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Underwrite and Under-Write

Anyone who doubts the potential for a Depression needs to read the newspaper. No, don’t bother with the front page or the business section – skip over to the part that matters.  A quick glance at the ads taken out by retail stores shows an amazing number of deep sales, running 50 or even 75 percent off on everything.  They’re doing this because the stores are unusually, unreasonably quiet.  That’s the defining characteristic of any market failure, whether you’re looking at it from the strip mall or the Capitol Mall.  It’s the unusual quiet that comes from everyone staring at each other, shrugging their shoulders.

What we need to realize is that this eerie calm is exactly what comes after a natural disaster, like Hurricane Katrina.  When you’d love to hear the helicopters flying to your rescue, the first thing that you hear is a dead silence.  That says more about this situation than anything else.

When FDR took the oath of office, one of the first things he did was to order all banks closed for 100 days.  That turned the panicked run on the banks into a dead calm that gave room for action.  When the banks re-opened, there was a new program called Federal Deposit Insurance, literally guaranteeing all deposits up to $100k with taxpayer money.  It was a radical idea that seemed like it was throwing money away to some, but it was the rescue everyone wanted to fill the calm.  The program was later funded by insurance payments from banks once the one-time hit was absorbed.

In an effort to avoid another Depression, the latest proposal (which has been floated before) is to create a “Bad Bank” that will absorb all the “toxic assets”.  This has created a flurry of noise and debate to fill a moment that should reasonably be filled with contemplative quiet.  These “toxic assets” are nothing more than securities, usually mortgage—backed, that have an utterly unknown value because the market for them does not exist.  Normally, they are “marked to market”, or valued at whatever someone will pay for them; that number is current zero, but may be a lot more later.  A “Bad Bank” will take them off of a company’s balance sheet and allow them to re-start the process of loaning money again.

Some people, especially a few fancy editorialists,  hate this because they believe the “toxic assets” are worthless.  This short-sighted way of looking at things ignores the necessity of re-starting the market and getting mortgage lenders to start loaning again.  Would it be a massive one-time hit to the Treasury?  Oh, yes, it will be.  But, like FDR, you make it up later by setting up the appropriate framework – the system of insurance that should have been there in the first place.

The truth is that banks, themselves, are a bit outdated.  The liquidity we enjoy in nearly every market, which is to say the ability to convert nearly anything to cash, was unheard of in 1933.  Stocks, eBay-able merchandise, and even home equity have become things that can be converted into cash easily.  If it was essential to appropriately insure the banks in the last Depression, it is reasonable to have the same insurance on all financial instruments, modeled on the highly successful FDIC.

Why do we need such insurance?  The outlay of $700B (and maybe $200B more) to the financial institutions shows exactly why.  So much is “too big to fail” and will be bailed out.  They must bear the costs of this system of insurance down the road, even if they can’t possibly now.  They have one “Ma Bad” and that’s it.  Just like the banks got.

Furthermore, anyone who has taken out insurance on a property knows that a good insurance policy has pages of provisions, requirements that the insured will keep things up and not do anything to create an obvious hazard.  When we insure all aspects of the financial system, that means regulation.  A system of regulation that is designed to keep the insurance from incurring any undue risk is a system that is focused on what the market really needs.

Exactly how the assets are dealt with is relatively unimportant to me.  We’re not going to come to a resolution until that moment of calm really sinks in and the enormity of the task shuts up the petty arguments.  There’s only one real answer to that calm that comes after the disaster, as anyone who’s cleaned up after a hurricane can tell you.  You get to work and do what needs to be done – knowing your insurance agent is going to be there any moment now.

6 thoughts on “Underwrite and Under-Write

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