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Tuesday, March 2nd, 2010
The results of the NAIC’s survey of insurance departments across the US is in, and the answer is the Model Investment Law, which only took over five years to write, needs a serious overhaul. Without going into the answer to every detailed question, about 90% or more of the states wanted to see changes in the following:
- Special designations/asset class treatment for structured securities
- Current maximum of 45% of assets for first mortgage loans and income producing property
- Diversification rules where the investments are insured by mono-line insurers.
- Securities lending limits
- Specific limits for hybrid securities
- Include credit risk from Credit Default Swaps in credit risk limits
- Pledged asset limitations
The states were also asked for suggestions of other areas for change and they did not hold back on this, as they included:
- Investment pools, BA assets, FHLB pledged assets, basket clause, auction rate securities, foreign sweep accounts, internal controls, prudence evaluation criteria, standards found in the ‘prudent person’ version of the Model Investment Law.
Tellingly, the states noted additional areas where they needed guidance on defining certain asset classes, including:
- securities lending, hybrids, pledged assets, CDS, mutual fund treatment, bank sweep accounts
If there is some good news here, it is that only about half the states wanted to make the Model Investment Law the law of their state and an accreditation standard. That’s about where we are today with Model Investment Law adoption, so the ‘good news’ is really ‘no news’.
My guess is that the NAIC will eventually begin the process of ameding the Model Investment Law - with more changes than are even noted in this survey. We’ve talked about it before in this blog, but we’re looking at a long slog to adoption. During that time, we expect insurers will keep one eye on their portfolio and the other on what the NAIC is mulling over doing to that portfolio.
Recently, with changes to statutory accounting rules and capital relief via their joint venture with PIMCO on structured securities, the NAIC has acted like ‘captured’ regulators. However, as the economic recovery continues, they may start to seem less ‘captured’ and more ‘capricious’ in their approach to investments.
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Thursday, February 18th, 2010
From the Northwest Quadrant attempts to be an ‘early warning’ blog on issues important to insurance investment professionals.
As Harrisburg contemplates bankruptcy under Chapter 9 and a few other municipalities either have declared or are contemplating per the Wall Street Journal, let’s take a look at the Northwest Quadrant blog (still applicable) from March 1, 2009:
So what if Warren Buffett’s annual letter to shareholders says the economy will remain in a shambles through 2009 and probably beyond? We didn’t need the Oracle of Omaha to tell us things in the economy look ugly.
However, when reading any good narrative, it is important to view the entire tome before drawing conclusions and here is where the popular press has once again missed the boat.. And investors in insured municipal bonds will not like what they see.
Buffett’s Berkshire Hathaway Acceptance Corp is a new entrant in bond insurance, so his group has done more than a passing analysis of the market for insured munis and Mr. B’s basic thesis is centered around poor analytics that sound eerily similar to the simplistic approach utilized for residential mortgages.
"The rationale for very low premium rates for insuring tax-exempts has been that defaults have historically been few. But that record largely refelcts the experience of entities that issued uninsured bonds. Insurance of tax-exempt bonds didn’t exist before 1971, and even after that most bonds remained uninsured."
So, because we’ve never had big problems with munis, there is little or no chance of that occuring in the future. Just like home prices, right?
"Local governments are going to face far tougher fiscal problems in the future than they have to date." (He cites pension problems as a large contributing factor…in addition to the recession, of course)"
Warren seemingly pines for the days when New York City declared bankruptcy, but the confluence of interests of uninsured bondholders (many wealthy New Yorkers and institutions with material NYC interests) caused a financial reorganization plan without the use of insurance. Remember the old Municipal Acceptance Corp? Mr. B. then applies this lesson to potential future scenarios.
"When faced with large revenue shortfalls, communities that have all of their bonds insured will be more prone to develop ’solutions’ less favorable to bondholders than those communities that have uninsured bonds held by local banks and residents. Losses in the tax-exempt arena, when they come, are also likely to be highly correlated among issuers. If a few communities stiff their creditors and get away with it, the change that others will follow in their footsteps will grow. What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far-away bond insurer?"
