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Will U.S. Default? $4.8 Billion Investment Says Yes

Comstock Images/Thinkstock(WASHINGTON) -- Investors are spending $4.8 billion to hedge against the possibility that credit rating agencies will downgrade U.S. debt -- or worse, that the U.S. actually will default. Doomsayers predict these and other dire consequences if Congress fails to act by August 2 to raise the nation's debt ceiling.

Rating agency Standard & Poor's earlier in July warned the U.S. that it risks a downgrade of its top AAA rating to AA status, unless Congress lifts the $14.3 trillion ceiling and reduces total debt by $4 trillion over 10 years. In April, the agency lowered its rating outlook for the U.S. from "stable" to "negative."

Investors worried at the prospect of a U.S. downgrade or default could protect themselves several ways, say experts. Joe Magyer, senior analyst at the financial website Motley Fool, says an investor could go entirely to cash. Otis C. Casey, director of credit research for Markit, a financial information services company, says an investor could unload any U.S. debt he might own and move into some other safe-haven asset, such as gold, the price of which has recently hit record highs on fears over the debt fight.

A person also could invest in a mutual fund, the return for which goes up when U.S. treasuries go down. Such funds allow investors to bet against U.S. debt.

Big institutions and the most sophisticated investors use credit-default swaps (CDS), which act like insurance policies against the deterioration of debt, be it corporate or the debt of a sovereign nation. If the debt is downgraded or if the borrower defaults, a swap makes the debt-holder whole again.
The amount of money in U.S. credit-default swaps increased 57 percent this year to $4.8 billion, according to the Depository Trust & Clearing Corp, which provides clearing, settlement and information services.

Any increase in the price of a swap is a sign of investors' declining confidence in the soundness of the underlying debt. Casey, for that reason, calls swaps early warning indicators. As Congress has continued to wrestle over raising the debt ceiling, the price of U.S. swaps has risen.
Suppose that August 2 arrives, and that Congress fails to act. What happens then to holders of U.S. debt?

"Some people have speculated," says Casey, "that there are so few safe havens for investors that U.S. bonds might actually benefit if the debt ceiling isn't raised." Panicky investors, in other words, might flock to U.S. treasuries as their least-bad option. "That," says Casey, "would be the ultimate irony.”

Copyright 2011 ABC News Radio

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