Wednesday, April 15, 2009

the only alternative is to allow the banks a zombie existence cannibalizing the “toxic” assets left over from the structuring excesses of the boom

TO BE NOTED: From Inner Workings:

And another reminder: what happens if the insurers ago? April 15th, 2009
David Goldman

The answer is, “everything,” including the most mundane transactions in trade — because everything requires insurance. This from the FT this morning:

The front page of Wednesday’s FT runs with the following story - that the UK government’s forthcoming budget is to include a “supply-chain insurance plan”:
The scheme will form a centrepiece of the Budget initiatives to help small to medium-sized businesses cope with the recession. Its unveiling marks the culmination of months of negotiations with insurers spearheaded by Lord Mandelson, the business secretary.

The initiative responds to concerns that hundreds of supply chains are threatened by the recession-fuelled reduction in credit insurance, which protects companies that supply goods on credit against the risk that they will not get paid.

Industry has been lobbying for the government to step in for months. The EEF manufacturers’ organisation warned weeks ago: “The speed at which credit insurance is being withdrawn threatens the supply chains that are the heart of the UK’s manufacturing base.”

Supply-chain insurance is crucial to the functioning of the economy and is really one of those things that has been somewhat ignored in the financial crisis so far, what with all the other credit-linked troubles around.

The point is that forms of credit - trust - are critical to lubricating trade. The collapse of the Baltic Dry Index months ago was the thin end of the wedge: global shipping ground to a halt as participants in the market found themselves unable to secure crucial letters of credit from banks and commodity brokers that mitigated counterparty risk.

In fact, as with so much in this crisis, much of the recent ructions in trade credit can be traced back to the activities of very small specialist units at financial sector firms. In the case of trade credit and surety, the activities of the reinsurers are crucial. And the reinsurers are pulling back.

FT Alphaville understands that Swiss Re has cut 45 of 65 jobs in its credit and reinsurance department, with a view, we believe to quitting the trade credit insurance and surety bond reinsurance sector entirely by year end.

Swiss Re confirmed to FT Alphaville that activities are being reduced but precise numbers could not be confirmed. “We will continue to accommodate the needs of key core multi-line clients” a spokesman for the company said.

The numbers might seem small, but such re departments are of huge importance.

Much like the way AIG FP functioned, trade credit and surety reinsurance operations write contracts with, effectively (though not necessarily we stress, directly) a huge amount of leverage, based on the notion that such contracts being written are virtually risk free. (Indeed historically the industry was renowned for reinsurance contracts that came with secret confidential ’side letters’, hidden from regulators, promising in legally binding terms that their contracts would never be exercised). Just as AIG’s 650 people were a primary force in the explosive growth of the multi-trillion dollar CDS market, so too are small trade credit and surety reinsurance departments like Swiss Re’s, then, critical for the functioning of trillions of dollars of global trade credit insurance further down the chain.

And while Swiss Re is not the largest reinsurance player in the trade credit space, it’s pullback is nonetheless instructive. It seems representative of a broader trend - one that has the potential to be so damaging that the UK government is forced to make filling the vacuum in the trade credit space a centrepiece of its upcoming historic budget.

Indeed, brokers, trade credit insurers and surety bond companies are all understood to be very worried about the declining availability of reinsurance - which is critical to their own ability to continue to operate effectively. The government’s move should hopefully do something to fill the vacuum - but until details about what price, terms and conditions new reinsurance - government sponsored or otherwise - are available, trade insurers and indeed trade full stop will continue to languish.

Of course it was a pyramid scheme: of course the insurers who allow a load of kasha to get from Minsk to Pinsk should not have owned the bottom of the banks’ capital structure, and so forth. No-one should have owned bank preferred shares but misers living in caves in the Swiss alps living exclusively on home-grown goats’ milk, so that the vaporization of these securities under nationalization would not even have gone noticed. Bank subordinated debt should have been sold exclusively to the hoards of sleeping dragons who would not hear the crash of the isser thousands of miles away. We know that now. My recommendation is that Larry Summers and Timothy Geithner should be deputized to find sufficient dragons and Swiss misers to place the $135 billion in TARP capital injections to the banks….

…but in the meantime, the only alternative is to allow the banks a zombie existence cannibalizing the “toxic” assets left over from the structuring excesses of the boom."

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