"Insuring tax-exempts, therefore, has the look today of a dangerous business - one with similarities, in fact, to the insuring of natural catastrophes. In both cases, a string of loss free years can be followed by a devastating experience that more than wipes out all earlier profits."
You might say this is all hogwash and posturing on the part of an owner of the only AAA rated bond insurer. However, the logical progression of the argument cannot easily be dismissed. With that in mind, if you or your company own municipals, please don’t think they are safe because they are "insured", or because after the recent MBIA bifurcation, the insurance is backed by the ‘good insurer’, etc.
Once more, we cannot stress enough that your investment manager review with you the underlying credit of every municipal bond in the portfolio - even GO’s - hello California. And, by all means, feel free to ignore the value of the bond insurance in your analysis.
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Sunday, February 7th, 2010
Just ask the Super Bowl winning New Orleans Saints.
In 1980, they did not win their first game until the next to last game of the season finishing with a franchise worst record of 1-15. During the season Saints fans would show up at the Superdome wearing paper bags over the heads, while carrying signs suggesting the team should be called the "Aints".
Although we don’t expect critics of current economic policy will don paper bags, we do expect that it will take time for the US economy to recover from the Great Recession. Headwinds created by the Greatest Deleveraging in the History of the World will continue to challenge the Greatest Releveraging being engineered by government stimuli the world over.
But, government efforts do have limits. Starting with small overlevered economies (Dubai, UAE), moving to medium sized and larger overlevered economies (Greece, Portugal, Spain) and even, probably, eventually impacting large overlevered economies (UK, Japan, US).
Of course, when you’re printing the world’s reserve currency, you’ve got a big advantage. But, the US was just put on notice by an entity it regulates (Moody’s) which noted that reduced deficits or solid economic growth will be a requirement to maintain a AAA rating. But, the most likely case remains historically high deficits coupled with slow, normative growth numbers.
Undoubtedly, now is neither the time to panic nor don those paper bags. We can expect the EU and/or the IMF and/or a group of world finance ministers to work through the issues posed by sovereign credit. The adjustments won’t be pretty, but there will be adjustments across world economies. And the results will not only challenge governments, but the very social fabric of some countries.
Importantly, it will be increasingly difficult for the world’s top rated countries to maintain that AAA rating. The fallout for insurer portfolios would be greater from a mindset change than from an actual credit risk standpoint. Historically, there is really very little difference in credit rating between AA and AAA. However, insurance investment laws and insurer policies were constructed with the idea that US government guaranteed (direct or implied) securities are the safest of investments. In a deleveraging world economy, credit risk must be constantly monitored and reconsidered.
What to do now?
Take a good hard look at what your company’s investment policy and portfolio is allowing in terms of credit risk.
For years, Strategic Asset Alliance has provided clients the opportunity to review credit risk in terms of both price degradation (due to ratings migration) as well as loss given default. Our Portfolio Credit Review uses a contingent claims approach that highlights that expected net income from credit instruments is practically never a ‘normal’ distribution. And consider all of this in light of policy limitations, as well.
It will take time for the full impact of the Greatest Deleveraging in the History of the World to be felt in all of its aspects. And it will take time for world economies to fully recover since, ultimately, deleveraging requires debt repayment ; which is most easily accomplished over time if it cannot be done all at once.
It took thirty years for the Saints to recover from the depths to the summit of their sport. World economies should take much less time than that to recover…but it will take time.
Meanwhile, just to be sure, on my next supermarket trip, I will request paper instead of plastic.
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Sunday, November 29th, 2009
Far be it from me to improve upon the excellent, though government shielded, coverage of the credit default originating in Dubai. Apparently rooted in a hangover from a major commercial building boom, this default does have some parallels in Western economies.
But, we must once again raise the issue of credit default swaps and counter party risk. Worldwide, zombie banks, propped up by their local governments and tending to survival instead of lending, are showing good profits from trading. And that trading is tied to the ‘risk trade’ – both on and off- balance sheet manuevers using derivatives, including credit default swaps.
