The Credit Crisis and Insurance, Continued: Part 2.
There have certainly been financial crises before. The major thing that makes the current credit crisis different is that this one comes from an infection of the system. The old tools used in the past by the U.S. Federal Reserve may actually hurt, rather than help, in fixing what is in reality a system-wide breakdown. Tom Petruno, "This Big Rescue May be Just the Beginning" (Los Angeles Times Online, Saturday, March 15, 2008); Jenny Anderson & Vikas Bajaj, "News Analysis/A Wall St. Domino Theory" p. A1, col. 5 (New York Times Nat'l Ed., Saturday, March 15, 2008). See generally Floyd Norris, "News Analysis/For Some Lenders the Risk is Too Great" [Published Online As: "F.D.R.'s Safety Net Gets a Big Stretch"], p. B1. col. 2 "Business Day" Section (New York Times Nat'l Ed., Saturday, March 15, 2008).
This is because the current credit crisis is more analogous to a septic infection of the ways in which credit is bartered in the present-day market, if you will:
- Many lenders of money, i.e., so many extenders of credit like banks, brokerage firms and investors, extended credit by direct loans or by investing their money in real estate. When subprime mortgages began to default, later joined by defaults on paying the ever-increasing interest rates due on adjustable rate mortgages -- foolishly agreed to even by home buyers who might have otherwise had good credit compared to the people who could get only subprime rates -- mortgage defaults soon became a problem that accordingly spread to many banks, many brokerage firms, and many investors, not just a few.
The increasing fear that fuels the prevailing credit crisis will almost certainly lead to more Claims on Mortgage Insurance Policies as homeowners increasingly default on their Mortgage payments.
- Since the credit crisis is fueled by fear that money lent will never be repaid, and thus that money borrowed cannot be repaid either, mortgage defaults and declining house prices have made investors fearful about all kinds of debt securities, including securities that have nothing to do with housing or mortgages. If lenders cannot raise the capital to make loans because investors will not buy the securities that back such loans, then those are loans that may not be made. For example, some banks are reluctant to make student loans even as part of a U.S. Government program: "Investors have proved reluctant to buy securities backed by student debts, making it more difficult for lenders to raise the capital they need to make loans." Jonathan D. Glater, "Student Aid Availability Questioned" p. A9, col. 6 (New York Times Nat'l Ed., Saturday, March 15, 2008).
- As an example, demand has recently deteriorated big-time for Munis or Municipal Bonds.
Bond Insurance on Municipal Bonds may not even be necessary for most Government entities that have the authority to issue Bonds. As was written in this space in many previous posts, these authorized government bodies generally do not default. They repay their debts. Corporations issuing Bonds are 100 times more likely to default on their bonds. Yet, at a time when more corporations are likely to default on repaying their Bonds, then at least where Insured Corporate Bonds are involved, Claims can be anticipated on the Bond Insurance Policies that insure the repayment of such debts.
- Cf. Anderson & Bajaj, supra: "Of particular concern [to hedge funds and other business partners of Bear Stearns] are the insurance contracts known as credit default swaps in which one party agrees to guarantee interest and principal payments in case an issuer defaults on its bonds."
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