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24 December 2007

Subprime crisis - Comments

It is always instructive to watch what a smart & successful company like General Electric* does and try to work out why they are doing it.

Several years ago GE spun off their insurance businesses and this divestment was of interest to me at the time because GE was removing a number of capital intensive operations from their business while retaining an equity interest. By this move GE no longer had to maintain tier-1 capital for these insurance businesses but instead retained a dividend stream from their equity, they also substantially reduced their own risk in those operations. By 2006 GE had sold their remaining equity in these operations, noting in their 2006 annual accounts that:

"In 2006, we substantially completed our planned exit of the insurance businesses through the sale of the property and casualty insurance and reinsurance businesses and the European life and health operations of GE Insurance Solutions Corporation (GE Insurance Solutions) and the sale of GE Life, our U.K.-based life insurance operation, to Swiss Reinsurance Company (Swiss Re). Also during 2006, we completed the sale of our remaining 18% investment in Genworth Financial, Inc. (Genworth), our formerly wholly-owned subsidiary that conducted most of our consumer insurance business, including life and mortgage operations, through a secondary public offering." (Source: GE 2006 annual report p. 49)


This deal by GE really got me thinking about the problems associated with insurance products in the globalised markets where risk is interlinked between geographies and products. With the sub prime mortgages problem in the US lenders have loaned money to people who cannot repay their mortgages. The lenders don't really care because all the mortgages are insured, but the insurers are probably very worried right now. And, if the mortgage insurers have been following the lead of the lenders you can bet that they also relaxed their underwriting rules to write those policies.

The credit crunch is going to be worse for the insurers because often they not only insured the mortgages, but also provided the deposit bonds. Also the ratings agencies are really going to come under some scrutiny - the real question is do they have any clue as to the underlying risk of the products they are rating? I suspect the answer is about to be revealed as a resounding not really.

The sub prime mortgage problem exists because lenders ignored prudent credit policy on the optimistic basis of a rising property market. We are now seeing the almost inevitable consequence of these poor credit policies. GE had the foresight to reduce their exposure to these insurance businesses, a pity some of the other players were not so prudent.


* Note: A few years ago I worked for GE in Australia, but no longer have any business relationship with the company. I have no personal knowledge of the GE business strategy behind these deals and the comments above are based on publicly available sources and my own interpretations.

via Aide-mémoire

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