Investors prepare for worst as debt talks drag on

NEW YORK --- Scrambling to protect themselves against a U.S. default, investors are buying gold and foreign currencies, using derivatives to bet on a stock market collapse and taking out complicated insurance policies.


They might want to consider crossing their fingers.

If the United States suddenly stiffed its creditors, the impact would be so widespread, complex and unpredictable that it is next to impossible to shield against steep losses, experts say.

A default could cause turmoil in the stock and bond markets, plus a replay of the fear that froze lending in the depths of the 2008 financial crisis.

In the chaos, investments you would think were a sure bet to fall might rise instead, and vice versa.

Consider the assets at the heart of the crisis -- Treasury bonds.

You would expect interest rates on Treasurys to rise the closer Washington gets to missing a debt payment.

Investors would demand higher rates because of the greater risk they wouldn't get their money back. After Argentina defaulted in 2002, foreign lenders required higher rates. But some bond traders are betting the opposite will happen.

They think nervous money managers could rush into Treasurys if Washington blows past the Aug. 2 deadline to raise the debt ceiling. The buying would push interest rates lower.

The logic behind this seemingly illogical reaction: Treasurys are widely traded around the world, with plenty of buyers and sellers ready at a moment's notice, a quality known as liquidity.

Investors like that, especially in a crisis, and might overlook fears of missed payments.

Gifford Combs, a portfolio manager at Dalton Investments, which manages $1.3 billion in assets, has been buying short-term Treasury bills for this reason, but he concedes he's not sure what could happen in the event of a default.

"If there is a financial meltdown and panic, you don't know where investors will go," he says.

A second reason to like Treasurys: A default could help sink the economic recovery. Dan Greenhaus, the chief global strategist at brokerage BTIG, thinks Washington is likely to continue paying interest on its bonds, keeping creditors happy even if it means gutting other government spending. The massive drop in government spending would then drag down the economy. And when economic growth looks grim, traders turn to Treasurys.

"No matter what happens, Treasurys are still the safe haven," Greenhaus says. "No other market is as large or as liquid."

Some investors are hoping high-quality corporate bonds serve as a backup safe haven. Wilmer Stith, the portfolio manager of the $3 billion MTB Intermediate-Term Bond Fund, has been buying bonds of companies such as IBM and Microsoft that have strong balance sheets and high credit ratings.

Others are seeking protection in credit default swaps, the insurance policies that pay off if a company or country defaults on its debt. The cost of buying protections against a U.S. default has been rising fast, reflecting high investor demand.

To insure $10 million in Treasurys for a year, investors now have to pay almost $50,000 -- double what it would have cost them just two months ago. That's about what it costs to insure an equal amount of bonds issued by Russia.

As with bonds, stocks could be thrown into turmoil in a default.

To help protect his clients, Stuart Speer, a financial adviser at Heritage Advisors in Overland Park, Kan., has bought "puts" for shares that track two stock indexes -- the Standard & Poor's 500 and the Dow Jones industrial average.

The "puts" give him the right to sell those shares in the future at roughly today's prices. So if stocks tumble on a U.S. default, his clients can buy shares at low prices, sell them for the locked-in higher prices and pocket the difference. Those profits will help offset any losses they face from their own stock holdings.

Speer thinks the odds of default are slim -- but he's still worried.

"If the U.S. defaults, it could be a calamity," he says. "People will lose confidence in the markets."

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Americans worry

WASHINGTON --- Just last fall, Americans were feeling better about their personal finances. Now they're starting to worry more about how they'll pay off debts as they feel the nation's economic recovery wobbling.

With Congress deadlocked over how to deal with the national debt, household debt is causing stress for nearly half the country, according to a new Associated Press-GfK poll.

One in five adults worries about debt most or all of the time. If they bought something on a credit card in the past month, more than a third say they won't pay it off when the bill comes.

The increased stress represents a reversal from last fall's AP-GfK poll, which found increasing confidence about personal finances. Debt-related stress is up 17 percent from that November survey, bumping such worries back up to levels seen in 2009 and in the spring of last year.

- Associated Press