutdown should be a definite no. Those waste money in that there's extra work to prepare for closing and to reopen, that prevents people from doing the actual work they should be doing, as well as the fact that all of the government workers unable to work because of the shutdown end up getting paid anyway.
> Isn't that what the annual budget process is about? Why do we need a separate process to allow for the borrowing to make the payments for the things that were individually authorized (often with renewals every so often) and then collectively authorized in the budget?
Well, you answered your own question. There is a separate process because the budget process has been broken in a spectacular way.
> If you don't think the programs are efficient enough as it is, the collosal waste of a government shutdown should be a definite no. Those waste money in that there's extra work to prepare for closing and to reopen, that prevents people from doing the actual work they should be doing, as well as the fact that all of the government workers unable to work because of the shutdown end up getting paid anyway.
> Maybe we should revisit those decisions. Even individuals revisit decisions, it is insane that we don't revisit certain decisions.
Maybe you could revisit those decisions by passing laws that directly change them, instead of threatening to keep the decision in place and just not allocate the funds you promised for it?
Was wasting trillions of dollars also part of the original promise? No. So the original contract has already been broken.
Btw, not all spending is "promised" spending. Around 30-40% is discretionary spending. Spending that was not promised and is optional. This is on top of the massive levels of waste.
Better yet is just getting rid of it. It's unconstitutional ("full faith and credit shall not be questioned"), if the Treasury decided to ignore it nobody would have standing to sue anyway, and it's just redundant: Congress already has the power of the purse, if they want to cut spending, they can propose a budget which does this. The debt ceiling is nothing but Congress shirking its responsibility.
> The debt ceiling functions primarily to give negotiation leverage to the minority party.
Have Democrats ever actually made such a big deal out of this though? It seems like the increases were fairly painless during the Trump years when the Dems controlled the House.[0]
The reason is that at least officially, the Republican Party is in favor of small government. So if the Democrats as the minority party were to say,"Compromise with us or we won't raise the debt ceiling," the Republican Party's response would be a sarcastic, "Oh no! Don't impose drastic spending cuts! Anything but that!" Thus the Democrats have no leverage to hold back a Republican Administration's spending priorities.
Actually, if the Dems had done this in response to Trump's tax cuts, I think the Republicans would have been pretty cornered. After all, the three things you can't touch (and the GOP have promised not to this time around) are the military, Social Security, and Medicare.
> The debt ceiling functions primarily to give negotiation leverage to the m̶i̶n̶o̶r̶i̶t̶y̶ Republican party.
Fixed that.
And the Republicans only caring about it when they're in power should give you some indication of the level of commitment they have to smaller government.
Not your finance person, but a good way to think about an abstract event like “US debt default” is through two lenses.
1) it’s an event that can’t happen unless a lot of powerful folks take a bath. Odds are good that energy will be directed to prevent it - or failing the ability to muster energy, you won’t care.
2) If the dollar collapses, what asset would you want to hold? Would it make sense to hold that asset absent a crash?
The federal government is not the main enforcer of this. Counties generally do the work of tracking this. It's the job of the register of deeds. Failing that, normally the state would step in.
You would require a failure of the federal, state, and county government for this to occur
It might be a failure of imagination but I can’t perceive a scenario where the federal government collapses and the county sheriff holds things together until a new government can be rebuilt.
Who's invading who if the federal government collapses? Has Arlington, VA been amassing guns and ammo this whole time, just waiting for the federal government to fall so they can invade Washington DC? I'm sure it's a failure of my imagination too, or a faith in humanity, but I don't see roving hordes forming and raiding the countryside like something out of mad max or a zombie movie the instant the federal government falls. At which point my county, and its sheriff is the closest government, holding down order.
The us has an extremely large number of munitions spread across individuals, state run national guard and reserve units, and the federal military.
In a situation where the federal government ceased to be - I don’t think it’s fair to make any assumptions on what successor states would look like. Nor what boundaries thise successor states would keep.
