My original topic was deleted. Regardless, is anyone planning to purchase S&P Spdr puts or sell portions of their portfolio out of fear that the debt talks may falter? Any thoughts on risk mitigation?
Hmm. It really depends on your degree of risk aversion. For example, SPY September 120 puts are offered at about 1.15 right now. So you would be paying about 0.9% to protect against a loss of greater than 10%. I probably wouldn’t do it, but other people might.
I highly doubt they will let the US default.
Historically, markets rarely react to events like this, that seem so unlikely, until it actually happens and then everything crashes. Could it happen? I think it could. Its more likely that the recent delaying is just the two parties negotiating terms of the debt ceiling being raised. I think there is a danger in assuming that it won’t happen at all because the markets haven’t really reacted to it all that much.
The current market price probably reflects something like 0.05*(Default Scenario) + 0.95*(No Default Scenario). So, if I had to make a binary guess of the outcome, I would guess that there will be no default. The default scenario is unlikely, but if it does happen, there will be pretty catastrophic losses. So, this might still mean that the risk is non-negligible.
I think the Tea Partiers are just going to push as hard as they can. They don’t really care if there is a default, because they figure that they can blame it on Obamer and solidify their campaign in 2012. I think the Tea Party isn’t just against the Dems, but against the moderate wing of the Republicans, too. Whether Obama or the Tea Party gets the blame for a situation like that remains to be seen. I actually think it may blow back in the Tea Party’s face, but I’m not at all sure about that. It’s really very scary, and I think the chance of a real default (though not permanent default) is a lot higher than we’re willing to admit. That doesn’t mean that it’s greater than 50-50, but I think it may be surprisingly close 50-50. The US is not truly insolvent yet, but the panic that will ensue if the US actually misses a payment will basically make pretty much all assets other than precious metals and food collapse as the risk premium shoots through the roof. If there is no extension of the debt ceiling, that doesn’t automatically mean that the US won’t pay its interest, though. It just means that it’s a choice between a partial government shutdown and paying the interest. So probably it will be a partial shutdown, because the administration doesn’t want to get the blame for actively choosing not to pay interest. But it’s scary. This is one of those boundaries that - if we cross - the consequences are likely to be very extreme and unpredictable. FWIW, I’m about 60% cash right now.
I have heard people say that they would prefer default if it means the GOTUS actually gets its finances in order. I wonder though, in finance in so many things we assume that US debt is default risk free, I wonder what an actual default would do to security prices…
Palantir Wrote: ------------------------------------------------------- > I have heard people say that they would prefer > default if it means the GOTUS actually gets its > finances in order. Yes, people say that. But it’s because people haven’t thought through what a default would actually mean. Did you see what happened when the market decided that Greece was going to default? Greece. A tiny $300 billion economy (the US is about $14,000 billion). What happens when people have to find a place to put assets they want to be safe, and the $13.5 trillion that is in US Treasury securities is no longer considered safe? And what other safe asset is there? Yuan? Euro? Yen? You can’t even get your hands on $13.5 trillion of Yuan, and even if you could, your counterparty would be an authoritarian government with a history of jingoism/xenophobia, particularly when there is unrest in the countryside. Anyone see those inflation figures in China recently? With no safe place for *any* asset, that means that people will demand higher rates for all kinds of risk. So *all* risky assets will suddenly have higher risk premiums. And “safe” assets will become risky. And the price of pretty much all assets will plummet, because they’re now being discounted at a higher rate. Which means that corporations will have trouble raising capital (good thing they have all that cash on their balance sheets, which will go farther to buy things in the aftermath, except for the little issue of where that cash is actually going to be stored - remember, it’s probably been in Treasury securities, which have defaulted in this scenario). Which means that unemployment will shoot up, which means that aggregate demand will collapse, which means that the economy will contract further. And this will be contagious, because the risk premium will be up around the world, and emerging markets won’t be exporting nearly as much to the US because we can’t buy anything, and that means that they won’t be buying equipment and machinery from us because they don’t need to expand their capital base. It’s really really horrific… People are saying it won’t happen because it’s “unthinkable.” But Lehman going under was “unthinkable” too. And religious fanaticism from the Tea Party is precisely the thing that makes the unthinkable thinkable. That, plus the idea that “we can be intransigent, because the dems won’t push the button on financial Armageddon, and if they do, we’ll blame them for it.”
bchadwick Wrote: > People are saying it won’t happen because it’s > “unthinkable.” But Lehman going under was > “unthinkable” too. And religious fanaticism from > the Tea Party is precisely the thing that makes > the unthinkable thinkable. That, plus the idea > that “we can be intransigent, because the dems > won’t push the button on financial Armageddon, and > if they do, we’ll blame them for it.” Yeah. Who cares about the health of the US and the global financial system? There are elections to be won!!!
At some point there will be a deal reached and the US will not default. If it takes a couple of days past the deadline to reach a deal so that there is technically a default, the US will still pay in full for all of its obligations.
Whoever believes that this “can’t” or “won’t” happen does not know how to properly quantify risk in my book. Make no mistake this can really happen!
I decided to put contingent sell orders on all my equities executed at 20% loss and I’m going to hope for the best.
What probably happens to the dollar, stocks, gold if this happens?
there is no such thing as risk-free, ever. i don’t think it would be a quick and catastrophic event as USTs were never risk free to begin with. if they were risk-free, CDS on USTs wouldn’t exist, or they would trade in the low single digits, kind of like defunct GM shares. you could argue that all assets are already under pressure because CDS on USTs are already historically high, and that if some LT solutions and short-term resolutions are made in terms of GOTUS finances, that all assets would benefit from the decline in CDS. sure a 50% increase in CDS on USTs would be bad for all assets, but a 50% decrease in CDS on USTs would have to be almost as good on the upside. saying there isn’t a second side to this coin is to ignore what CDS markets are already telling you, “no assets are risk free!”.
I think you’re splitting hairs here, MLA. When people teach that UST’s are a reasonable reflection of the (nominal) risk-free rate, they say… “It’s about as risk free as you can get. The USG can always print money if necessary to pay the debt, so there is zero default risk. And if the USG can’t pay it’s debt, well, then we’re in a situation where the return on cash is going to be the least of your problems.” And so, perhaps, we are coming to a situation where this is going to be the least of our problems.
bchadwick Wrote: ------------------------------------------------------- > FWIW, I’m about 60% cash right now. What’s your YTD return? Absolute term and risk adjusted…