Sunday, September 06, 2009

Is all complexity bad?

When it comes to finance, the New York Times lead front page article today seems to suggest that. The article, "New Exotic Instrument Emerging on Wall Street", discusses possible securities backed by purchased life insurance contracts as well as repackaging of some types of residential mortgage securities as if they were another looming conspiracy. Anyone can read the article at, so here are a few thoughts.

Complexity can be creative and productive. Before Fannie Mae and Freddie Mac were browbeaten by Congress into going downmarket in the late 1990's and before those firms, essentially back office processors, began paying everyone there like superstar traders, they served a wonderful and productive purpose. The process and role that they served was complex but it worked. Congress had virtually direct oversight authority over these entities and encouraged greater complexity for perhaps well intended but more often blatently self serving ones. The point of this paragraph is to remind people that all misguided or dangerous complexity does not originate on Wall Street.

If the new securities discussed in the article seem dangerous, they don't need to be. The SEC by now, after all we've been through, should be awake as far as doing its job. If rating agencies don't do an intelligent and thorough analysis, at this point they should be quickly shut down. The SEC can and should mandate that securities with a certain degree of complexity only be sold to institutional or presumably savvy investors who get paid to do analysis, and not get chopped up into small illiquid pieces and sold to retail investors--- just put in a limit, no sale or distribution in pieces below $500,000. The point of this paragraph is that there should be and can be regulation and regulatory agencies should do their job.

If any complexity is scorned, and used by some inexperienced reporter and allowed by an editor to seek attention, where could that lead. This may sound silly but it could lead back to a system with minimal distribution of risk and banks limited by their capital to what they can originate. What's wrong with that one might ask and the answer is that credit availabity, which is essentially risk capital for small businesses and individuals that don't have a high net worth, will not rebound at all from current subdued levels. Job growth will not rebound. Complexity and creativity are necessary to rebuild our global credit infrastructure. It needs to be transparent to analysts, regulators, and investors, but it needs to be.

As an aside, I found some of the discussion in the article about the "life settlements securtization" idea amusing. With the reporter's razor vision focused only on catching Wall Street in their latest heist, she treated the life insurance companies' dilemma in a matter of fact way, if not with sympathy. Basically she was pointing out that this type of securitization would disintemediate the life insurers from their ongoing scam of the last 100 years or more and pay individuals who need money early far more than the insurers would. It was interesting to read how the insurers actuarily calculate how many policyholers as they age, pay health bill, and live on fixed incomes can no longer pay their premiums, so after maybe 40 years of payments they forfeit all or maybe 95% of their beneficiarie's death benefit. But this new security is a bad thing because it would blow up the insurer's scam, pay elderly people much more of their money back, and because it is complex?


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