The Other D-Word: Default

How bad is the current spate of financial upheavals (the federally backed buyout of Bear Stearns, the federal takeover of Fannie Mae and Freddie Mac, the hasty buyout of Merrill Lynch, the bankruptcy of Lehman Brothers, the impending joint federal-private bailout of American International Group)? In trying to explain the seeming double standard in the actions taken by the federal government in response to Bear Stearns back in March and Lehman Brothers this past weekend, today’s Financial Times Comment & Analysis section includes the following tidbit as one of a number of explanations (Persaud, Avinash, “Lehman Had to Fall to Save the Financial System,” 16 September 2008):

Third, there was an alarming factor not present at the time of Bear Stearns’ collapse that argued strongly against new government guarantees. Since the August rescue of Freddie Mac and Fannie Mae, credit markets have begun to price in the possibility of a default by the US government. The implied probability remains a fraction of 1 per cent but it is an unprecedented development.

It’s hard to know what to make of this. It could be just an investors’ parlor game, like the market on Hollywood has-been career comebacks. Or it could just go to show that unhinged paranoiacs aren’t confined to remote cabins. Some work in the bowels of high finance as well. After the past few months it would hardly be the first sign of a less than steady hand on the till. But there it is. The possibility of a default by the U.S. government has gone from beyond the pale to remote.

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