Wednesday, November 07, 2007
Credit Crunch - are we going to be Piper Alphad into a crash?
The financial turmoil after the sub-prime mess in the USA continues. Sombre question – are we going to be 'Piper Alpha' cursed?
Piper Alpha was a North Sea oil rig that exploded in 1988 killing 167 people. After cleanup and compensation for victims the owners put in an insurance claim for £1 billion (one thousand million pounds). Because of re-insurance deals the result was a tide of claims across the insurance industry that finally totalled £16 billion. This wrecked Lloyds of London and caused the complete reorganisation of insurance in the City of London.
Why is this relevant to today’s credit problems? Well the primary insurers in 1988 sold on part of the risks to other insurers in various financial packages, and they in turn repackaged part of their risks in other financial instruments and sold them on. Sometimes the primary insurers purchased these repackaged instruments without realising they were actually taking on again part of the risks they had sold on. Come the day of reckoning and the claims went round and round and round…some people having to pay several times.
The sub-prime mortgages (sold to people who are bad financial risks) at the heart of today’s problems presented a risk for the original lenders. They repackaged some of this risk in further financial instruments and sold them on to other people, many of whom repackaged several of those packages and sold them on again – and so on and so on. Bottom line, nobody actually knows how many rounds of this pass the parcel act went on, nor what the actual level of dud values is incorporated in financial securities underpinning otherwise quite respectable holdings. Nobody knows what will happen in a Piper Alpha like unravelling goes the rounds.
The uproar in the Financial Markets is chronicled for example in the Financial Times, Daily Telegraph, Guardian and Independent.
I rather suspect that the concept of ‘a market’ is about to get one of its periodic mass bad press episodes, of the kind wearily summed up by ‘John Kenneth Galbraith’ in the phrase 'Financial Genius Comes before the Fall'. Of course the financial markets are not ‘The Markets’ that give choice in a free economy – but since defenders of ‘market systems’ have been shy of emphasising this elementary fact we cannot complain if the general public conclude for the next few years that markets in general are evil and political poison. The political and economic results could be grim, as Cicero notes…
Piper Alpha was a North Sea oil rig that exploded in 1988 killing 167 people. After cleanup and compensation for victims the owners put in an insurance claim for £1 billion (one thousand million pounds). Because of re-insurance deals the result was a tide of claims across the insurance industry that finally totalled £16 billion. This wrecked Lloyds of London and caused the complete reorganisation of insurance in the City of London.
Why is this relevant to today’s credit problems? Well the primary insurers in 1988 sold on part of the risks to other insurers in various financial packages, and they in turn repackaged part of their risks in other financial instruments and sold them on. Sometimes the primary insurers purchased these repackaged instruments without realising they were actually taking on again part of the risks they had sold on. Come the day of reckoning and the claims went round and round and round…some people having to pay several times.
The sub-prime mortgages (sold to people who are bad financial risks) at the heart of today’s problems presented a risk for the original lenders. They repackaged some of this risk in further financial instruments and sold them on to other people, many of whom repackaged several of those packages and sold them on again – and so on and so on. Bottom line, nobody actually knows how many rounds of this pass the parcel act went on, nor what the actual level of dud values is incorporated in financial securities underpinning otherwise quite respectable holdings. Nobody knows what will happen in a Piper Alpha like unravelling goes the rounds.
The uproar in the Financial Markets is chronicled for example in the Financial Times, Daily Telegraph, Guardian and Independent.
I rather suspect that the concept of ‘a market’ is about to get one of its periodic mass bad press episodes, of the kind wearily summed up by ‘John Kenneth Galbraith’ in the phrase 'Financial Genius Comes before the Fall'. Of course the financial markets are not ‘The Markets’ that give choice in a free economy – but since defenders of ‘market systems’ have been shy of emphasising this elementary fact we cannot complain if the general public conclude for the next few years that markets in general are evil and political poison. The political and economic results could be grim, as Cicero notes…
Labels: crash, economics, Financial markets, Galbraith, insurance
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