| atbell |
This was in a recent Economist and I found it interesting if a little disturbing.
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IT IS a simple but brilliant idea. Pooling risks—the essence of insurance—allows people and businesses to protect themselves from disaster. The insured have the incentive to buy homes or build business, knowing that they will be saved from the worst outcome. That enables the economy to grow faster and everyone to enjoy a higher standard of living.
But one assumption is crucial. The pool of risks must be genuinely diversified, so that only a small proportion of policyholders will be making claims at any one time. If not, then the insurer could go bankrupt.
When it comes to insuring whole industries, that is a problem. In America bank deposits and company pensions are protected through sector-wide schemes, funded by a levy on those that participate. The problem, as the Federal Deposit Insurance Corporation (FDIC) and the Pension Benefit Guarantee Corporation (PBGC) have found, is that banks and pension funds engage in herd-like behaviour.
Banks compete in similar lines of business, lending against commercial or residential property or (in the late 1970s) channelling money to developing nations. That other banks are doing the same thing tends to breed confidence, rather than caution. Indeed, executives may come under pressure if they are losing market share in a popular area. When banks lend money so that people can buy assets, the prices of those assets rise; in turn, that makes the banks more confident about their original lending decision. As a result when the market turns, a lot of banks can have similar problems.
Full article ...
http://www.economist.com/finance/di...ory_id=12059405
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