As in the days of Lehman and Bear Stearns, investors do not have a good clue as to the exposure in these instruments (direct and indirect) at these largest of institutions. Yet, we insurers dutifully list every single investment and credit derivative exposure on our annual statements. Well, I guess transparency is only good for certain regulated institutions…
Meanwhile, certainly the current Dubai incident may be prompting a call to your investment manager, or at least a glance at the latest portfolio holdings. But, as we continue to state, the key to solid investment results is a solid investment process. And, that includes understanding, in advance, how your company’s investment process is designed to deal with shocks (large and small) to financial markets.
In reality, many insurers may be focusing on the investment manager at the expense of the investment process. David Holmes’ excellent Asset Outsourcing Exchange registered a strong 64% increase in number of manager searches by insurers, this year to date versus last year. But, to the extent these searches are replacements of investment managers, one must wonder. To what end result?
Insurance companies rightfully provide a benchmark for the manager and the manager typically refuses to stray far from that benchmark. (You’ve probably heard the overused, ‘we try to hit singles, not home runs’ from managers.) With that approach in mind, can the manager truly add large amounts of value? The answer is an unequivocal, no.
The key to adding lasting, significant value is improving the investment process.
Think of it this way. The manager is like the mechanic who can fine tune your car and keep it running well. And the investment process is like the car. But, if you’ve got a VW Beetle, you really don’t have much of a chance of winning the Indy 500, do you? And, if your investment process seems to be running okay to you, perhaps you are simply settling for satisfactory Beetle-like performance?
We can tell you stories of companies that realize this and have seen rather impressive, documented improvements in investment results directly tied to improvements in their investment process.
But, the more interesting stories, quite frankly, are those companies that only get concerned when their manager ‘under performs’ or they have to deal with ‘impairments’.
The ‘risk trade’, where any security carrying credit or other risk has done quite well since March of this year, has buoyed the performance of many an investment manager. And, where Boards may have been very concerned about investments in Q4, 2008 and Q1, 2009, those concerns have somewhat ebbed due to the ‘risk trade’. Alas, that is truly a short sighted view.
The question all Boards should be asking now must include, “how will our investment process deal with the next ‘shock’ to the system?” And this is a small part of a larger look at the overall investment process.
What should your company be focusing on now? How the (mechanic) manager performs or how well your (automobile) investment process is built?
As Dubai’s friends in the Middle East might say, "Happy Motoring!"
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Wednesday, November 25th, 2009
They say if you want to get out ‘bad’ news, the best time is on a Friday evening. Even better is on the day before a major holiday, like Thanksgiving. Well, Happy Thanksgiving!
It seems our friends at the NAIC have been reading the public relations playbook and just released an outline of the new non-agency RMBS modelling performed by PIMCO.
I have been assured that this will be used for determining risk based capital (RBC) factors only. And that issues such as impairment, will not be addressed by this methodology. However, let’s put that in perspective.
You have valued a bond at 85 - no review for impairment necessary per policy as it does not impinge on the typical ‘below 80% for more than six months’ standard. PIMCO, in the infinite wisdom of their arbitrary model (see below for more on this), decides that valuation is 70.
The reasonable news on this: If you want to carry it at 85, you will have to allocate more RBC than a company holding the same bond and valuing it at 70.
The problemmatic news: Your auditor sees the valuation and says, ‘This should probably be impaired since that’s what the NAIC (PIMCO) says. In fact our audit firm audits both your company and the one holdling the bond at 70, so take the write down…but atleast you won’t have to maintain as much RBC.’
As noted in my prior post, if you are a large, leveraged life insurer, RBC is more important than the earnings hit. Adequate RBC is tied to survival, while earnings is more transitory. However, across the entire insurance industry, the earnings hit and subsequent disclosure is much worse than holding more RBC, since capital is usually not as large an issue as earnings. As noted previously, score one for the large life insurers. Those hefty dues to the American Council of Life Insurance sure look like a good deal for them.
