Archive for the ‘economics’ Category



One of my favourite blogs is the Money Illusion written by Scott Sumner. He’s risen to some prominence in the blogosphere because he’s giving a coherent, convincing narrative and counter-factual narrative of the crisis. Great stuff and highly recommended.

Except that he wants to destroy insurance companies.

Basically it seems that his point is that we need to avoid a nominal decline in GDP, even when real GDP growth is negative. I’m not an economist, so I won’t get into the macro here, but suffice it to say that he presents a very convincing argument. Tyler Cowen says this is the “best free lunch I’ve seen in years”. Yikes.

My comment is that because inflation is a transfer of wealth from creditors to debtors, insurance companies, the backstop of the world, get screwed. Massively. See here [warning, boring insurance press alert].

What’s one to think of this?

Well, I can think of a few consequences:

1. Insurance premiums go up, especially for long tail lines of business

2. Maybe we’re finally going to find that hard market.

3. There’s going to be no refuge, because Scott wants everyone to inflate simultaneously.

4. Maybe bank-insurance mega-conglomeration is the optimal strategy. The banks go mental and nearly bring the system down while old fogey insurance companies, being the last outpost of solvent capital, lose their shirts in the ensuing inflation. If they merge, at least nobody goes down.

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ur doing it rong

Occasionally financial professionals really don’t understand insurance and it amuses me to point this out. Today, I will indulge myself on this piece. You don’t need to go much farther than the first line of the abstract for a head-scratcher:

We provide a model of the effects of catastrophic risk on real estate financing and prices and demonstrate that insurance market imperfections can restrict the supply of credit for catastrophe- susceptible properties.

Insurance market imperfections? Hmm… Let’s get back to that in a sec. First, my summary of the article: insurance markets don’t supply enough catastrophe cover, so banks don’t want to lend to businesses because they don’t want to bear the risk. There’s the usual GIGO about positive NPV projects being rejected by banks because they can’t get the cover. Well, obviously it’s positive NPV if you truncate the downside to not include it being wiped out by a natural disaster every few years. duh.

So, back to the insurance market ‘imperfections’. Turns out our intrepid academic didn’t figure this one out on his own, but cited a few papers that did the work for him. I’ve chosen two papers that seem to discuss this, first this (gated, sadly, so I’ve only read the outline), and this one. It appears that the authors conclude that there is an undersupply of insurance because the insurance industry can’t pay for 100% of losses and, puzzling over this fact, suggest that the problem lies in market power of reinsurers (price-gouging?) and inadequate supply of capital.

Think Swiss Re agrees?

Here’s the logic:

Insurers are overcharging, the evidence being that someone’s fancy little model says so and, lo, insurers don’t have 100% coverage (no margin at which customers are happy to run the risk?). Presumably this would lead to higher profits, but wait, capital markets don’t want to invest in insurance because all those excess uncorrelated excess returns are just so unwelcome.

Um, right.

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I’ve said it before: innovation is tough to come by in financial services. It’s all about research and producing more and better information. Usually what is called innovation is a shell game of repackaging data and finding suckers.

Why, for instance, would oil companies, these global conglomerates with gigantic operations and balance sheets to match, ever buy anything from a highly leveraged financial institution that they dwarf? They don’t even have the Florida government to shield their virgin eyes from the real market cost of insuring big expensive structures in an incredibly dangerous neighborhood.  So if they had any real need for insurance, they’d have to buy, right? But instead they’ve been starving the market of demand recently, after cleaning the insurers’ clocks a few times over the years (Katrina, Rita, Ivan, Ike, Gustav…).  Could it be that they’re just waiting for a sucker?

Enter Willis.

Artemis is right in that we don’t know of the details of this transaction. Maybe they’ve successfully reinvented the wheel. Maybe they’ve figured something out that none of the rest of us have. Maybe they found some suckers.

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Good One

Good One

So there are a pile of earnings releases coming out now and there’s an interesting common theme: even though rate increases aren’t here yet, they’re just around the corner.

Yeah, right.

