Stephen Foley: New life industry rules will not insure against another financial crisis
Saturday 24 July 2010
US outlook The presidential ink wasn't even dry. Less than 24 hours after Barack Obama signed into US law the financial reforms that will prevent a repeat of the credit crunch, one of his government agencies laid the foundation for what could be the next great financial crisis.
Last time it was sub-prime mortgages, next time it could be life insurance. You really can't let your guard down for a minute.
Thursday's report by the Securities and Exchange Commission on the market for so-called "life settlements" – policies that are sold to investors, rather than surrendered – took a depressingly complacent tone. The market has stalled, declining from $12bn two years ago to $7bn last year, and some key proponents including Goldman Sachs have backed away, but these look like only temporary setbacks. The SEC took a neutral tone when it should have taken a sceptical one. Anything that breaks the link between the insured and the financial beneficiary of insurance has dangerous consequences.
Life settlements took off in the Eighties, when terminal Aids patients needed cash to pay medical bills that their health insurance refused to cover, and it grew exponentially over 20 years. Settlement investors take over the premiums and pocket the windfall on the policyholder's death, in return for an upfront payment that is substantially larger than the surrender value of the policy.
The development has already changed the nature of life cover. Many rich individuals now buy life insurance with at least half an eye on selling it before their death, treating it more like an investment. And increasingly, brokers are targeting senior citizens, asking them to take out insurance specifically in order to sell it on. Officially, "stranger originated" life insurance is banned in most states, but there are plenty of grey areas in which to build an industry.
The SEC's report can be seen in two ways. It proposes that life settlements be officially designated as securities and therefore explicitly brought under their regulatory remit. That will mean an end to ad hoc, costly and opaque trading between financial institutions, of the kind of that exacerbates financial panics when they start. But it also works to legitimise the market and to make the products more marketable to more investors. Paradoxically, the patchwork of state laws and regulatory uncertainty that the SEC proposes to sweep away are the very things keeping this dangerous market in check.
A companion report by the Government Accountability Office in Congress proposed similar standardisation and transparency at the sharp end, where settlements are arranged by brokers, many of whom are unlicensed, with policyholders and putative policyholders, many of whom may be vulnerable to exploitation.
Seeing the prospect of more standardised products to sell, the Institutional Life Markets Association – the lobby group set up by JP Morgan, Credit Suisse and other firms to promote life settlement markets – welcomed the thrust of the GAO report. That's worrying in itself.
Wall Street got its fingers, hands and forearms burnt by the sub-prime mortgage crisis, and the idea of structuring complex derivatives out of life settlements has thankfully been sent back to the drawing board. But it has not gone forever. On Thursday, the SEC issued an "investor bulletin" setting out the complexities of investing in life settlements. Maybe it thought it was warning investors off. It may just find it has given them a green light.
Smart, funny, sarcastic: Wall St fears Ms Warren
Will the White House nominate Elizabeth Warren, Harvard law professor, to head the new bureau of financial consumer protection, an agency she was first to propose in 2007 and which could turn out to be the signature achievement of the Dodd-Frank Wall Street Reform and Consumer Protection Act signed this week? The stakes have got very high, so high in fact that not appointing her would hobble the agency before it even takes its first steps.
Having failed to prevent the creation of the agency in the first place, Wall Street is briefing against Ms Warren; consumer advocates and unions on the left are banging the drum on her behalf. Congressional confirmation hearings could be more fractious than for a Supreme Court nominee.
So Ms Warren is now central to the morale of the new agency, which must immediately launch into the task of ripping up screeds of legalistic small print in financial products and insisting on plain language, as is the case in the UK. There will be even bigger battles to come over the actual rules for loans and Ms Warren is among academia's foremost experts on this topic, having studied the causes and effects of personal bankruptcies throughout her career. As she put it when she first proposed setting up a dedicated consumer protection agency, you wouldn't be allowed to sell a toaster that had a one-in-five chance of exploding, so why should lenders be able to build a business harvesting penalties from one in five borrowers breaching their constantly-shifting terms and conditions?
I would add another qualification for Ms Warren: she is very funny. In her current role as Congressional watchdog over the government's bailout funds, her sarcastic schoolma'am act has been going down a charm on the chat show circuit. Sometimes she has dumbed down the complexities of high finance, but as a consumer champion, she is unsurpassed. By giving the new agency an in-demand public face, the White House will add to the pressure on banks to clean up their act.
This is not just about the finance industry taking its medicine after the abuses of the credit crisis. Protecting consumers is central to the task of restoring financial stability. There can be no confidence in banks built on shady practices or balance sheets built out of shaky products. With securitised loans flying round the global financial system, the quality of lending practices in the US affects us all.
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