But, what of PIMCO’s model? It looks like a relatively common approach to modeling non-agency RMBS. And many of the details ‘under the hood’ still appear hidden in the latest memorandum from the NAIC. However, one item not hidden is a very key assumption, Expected home price depreciation or, peak to trough HPA, as shown below:
| Scenario |
Probability |
Peak to Trough HPA |
| Most Aggressive |
2.5% |
-33% |
| Aggressive |
22.5% |
-35% |
| Base Case |
50.0% |
-38% |
| Conservative |
22.5% |
-41% |
| Most Conservative |
2.5% |
-61% |
This deserves a few comments:
1- This assumes geography has zero to do with HPA declines. More sophisticated models tend to use this very significant factor when using HPA as a driver in determining incidence and severity of loss.
2 - Recent readings of Case-Shiller indices show a slowing in HPA declines to a leveling in some areas. Is it reasonable to assume further declines? I do not know the answer to this, but it is a very difficult and important point tied to the ‘most likely’ case of slow economic growth versus a double dip recession in the future.
Besides my nagging feeling about ‘conflicts of interest’ when an investment manager of assets, including RMBS, is called upon to value such assets for regulatory purposes, I remain concerned about the use of these arbitrary valuations.
Will they produce ‘more accurate’ RBC than the ratings? Perhaps, perhaps not. Remember, we all got into this mess relying upon inadequate models. Who is to say that PIMCO’s modeling for the NAIC will not prove just as inadequate?
Will they produce problems when auditors notice your company’s valuation, based upon perhaps more strenuous modeling than PIMCO’s, has a higher value than PIMCO’s valuation, prompting concerns about impairment? I don’t see how they won’t.
Will your voice be heard in the deliberations on this? Probably not, unless your company is a large life insurer. However, there is a public meeting and open conference call scheduled for next Monday (so soon) at 11am ET. If you would like to participate, please contact Chorus Call (866-332-4905), the NAIC conference call coordinator, in advance and ask for the Evangel Call (there is a fee for participation). And if you cannot participate via telephone, it has been requested that your comments be made in written to Bob Carcano (RCarcano@naic.org).
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Friday, November 6th, 2009
“Be careful what you wish for” could be the most appropriate saying for the insurance industry, when reviewing the NAIC’s latest attempt to diminish increasing risk based capital charges (RBC) at mostly large, capital starved insurers.
One only has to visit the NAIC’s website and note how proud they are of the latest change to RBC rules for residential mortgage backed securities (RMBS). The reasoning is simple enough and goes something like this. 1 – The rating agencies did a poor job of rating these non-agency RMBS in the past and their current model is too punitive on the most conservative tranches of these securities. Ergo…
2 – The NAIC can do a better job of assessing RBC charges by partnering with a so-called ‘independent’ firm to re-analyze and provide a ‘revised’ rating for purposes of the Securities Valuation Office (SVO) of the NAIC.
This is all well and good, once you get over the fact that no firm we know of can possibly be completely independent in their modeling.
But, putting that "small" fact aside, we move towards valuation and how this jives with impairment rules. Here is how one might expect the NAIC to compare expected losses to NAIC SVO ratings (remember below investment grade is 3 through 6):
|
NAIC SVO Rating
|
Expected Loss
|
|
1
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< 0.5%
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2
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0.5-1%
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3
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1-6%
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4
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6-15%
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5
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15-27%
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6
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>27%
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This chart seems reasonable, prima facie, since the relationship between expected loss and SVO rating are similar to that imbedded in the NAIC risk based capital models.
On the valuation front, please remember that most insurers use some kind of arbitrary dividing line to determine if a bond needs to be reviewed for potential write down. We typically see that level at about 20% below book value. Most of this decline in book value is unsurprisingly due to expected losses.
Now imagine an insurer dutifully analyzing a non-agency RMBS and determining that due to expected losses, the bond is worth about 85. No write down is needed since it has not pierced 20% below book. Now, let’s say the ‘independent’ firm employed by the NAIC to model bonds agrees with that assessment. So, it’s time to slap an SVO 5 on the bond, even though using the old model of relying upon the rating agencies may not produce a rating as low as SVO 5 (a CCC rated bond).