The only way rates go up in the P&C market is if something goes horribly wrong and capacity leaves the market. If you talk about hardening rates, you need to have a reason why they’re going to harden. What happens to make people suddenly actually NEED to charge more?

Something nasty has to happen out there. AIG going down would have done it. Didn’t happen. That’s the scale we’re talking about, though.

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I pay a lot more attention to the blogosphere than I ever have (or will) to the “pundits”  in the MSM. The reason is simply that I think bloggers operate in a more intellectually competitive environment. That, and that I can get a massive dose of commentary and links about the relatively narrow range of my interests every day.

That doesn’t save them from availability bias, though. Take Steve Randy Waldman, possibly the most compelling combination of originality and coherence in financial commentary. His post today is finally tipping my opinion away from his views, though. I’m hardly in a position to line myself up against Steve, Felix, Krugman (etc etc etc) and declare that nationalization is a bad idea, but I’m starting to wonder who really knows what they’re talking about.

The case for nationalization has been made and, I think, hasn’t been refuted in any strong way. This was clear in January. Obama has said his problem isn’t that the idea of nationalization sucks, it’s that he views the execution risk of that strategy to outweigh the downside risk of not doing it.

What was the commentators’ response? Mostly they came up with ideas for why it isn’t such a big deal to execute this strategy. It makes me think these people have never executed a damn thing in their lives. You don’t sit around and think about it, you put together a detailed plan, screw it up and hope that your screw-ups aren’t enough to sink the ship. It’s messy, extremely complex and often very boring.

Most of all, it isn’t suited for blogging commentary because bloggers aren’t willing to spend more than, at most, an hour on a single post. The kind of feasibility study this scale of bank nationalization requires would take hundreds of (man-)hours. And it would be wrong.

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Be honest. You're a geek, too.

Be honest. You're a geek, too.

I’ve been trying to get a chance to read through this paper by Philipe Swagel on the insider view of the financial crisis and I’m happy to say I’m half done.

In typical blogging fashion, I’m going to post something now and, hopefully, finish it and post further thoughts later.

Two things have jumped out at me: first, when staring down massive financial risks, the proposed solutions are often commonplace in (re)insurance; and, second, how inevitably technocrats fail.

I didn’t fully realize this last year, but the US Treasury originally proposed to create a runoff company (aka, Bad Bank) to suck in all the mortgage assets and give constituent banks ownership, presumably along with some kind of gbmnt particiaption.

Amazingly, they would take it one step further and actually increase the information available by creating a centralized database with policy level data on all of the mortgages. It appears that one of the issues behind this whole mess is that the holders of the risk don’t actually know too much about it; indeed, the implication is that they know far less than those who sold it on to them and will be stocking the database.

What a win/win. As any intermediary worth a damn quickly finds out, you can restructure deals all day long but they don’t get done without real data. The only hope you have of making a “toxic” deal better is to introduce information.

Wasn’t implemented, though, which brings me to pointe deux. Technocrats fail because their second-rate pay yields second-rate talent and stale or non-existent private-sector expertise means they have less information. The experts in the private sector, though, are always happy to give ‘advice’, which comes packaged with some serious bias.

The above solution was killed because the same banks that, only nine months later, would get outed as irony_ruleszombies and quasi-nationalized allegedly got all twitchy with the UST telling them what to do. 

That would be called irony.

Any chance that the banks were really worried about those assets being marked down?

Generally, voters get frustrated because like to think (hope) that those working on their behalf know what they are doing but really have no way of seeing the difference between the 85th percentile of knowledge (gbmnt avg?) and the 99th (avg Wall Street jobber). Most voters, after all, are even lower down the (nonlinear) ladder.

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The Frontier?

2001Througout this crisis, there has been quite a lot of analysis to do with the linkages between the banking sector and the economy as a whole. It happened following the great depression, too.

What about the insurance sector? I haven’t seen much analysis that is at all interesting examining the linkages between insurance and the economy as a whole.  Maybe it’s because there hasn’t been a widespread catastrophic failure and subsequent recession.

Maybe this is my summer project?


Update: found something. I’m not totally satisfied, though.

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