Credit Crisis and Insurance, Part 1: The Background.

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    Insurance Policies at risk in the credit crisis potentially include Mortgage Insurance and Bond Insurance Policies.  Their role, and the role of Claims upon those Policies, requires a little background, what we lawyers like to call a "predicate".

• Three decades or so ago, the use and extension of credit in the United States began to change markedly.  Investors were hungry for more and different kinds of interest income.  Wall Street crafted more and more ways to change loans into interest-bearing bonds.
• Ultimately, the search for ever more ways to make loans required finding, or making, a larger pool of people to whom loans could be made.  The more and riskier the loans, the greater the chance of high rates of interest, if only the borrowers could repay.  That stressful search led to loans made to people who could not likely pay the money back, and their "collateral" was made from subprime mortgages.
• At this time, the credit market has collapsed.  To put it another way, the financial system in the United States is overleveraged, meaning there is just plain too much debt now for Wall Street to tolerate.  Many investors respond to this stress by not taking risks at all -- exactly the opposite behavior they indulged in starting nearly 3 decades ago.  Clearly, this is a big change in behavior, so big that currently, many investors do not wish to run the slightest risk of taking on any more debt.  Unless the debt is owed to them directly by the United States Treasury.  That is how the recent bailout of Bear Stearns, the investment bank, by J.P. Morgan, came about with the approval of the U.S. Federal Reserve.  "The troubles at Bear Sterns have come quickly and savagely and hurt some of the putatively smartest money in finance."  Landon Thomas, Jr., "Run on Big Wall St. Bank Spurs U.S.-Backed Rescue" p. A1, col. 5 (New York Times Nat'l Ed., Saturday, March 15, 2008).
• Tom Petruno, "This Big Rescue May Be Just the Beginning" (Los Angeles Times Online, Saturday, March 15, 2008).   See generally 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 also Landon Thomas, Jr., supra. 

    In the next post, the implications for debt insured by Mortgage Insurance and Bond Insurance.

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