ES -- DX/CL -- isee -- cboe put/call -- specialist/public short ratio -- trinq -- trin -- aaii bull ratio -- abx -- cmbx -- cdx -- vxo p&f -- SPX volatility curve -- VIX:VXO skew -- commodity screen -- cot -- conference board

Wednesday, April 08, 2009


TARP for insurers too

david goldman comments on speculation that TARP will be opened to insurers.

The insurers own the capital structure of the banks, and you can’t haircut the banks’ capital securities without beheading the insurers. ... Let folks know that even their insurance policy and their annuity isn’t safe, and you will see a degree of panic that would make the consumer slump of the past six months seem like boom times by comparison.

i've changed my thinking fairly radically upon a more comprehensive reading of richard koo among others. whereas i was even recently quite skeptical of the ability of the united states to avoid major bank nationalizations, it seems to me less and less that such resolutions are an approachable option if the very worst is to be mitigated. goldman's assessment of the position of the insurance industry only entrenches that change of mind.

to coin an imperfect metaphor, banks should perhaps be thought of as the castle wall, rather than (as i'm sure they widely are now) the castle keep. the outer defenses are already overrun. if the walls are breached, it isn't the end of the attack -- it's the beginning of the slaughter.

Labels: , ,

Hussman seems to think that you could give the bondholders a haircut if you allow the company to fail with a conservatorship for the existing business. He thinks Wamu is an example of how you could have an orderly failure of banks.

------ ------- ------
Why not guarantee the insurance contracts and annuities at their present levels (well, maybe not the "guaranteed" death benefits and high-water mark annuitization values pushed by many annuity sellers in the last six years) just as the FDIC backs depositor money. The banks and insurance companies could be liquidated without the catastrophic loss to their customers. I think the question is more where you draw the line--protect the customers, or protect the companies. I believe that you could do the former without the latter (after all, the run on money market funds was stopped last fall after the Feds issued a blanket guarantee).

Maybe I'm being naive, but aren't there established procedures for winding down insolvent insurance companies, as well as state insurance funds for making the customers whole? I'm sure they aren't anywhere near fully funded, but the federal government could simply throw the money into the pot for the difference, if we're trying to prevent Mom and Pop from taking any losses here.

He who defends everything defends nothing.

------ ------- ------
In virtually all cases, the liabilities of these companies to their own bondholders are capable of fully absorbing all losses without the need for public funds to defend those bondholders.

this is why he thinks so, rb, and he's right -- i've said the same.

trouble is in who owns these bonds. goldman's point is that it is both other banks and (more importantly, on his view) non-bank financial institutions like insurance companies. these institutions are already underfunded thanks to the asset crash of 2008. to give the heretofore undamaged assets of these companies a big haircut -- and it would be very big, well into if not through the senior debt, if all the losses are foisted onto the capital structure -- precipitates what goldman sees as the third stage of financial panic, where even insurance policies and annuities are potentially worthless. these are older folks' rainy day funds. remember that there is no FDIC for folks with big equity stakes in such products -- they are managed and backed at the state level.

in the event, presumably the federal government would have to launch a program analogous to the FDIC to assure the general public of the value of these products -- but that amounts to yet another tremendous contingent liability, and by then much more damage will have been wrought through fear.

hussman, like many, makes great hay out of the losses to be suffered by taxpayers through capital infusions. and i would agree -- these are capital transfers, not investments.

what he and others seem not to understand is that the losses for the taxpayer are, rather like the massive debt pile everyone fears calling into existence through fiscal stimulus, already there.

what is left for the taxpayer to decide, ihmo, is whether s/he wants to take large losses as a collective on defending the banks and promoting aggregate demand -- or take utterly unfathomable losses both as a collective and as individuals on a precipitate run through not only the banks but the entire system of financial intermediaries as well as an absolute trashing of monetary aggregates and economic activity.

the counterpoint to the tradeoff -- no free lunches -- is the assumption of nebulous incremental capital flight risk. such flight risk already exists -- it could happen regardless of US policy choices in response to external events. and i've come to think that careful use of domestic cash flows coming into banks for demand management and (rather less) for recapitalization minimizes that risk responsibly. but the risk nevertheless exists and could be amplified by offsetting private balance sheet remediation with public balance sheet expansion if it isn't done carefully.

