#insurance

Karen Petrou: Will There Also be a Financial Firestorm?

Eliza Allen2025-01-21T13:57:41-05:00January 21st, 2025|The Vault|

I live two short blocks from Rock Creek National Park, one of D.C.’s hidden wonders. As befits a national park, Rock Creek is very large and densely wooded, but no one has thought much about fire hazard until last summer’s drought led to some significant brush fires. I thus asked a forestry professor next to whom I happened to be seated waiting for a plane if those of us living near Rock Creek Park should worry. Instantly and unequivocally, his answer was emphatically, “Yes.” I’m still not sure what I or any of us now at risks we never contemplated can do, but I’m even less sure that what can clearly be done to reduce financial-system risk due to natural disasters will be done until after it’s too late.

Is risk really this frightening? A report last week from the Financial Stability Board lays out what it believes to be plausible, yet-severe scenarios demonstrating that the extent to which property insurers and reinsurers are able to absorb natural-disaster risk determines whether a disaster leads to systemic financial risk. In the U.S., this is a thin reed.

We know that the National Flood Insurance Program is woefully unable to address the scale of recent hurricanes and inundations. A treasury study last Friday shows that private insurance is in at least as much disarray. Homeowners in the highest climate-risk zip codes pay premiums about eighty percent higher than those in the lowest-risk codes and have far, far higher non-renewal rates. Fifteen of …

Karen Petrou: The Toxic Brew of Insurance Companies, Private Equity, and High-Risk Mortgages

Eliza Allen2024-07-22T11:13:54-04:00July 22nd, 2024|The Vault|

As financial regulators fret about risk migration to nonbank financial intermediaries, a new race to the sunny side of the regulatory street is already underway. As detailed in a comprehensive Bloomberg article, insurance companies are increasingly investing in high-risk whole residential-mortgage loans, doing so either with no capacity to service them unless they rely on parent-company private-equity firms to do so somehow. What could go wrong?

This transaction is redolent – indeed, it’s a repeat – of how nonbanks barged into mortgage finance before the great financial crisis without a clue about the real risks they ran. Well, I recall Bear Stearns’ big bet on mortgages placed without any concomitant servicing capacity because, as they said at the time, mortgages never go to foreclosure. Speculative house-price increases led them to this sanguine conclusion because there hadn’t been many foreclosures for a couple of years, but neither Bear Stearns’ mortgage portfolio nor the firm is here today to ruminate over hard lessons learned in the 1980s.

Bear Stearns’ failure quickly became a systemic threat, with wider damage delayed until the 2008 crash thanks only to the first of the Fed’s high-cost subsidized mergers that bred moral hazard that fired speculation up to a still more frenzied height until Lehman Brothers failed.

As before the great financial crisis, insurance companies are investing in high-risk mortgages because yield-chasing and capital arbitrage rewards them, at least for now. The whole mortgage loans insurance companies are buying carry wide spreads over RMBS is only …