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Monday, March 30, 2009


runs on insurance companies

this is something i noted was mentioned by rolfe winkler recently. now the risk is apparently materializing in some cases. clusterstock passes on david goldman of asia times.

Why would anyone hold an annuity from a life insurance company whose credit protection is trading at double-digit points up front? Annuity and whole life policies are at risk, and the blogs are starting to buzz about it. If customers rush to cash policies in, a number of insurers will be at serious risk.

Once again: the Treasury is pursuing the phantom of a bank-led economic recovery, when it should be fighting the risk of an insurer-led crash. If Americans think their insurance policies and annuities are at risk, it’s a different and much worse sort of crisis.

goldman earlier commented on the wrongness of the approach being taken by tim geithner and larry summers.

... They [Geithner and Summers] want the banks to lend more to the economy in order to stimulate economic recovery. This is perfectly ridiculous because no-one wants to borrow. Everyone with two synapses that fire in the same direction wants to pay down debt.

What Summers and Geithner haven’t absorbed is what a friend of mine who manages an enormous insurance portfolio worries about. The banks, he fears, have gotten themselves into such a hole that they will wear through their capital structure, starting with the preferred stock that Citigroup just proposed to turn into equity, and thence up the capital structure to subordinated debt and so forth. In the process, the necrosis in the bank capital structure will kill the insurance industry, just as AIG warned in a memo to Congress posted on the Financial Times website.

It’s not about getting a recovery going. That’s not going to happen, not if Martians land in flying saucers with a billion tons of gold to invest in bank capital. It’s about preventing something worse than we have now, namely screaming, bug-eyed, blood-in-the-streets, rape-the-crops-and-burn-the-women panic. ... The best we can get out of this is a zombie banking system, one that still pays its debts because it earns enough interest from the toxic assets left over from the last boom.

add goldman's asia times blog to the roll. this is really salient stuff, and he isn't shy to acknowledge the triumph of japanese fiscal policy in the 1990-2005 period as having avoided a catastrophic depression in japan. his diagnosis of what has happened in the real economy comports well with the conclusions i'm coming to, and he here presents it in the context of insurance.

For many families, a whole life insurance policy or an annuity is the financial shelter of last resort. An intimation that these might not be safe would have catastrophic effects on consumer behavior. The economy is in free fall because households are playing catchup with life-cycle savings. Rather than substitute capital gains on homes for ordinary savings, Americans are attempting to save as much as they can, which is to say that they are spending less, depressing economic activity. That prompts a secondary effect, or what economists call precautionary saving. Last year you started saving because you realized that your retirement wasn’t funded; this year you save even more because your job isn’t safe. That is how auto sales end up falling by half, and so forth.

There is yet a third-order effect that could take hold were the insurance companies’ viability to come into doubt, and that is the possibility that your savings aren’t safe. Not only do you not have a retirement plan, and not only do you not have enough in the cookie jar to tide you over if you lose your job, but the cookie jar itself might not be safe! In this event we will get full-tilt, uncontrollable panic, something America has not seen since the run on the banks when FDR was inaugurated.

That’s the sort of thing that academic tinkerers like Profs. Krugman and Roubini do not think about, and that is the government cannot let the capital securities of the banks evaporate.

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Japan managed to avoid a depression and suffered 20 years of sub par economic growth, and now is facing what looks like a depression far more severe than what they would have suffered had they not intervened so much. How can that be considered any sort of success? It seems more like a Pyrrhic Victory than something to be celebrated. They now have almost no fiscal flexibility, with gov debt to GDP likely to reach 200% in the near future.

We'll see how Japan ends up, but I believe it is too early to claim that their interventionist policies were a success. I would be inclined to call them an out and out disaster when depression part deux hits with full force over the next few years. I could be wrong, but I think they would be in much better shape today had they allowed a correction to happen, and the depression they are currently enduring will be much worse than it otherwise would have been.

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Any comments on FT's quote of Richard Katz on why comparisons with Japan may not be appropriate?

