From Bad to Worse

Three market developments keeping me up at night

I’m a worrier by nature. I can’t help it. My job is to peer around the corner, figure out what’s next, and most importantly, discern what can really go WRONG in the economy and the markets.

And right now, I see three troubling developments that are keeping me up at night. These problems aren’t front-page news … yet. But they are circling in the background and threatening to explode into the headlines — derailing the market in the process. I suggest you sit up and take notice. I sure am.

For me, the biggest one is the cost to insure United States debt against default. Right now, I'd have to pay roughly 1% to do it. As seen in the chart within the link, that is way up in the last year as things went from bad to worse. 1% is what the market says I should pay though, per year, if I want to sleep better at night.

Here's what really makes me not sleep so well. Let's say I did buy the insurance that costs 1% per year. Let's say the US did default on its debt. Am I sure that I would actually be paid? Doesn't it seem likely that I should also have insurance against that bet defaulting? I mean, surely there would be vast ripples throughout the world if the reserve currency of the world went belly up.

So here's my nightmare.

1. I buy CDS in case the US defaults.
2. I buy CDS in case the CDS defaults.
3. I buy CDS in case the CDS's CDS defaults.
4. I buy CDS in case the CDS's CDS's CDS defaults.
5. And so on, until I've spent all my money on CDS insurance and there's nothing left to actually insure.

Yeah, I tend to dream of cascading defaults. Go figure. Therefore, I don't have any insurance at all. What's the point?

Last year I was basically playing Russian Roulette with a 1,000 chamber revolver and one bullet. This year I'm playing Russian Roulette with a 100 chamber revolver and one bullet. I really don't like this trend. In 2010, am I going to be playing this game with 10 chambers and one bullet? How about in 2011? Playing with one chamber and one bullet might be just about the stupidest game I will ever play.

Yet here I sit. In comparison, the stock market played with a fully loaded machine gun. Fortunately, the shooting accuracy was somewhat reduced. It did end up being a bloodbath though.

Say hello to my little friend! - Tony Montana, Scarface, 1983

That's just one of the three things that should keep me up at night. Fortunately, the other two can't keep me up at night more than I already am. It's like painting a wall white. Once the wall is fully white, two more additional coats of white paint won't make it any whiter.