Sunday, September 06, 2009

stop me before i securitize again

News from the New York Times to warm the cockles of a quant's heart - and send shivers down the spine of the rest of us who don't make a living selling financial products to suckers I mean investors. The geniuses on Wall Street want to
buy “life settlements,” life insurance policies that ill and elderly people sell for cash — $400,000 for a $1 million policy, say, depending on the life expectancy of the insured person. Then they plan to “securitize” these policies, in Wall Street jargon, by packaging hundreds or thousands together into bonds. They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.

The earlier the policyholder dies, the bigger the return — though if people live longer than expected, investors could get poor returns or even lose money.

Sound familiar? It's like what they did with mortgages and car loans and student loans - buy a bunch without regard for whether they were risky or solid bets, cut them into little itty bitty pieces, convince us (with the help of their lap-dog credit rating agencies, who would rate a CEO's loose bowel movement AA) that it was a good deal, and this distribute risk widely. Of course, it was predicated on people not going into default on mortgages above a certain rate. And THAT was predicated on the real estate market rising continually. Which was a false hope.

So what's wrong with this insurance thing? Already even without securitization investors are taking advantage of the sick and elderly on life settlements. Note that I don't oppose them - but they should be regulated because betting that somebody will die creates some perverse incentives.

And these insurance securities would be based on the idea that people will die on schedule. In other words, if there were a medical breakthrough and life expectancy for these policy holders increased 10%, they could become a losing proposition. So you'd create an incentive on Wall Street that would not favor medical research? Good idea.

Some Wall Street banks are also doing something called "re-remics" - resecuritization of real estate mortgage investment conduits. In other words, repackagins MONEY-LOSING investments into higher-rated ones. How does THAT work?

This all just reinforces the lesson some of us have learned over the past 18 months or so that better financial regulation is critical to the REAL economy, not just to protect the investor class.



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