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Cost to Insure U.S. Government Debt Soars

September 27, 2013
The Wall Street Journal
Katy Burne and Damian Paletta

The cost of insuring against a U.S. default for a year has risen sixfold in the past week, reaching its highest level since 2011, reflecting investor bets that the government could fall behind on its debt payments in the coming weeks.

The Treasury Department said on Wednesday that by Oct. 17 it would have only $30 billion left to pay bills, and that money is only expected to last one or two more weeks unless Congress raises the so-called debt ceiling, which limits U.S. borrowing. Many Republicans have said they would approve such a move only in exchange for a long list of demands, such as changes to the White House's health-care law and lower tax rates. The White House has said it won't negotiate with Republicans at all and wants the debt ceiling raised immediately.

The stark political divisions have led many lawmakers, analysts and investors to wonder whether policy makers will be able to reach an agreement in time.

This has driven the annual cost to insure $10 million of U.S. government debt for one year using derivatives called credit-default swaps, or CDS, to €31,000 ($41,930), according to Markit data. That is up from about €5,000 as recently as last Friday and is the highest it has been since August 2011, the month in which U.S. debt was downgraded from the highest level by Standard & Poor's Ratings Services.

Default protection on U.S. Treasurys is quoted in euros, just as European sovereign CDS contracts are quoted in dollars, sparing investors the risk the hedge will fall in value at the same time as the currency itself.

In a sign of how jittery investors have become about near-term payment risk, the cost of insuring the debt over the next year is the same as protecting it over five, Markit data show. The last time the gap between the two prices closed was in mid-2011, when the White House and Congress last had an acrimonious debate about the debt ceiling.

Those talks were resolved after Treasury warned it was close to falling behind on certain payments.

While five-year protection is more routinely traded, the one-year contract is often what moves sharply when budget talks in Washington reach fever pitch. That is largely because they feature an odd or nonstandard tenor, giving individual trades an outsize impact on prices. Treasury Department officials are watching the rising price carefully as they monitor fluctuations in the market.

CDS function like an insurance contract against nonpayment on debt. If a borrower defaults, sellers compensate buyers. If a borrower fails to meet its obligations, credit swaps pay the buyer face value, less the value of the defaulted debt.

The U.S. government hasn't said what it would do if the debt ceiling isn't raised. Many investors believe the government would make interest payments on government debt to ensure it doesn't default, but the White House would potentially face a difficult political dilemma of cutting money for domestic programs to pay off investors.

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