------ ------- ------
aren't there established procedures for winding down insolvent insurance companies, as well as state insurance funds for making the customers whole? I'm sure they aren't anywhere near fully funded, but the federal government could simply throw the money into the pot for the difference, if we're trying to prevent Mom and Pop from taking any losses here.

there are, but not for winding down whole industries. most insurance companies, large and small, are to my knowledge heavily exposed not to small banks (who have little capital structure for sale) but to the majors.

and you're right of course, bwdik -- the state funds have nothing in them and would ultimately have to be paid out by the feds.

i would use your witticism...

He who defends everything defends nothing

... alternatively as an analysis of federal financial product insurance programs. already there are louder and growing calls about solvency issues at the FDIC. plenty of smart people don't think the FDIC guarantee is worth a damn because the government would have tremendous difficulty floating the debt against a truly systemic run. now we would add another massive unfunded layer to the government's contingent liability?

i'm not so sure we don't begin to challenge and ridicule the entire concept of government backstops if we do. and if that dam breaks, we may all wash away. such guarantees work best, maybe work at all only in being never tested.

moving to slowly repair and fortify banks as the "castle wall" and support demand is, in essence, a massive refinancing of the gargantuan private debt bubble that was created over the last 30 years. once that refinancing is completed, several years from now, government will be able to tap truly secure long-term cash flows to gradually pay down the debt in the subsequent private sector growth phase.

i wouldn't consider that defending everything by a long shot -- much damage has already been done and we're in for a long period of essentially no growth. and i think it's about as morally reprehensible as a homeowner refinancing from a 5-yr ARM on a 10-yr amortization schedule into a 30-yr fixed in order to keep his house.

it is also effectively putting the full power of our society affirmatively behind the capitalist system, warts and all. to say that it rewards the few to punish the many to do so does, i think, radically underestimate the degree of benefit accrued to even the parsimonious by the economic activity of the profligate. when all these idiots took out 120% LTV neg-am timebombs en masse, ALL of our incomes increased incrementally because of it. i don't think the individualist fantasy has ever had much to back it up, whether espoused by some leave-my-profits-alone trader superstar in the boom or a leave-my-taxes-alone thrifty worrywart in the bust, in the context of civilization. just as you can make an excellent case for greater efforts to redistribute wealth from the top through govenrment in booms to increase equality, so i think can you make as good a case for the many saving the few in disaster. fwiw, my view is that we're in the soup together -- even though we haven't heard a lot of that in either the boom or the bust, even though i myself at times have not been as true to that dictum as i might like to have been.

------ ------- ------
thought-provoking as usual, fellows. thank you, and pardon my tangential ramblings. :)

------ ------- ------

Here's the thing the concerns me about Goldman's analysis and that of his fellow preachers of Armageddon - there aren't any facts presented to support his argument. For example, Goldman says insurance companies "own the capital structure of banks". Ok, how much? 100%? Can't be, 2 minutes work on Vanguard's site and I know that Vanguard bond funds own $1,375,000,000 in Citi debt alone. Granted, that's only about 0.16%(!) of the Citi total, but there are a lot of mutual funds, hedge funds, and private investors holding that debt too, so insurance companies don't own it all. How much do they own?

As an aside, if Citi has $859,000,000,000 in debt, can we all agree that this behemoth is too big for the financial safety of the world? And when are we going to re-impose Glass-Steagall?

None of the myriad sides in this debate are putting all the cards on the table. The banks are obfuscating about the full nature and value of their assets, Geithner can't articulate the reasons to Congress why taxpayers should underwrite a massive bank bailout so he resorts to gimmicks like PPIP, and the talking heads pontificate with certainty but present few facts.

If we taxpayers are going to be roasting squirrels on a stick and digging for tubers in the public square if bank stockholders are wiped out and debt is swapped for equity, why can't anyone explain why this is so with facts *and* figures? I hold Congress in as low a regard as the next person, but are they collectively so stupid that Geithner can't convince them of the necessity for a taxpayer bailout? Or is Geithner so incompetent? Well, maybe I just answered my own question...

