Who Will Insure the Insurers?

Newt Gingrich was the only member of government who sounded like he had a clue about what was going on this past week, Paulson and Bernanke included. Gingrich recognized, correctly, that the main thrust of the Paulson plan was to give more power to well… Paulson.

But since the bill was defeated on Monday, Gingrich has been talking as though tweaking the Paulson plan on a couple of things would be enough to get it through next time. One tweak, he suggests, would be to have the government insure the bad loans on the books of financial institutions. This is somehow supposed to be an improvement on the plan that would make it acceptable to Republicans (along with the removal of mark-to-market accounting).

Well, insurance is actually already a part of the bill that was just defeated (Section 102). Section 102 would guarantee bad loans (sorry, troubled assets) by creating risk-based premiums to cover anticipated claims.

So, rather than buying bad loans, which at least has the remote chance that the government would get the price increase if they ever recovered their value, the government is proposing to guarantee them. That means if these troubled assets got less troubled, even positively robust, the banks — not the government — would get the price increase. But if they don’t get better, who picks up the tab? The government.

An insurance fund offers the prospect of all kinds of interesting shenanigans. Banks could claim to make losses, while actually taking in profits. They could keep doing that for another whole cycle. The possibilities are endless for savvy professionals with degrees in math and sophisticated risk-models.

Why would I suspect these respectable institutions of doing any such thing? Because that’s just what they’ve been doing for a long time — as the ongoing FBI investigations into over two dozen of the firms involved in the bail- outs is showing.

So when I read that Barack Obama also wants to ‘do something’ about insurance, I have to wonder at this bi-partisan interest. Especially when I know that the Treasury Secretary’s former bank, Goldman Sachs, made huge profits from derivative trading and created the complex structures that have got the banks into such a mess. Goldman has behaved almost like a hedge fund over the last two decades, setting up some of the most questionable financial structures for clients that range from media moghul Robert Maxwell (who swindled pensioners), to Enron (we know how that went), to Fannie and Freddie (ditto), Ghana’s Ashanti Gold (which was ruined by the disastrous hedge portfolio Goldman created) and AIG ( now under FBI investigation).

My suspicions mount when I find that Goldman has turned itself into a commercial bank that can take in deposits; that it was showing signs of having taken a hit before it did so; that Warren Buffett is so certain about Goldman’s future growth he’s taken a multibillion dollar stake in it; that Buffett’s firm General Re was involved in fraud with AIG; that Goldman was the counterparty in a lot of AIG’s credit default contracts; that AIG continues to be under investigation for insurance fraud dating back to the 1990s; that Goldman is also a large government contractor and has been involved in fraud there too, including on sales of bonds to municipalities.

And now Obama wants to raise the amount of money that government insurance on deposits in banks would back, from $100,000 to $250,000. Who could be against that, right?

Actually, they could. Raising the amount of money insured certainly is good for the banks. It encourages depositors to keep money in them, which helps keep capital in the system and lets the banks keep lending and making money.

It also seems to be good for depositors. Their money now has the full faith and credit of the US government behind it. If the banks lose the money, the government fund (FDIC) pays.

The only problem in this is that FDIC is tax-payer money, so ultimately it’s the tax-payer who foots the bill. By spreading risk, insurance can actually create a moral hazard problem, encouraging the very practices it is supposedly insuring against. That is, the fact that the deposits are insured, makes the banks much more willing to make risky investments with your money. You go along because you’re getting higher interest rates. In the competition for getting higher and higher interest rates, the banks do riskier things and they get right back into the mess they’re in now.

But it gets worse. The deposit insurance fund is already nearly depleted from repeated bail-outs of failed banks. So where does the money to replenish it come from, right now, should there be claims? (You know there will be claims… and lots of them coming. And insurance will encourage even more).

Put another way: who will insure the insurers?

Lila Rajiva is a freelance journalist and the author of The Language of Empire: Abu Ghraib and the US Media (Monthly Review Press, 2005) and Mobs, Messiahs and Markets (with Bill Bonner-Wiley, September 2007). She has also contributed chapters to One of the Guys (Ed., Tara McKelvey and Barbara Ehrenreich, Seal Press, 2007), an anthology of writing on women as torturers, and to The Third World: Opposing Viewpoints (Ed., David Haugen, Greenhaven, 2006). Read other articles by Lila, or visit Lila's website.

6 comments on this article so far ...

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  1. nwkec said on October 2nd, 2008 at 9:42am #

    Newt Gingrich may understand the problem but he is not a member of government. The one member of government who does understand the problem is congressman Ron Paul. He has been speaking about the financial condition of America for a number of years now and has specifically addressed the current problem over the last 12 months. Generally a good article.

  2. Lila Rajiva said on October 2nd, 2008 at 10:05am #

    Hi –

    Yes – I corrected that in my final version. Apparently this one got published instead.
    My fault.

  3. MrSynec3 said on October 3rd, 2008 at 2:04am #

    To nwkec,

    Your hero Ron Paul, is a champion for completely unregulated banks
    and financial markest which got us in this mess. Unregulated financial
    houses will get so powerful and influential that they will control the
    government and Congress and the courts which is happening right now.

  4. Lila Rajiva said on October 3rd, 2008 at 4:59am #

    Libertarian recommendations work in a context. …

    And since Paul has correctly called every part of this crisis and talked about it for years before it unfolded, I would say he knows more about economics than all the charlatans and economic nitwits who led us down this path.

    I actively support certain forms of minimal (ground rules) regulation (to do with policing criminal behavior, preventing bank consolidation – since the rules change when institutions become big, and to prevent gaming of the system).

    I am also on record supporting very heavy sanctions for professional misconduct.

    However, a lot of the problem we have here is fundamentally due to one thing – cheapening of money beyond its market rate to make consumption, debt and the financial industry take up a gargantuan proportion of the economy at the expense of correct market allocation of resources. That accounts for the huge boost to speculative activity, huge compensations and shortsighted investment behavior …..and then human greed and corruption took over. …not just on Wall Street…on Main Street too – where people trade in the short term, flip houses, think nothing of defaulting on student loans and car loans…

    Didn’t hear any of them complaining about Wall Street when their portfolios were being artificially pumped up and the house values were tripling. Even now, I hear nothing about the people who really got stiffed – people with savings, who never got a fair market rate because of the manipulation of the interest rate, while the banks were gambling with their money and taking the profits.

    When the market tried to correct in 2000 and then again since 2004 and in 2004, the Federal reserve propped it up again…Don’t blame free markets when what we have here is a managed economy, crony capitalism, corporatism…….anything but free markets.

    Even AIG’s book cooking was all done to get around tax rules and operate in tax havens. Trying to conceal profits and reassure shareholders of their viability, they ended up doing fraudulent transactions.

    Then there’s the baptists and bootleggers problem….
    It’s much more complicated than simply “excessive deregulation.”
    Normal market downturns clear away excess. Keep trying to postpone the normal correction and induce an artificial boom and you get a problem.

  5. Lila Rajiva said on October 3rd, 2008 at 1:31pm #

    “and then again in 2005”

  6. Lila Rajiva said on October 3rd, 2008 at 1:32pm #

    sorry, 2007 – augus