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This is NOT Financial Innovation

(h/t War on Error)

There is a difference between financial innovation and a financial scheme to generate profits.  Financial innovation should address a social need and the social benefits should outweigh the social costs.  Recently, Wall Street has generated a lot of financial instruments that they are trying to pass off as financial innovation that is good.  Complex derivatives, such as credit default swaps and collateralized debt obligations are hardly financial innovations.  They are schemes or financial instruments just used to generate profits or in case of AIG to potentially crash the entire global financial system.

This is NOT an example of financial innovation:

The bankers plan 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.

Life settlements have been around a long time and serve a useful purpose.  A life settlement is where an insured person, such as an elderly person or person who is terminally ill, will sell their life insurance policy to a third party, typically an investor, for an amount less than face value of the life insurance policy.  The investor becomes the beneficiary of the life insurance policy and will receive the insurance proceeds upon the death of the insured.  In some cases it may be wise financially to obtain a life settlement.  But we don’t need to securitized this market!

The investor is betting that the insured person dies sooner than later so that they can make money between what they paid out to the insured and what they collect in insurance proceeds.  The longer the person lives the lower the return to the investor.  Cold and morbid stuff but it can serve a purpose.

But here comes Wall Street.  Investment banks would make a nice chunk of change issuing the bonds and trading these bonds secured by life insurance policies:

“We’re hoping to get a herd stampeding after the first offering,” said one investment banker not authorized to speak to the news media.

There is another Wall Street player looking to make money off this scheme - rating agencies.  A little known rating agency called DBRS is featured in the NYT article:

The idea is still in the planning stages. But already “our phones have been ringing off the hook with inquiries,” says Kathleen Tillwitz, a senior vice president at DBRS, which gives risk ratings to investments and is reviewing nine proposals for life-insurance securitizations from private investors and financial firms, including Credit Suisse.

This has all the makings of the subprime/predatory mortgage crisis all over again.  Can you imagine the frenzy this would cause amongst so-called insurance agents?  The mad rush to obtain more life insurance policies to satisfy the demand for these “securities”.  Fraud.  Fraud.  Fraud.

But the [life settlement] industry has been plagued by fraud complaints. State insurance regulators, hamstrung by a patchwork of laws and regulations, have criticized life settlement brokers for coercing the ill and elderly to take out policies with the sole purpose of selling them back to the brokers, called “stranger-owned life insurance.”

In 2006, while he was New York attorney general, Eliot Spitzer sued Coventry, one of the largest life settlement companies, accusing it of engaging in bid-rigging with rivals to keep down prices offered to people who wanted to sell their policies. The case is continuing.

“Predators in the life settlement market have the motive, means and, if left unchecked by legislators and regulators and by their own community, the opportunity to take advantage of seniors,” Stephan Leimberg, co-author of a book on life settlements, testified at a Senate Special Committee on Aging last April.

Wall Street will not be deterred in pursuing this life settlement market:

With $26 trillion of life insurance policies in force in the United States, the market could be huge.

Of course, that little known rating agency is positioning itself in this market.  Goldman Sachs and Credit Suisse are calling on them.  Why?  Because DBRS thinks it has this game all figured out.  How?

The solution? A bond made up of life settlements would ideally have policies from people with a range of diseases — leukemia, lung cancer, heart disease, breast cancer, diabetes, Alzheimer’s. That is because if too many people with leukemia are in the securitization portfolio, and a cure is developed, the value of the bond would plummet.

As an added precaution, DBRS would run background checks on all issuers. Also, a range of quality of life insurers would have to be included.

To test how different mixes of policies would perform, Mr. Buckler has run computer simulations to show what would happen to returns if people lived significantly longer than expected.

Oh yes. Those computer models. We know how accurate those computer models can be particularly when they have the wrong assumptions.  But hey this time it will be different.

We don’t need securitization of life insurance policies.  This is just another scheme by Wall Street to recoup their loses from their previous reckless and greedy decisions.  Same shit different day.

STOP THIS MADNESS.

Cross posted @ Economic Populist