Do You Hear The People Sing?

As one young Wall Street banker worded it, it was a new religion called Finance. When the rules for banking that were put into place in the 1930s were allowed to expire in 1999, banks began to make deals not only for their customers, but for themselves. These young bankers were dealing "for the house," and the house never loses (except in this case, several did) the more they earned for the banks selling made-up products called "swaps" or derivatives, the bigger their annual bonuses were. They became addicted to being millionaires, selling financial products even they didn't understand.

A Questionable Future
"Will you join in our crusade? Who will be strong and stand with me? Somewhere beyond the barricade is there a world you long to see? Do you hear the people sing, say do you hear the distant drums? It is the future that they bring when tomorrow comes." Les Misérables is about the French Revolution, where things did not work out quite as well as the rabble on the streets of Paris hoped. Sure, Marie Antoinette had said, "Let them eat cake," a reference to the cake of yeast necessary to leaven bread, but the people had responded, "Let her eat crow!" Well, we know what a royal pain in the neck that turned out to be. Sometimes politicians just don't "get it" until they get it! "The future … when tomorrow comes" may turn out to be a great big pile of debt. 

If finance is the new religion then, like the Hebrews in the Sinai desert casting their jewelry into the pot to fashion a golden calf to worship, then the new deity is that same golden calf, now fully grown into a golden bull … market, a deity we all love to worship. It makes our pension funds and 401Ks grow—if the bankers and corporate raiders have not already depleted them. The bankers can promise us anything, and we'll all toss in our treasure to participate. There is only one problem. Moses isn't there to castigate what's being done. Moses—in the form of banking regulations—has apparently wandered off up the mountain, and nobody is minding the store. That is supposed to be what Congress does, but if we're counting on Congress to be our savior under this new religion, then we may as well wish upon a star.

Was Insurance a Victim?
The PBS Frontline interviews revealed that the whiz kids with the graduate degrees from Stanford, Harvard, Columbia, MIT, and the London School of Economics who put together the financial instruments that led to the financial crisis of 2007 were also the sales personnel sent out by the banks—Morgan Stanley, UBS, Deutsche Bank, et. al—to sell these products. They admittedly tried to find buyers who could not possibly have understood what the product was that they were selling. In large part, the bankers didn't understand them either. They sold them to Italian cities, promising lower interest rates for bonds and loans as long as the markets remained strong. (They didn't, of course.) They sold them to the Birmingham, Alabama, Sewer Board, which is now in bankruptcy with no new sewage system. They sold them to the Spanish and Greek governments, and now those are near financial collapse. Often the bankers used their offices in London as the marketing center because British rules were even less stringent than those in the U.S. But don't look to Congress to tighten the rules for U.S. banks, not when the boys from K Street—the banking lobbyists—are handing out campaign dough.

The big question to me is, did they also sell them to insurance companies as investments? Insurers must have investments and maintain surplus. Investment income is crucial in the industry, especially when combined loss ratios near or exceed 100. It is the role of state insurance regulators to monitor every insurer's surplus and investments and make sure the insurers remain solvent, for one never knows when "the next big one" will hit. However, if hedge fund managers, and even the bankers themselves, cannot understand these "swap products" and derivatives, how can we be certain that our insurance company employers haven't invested in such garbage? The London crew of AIG was in the "credit swap" business, and the guys back in New York apparently didn't realize what AIG had sold until the claims came in. Can we rely on a politician—the state insurance commissioner or regulator—to understand the filings that insurers are required to make that demonstrate solvency? 

Each month I receive a courtesy copy of Best's Review, and I frequently look at the back pages called "Credit Rating Actions." On the P&C side there are a lot of "A"s and an occasional "A-," but lately there have also been a number of "B"s and even an occasional "C." Just as Moody's or Standard & Poor rates the states and nations, Best's rates insurers. There are not many "A+"s out there.

The Election and Risk Management
Regardless of who gets elected President next month, it is highly doubtful that the balance in Congress will shift much from its polarized left/right positions and lack of accomplishments. Who knows, maybe we need a new kind of legislature, or at least some way to revive the old one. If so, then it needs to take into account this new religion of Finance and incorporate some controls that can't get watered down and washed away with lobbyist money. If it is not yet clear to Americans that bankers are not what they used to be, then it's time for the nation to wake up. It really is a new century, and a new game.

As I mentioned in my July, 2009, column, "The Risk of Non-Risk Management," I met with our corporate CFO, my boss, one day. While waiting in his outer office I picked up a magazine on his table and was surprised to find that it was called Risk Management (or something of the sort). It was not the same Risk Management Magazine that I, as a member of the Risk & Insurance Management Society (RIMS), received each month. I paged through it. It was all about financial investments, debentures, derivitatives and similar financial mechanisms – what those of us who had taken the IIA Associate in Risk Management termed "speculative risk" as opposed to pure risk. Insurance is supposed to deal only with pure risk, quantifiable and predictable risk of loss from specific causes, called perils. Speculative risk is the kind where there may be either loss or gain. One technical aspect of insurance is that it is an aleatory contract – all or nothing, akin to gambling. One pays premium and may get nothing back in return; or one pays the same premium and, if there is a covered loss, recovers many times the premium amount. 

But it is not speculative. It is carefully and actuarially calculated. Finance is not – with the wild fluctuations in the markets, the old adage that the market always goes up is no longer a guaranteed truth. So those who deal in speculative risk, from derivatives to currency fluctuation, are gambling. About the same time as this grand revelation (to me, anyway) that speculative risk was also being called "risk management," the idea of "enterprise risk management" began to be pushed by the business academics and the insurance press. In my mind it was a melding of pure risk with speculative risk, though that may be a simplification. Now, years later, we also hear of "strategic risk management," and the guy who used to blend pure risk control processes with pure risk finance processes is now called a Chief Risk Officer. So, with the CRO busy monitoring the financial markets, who is monitoring the OSHA requirements and fire codes, fleet safety issues and liability claims? If the guy in charge of risk is busy worrying about derivatives and "swaps," how does he or she have time to monitor the pure risks – fire, thefts, injuries, or global warming?

Old fashioned risk management, one of these earlier columns said, was a sort of mirror image of claim adjusting. It was looking at loss before it happened rather than after it happened. When financial risk management goes wrong and there is a loss, there is no adjuster to handle the claim, no insurer to pay off the debt (unless it was some fool in London writing financial guarantee – credit swap—coverages.) The mess will usually wind up in a courtroom – all too often a bankruptcy court's chambers where somebody will get a foreclosure notice, someone else will lose a job or a home or a business, and a local government will lose another taxpayer. That's the "hell" of this new religion of Finance. 

Yes, I hear the people sing, singing the song of angry men. They sing of college debt, mortgage foreclosures, maxed-out credit cards and debit card fees. But I fear that those angry men will need to do more than just sing and stand behind barricades.