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
By 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 The EEF manufacturers’ organisation warned weeks ago: “The speed at which credit insurance is being withdrawn threatens the supply chains that are the heart of the UK’s manufacturing base.”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."

No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis

TO BE NOTED: From The Big Picture:

"AIG: Before CDS, There Was Reinsurance

Posted By Chris Whalen On April 2, 2009 @ 5:38 am In Markets | 51 Comments

Updated!!

Below is the latest issue of [1] The Institutional Risk Analyst. We did a lot of work on this one. Look forward to your comments.

Also, check out the earlier writings of Lucy Komisar on offshore shenanigans of AIG and the offshore transaction set:

[2] http://www.ritholtz.com/blog/2009/04/aig-before-cds-there-was-reinsurance-part-2/

– Chris

“What do many corporate buyers of insurance have in common with American International Group? Perhaps more than they would like to admit. Like AIG, many companies in the past few years have bought finite insurance, which transfers a prescribed amount of risk for a particular liability. What regulators now want to know is, how many companies, like AIG, have used finite insurance to artificially inflate their financial results?”

Infinite Risk?

CFO Magazine

June 1, 2005

“In the regulatory world, a ’side letter’ is perhaps the most insidious and destructive weapon in the white-collar criminal’s arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless.”
Fraud Magazine

July/August 2006

PRMIA Event: Market & Liquidity Risk Management for Financial Institutions

First, a housekeeping item. On Monday, May 4, 2009, in partnership with the Federal Deposit Insurance Corporation (FDIC) & the Office of Thrift Supervision (OTS), the Washington DC chapter of Professional Risk Managers’ International Association (PRMIA) is presenting an important day-long conference on managing liquidity and market risk for financial institutions. Speakers include some of the leading risk practitioners, investors, researchers, bank executives and regulators in the US financial community. [3] PRMIA free and sustaining members may register on the PRMIA web site. Members of the regulatory community may register via the FDIC University. IRA co-founder Christopher Whalen will participate in the conference and serve as MC. See the PRMIA web site for more information on the program and speakers.

And yes, our favorite bank regulator is making the opening remarks.

For some time now, we have been trying to reconcile the apparent paradox of American International Group (NYSE:AIG) walking away from the highly profitable, double-digit RAROC business of underwriting property and casualty (P&C) risk and diving into the rancid cesspool of credit default swaps (”CDS”) contracts and other types of “high beta” risks, business lines that are highly correlated with the financial markets.

In our interview with Robert Arvanitis last year, [4] “‘Bailout: It’s About Capital, Not Liquidity; Seeking Beta: Interview with Robert Arvanitis’, September 29, 2008,” we discussed the difference between high and low beta. We also learned from Arvanitis, who worked for AIG during much of the relevant period, that the decision by Hank Greenberg and the AIG board to enter the CDS market was, at best, chasing revenue. No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis, could have resulted in a favorable decision to pursue CDS and other “high beta” risks, at least from our perspective. ( NB DON )

In an effort to resolve this conundrum, over the past several months The IRA has interviewed a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem. Below we present our preliminary findings and invite your comments.

One of the first things we learned about the insurance world is that the concept of “shifting risk” for a variety of business and regulatory reasons has been ongoing in the insurance world for decades. Finite insurance and other scams have been at least visible to the investment community for years and have been documented in the media, but what is less understood is that firms like AIG took the risk shifting shell game to a whole new level long before the firm’s entry into the CDS market.

In fact, our investigation suggests that by the time AIG had entered the CDS fray in a serious way more than five years ago, the firm was already doomed. No longer able to prop up its earnings using reinsurance because of growing scrutiny from state insurance regulators and federal law enforcement agencies, AIG’s foray into CDS was really the grand finale. AIG was a Ponzi scheme plain and simple, yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.