Dumb Money Watch: ZIRP-Starved Insurers Beefing Up in Lending as Banks Exit the Pool

We’ve pointed out that long-term investors like pension funds and life insurers are in an impossible position thanks to negative real and increasingly nominal risk-free rates, and the resulting pervasive underpricing of risky investments as investors hunt desperately for return.

Even worse, central bank actions, starting with doing as much as possible to preserve status quo ante, meaning banks, at the expense of taxpayers and borrowers who were hit hard by the crisis, is increasingly producing political instability. As David Llewllyn-Smith pointed out in a recent post:

I see an environment in which Black Swan events become more frequent and more extreme as political event risk overtakes the delicate machinery of financial globalisation:…

The first point to make about asset allocations in this emerging environment is that it is as much higher risk of asymmetric shocks than the decades that preceded it. Thus the strategic narrative for allocations should reflect that risk. In general terms that will mean:

• avoid leveraged and illiquid assets;
• safe haven assets will trade at a premium, and
• cash and cash-like instruments should occupy a much larger percentage allocation than in the past.

Mind you, shocks like the Brexit vote were not “Black Swan” events. Taleb was referring to what Donald Rumsfeld called “unknown unknowns”. But as the Brexit results demonstrated, investors were and remain complacent about political fractures, since they live in 1%/0.1% cocoons. That means those risks are underpriced and asset values can and will move abruptly when the peasants revolt.

But the life insurers’ latest grasping for return looks none too bright even before you allow for political-fracture-induced downsides. From a Bloomberg story late last week:

The largest U.S. banks are constrained by post-2008 rules that make it tougher for them to extend loans. So companies such as MetLife Inc. and American International Group Inc. are grasping more market share. While many insurers have been in the commercial real-estate market for decades, the industry is branching out into home mortgages, small-business lending, car loans, renewable-energy financing and student debt….

Insurers are becoming the new financial supermarkets in part because traditional investments offer minuscule returns — 10-year U.S. Treasury notes yield less than 1.6 percent while some European sovereign debt is negative, meaning investors pay to park their money there. And pushing into more aggressive investments, such as hedge funds, tied up too much capital and resulted in losses in recent quarters.

The article has more than a wee bit of spin in it. “The largest U.S. banks are constrained by post-2008 rules that make it tougher for them to extend loans” actually means “Banks revealed themselves to be pretty bad at assessing risk, so Uncle Sam implemented some rules designed to force them to be less reckless.” And I’ve seen that “financial supermarket” strategy touted repeatedly by consultants bearing PowerPoint since the 1980s. It’s pretty much never worked out well. Ask poster children Merrill and Citigroup.

So do we have any basis for thinking insurers, who are generally viewed as dumber money than banks (and look, how the one supposedly smart one, AIG, blew itself up) will be better at this gam than banks? Historically, on the credit side, they’ve stuck mainly with bonds or commercial real estate, which in theory can be analyzed reasonably well (you look at the terms of the leases and when they roll off), to venture where banks have been required to pull back? The answer is no, because they’d be starting from zero in many of these areas in developing underwriting skills. Again from Bloomberg:

While insurers are viewed as safe lenders because they can deploy funds for a long time and don’t have to worry about depositors withdrawing money at a moment’s notice, they may not have the loan-underwriting expertise of longtime lenders, said Yariv Itah, an asset-management adviser at Deloitte Consulting…

“There’s the risk of not knowing exactly how to do this,” Itah said. “So whenever you have an investor wading into a new area of investing, there’s some operational risk.”

And on top of that, the timing for loading up on risk looks poor. In mid-July, the Comptroller of the Currency flagged commercial real estate loans as the biggest risk for banks. From the Financial Times:

A top US regulator has sounded a new alert over banks’ commercial real estate lending, adding to concerns that bubbles may be forming in parts of the country’s property market.

Thomas Curry, comptroller of the currency, used the watchdog’s twice-yearly report on financial risks published on Monday to warn about looser underwriting standards and concentrations in banks’ CRE portfolios….

CRE loans originated by banks in the first quarter leapt by 44 per cent from the same period in 2015, according to Morgan Stanley. Banks’ share of CRE originations has risen from just over a third in 2014 to more than half in the first quarter of 2016 — a record…

“Our exams found looser underwriting standards with less-restrictive covenants, extended maturities, longer interest-only periods, limited guarantor requirements, and deficient-stress testing practices.”…

Banks have pushed into CRE as other lenders — notably capital market investors — have retreated from the market. Issuance of commercial mortgage-backed securities has dropped to four-year lows.

So contrary to Bloomberg, it’s not even true that banks are retreating from this area. Mid and smaller sized banks are moving in, just as the insurers are, as securitizers are backing off. That presumably means cooler headed bond investors can see the market is toppy, but other players are rushing in to fill the void, and with loose to non-existant covenants to boot.

