I am not sure I agree with this... The traditional insurance industry seems to have done OK, black swans or no black swans. Sure, you hear about the large payouts that insurance companies have to make, but they mostly seem to take the unexpected in stride. I don't see why this can't work in finance.
Several risks need to be addressed with regard to banking. The risk of loss due to bank failure as a result of poor business practices is of course always a possibility and certainly one could say compounded by the merging of investment with commercial banking. Additionally the risk of outright fraud weighs heavy too. The role of Gov't in backstopping is muddy as Ireland, AIG, Fannie, illustrate. There are no shortage of examples of these situations, LTCM, Madoff, Lehman, MF Global, ... Consistency with regard to banking reorganization would be a healthy step toward reform. Reform does appear to be necessary as the pattern continues to repeat. With the current state of economic affairs it seems likely that volatility will continue to remain high going forward with a more frequent boom bust cycle. In the context of these economic, legal, and business conditions complicated by differing laws between sovereignties unified rule with regard to reorganization in the EU makes perfect sense. Clearly there is no way to engineer out all risk but it is harder to quantify risk in the context of reorganizations handled willy-nilly on an individual ad hoc basis. But I do suppose nothing will really change it is more like whacka- mole. Putting out fires addressing the crisis de jour and most importantly for the individual investor, business, fund, or citizen caveat emptor.
Fair comment and I make a generalization of course. The missing link is that the government is standing behind the insurance companies and they are heavily regulated because the government has been burned before. AIG was taken over by the government when a multiple sigma event ( black swan) occurred. All banks doing underwriting were backstopped by the TARP and government. There have been lots of insurance company failures before. Looking from an option point of view. Can one correctly price risk of a put option for 20 years out? Who would sell one unhedged? There have been 6 sigma events all over lately, 1987 was a 22 sigma event reportedly caused by portfolio insurance itself. 1987 is not likely the worse case either, meaning that most market risk assessments are wrong IMO. I think then market pricing of risk is highly suspect without a fiat money supply.
there is a possibiity that this is like a soprano episode where the goldman sax's are the sopranos and laughing at the inept DC crew whilst backing up trucks to the treasury dept and hauling away the taxpayers money ,by the time there i s any reform, they will have it all and be long gone
Again, with all due respect, I have to disagree with you. Obviously, perfection is impossible, but traditional insurance companies exhibit a failure rate that is several orders of magnitude below that of financial institutions. Consider that between 1970 and 2000 there were around 700 insurance company failures across the developed world. How many financial institutions failed during the same period? And do you really believe that the actuaries in the traditional insurance companies face less uncertainty and fewer "black swans" than the financial mkt participants? As to the govt standing behind these insurers, that's not really true. AIG got bailed out because it was really, for all effects and purposes, a large levered bank. IMHO, the key contrast is not the different "unknown unknowns" risks that the two industries face. It's simply that the leverage in the insurance industry is tightly regulated, not just by the govt, but by the industry itself. Tradional insurance companies are required to reserve conservatively, because everyone knows that leverage is what kills, rather than "black swans". Consider that, according to the results of the best study on ins co failure (A M Best, 1999), of the 640 or so failures between 1960 and 1998 in the US, only 8% occurred as a result of heavy losses following large catastrophe payouts. the largest proportion of failures (34%) was a result of "underreserving", aka excess leverage. Now, obviously, the insurance co's can't completely resist the lure of leverage, so every chance they get to work around the rules, they use it. For instance, the "side letter" mini-scandal comes to mind. But, again, such creativity is orders of magnitude behind what banks have done and continue to do. Finally, who would sell 20y expiry puts? I can think of one very wealthy guy who seems to love doing that. Lives in Omaha, I think. As to the mkt price of risk being wrong, how can we possibly know what the "right" price is? In my mind, the mkt price, in the medium to long run, is always the right price. And like I said above, it's almost never the trade or the price that kills you, it's the size and the leverage.
(I am glad you disagree with my arguments and present sound comments to support your side. It forces me to re-examine my thinking. If I am right then it doesn't matter, and if I am wrong, I should re-examine them ASAP.) I agree that risks are similar and that regulated leverage is lower for insurance. Also, insurance have a positive cost of carry on borrowed money which should lessen costs for the same sized black swan damage events. I think banks are a spread business, which means that they seek higher leverage in lower interest rate environments to boost profits. If they are considered TBTF, then any increase is pushed onto others as mentioned in this thread. That ability to make up losses from clients for the insurance companies, I think, gives an edge to their general business and in theory should lead to less failures overall long term. Perhaps TBTF is a move to push bank business to be more like the insurance business? Lets speak of true black swans, not every bad business cycle. I mean those surprise high sigma events that burst upon us seemingly out of nowhere. Events that the market could not price in since they was unforeseen. Price often begins to catchup the next day. Stockton says that AIG could have gone down without a contagion effect. (I am not sure if that is true since short term liquidity can still bankrupt a business that is solvent on paper.) It's my understanding that most of the AIG rescue money went to overseas banks and that it was the CDS portion of the business that was exposed when they were downgraded from AAA to A. So again, they didn't charge enough to compensate for their true CDS exposure. (Essentially my complaint. They wanted more leverage and underestimated and under compensated themselves for the worst case risk involved.) I don't know why American taxpayers would bail out foreign banks unless some significant event had arrived. I didn't know that AIG was a bank as well. My point on 20 year exposure is not which particular greater fool will buy them (although your example is excellent), but how can they be properly priced by a competitive market for the unknown multi-sigma risks that will come. I don't think that is really possible, but that is simply my opinion. Pricing is bid to the average risk each day and not to the limit conditions. The market would IMO, push prices to the lower more typical risk price. In the long run, I believe that all traders and all risk takers will meet their waterloo. It is money management that will keep them in the game at that time. So is it excess leverage or over time that every possible risk will occur and some of the tail risks are massive and undercompensated? Perhaps just semantics and we are actually saying the same thing, perhaps not. Good comments, thinking, and data though. Thanks for that.
This remark by George Soros might be of interest to some of you: "I passionately disagreed with Treasury Secretary Hank Paulson's plan to bail out the banks by using a public fund called TARP to take toxic assets off their balance sheets. I argued that it would be much better to put the money where the hole was and replenish the equity of the banks. I worked closely with the democratic leadership in Congress to modify the TARP Act so as to allow the money to be used for the purpose of equity interests. I had many other ideas I hoped to put into practice when Obama became President, including a fundamental reform of the mortgage system, but that did not happen. I published a series of articles in the 'Financial Times' but got little response from the Obama administration. I had many more discussions with Larry Summers before he became the president's economic adviser than after. My greatest disappointment was that I was unable to establish any kind of personal contact with President Obama himself." [from pages 48-9 of Chuck Sudetic, "The Philanthropy of George Soros," Public Affairs, New York (2011).]
l am going thru a divorce,bankruptcy,loss of a spouse,child,a limb,cancer,not everyday for most people,who day by day adhere to reality to avoid the intuitive price of ignoring it,our first option is denial,trhis one emotion above the rest is where wall street absorbs just by being ther,most of it's money..simple enough. .now those members of the THEY club ,aside from attaining massive ,seemimgly easy wealth,are just as simple as the rest of us,just members of the community running the arcade collecting quarters....unlike the folks in the 1st paragraph,they are members of the secret arcade society, whenever there is a secret society,lies are being told,and laws are made, to above all endeavors , never reveal those lies there lies the unbreakable paradox trying to right the ship without admitting that the iceberg is too big and will kill us all so do they break the secret code and fight to live or do they ignore it and perish at the moment they are still protecting the secret arcade member handshake