Posted on 09/28/2008 7:52:44 AM PDT by FlameThrower
KEEP POLITICIANS AS FAR AWAY AS POSSIBLE FROM ANYTHING REMOTELY RESEMBLING INSURANCE
Only to politicians – to whom a promise of future performance requires no current financial or intentional adjustments – would the distinction between the purchase of risky assets and insurance of the risk inherent in the assets be worth the donnybrook we have recently seen in Washington.
If we purchase the assets, we will pay a price equal to the best estimates of the ultimate value of the assets minus a deep discount (premium) for the risk associated with the uncertainty of the estimates. If we insure the risks, leaving the assets where they are, we will collect a premium for assuming that risk. In the context of unlocking the credit markets, the fundamental transactions are equivalent, except for peripheral distinctions.
But the devil is in the peripheral distinctions.
American International group (AIG), my alma mater, was brought down by one of the peripheral distinctions. Credit Default Swaps are a protean sort of thing that can be either traded instruments or, depending on your role, an insurance policy or speculative wager. AIG effectively sold insurance; but it treated the swaps as traded instruments, without the sort of discipline insurance requires. The subtle distinction eventually killed the world's largest insurer.
If the politicians were to insure the holders of distressed loans, really insure them, they would need to post current reserves for the actuarially determined future losses. The reason the insurance option looks so attractive to them is that they have no real concept of this need. And even if they did, being politicians, they would play politics with the calculations to the detriment of future voters. Future voters are people who are not likely to vote for or against current politicians. Or, if they do, they are people not likely to remember or comprehend what the politicians did or did not do on this sort of issue.
“Spending” real dollars today for assets is more likely to impose discipline on Washington than merely issuing contingent promises to pay in the future.
The politicians have also fooled themselves into believing that, by charging “premiums” for the proposed insurance, they are making it more self-funding than purchase with borrowed public funds. But these premiums are virtually identical to the discounts implicit in the asset purchase proposal. The big difference between the two is that an insurer does not normally participate in the upside, whereas a purchaser of an asset does. At any estimate of future value, therefore, the insurance premium needs to be higher than the discount to insulate the insurer from potential loss without the offsetting chance of possible gain. Higher premiums from distressed financial institutions are unlikely in this environment. Even if we do get them, they will be counterproductive to the real purpose of the transactions.
It also seems to me that the insurance proposal would require, to fulfill the essential purpose, outside capital to be attracted to buy the insured assets. This is likely to be slower and less additive than would be the solution of buying the assets with funds generated by public borrowing. Some of the outside capital would have been attracted, in any case, by the opportunities of acquiring risky assets even without the high premium charge for insurance.
Whether done as insurance or through leveraged acquisition, someone is going to have to implement the plan. And it ought to be integrated into a holistic regulatory regime to prevent more damaging defaults and the excesses that cause them. The only regulatory entity that has emerged with honors so far in the current crisis is the FDIC.
The FDIC is in the awkward position of participating in the regulation of banks while insuring only the liability (deposit) side of their ledgers. We need to give the FDIC the ability to intervene in the asset side to avoid costly defaults before they happen, by purchasing or insuring illiquid loans and investments, as part of their tool-kit. This would take implementation out of the hands of politicians, make it part and parcel of a well-rounded regulatory regime, employ the existing powers of bank regulators with respect to the operation and ownership of banks, reduce insurance losses on the liabilities (deposits) of banks, warehouse distressed assets (loans and investments) for future resale at a profit, reduce foreclosures which further depress property values....
And it would give the job to people who (witness the WaMu take-over) have the actual talent to do it.
If I have learned anything from my 32 years in insurance and 40 years as a voter (and from being six years from Social Security) it is this: Keep politicians as far away as possible from anything remotely resembling insurance.
In communism/socialism/liberalism ther is no insurance. That would be unessessary in the utopian state brought in by Obama and his useless idiots.
Agreed. I was a little distressed by reports that insurance was the “conservative” proposal.
As to the analysis - this makes sense to me. Although I have great respect for Gingrich and the Republican House members who fought for this plank in the bailout bill I have yet to see an explanation of why it would work any better than the plan that is about to pass where the equities are purchased by the Government at a discount.
Based on this article I'm inclined to believe that the insurance plan would not be better.
But, I would like to hear arguments to contrary. They have been few and far between. In fact they seem to be non-existent on FR despite the general support here for this approach.
This kind of thinking is not allowed at Free Republic, where knee-jerk financial ignorance is the order of the day.
I have been posting similar criticisms of the insurance proposal for days.
http://www.freerepublic.com/focus/news/2090673/posts?page=31#31
Furthermore, if the banks are required to pay the government for the insurance premium upfront, then we are pulling a significant amount of financial resources out of the banks at the very time we are trying to reverse the credit contraction and get funds flowing back to businesses in the real economy, which is counterproductive. And a deferred payment scheme on the premiums increases the exposure of the taxpayers.
The insurance scheme is actually a more socialistic approach than the purchase of the distressed assets and is also more likely to become a permanent feature of the market in the future than government intervention to purchase assets in the market.
People wrongly assume that because the House Republicans proposed it, it must therefore be a more free market solution.
He is VP in charge of operational risk underwriting for Financial Institutions at a large US insurer. He’s been in the business over 30 years. He was once, long ago, a VP at AIG. He is a conservative Republican. He is fed up with politicians of any stripe.
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