The Office of the Controller of the Currency, in that same report, echoed existing warnings about auto loans, another area targeted by insurers. From CNN:

A top banking regulator warned that the $1 trillion car loan industry has gotten more dangerous. The Office of the Comptroller of the Currency cited “unprecedented” growth in auto loans, rising delinquencies and shrinking used car values.

The banking watchdog also pointed to cutthroat competition among banks, which has led them to relax underwriting standards….

Still, the report echoes concerns raised by others about auto loans, especially the lower-quality ones known as subprime. JPMorgan Chase (JPM) boss Jamie Dimon said at a recent industry conference that auto lending looks “stretched” even though his bank has been careful about issuing them.

Earlier this year, Fitch Ratings pointed out that the rate of seriously delinquent subprime car loans has climbed to the highest level since 1996.

Funny, that “cutthroat competition” again is at odds with insurer PR that they are targeting underserved markets.

But again, as much as this reaching for return is almost certain to end in tears, the ultimate responsibility lies with the likes of Janet Yellen and Mario Draghi, who are certain never to be held to account.

Print Friendly, PDF & Email


  1. walt

    Seems to me Yellen and FOMC are aware of most of these risks. So far they have mostly just threatened rate hikes, but since that does not appear to be enough, they will soon raise rates by cutting back QE. Let bond holders like me be aware.

    1. Synoia

      Seems to me Yellen and FOMC are aware of most of these risks.

      If the Fed raises raise rates, what happens to the Bond Market? Goes down, accompanied by the Bond Holders?

      Seems to me the Fed (and the US) is in a trap of its own making, having shot itself in the foot with ZIRP (monetary actions) in place of stimulus.

      1. sunny129

        Mind you, there is still NRP, deep NRP and then ‘ Japanification’ for decades!

        As long as Investors go along, CBers can continue the charade!

  2. Whine Country

    walt – I may be wrong but you strike me as an investor. Bonds like stocks have not been an investment for quite a while now – they are a trade. If I am wrong, by all means wait for the most opportune time to exit your trades. This whole nonsense about lowering rates to zero and then even below, is solely about keeping the trades alive by reducing the discount rate at which an investment trades. It will end badly. It is a mystery to me why most all can’t see that our presidential election is really just a reflection of our current state of leadership at all levels. Prepare for what I like to call a “Roy Hobbs Moment”. (You need to have seen the movie “The Natural”, where Robert Redford played Roy Hobbs). Years after Roy’s baseball career was virtually destroyed by a misguided dalliance with a mysterious young woman, he lamented: :”I shoulda seen it coming”. You shoulda seen it coming, trust me.

    1. sunny129

      ‘by all means wait for the most opportune time to exit your trades’

      I am all ears to find about (the secret of) THAT ‘opportune’ time to exit?!


      1. Whine Country

        That’s the problem. We plain folks usually only “learn” it much after it has passed. The major players know that the markets are rigged. They are just confident (some say foolish) enough to really believe that they can get through the exit before it is too late. Seriously, without the support of the Fed, stocks and bonds are as much an investment as the Lottery. Talk about mission creep, the creeps at the Fed take the cake!

        1. sunny129

          They couldn’t stop 2000 or 2008 but postponed by QEs & ZRP ( may be NRP in the horizon!?).

          Mr. MKt will decide ‘when’ to pull the curtain, once the ‘confidence fairy’ disappears!

          No Country in human history has prospered by spending debt on debt but the CBers delude themselves otherwise!

          We are in uncharted water

      2. Lord Koos

        I would be leaving now, if I was in the market. Or least weight the portfolio heavily to cash and some gold.

  3. apber

    The prognosis for all insurers is dire, even those auto only because there is a finite limit to premium increases for the majority living paycheck to paycheck. Where is the money going to come from to pay off accident, life, annuity policies. If the benchmark less than 10 years ago was a 6% return (or greater), there are going to be a lot of disappointed policy holders going forward as all insurers head to bankruptcy. What then? The commercial and civilian world cannot live without insurance. What happens to transporters if the vehicles cannot be insured? The average bloke who lapses his auto insurance gets his license suspended within 3 months. It will be interesting to see what happens; probably another bailout by the taxpayers; it never ends, does it?

    1. Whine Country

      You make an excellent point about finite limit to premiums. But what does that say about the Fed. They want inflation and then they will raise rates. So are we at an impasse. Raise premiums = inflation and then rates rise and “investments” are rejuvenated. That’s the corner that the Fed has put us in. Businesses find ways up to and including financial suicide (see the oil industry in the US). If the think they can’t raise prices, the Fed has made it very easy to borrow to extend and pretend. The phrase zombie companies comes to mind. To the typical business person the dilemma is: raise prices = inflation; inflation = higher interest rates; higher interest rates = go out of business, so they extend and pretend. The sad part is that we are now in a situation where the people in the know are certain that we’re doomed and they’ve turned inward. My bet is that they feel they have no choice but to prepare for survival and cannot risk admitting how really bad it is, for fear of a panic. It is going to take someone outside of the establishment. It might have been Bernie (except for the criminals at the DNC who his supporters are ready to back now), it absolutely IS NOT Hillary, and there is a possibility it could be that scary bogeyman, Trump. My sense is that no matter how bad you can imagine Trump being, in another 4 years of this insanity, the pain will be much worse if we retain the status quo.

