Sunday, March 01, 2009

Another connection to keep in mind...

I have been trying to shed a little light on how the "bailouts" so many folks are upset about are more than simply solving a problem in New York.  I'm not crazy about the excesses and can certainly empathize with the desire for comeuppance to be ladled out in full measure the pretentious twits who thought they could create money from thin air.

But it is important to set aside the longing for just deserts and contemplate the institutions where these bad guys worked and how they impact my life here on 2100th Street.  Bailing out the banks is not simply about rich guys.

For example, where exactly do you think your life insurance company stashes the premium you send each month?

It's easy to blithely say "Why don't they just make the bondholders take a haircut?"  Harder when you think about who those bondholders are:  insurers.  pension funds.  the bond component of your 401(k).  Financial debt makes up something like a third of the bond market, and the largest holders are pensions and insurers.

The insurers are the biggest problem, because they're just so heavily regulated.  They're not allowed to hold risky assets.  Convert their bonds to equity and they will be forced to dump that equity at prices that will trend towards zero.  Many insurers will see their capital impaired below the regulatory limits, requiring a government bailout.

Pension funds are the next biggest problem.  They're already in big trouble because of stock market declines.  The bonds are the "safe" portion of their portfolio, the stuff that's supposed ot be akin to ready cash.  Convert their bonds to equity--or worse, default--and suddenly they're illiquid and even further underwater.

Nor is the 401(k) problem small.  Bond funds are typically held most heavily by the people closest to retirement; they're for income, not capital gains.  What is your mother going to do when a third of her mutual fund income gets converted to equity that produces no cash and can't be sold because the insurers have all had to dump their shares on the market at once?  Or simply disappears into the land of bankruptcy lawsuits? [More]
Not only are insurance premiums for any kind of insurance you can imagine going to zoom upward, even the highly regulated insurance companies are at enormous risk if we do not find a way to make our banks work again.  Contemplate the shattering impact of life insurance policies being voided, and then try to get to sleep.

Nor is the crisp, neat idea of nationalization as straightforward as it seems. One reason the administration tiptoes around this suggestion is an increasingly clear picture of the consequences.
The most obvious problem with nationalization is the risk of contagion. If the government wipes out equity holders at some banks, why would investors want to put money into healthier but still marginal institutions? A small number of planned nationalizations could thus lead to a much larger number of undesired nationalizations. [More]
We have woven an enormous web of economic ties throughout our nation, and just because you can't get good cellphone reception, it doesn't mean you are safe from the financial implosion that only appears to be centered on Wall Street.

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