Archive for the ‘finance’ Category

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 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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Stick ’em Up

Go Ahead, Make My Day

I'm gonna blow the hair off your head

I’ve been wanting to do an AIG roundup, so here it is.

AIG has released a supposedly confidential document (H/T CalculatedRisk) that lists out all the things that AIG does and tries to give a flavour for all the various exposures different companies have to it.

It looks like it’s supposed to work like a mob boss asking a reluctant extorion victim, “So, how’s your wife and kids?”, the implication being that he has the guy by the balls.

AIG is trying to make the case that it is some kind of near-monopoly and its failure is armageddon. But it is not; at least, in insurance it is not. The insurance industry is going to be fine and every executive worth worth a damn is itching to write the bejesus out of the market as soon as AIG gets ITS balls clipped by unkie Sam.

Speaking of those executives, they’re coming out and slamming AIG publicly.

First, there’s Brit (HT: ReinsuranceGuru)

He added that AIG – which has a large UK presence – was “haemorrhaging teams of people” but still winning business. “In order to win business they are offering premiums so low they are unsustainable,” he said.

And Liberty Mutual‘s Ted Kelly

In a conference call to address Liberty Mutual’s fourth-quarter earnings, Kelly said the federal money given to American International Group Inc. gave it an unfair advantage, allowing the struggling enterprise to be “overly aggressive.”

I think that one or two of these guys are going to really start cranking out the public statements because AIG is very sensitive to publicity and they’re possibly more ready to swipe AIG’s lunch than they were 9 months ago. Shareholders of insurers are going to make a killing at some point because of this.

Lastly, for the geeks out there, there’s a great post at a new blog on credit trading that goes through AIG’s strategy, describing it as being a nice combination of arrogance and regulatory mismanagement. 

My big question after this whole mess subsides is: what’s going to happen with the rating agencies?

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Anybody Hiring?

Anybody Hiring?

It’s not going to be a surprise to anyone that Hedge Funds are laying people off:

Hedge funds may eliminate 20,000 jobs worldwide this year, a record 14 percent of the industry’s work force, as investment losses and client withdrawals erode fees, executive recruiters estimate.

And it’s not an absolute decline, either. There is a shift in the kinds of strategies managers are pursuing. Fancy, illiquid or long-term stuff like reinsurance, for example, is out, and something called ‘frequency trading’ is in, with lead times of something like 10 minutes.

Last year, Citadel Investment Group, a hedge fund in Chicago run by Kenneth Griffin, cut about 150 jobs, or 11 percent of its work force, as it left investment areas including emerging markets and reinsurance.

This is borne out in the catastrophe bond data, which is put together by Guy Carpenter (ht Artemis).

Two more pieces of info that I’d want to see is how large the transactions are relative to the other shelf offerings and a quarter by quarter breakdown.

In fact, Trading Risk reported last summer (no link, but it claims as its source the same GCC Capital Ideas blog) that as of June 27th, 2008, there had been 2.1bcapital put in 8 deals in the first six months of 08, which moves up to 2.6 for 10 deals by the end of the year. Again, it’s all about the pre-post-Lehman comparison.

The market isn’t dead and, yes, shelf offerings are much easier to put money into, so they’ll definitely be the first to fill up. But we might be seeing a few core specialist funds doing all the activity for some time. As long as they aren’t pillaged by investors whose money all gated at the big fancy multi-strats elsewhere.

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What takes my breath away about this chart?



No, it isn’t the low P/E today; it’s the insane valuation around Y2K.

I look at these valuations as expectations for the economy and I’d say that a below-trend valuation accurately reflects crappy economic prospects. But holy cow, what were people thinking at that peak? I don’t feel confident that I know when and how we will come out of this recession, so I can hardly say that this is the “time to buy”. The only companies that I would invest in now are those with zero debt and high historical return on assets (to control for other kinds of leverage).  Companies that look like that with a p/e of under 10 might be interesting.

Anything else is just too scary.

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Tyler refers us to an interesting post on a peculiar kind of soft operating leverage at big Law Firms.

…firms increase their profitability by increasing the amount billed in respect of each equity partner. Since there is only so much time in the day, firms have tended to increase the ratio of attorneys per equity partner.  Without irony, this ratio is known as…”leverage,”

I call it soft leverage because it doesn’t seem to be particularly costly to lay these people off when revenue falls. Perhaps employment contracts for young lawyers are loose. If you need to lever up with highly skilled labour that demand gurantees or big severance payments or something, you’ve suddenly got more problems.

I’m reminded of the collapse of a reinsurance broker called Gallagher Re that loaded up with skilled employees (actuaries and the like) without the revenue to support them. When the business didn’t come, they couldn’t pay the bills.

We’re straying away from what I think of as leverage, though, because you’re arguably adding new capabilities, not just magnifying outcomes that would otherwise have happened anyway by applying fixed costs to variable/volatile revenue.

I like Tyler’s conclusion:

As I’ve already written, “[A] central lesson of this depression will be how many different ways there are to leverage.”

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