  4. JohnBuzzKill

    That’s a stretch if I’m interpreting it correctly: ‘the average bloke’ getting a bailout? ‘the average bloke’ will NEVER get a bailout.
    What we’re seeing is the system of capitalism slowly ramping up the rate of cannibalizing not only itself, but the planet. The number of ticks is slowly growing, their appetite for blood has not decreased, but the dog is getting weaker all the time.

  5. shinola

    Historically, personal auto insurers were happy with a “pure” loss ratio (premiums paid in vs. claims paid out) of 100% or less; a loss ratio of 98% was considered a great year. Nearly all profit from this line of business came from investment returns on the cash flow.

    With ROI running from pitiful to non-existent, guess what has to happen…

  6. sunny129

    Just like in 2000 and 2008, Mr. Market(s) will decide ‘when’ the ongoing charade will be over and definitely NOT the CBers.

    They will extend the ‘circu’s as long as thery can with NRP and deep NRP and then there is always ‘Japanification’!

    Until then let the pontification continue!

  7. sunny129

    ‘When all asset classes rise in unison, one is hard pressed to provide a fundamental reason other than expected and concerted central-bank action. So far, they have whiffed, though, and one has to wonder if they can and will deliver the goods this time around. When do investors feel that their omnipotent powers have diminished? Given the distribution of gains seen in the above charts, one has to think that day of reckoning draws closer’


  8. Whine Country

    What you are witnessing is precisely what happens when you make debt easily available as we are now doing. As shinola points out, when investment income falls, something has to give in your business model. In the past prices would rise to make up the shortfall. But now we are in a Catch-22 situation. Even though the Fed wants inflation to rise (not too hot and not too cold, kind of like in Goldilocks), the conventional wisdom is never raise prices, just keep on trying to change lead into gold by borrowing money, holding your breath and trying to “earn” your way back to health. Some correctly call it a race to the bottom. It’ ain’t working but the idiots at the Fed will just keep on keeping on rather than admit that their policies have been foolish and are failing. The problem is that Greenspan planted and idea that has just grown and grown with each successor – and that idea is that one of the principal duties of the Fed is to assure that the markets rise. My God, can any truly sane person say, with a straight face) that the wealth effect is helping our economy? I say again, the bond and stock markets are not investing, they are trading. They keep rising because people have to do something with their idle funds and it has become a self-fulfilling prophecy. It is not a freely operating market by any definition. Let’s discuss this further when we’re on QE 6. (hopefully I’ll life long enough)

    1. jcc2455

      too bad our health care providers don’t adopt “never raise prices” as a mantra. They manage to borrow huge sums of money, but never seem to forget to jack up prices, either.

  9. steelhead23

    While ZIRP policies of the globe’s CBs are a problem, the larger issue preventing recovery is austerity. Expansive fiscal policy would increase economic activity, raising all boats. As regards the ongoing election cycle and our economic fragility, neither of the major party candidates understands economics and will very likely cling to the status quo – tight fiscal policy, insane monetary policy, and a total lack of individual responsibility.

    1. Whine Country

      So now that trickle down has failed, we’re going to flood the market with money and raise all boats. This will end the insanity?

  10. Lune

    This is not a bug, it’s a feature. They’re supposed to be dumb money, or else how can they be roped into bailing out the ‘smart’ money?

    TBTF Banks are the favored class, not small banks, insurance companies, pension funds, or individual investors. As much as TBTF banks like Deutsche whine about their inability to make profits under ZIRP, they conveniently forget that the only way they survived after 2008 was through ZIRP, which was designed as a massive transfer of wealth from the rest of the financial / investment industry to the big banks.

    Even the bailout of AIG was nothing more than a politically expedient way to payout Goldman Sachs at par on their contracts while everyone else was forced into accepting pennies in the bankruptcy of e.g GMAC. Here’s a thought: if GS had held $20 bil in GMAC bonds while pension funds and mom n pops held $20 bil in AIG CDS, which company would have been declared critical to the financial system? Which would have been repaid at par and which would have had massive haircuts?

    So now, in a desperate bid to fund their commitments, the dumb money are providing the bid for the big banks to exit. What previous actions or statements by yellen et al indicate that this isn’t the intended effect? Or does anyone seriously believe the Fed and Congress care about insurance buyers over TBTF banks?

    After all, the possible dissolution of Deutsche Bank is being treated as a potential world-ending event that must be prevented at all costs (to us, no costs may be imposed on the bankers, those fragile titans).

    OTOH, retired folks having to eat cat food in the USA, or an entire generation of young people in Greece and Spain having their futures shattered, is, at best, regrettable collateral damage, at worst, explicitly part of the plan.

    Just like onions, these are trading policies, not meant to be actually used as insurance!

Comments are closed.