US Government Debt Different - Finance Department - University of ...

82 A Market for End-of-the-World Insurance? Credit Default Swaps on US Government DebtTo date, the only categories of CDS that regulators have proposedto subject to the clearing mandate reference pools of corporateborrowers. 35 Whether the regulators are likely in the future toconsider CDS on USA a good candidate for mandatory clearing isquestionable. As a general matter, clearinghouses seem particularlylikely to suffer financial distress if the US Treasury ever defaulted onits debt. Clearinghouses rely heavily on posted collateral to protectthemselves against counterparty risk, and by necessity a large portionof such collateral is US Treasury debt and other securities whosevalue is highly correlated with that of US Treasury debt. Moreover,clearinghouses do not post collateral to their counterparties, whotherefore are exposed fully to the credit risk of the clearinghouse itself.In a “bilateral” (uncleared) CDS contract, by contrast, the protectionseller posts collateral directly to the protection buyer, andthat collateral can be selected for its likely resilience in the face of aUS Treasury default. For these reasons, market demand for centrallycleared CDS on USA seems unlikely to emerge, and without suchdemand regulators are unlikely to make central clearing of that particulartype of swap mandatory. 36While the thinness of the market for CDS on USA is not readily explainedby counterparty risk as that term is normally defined, anotherfactor that is peculiar to US government debt might be relevant.Given the central role that US government debt plays in the worldeconomic system, market participants might fear that a US Treasurydefault is highly likely to accompany a political or social crisis thatthreatens the rule of law and leaves the enforceability of all contractsin doubt. Put another way, CDS on USA is valuable only in a futurestate of the world in which a US Treasury default does not occasiona general breakdown of social order, and the probability of such afuture state is difficult to estimate.35 See Commodity Futures Trading Organization, Clearing Requirement DeterminationUnder Section 2(h) of the CEA, 17 C.F.R. Part 50 (Aug. 7, 2012).36 Strictly speaking, US regulators could subject a category of CDS contract to theclearing mandate even if no clearinghouse has announced a willingness to acceptthe contract for clearing. As a practical matter, however, regulators seem unlikely totake such a step. For a useful discussion, see Mark Jickling & Kathleen Ann Ruane,The Dodd-Frank Wall Street Reform and Consumer Protection Act: Title VII, Derivatives,Congressional Research Service Report for Congress (Aug. 30, 2010), http://www.llsdc.org/attachments/files/239/CRS-R41398.pdf.