Or how about a non-agency RMBS modeled at 98, with a 2% expected loss? No write down necessary under impairment rules, but it would be an SVO 3 under the new rubric, subject to immediate write down for P/C insurers.
Insurance regulation is a very difficult task. It is made more difficult by a few companies who did a less than stellar job in their investment process and who are now are asking for regulatory relief. These companies have undoubtedly run all the numbers and believe they have ‘won’ in this latest NAIC ruling. However, the impact on each individual company in the industry has undoubtedly not been completely assessed….certainly not by the NAIC, captured by the largest insurers in this latest regulatory bailout.
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Tuesday, October 13th, 2009
With apologies to Marx and Engels, this may also sound like the clarion call for those responsible for regulating financial institutions.
We have already seen developed countries discuss how regulations on banking, derivatives, etc, can better be coordinated…all the better to keep the financial players from picking the best domicile for their activity.
And, now, we have the US Government looking to create a national office of insurance. Although the initial and ultimate authority of such a new department is still open for debate…even the insurance industry does not agree on what that should be…the trend is clear. Many regulators believe they must unite to throw off the yolk of the oppressive insurers who look for optimal domiciles or otherwise ‘game the system’. And, in some instances, insurers (some of who support an ‘optional federal charter’) are supportive of this view of the world.
Of course, in the insurance industry, the granddaddy of this approach is the National Association of Insurance Commissioners (NAIC), that trade association or regulatory body (I’m not sure even the NAIC agrees on which it is). The NAIC developed a unification tool called ‘accreditation’ to keep all its ‘members’ on the same page on key ‘model law’ issues. Yet, one of the most prestigious members, New York, takes the approach of a different Marx (Groucho), who said “I don’t care to belong to a club that accepts people like me as members.” New York remains ‘unaccredited’, preferring to buck the system, while still having a large hand in how it operates.
However, this misses something that we all should remember. Whether in banking or insurance, the regulators are ‘captured’ by the largest of those they regulate. In other words, the regulators must bend to the wishes of the largest firms they regulate, especially in difficult times.
If you don’t believe this happens in insurance, we have only to look at the topic of ‘permitted practices’, those actions that are OK for certain companies, but probably not for yours.
For example, the Insurance Underwriter recently reported that the number of life insurers using permitted practices increased from 25 companies in 2007 to 80 in 2008, and that the combined effect on surplus for those companies went from a reduction in surplus of $313 million in 2007 to an increase in surplus of $8 billion in 2008.
Capital out of thin air.
But, wait, there’s more.
The life industry is advocating relaxing capital requirements for many residential mortgage backed securities because using rating agency ratings are inaccurate. Their alternative would revolve around using third party modeling. But, isn’t the incorrect use of models one of the problems encountered by investors (and the rating agencies) in the recent financial crisis? Based upon continuing discussions, this proposal or something like it, may pass.
Regulators of the World Unite!
Indeed.
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Tuesday, October 13th, 2009
Although you probably won’t hear this from the economic analysis or similar palaver at your quarterly investment manager meetings, the crucial issue facing the US economy today is not the letter of the recovery. In fact, you may feel like your friendly economist is telling you that the economy is brought to you by a letter, V, U, W, much like an old Sesame Street episode.
But, the sad truth is that the US economy is facing a series of races between desirable and undersirable outcomes.
Submitted for your approval, here are a few inconvenient, yet likely truths .
1 - We are saddled with large zombie banks focused on drinking the blood of risk free net interest margin (between US Treasury purchases and zero cost reserves provided by the Fed) at no additional cost of required capital. This blood is important for the ongoing existence of most of the zombies (who try not to act like banks by earning net interest margin on the difference between loan and deposit rates). These zombie banks realize they will slowly be losing body parts in the form of credit losses. Those losses are hidden from sight due to loosened accounting rules, but they will eventually surface. And when the do, look out. In fact, at year end, the FASB may require many SIVs and the like be put back on the balance sheet of sponsoring banks. Ouch!
So, the question here is which zombie banks will get enough blood to offset credit losses and at what rate. Thus, ‘more blood’ is the refrain from these zombies and the US Government is obliging.
The race is on.