I'm an engineer, but I can read a P&L and balance sheet. Let's have a fact-based debate about the best way forward instead of this back-room wheeling-dealing by the Banks, Hedge Funds, PIMCO, Blackrock, and the Feds. The cacophony of the chattering classes just makes it harder to think.

Give me the facts; I can handle the truth. At least I think I can.

------ ------- ------
from perrone: well, those ramblings are hardly tangential, gm. but dig this, if I may be somewhat crude: if you want to fuck me, you have to kiss me first. this is largely the problem, I think. we've got plenty of enthusiasm and urgency at the top now for "the many saving the few," but where were those guys over the last 30 years when it came to helping "increase equality?" I'll tell you -- hiding their dough from the taxman, paying off political hacks and morons to kneecap the taxman, and generally lining up cronies to preserve and expand their license to steal. um, have I got it wrong?

so there's more anger than pundits even understand, I think, just beginning to churn up through that "society" that has to sacrifice to save the system. in the end the many will get fucked, probably pretty roughly, so that the few get off (dual meaning intended) and mortal havoc is at least postponed. but the bad blood that's oozing now is going to gush later, and leave big puddles. that's what happens when you skip part one and go right to part two.

what does that mean? it means the biggest job for our government, bigger even than managing its balance sheet or guarding a strong market for T-bills, is going to be proving that capitalism isn't just a con. that part one can really work, and keep us generally healthy. otherwise, eventually, who knows when, it just isn't going to be possible to summon or hoist enough "weight" to stave off chaos.

I hope we're up to job, I think we are. I think we'll take some lessons away from this that enlarge our perspective and sympathy and understanding and connectedness. I hope so. but I wish I felt surer.

damn, how I long for some kissing.

------ ------- ------
og, i'd say the insurers own enough of the bank debt to say that significant haircuts would undermine their balance sheets precipitously, given that many own equities as well as other forms of debt that have been smashed in the rout of 2008.

isolating out the life/all-lines insurers -- the most troubled of the various sectors as i understand it -- using the 2008 ACLI life insurers fact book as a source, they hold about $5.1tn in american assets. $1.9tn of this is held in separate account (backing risk-pass-thrus like variable annuities and pensions), much of which is funneled into risk assets (common stock, mortgages, etc). the other $3.2tn is general account (backing fixed payout like life).

bond holdings represent $244bn of the separate account assets (13%) and $2.3tn (72%) of general account.

the separate account has, along with all manner of pensions and endowments, been savaged in the last year -- life insurers nowadays (thanks to deregulation) hold $1.7tn in stocks, about 4% of the total capitalization of american stocks, almost all of it in the separate account. but let's concentrate on general account. of the general account assets, government debt (fed, state and muni, foreign and domestic) represents just $156bn (5%) of holdings. another $250bn (8%) is GSE, including FHLB.

corporate debt holdings, however, amount to $2.0tn, and at $1.8tn substantially 60% of the general account.

now, this is far from being the entirety of corporate debt. but by many accounts, insurers went wild for higher-yielding bank debt in recent years. and the losses being recorded by some insurers reflect their concentration. goldman has previously noted that insurers own "perhaps 40% or more of $800 billion in outstanding bank hybrid paper". note also the bank hybrid debt is a small slice of bank debt, the majority of which is the long-term senior stuff that insurers favor -- they are similarly concentrated in that stuff. this concentration is why their fixed income portfolios have suffered so badly of late.

far be it from me to trust anyone. after some searching, i can't find a proper analysis of the weighting of insurer fixed-income assets by industry. but i wouldn't expect a public admission of facts, even open secrets within the financial sphere, for fear of inciting a panic.

------ ------- ------

Thanks for the link to the insurance company holdings. Very informative.

Exchanging the insurance company's bank debt holdings for equity could be the best thing that ever happened to the insurance companies. With the Fed guaranteeing wide interest spreads, the Government juicing the stock market, and inflationary policies firmly in place, the insurance companies would probably make out better in equity than bonds.

Unless of course the whole rotten, debt-laden mess crashes down around us. I'm making note of where the squirrels live in my neighborhood just in case.

Best wishes for a Happy Easter.

------ ------- ------
more from goldman.

------ ------- ------

Post a Comment

Hide comments

This page is powered by Blogger. Isn't yours?