US banks show what they have learned

By Allen Myers

The big US banks that had to be saved with government money a year ago after they gambled too freely with “mortgage-backed securities” have learned their lesson. The lesson is that they can gamble as wildly as they like, keep the profits if they win and count on government paying for them if they lose.

As a result, Wall Street investment banks are already inventing a new “financial instrument” that will allow them to gamble without real risk. Last month the New York Times carried a report on this development. It involves the combination of two different types of scam — excuse me, I mean “financial instruments”.

‘Life settlement’

The first, which already exists, is known as a “life settlement”. It works like this: suppose that for years you have been paying premiums on a life insurance policy to provide for your spouse or children when you die. But now you are old, or sick, and you’re short of money to cover living expenses, let alone insurance premiums. Along comes an “investor” who offers to buy your insurance policy: if its face value is $500,000, the investor might offer you $250,000 or $200,000, depending on how close to death and desperate for cash you are. The investor keeps up the premium payments and collects the full $500,000 when you die, hopefully soon.

The second step, according to the NYT article, is that US investment banks are planning to buy life settlements and then “securitise” them. That is, they will bundle hundreds or thousands of these purchases into bonds and sell them to investors, “like big pension funds, who will receive the payouts when people with the insurance die”.

If this sounds familiar, that’s because it’s the same procedure that Wall Street used to make billions with mortgage-backed securities. Large numbers of mortgages from different regions of the US were combined in bonds that were given Triple-A (most risk-free) ratings by the agencies that the investment banks paid. The argument was that the bonds were secure because, while house prices might fall in one region, they wouldn’t fall at the same time in most or all regions — an argument that “was, in retrospect, badly flawed”, as the NYT article put it. A further problem was that many of the securitised mortgages were essentially fraudulent: issued to people incapable of paying them by lenders who were confident they could on-sell the mortgages at a profit before they were defaulted on.

Nothing succeeds like death

The new financial instrument is also geared for quick sale, even though the eventual death of an insured person is considerably more likely than US house prices rising forever. A problem is that investors in life settlements or the bonds based on them have to keep paying the premiums until the insured dies, and this creates some risks. For example, investors in the 1980s bought up life insurance policies of AIDS patients, expecting them to die within two years; then, horror of horrors, improved medical treatments extended the lives of many, and investors ended up losing money. Imagine the disaster for investors if medical science came up with a “magic-bullet cure” for cancer! The investment banks would prefer just to rake in the “sizable fees for creating the bonds, reselling them and subsequently trading them”. Let workers’ pensions again be the losers if things collapse.

One other possible problem will, fortunately, mostly affect people other than capitalists. Insurance companies know that a certain percentage of policy holders will let their policies lapse, or turn them in for a small “cash surrender value”, and the companies factor this knowledge into the premiums they charge. If life settlements increase in number, the companies will receive fewer such windfalls and will therefore need to raise premiums to maintain their profits. For this reason, insurance companies are reportedly opposing securitised life settlements.

But it’s easy to predict that a compromise will be found: after all, it’s workers who pay the premiums. And if the insurance companies buy into the settlement bonds, when policy holders die, the companies can pay the benefits to themselves. Capitalism certainly is inventive: it used to be that, aside from funeral companies, once we died, they couldn’t exploit us any more.