Sunday, November 2, 2008

Liability Structure

Ah, for, a block of prepaid, noncancellable term life policies!

A great deal of ink has been bled expressing angst at the bad loans, dubious securizations, toxic assets and so on currently clogging the financial system. Not as much attention has been paid to the liability side of the balance sheet.

Well, the liability structure of a typical investment banking operation vs. a traditional insurance company is why the crash of the former resembles a plane crash and the failure of the latter resembles a train wreck. (The AIG debacle is such a surprise because it was a capital markets player operating in the sheep's clothing of an insurance company--and now, six weeks on, those involved are still reasonably clinging to the value of the insurance operations as the way over the ever deepening abyss of its capital markets liabilities).

Liability structures are important. By focusing on liquidity instead of solvency issues for the first year of the financial crisis, the regulatory community has radically transformed the liability structures of many regulated institutions. The extent of this transformation isn't fully known and certainly isn't fully appreciated. How it play out remains to be seen. My suspicion is that this development may, in the intermediate term, be more important than the current round of capital injections, particularly in terms of its political ramifications.

Incidentally, the reason the liability associated with a block of prepaid term life insurance is so attractive is that the only way you have to pay anything out is when somebody dies. Unless you've insured a bunch of lemmings (a definite possibility nowadays, given underwriting standards), you don't have to worry about a run on the bank, as it were. One, two, altogether now, over the cliff . . .

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