United States citizens are watching a deteriorating tango between banks and the federal government. Bank depositors have been losing confidence in the value of their bank deposits, while credible market signals flag higher concerns about the credit quality of the United States Treasury.
In recent months, credit default swap spreads for Treasury debt have risen significantly. They are based on financial instruments that yield information about the implied probability of default. For the U.S. Treasury, that implied probability remains low, but it has been climbing to recent-record-high levels.
In the latest collection of market information reported at “WorldGovernmentBonds.com,” the United States ranked 16th among 25 countries in terms of the implied probability of default on their sovereign debt. In May 2020, after the market (and credit rating agencies) had begun to digest the implications of the COVID pandemic for economic and government finances, the United States ranked fourth on that list.
Appraisals of the probability, value, and wider implications of future bank bailouts have to consider the decline in confidence in US Treasury credit quality, both in absolute as well as relative terms, in the last few years.
Granted, the recent concerns have been driven in part by a rancorous but possibly temporary debt “ceiling” negotiation process. But these intensified tensions owe no small debt to the real deterioration in the federal government’s financial condition in recent decades.
Can we rely on still-high credit ratings for the US for comfort? Perhaps the wise sages in the credit rating agencies do a good job of “looking through” short-term political considerations in their appraisals of longer-term credit quality. But a careful look at historical experience suggests market signals lead credit ratings, not vice versa. And in the last three years, the distribution of rankings of countries based on the CDS market data did a much better job of anticipating the rankings for current country credit ratings than the three-year-old ratings rankings did in anticipating current rankings on CDS data.
For uninsured bank depositors in a bailout, getting par value may be better than not getting a bailout. But getting paid back “par” value in dollars that aren’t worth what they used to be generates real economic losses – for depositors as well as all of us.
