In Corporate Finance, when I teach my students about the Capital Asset Pricing Model, I tell them that we use the interest rate on short-term US Treasury notes as a proxy for the rate of return on a "risk free" asset precisely because those securities are essentially risk free.
Maybe we need to rethink that assumption. I noted a while back the troubling phenomenon that the price of credit default swaps on US Treasury bonds is rising.
It's a highly negative signal from the market. People are willing to bet that the USA can't get its financial house in order.
The news on this front, unfortunately, is getting worse rather than better:
The bond market is saying that it’s safer to lend to Warren Buffett than Barack Obama.
Two-year notes sold by the billionaire’s Berkshire Hathaway Inc. in February yield 3.5 basis points less than Treasuries of similar maturity, according to data compiled by Bloomberg. Procter & Gamble Co., Johnson & Johnson and Lowe’s Cos. debt also traded at lower yields in recent weeks, a situation former Lehman Brothers Holdings Inc. chief fixed-income strategist Jack Malvey calls an “exceedingly rare” event in the history of the bond market.
The $2.59 trillion of Treasury Department sales since the start of 2009 have created a glut as the budget deficit swelled to a post-World War II-record 10 percent of the economy and raised concerns whether the U.S. deserves its AAA credit rating. The increased borrowing may also undermine the first-quarter rally in Treasuries as the economy improves.
Why is this happening? Because the financial markets no longer regard the US government's predilection for deficit spending as sustainable:
While Treasuries backed by the full faith and credit of the government typically yield less than corporate debt, the relationship has flipped as Moody’s Investors Service predicts the U.S. will spend more on debt service as a percentage of revenue this year than any other top-rated country except the U.K. America will use about 7 percent of taxes for debt payments in 2010 and almost 11 percent in 2013, moving “substantially” closer to losing its AAA rating, Moody’s said last week.
Who's to blame? It's about time Obama stopped blaming Bush:
President Obama’s budget proposal would create bigger deficits every year of the next decade, with the gaps totaling $1.2 trillion more than his administration projects, the nonpartisan Congressional Budget Office said this month. Publicly held debt will zoom to $20.3 trillion, or 90 percent of gross domestic product, by 2020, the CBO forecast.It's about time Obama and the rest of the Democrats got serious about cutting spending. Yet, somehow, I'm not optimistic.
