They may well be, but that’s only because they are deemed risky. Yet Treasuries are supposed to be risk-free assets. Virtually all financial assets on the planet are priced in relation to Treasuries, so you could argue that if the U.S. Treasury defaulted, there would be nowhere safe to go. Under these circumstances, it’s difficult to assess the safety of anything in the financial world.
Default Insurance
Short-term Treasuries aren’t the only asset class directly affected by the U.S. debt ceiling. Worries have also crystallized in the credit default swaps market. This is an arena for deep-pocketed institutional investors — hedge funds, banks, pension funds and the like — and not a place that I usually spend a lot of time thinking about. But credit default swaps provide insight about the gratuitous damage that the political dysfunction in Washington is inflicting on the credit of the United States.
Consider that credit default swaps are essentially insurance. For a defined period, investors can obtain protection against losses from a debt default by a corporation or a government. The United States remains the world’s financial powerhouse. But until 2011, it also was in a select group of countries with the world’s highest credit rating. That year, though, Standard & Poor’s lowered its credit rating one notch because of the debt ceiling debacle.
Germany, on the other hand, still has a pristine, triple A credit rating. Although it doesn’t have the clout of the United States, it’s not surprising that Germany is deemed a better credit risk. But the extent to which that is now true is astonishing.
“Look at the credit default swaps market and you get a sense of how much the United States is being hurt by these debt ceiling crises,” said Richard Bernstein, a former chief investment strategist at the old Merrill Lynch who runs his own firm, Richard Bernstein Advisors.
I looked. While the probability of an actual debt default is still low, the cost of insurance for U.S. bonds over the next 12 months was about 50 times the price for Germany and about three to seven times that of countries like Bulgaria, Croatia, Greece, Mexico and the Philippines. That’s according to FactSet data. Over longer periods — three, five and 10 years — the cost of insuring against a U.S. default drops.
As you would expect, over longer periods, the United States is deemed safer than countries with weaker credit ratings, but it’s still about three times more expensive to insure U.S. debt than it is for Germany. And the yields on German sovereign bonds are generally lower than those for Treasuries, Mr. Bernstein pointed out. There are many reasons for this, but one important one is the safety of German debt. “Even when they are resolved, these debt crises are putting the United States at a long-term competitive disadvantage,” he said.