I don't see that either, but I also don't see a complete failure of the current power structure. State governments would step in and would put pressure on the counties to do more work and keep order. If the states collectively failed, I imagine some counties would be able to stand independent, but most won't
Well, those all use the dollar. I can't really see a situation where the federal government collapses but my local register of deeds keeps property lines up to date.
A collapsing dollar means no one’s interested in building anything so land value goes down and a collapsing dollar means all the industries that use gold are also collapsing reducing the value of that too.
The british sterling hasn't collapsed per se, but over the past 50 years, it certainly has lost a lot of its value, and mostly in the recent decade.
A collapsing dollar may not happen abruptly (which would happen in a war on US soil), but could happen slowly. In that case, holding US land (and plant&equipment etc) does still make sense, as these things will continue to function and provide goods.
For (2) - obvious answer here is crypto but again, the crypto market might implode because if (1) actually happens, the US gov is extremely incentivized to make crypto ownership and trading illegal.
Crypto may be a bad bet in a world where the dollar implodes. If crypto is predominantly healed by dollar holders - rebalancing from crypto to the dollar denominated assets they need to function could harm crypto prices.
Alternately, in the event of a dollar default - the world may not be conducive to the capex+energy expenditure required to mine crypto. If interest rates went to 20-30%, I’m not sure that crypto mining would be a viable concern - causing instability throughout the crypto world.
That being said, whether crypto is a good hedge or not really depends on whether it’s worth putting money in today - regardless of the potential for US default. Particularly in comparison to Yen, euro, and yuan assets.
If the US government outlawed crypto to save the USD, they'd have to also outlaw gold, because that's where all the money would flow to instead. The rest of the world wouldn't outlaw gold and crypto, so the effort to kill alternatives would fail and it would just accelerate fleeing USD into gold and crypto.
God were only like a few months in and im already so annoyed with people bringing up chat gpt. No this isnt a good question for chat gpt because chatgpt has no critical thinking skills, which is the foundation of a sound investment strategy.
Chat gpt is trained on the internet. The ratio of bad advice to good advice on the internet is about a million to one.
Asking ChatGPT "Why does the price of a Credit Default Swap rise?" gets you:
> The price of a Credit Default Swap (CDS) rises when the market perceives an increased risk of default by the underlying entity, such as a company or government.
> A CDS is a financial instrument that allows investors to protect themselves against the risk of default by an issuer of debt. The buyer of a CDS pays a premium to the seller, who agrees to pay a fixed amount in the event of a default. The price of the CDS reflects the perceived risk of default by the underlying entity.
> If the market perceives an increased risk of default by the underlying entity, such as due to a weakening financial position, deteriorating economic conditions, or a downgrade in credit rating, then the price of the CDS will rise. This is because investors will demand a higher premium to compensate for the increased risk.
> Conversely, if the market perceives a reduced risk of default, such as due to an improvement in the financial position or a credit rating upgrade, then the price of the CDS will fall, as investors require a lower premium to compensate for the lower risk.
I think it sounds that way because it probably was!
> Please don't post insinuations about astroturfing, shilling, bots, brigading, foreign agents and the like. It degrades discussion and is usually mistaken. If you're worried about abuse, email hn@ycombinator.com and we'll look at the data.
The site guidelines suggest not accusing posts of being written by bots :(
When I put the word 'bot' in that guideline I had in mind something quite different from LLMs - it was more about asking people not to post things like "zomg this thread is overrun by $nation bots i guess that's the end of hacker news".
The community response to LLMs (including to comments that read like they were generated by an LLM) is more complex and not necessarily abusive, and I'm inclined to let it play out. So yeah, technically we should probably take the word 'bots' out of that guideline as ozarker's sibling comment suggests.
The downvotes of your comment are interesting. Regardless if it's written by AI, I think it's good evidence that humans are almost certainly going to need to modify their writing style, to appear "more human".
https://archive.is/r0lI2