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dk, i'd say that what they're facing now is a different event -- something that actually aided them in getting out of the hole from 1990-2005 but has since remained their achilles heel: an export-oriented economy. there's little danger of the US becoming an export powerhouse for so long as we have the reserve currency.

but i do agree that japan's story isn't written yet. and if export revenues and profits helped their private sector recapitalize, and won't ours, it implies that our fiscal responsibility in demand management is going to be that much greater a burden for the united states.

but i don't think it very likely that their depression just beginning will really be insufferable for their public sector debt. firstly, their private sector is carrying the lowest level of debt-to-GDP seen since the 1950s. secondly, japanese interest rates are still extremely low, implying significant surplus funds in the system -- little loan demand relative to deposits. that implies a low-impact ability for the gov't to borrow further to tide over the demand shock. third, their banks are in perhaps the best condition of all major industrialized nations. fourth, household standards of living in japan have already corrected significantly over the last fifteen years.

so they may well be in a situation now near the end of the multiyear yen delevering with gov't balance sheet capacity remaining and a healthy financial system. as you say, only time will tell -- but i wouldn't be too sure that japan will emerge from the ashes of this depression in better forward-looking shape than most, even if their capacity remediation will be painful.

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rb, i can't offer a comprehensive critique of katz's argument, but -- while there's a lot to agree with -- some aspects of it strike me as strange prima facie.

the idea that there isn't a "real economy" problem in the united states presumes that we haven't undergone a massive misallocation of resources as a result of first the tech boom and then the housing boom. we in fact have, and with something like a third of the american economy linked to housing that is not a minor problem. that real economy distortion, once the bubble popped, has created the financial crisis.

while it is certainly true that sectors of the corporate sphere, as a result of the tech bust, already have trim balance sheets. but that is also to ignore the massive household balance sheet problem.

there are large parts of what katz says that make sense to me. he sees the major problem was loan demand, and notes the absolute need of fiscal stimulus:

There is a myth that Japan shows the uselessness of fiscal stimulus. Supposedly, Tokyo used massive stimulus and it accomplished nothing. The reality is that Japan applied fiscal stimulus is a very stop-go fashion. When Tokyo stepped on the fiscal gas, the Japanese economy did better. When it took its foot off the pedal or, worse yet, applied the brakes -- such as when it raised taxes in 1997 -- the economy faltered. Had Japan done nothing, it risked depression.

but katz also seems to believe that in the current case restoring the securitization market to function (by cutting out mark-to-market, recapitalizing banks, soaking up bad assets and restoring the regulatory oversight abandoned over the last several years) will solve the problem -- as would have a quicker remediation of NPLs in the japanese banking system. the presumption seems to be that, if banks clean up and get working again quickly, this is all much ado about nothing.

i would point him at this now-famous chart. i think we hit something like the zero hour bound and further debt growth is not an option. with the asset shock being felt by so many with shaky household balance sheets -- and here i think katz in figure 5 does a disservice in not examining the distribution of net worth as opposed to the aggregate -- debt reduction becomes the imperative.

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Good, thoughtful points. I have to agree with all of them. Japan's private sector certainly does have a nice stockpile of savings, I am just skeptical of whether that will be deployed or not. I think the Japanese people are more likely to take advantage of the strong yen (I think the Yen could go to 85/80) and buy assets abroad, which would spell trouble for the governments ability to fund itself should the crisis last longer than anticipated.

I guess it all depends on how long the current downturn last. I expect Japan's exports to be depressed for some time, and wouldn't be surprised to see the Japanese central bank print non stop to counter act the yen's rise. The current group of Japanese central bankers seems much less reticent to use the printing press than their predecessors were over the past two decades. But we shall see.

I agree with you that eventually, they will be in better shape, as they have already gone through much of the pain that is awaiting the US. I just think that the current downturn will be more severe and long-lasting, largely because they didn't allow their economy to properly adjust since their enormous property bubble in the 80's. Their banks equity base is/was (I believe the Japanese CB allowed some regulatory relief here) heavily in the highly depressed stock market, but on the whole, they are much healthier than most of their counterparts worldwide. Although from the rumblings I've read, it seems that Nomura has some indigestion from the Lehman acquisition, and if Asian economies collapse more than expected, not only Japanese banks, but also seemingly strong banks like HSBC (who has made some of the worst acquisitions out there and has a lot of Asian exposure), could come under fire. I'm not certain this situation is likely, but it seems a strong possibility to me, given the severity of the unwind I see coming.

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