2 - In response to the ‘Greatest Deleveraging in the History of the World’, the US Government has responded with the ‘Greatest Releveraging in the History of the World’. Add the increase in fiscal debt with the increase in monetary debt (Federal Reserve) to increased indirect and direct guarantees (FNMA, FHLMC, GNMA, FDIC) and there is little wonder why the economy is recovering. The Government can not only ‘print money’ (mainly in the form of bank reserves right now), but they can ‘encourage’ bank purchases of US Treasuries to bridge the divide of a record fiscal deficit by providing zero percent (reserve) financing at the Federal Reserve.
However, US Government actions are subject to public scrutiny and therein lies the rub.
The Federal Reserve was designed to be independent of the US Government (including the US Treasury) and acted as such for decades. However, the actions noted above call this into question. I recently read an article about China’s ‘bubble economy’ and how a key for future Chinese economic growth will be the development of an independent monetary authority. Undoubtedly, the same could be said for the US.
And, one wonders how a possible next stimulus bill (it may not be called that from a political perspective), or added funding for the FDIC, or a bailout of the FHA/VA, etc, will be received by a wary public. It should be noted that the on again, off again economic recovery during Japan’s lost decade was occasionally thwarted by those who felt the prior stimulus was ‘working’, so why vote for another one. It should also be noted that during the Great Depression, FDR’s calls for more aid for the unemployed was met with cries of concern about people just deciding to go ‘on the dole’. So, there is history on the side of those who think the releveraging of the US Government cannot continue unabated.
Of course, a growing economy can make the size of the deficit, national debt and even the Fed’s bloated balance sheet seem a lot more reasonable.
Thus, the race is on between economic growth (and it is on the way in a big way, per the reliable Economic Cycle Research Institute) and the limits to growth of the ‘greatest releveraging’ of the US Government.
3 - Most sentient economists believe that ‘sustainable growth’ of the US economy will not come from releveraging, but from remixing the components of GDP. Decreased participation from consumers would be offset by increased participation from net exports (now a negative contributor to GDP). However, changing the US from a net consumer of foreign goods and services to net producer of such is no easy task. Thus, step one is the slow downward glide of the US dollar, including increased pressure on countries with currencies tied to the USD (aka China). However, declining currency valuations can also mean eventual inflationary pressures.
So, the race is on between a declining dollar, fewer net exports and incipient inflation.
The discussion of whether this economy is brought to you by the letter U, V and W is truly not the point. The key point is how these races are won and lost, and how they will impact each other as well as many other segments of the economy. A careful consideration of each will assist all investors in determining how best to position their portfolios.
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Wednesday, September 9th, 2009
It has begun in earnest. A reconsideration of the NAIC Model Investment Law. And, in the current regulatory and financial environment, it is easy to expect over done and/or misguided results ahead.
Here’s the background:
In the mid-1990s, over the course of four to five years, I had the pleasure of being part of the insurance industry’s ‘interested parties’ group that provided input to the NAIC about what should be in a "Model Investment Law." Eventually, in 2001, both a defined limits (specific percentage limits by asset class, security, etc.) and a defined standards (basically a ‘prudent person’ approach) version of the law was adopted by the NAIC.
Originally, the Model Investment Law was supposed to become an "accreditation standard", one of a host of model laws that were required to be passed by a state’s legislature, else the state would not have an NAIC accredited insurance department. Today, all states and the District of Columbia are accredited, except for New York….but that is a long story. However, since the Model Investment Law is not an accreditation standard, less than half of the states have adopted the law, while some have adopted only portions of it.
Today, we truly live in a different world than the one that existed in the 1990s, so the NAIC has formed a Working Group to consider material revisions to the Model Investment Law. By the end of this month, the Group will survey all states on potential changes - some are small and some are rather large. Of course, the NAIC being the NAIC, this Group is only designed to determine if changes should be considered. Should the group report that there is support for changes, the NAIC Executive Committee must then decide to form a different Working Group (probably with the same/similar state membership) to actually recommend changes.
