Is this one of those era-defining trades? A chance to become the next John Paulson?

As some form of a default on Treasury bonds looms a bit more likely with every passing day, the push to find ways to capitalize on such an unprecedented event steps up. The longer we go without a debt deal, the higher the stakes go for the many funds and institutions that have long seen Treasuries as something as close as possible to rock solid. There's a reason they're used so widely as collateral against trading losses and the like. My guess is that we'll ultimately end up with some sort of a deal that will prevent an unprecedented default on Treasuries. But that's only my guess.

The New York Times notes that people are actively mulling the what-ifs. "Banks are sifting through their holdings and their customers' holdings to determine if these security deposits will retain their value. In addition, mutual funds--which own billions of dollars in Treasuries-- are working on presentations to persuade their boards that they can hold the bonds even if the government debt is downgraded. And hedge funds are stockpiling cash so they can buy up United States debt if other investors flee."

While it's definitely true that big-name hedge funds are adding cash, it reflects a lot of thorny global issues, not just the looming debt drama. The $25.5 billion Quantum Endowment Fund for Soros Fund Management has moved to 75 percent cash. KLS Diversified Asset Management has also raised cash until the global macroeconomic picture clears up a bit. But in the back of managers' minds, they are likely mulling the option of plowing into Treasuries and agency bonds if the buying opportunity presents itself.

A technical default would cause chaos in the markets, but as of now there's little panic. There's seems to be a blind faith that Washington will not allow the unthinkable to happen. That will change soon if the prospects for a debt ceiling and deficit reduction do not materialize fairly quickly.

While August 2 looms as a key date, reality is that a downgrade of U.S. and states securities could come before then-or it come after a debt ceiling deal has been reached. No matter when it comes, it will at some point lead to more anxiety. S&P says there is a 50-50 chance that the U.S. could lose its AAA rating within a few months--and yet there's not a lot of palpable worry, despite the potential consequences.

The agency wants to see more than a debt deal. It wants to see steps toward meaningful deficit reduction. The downgrade would ripple instantly as agency bonds and top-rated Federal Home Loan Banks Federal Farm Credit System Banks would be downgraded in step. Many muni bonds would also be downgraded as their ratings are tied to treasury debt by some agencies. U.S. insurance companies would also be downgraded de facto. Some states might be hit as well. The dollar would likely take a hit.

Some people may be hedging already, before anything smacking of panic has yet to set in. There may be some hedge funds out there betting on a default, which at this point seems foolish. But people said the same thing when the hedge fund iconoclasts starting making massive bets against subprime-backed bonds. We know how that turned out. That's how Paulson rocketed to fame.

We could be in for a wild ride--or not. - Jim