Importantly, the existing Working Group is open to meeting (physically or virtually) with industry interested persons in this process. However, the path is clear. We can expect material changes in the Model Investment Law…eventually. And, if some changes are discussed, you can be assured others, currently not under consideration, may be discussed as well. It will take time, but the regulatory landscape for insurer investments will undergo material change.
If you would like to receive a copy of the upcoming survey questions to be provided to the insurance departments, please click here.
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Saturday, August 8th, 2009
With the latest slight improvement in that most political economic lagging indicator called the US unemployment rate, economic pundits are forced to take one or both sides of the argument.
Resolved, the US recession is over.
Though you may never see a formal debate format as indicated by such resolution, the issue here is real.
If the recession is over (defined as positive real GDP growth in Q3), hold onto your hats. Most of the previously approved stimulus funds will be spent in the months ahead and that will serve to further improve GDP growth. And that may cause much stronger GDP growth than the consensus of economic pundits expect. The most likely results – a continuing flight from quality, which means improving equity prices, continued tightening of credit spreads and upward pressure on commodity prices. Eventually, we would even start hearing more about when and how the Fed should ‘unwind’ its programs and even start raising rates.
But, if the recession is really in a Pythonesque ‘not dead yet’ mode, the upcoming stimulus spending will have some heavy lifting to do. Remember that the average consumer will continue to deleverage (and I have yet to find the average US consumer, though I see the parodied version nearly everywhere I look) . That means continued increases in savings, paying down debt, and holding back on spending. And, when 80+% of GDP is being held back, how can GDP grow very much, if at all?
The most likely case, though, is probably something that most economists are not contemplating – primarily because the consensus, from which they seldom depart very far, has not been discussing it.
As low inventories are getting replaced, the economy will undoubtedly find its way out of recession either this quarter or Q4. However, how long can GDP growth last if the aforementioned average consumer is holding back spending? Will inventory replacement require job gains at some point, which will make consumers more sanguine?
And, therein lays the rub. GDP growth is undoubtedly on the way, but its level of sustainability is questionable. And, for investors, this means things may continue to get better in the short run, as the flight from quality continues. However, there are mighty big mountains to climb, as the ‘Greatest Deleveraging in the History of the World’ will continue.
Helping the economy climb those mountains will continue to be bailouts in several guises. As stated in our blog posting of November 30, 2008 (“Two Key Questions about the Great Re-Leveraging AKA Bailouts”), the US government (that would be ‘we the people’) is attempting to offset this great deleveraging. And, as we all have seen, success in doing so has produced uneven and politically controversial results. Alas, we can expect more political posturing to impact future bailout moves using existing or previously unannounced activities. The bottom line for investors: It is likely that the flight from quality will continue (subject to an unknown geo-political event temporarily reversing that flight), but whether it will continue past the next few quarters remains a huge question.
Thus, the question of what happens AFTER we see positive GDP growth is a discussion insurers should be having with their investment managers today.
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Welcome…
Friday, March 2nd, 2007
From the Northwest Quadrant. We chose that name for this blog for its multiple meanings and to highlight a new beginning. Investment professionals are all familiar with the preference for building portfolios that are in the Northwest Quadrant of the risk/reward graph — improved return with lower risk. And, those of you who know Strategic Asset Alliance (SAA) know that our headquarters are located in the Northwest Quadrant of the lower 48 United States - Bellingham, WA. Of course, those of you who know SAA also know that our approach to improving the investment process, and with it the financial results, of our insurer clients goes well beyond the typical efficient frontier risk/reward graphing so familiar to pensions, endowments, foundations and others. And, that is the main purpose of this blog. To provide an ongoing commentary on how INSURERS can go beyond the business as usual approach to investments and improve their financial results, with the Northwest Quadrant as a point of departure. Your comments are most welcome on any entry in this blog. And, simultaneously with the introduction of this blog, SAA is introducing the Insurer Investment Forum Online - an opportunity to enjoy an ongoing Q&A with your peers and other experts on the investment process for insurers. Like Lewis and Clark, we stand in the Northwest Quadrant together ready to forge a new approach, but this time to improve the insurance invesment process for insurers. I hope you will join me on this adventure. |
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