When did the 2007 banking crisis start ? How about 1985.

Saturday, 08 March, Year 6 d.Tr. | Author: Mircea Popescu

Excerpted form Berkshire Hathaway's letter to shareholders for 1985 :

But, in a development we did not foresee, we also are finding buyers drawn to us because our ability to insure substantial risks sets us apart from the crowd.

To understand this point, you need a few background facts about large risks. Traditionally, many insurers have wanted to write this kind of business. However, their willingness to do so has been almost always based upon reinsurance arrangements that allow the insurer to keep just a small portion of the risk itself while passing on (“laying off”) most of the risk to its reinsurers. Imagine, for example, a directors and officers (“D & O”) liability policy providing $25 million of coverage. By various “excess-of-loss” reinsurance contracts, the company issuing that policy might keep the liability for only the first $1 million of any loss that occurs. The liability for any loss above that amount up to $24 million would be borne by the reinsurers of the issuing insurer. In trade parlance, a company that issues large policies but retains relatively little of the risk for its own account writes a large gross line but a small net line.

In any reinsurance arrangement, a key question is how the premiums paid for the policy should be divided among the various “layers” of risk. In our D & O policy, for example. what part of the premium received should be kept by the issuing company to compensate it fairly for taking the first $1 million of risk and how much should be passed on to the reinsurers to compensate them fairly for taking the risk between $1 million and $25 million?

One way to solve this problem might be deemed the Patrick Henry approach: “I have but one lamp by which my feet are guided, and that is the lamp of experience.” In other words, how much of the total premium would reinsurers have needed in the past to compensate them fairly for the losses they actually had to bear?

Unfortunately, the lamp of experience has always provided imperfect illumination for reinsurers because so much of their business is “long-tail”, meaning it takes many years before they know what their losses are. Lately, however, the light has not only been dim but also grossly misleading in the images it has revealed. That is, the courts’ tendency to grant awards that are both huge and lacking in precedent makes reinsurers’ usual extrapolations or inferences from past data a formula for disaster. Out with Patrick Henry and in with Pogo: “The future ain’t what it used to be.”

The burgeoning uncertainties of the business, coupled with the entry into reinsurance of many unsophisticated participants, worked in recent years in favor of issuing companies writing a small net line: they were able to keep a far greater percentage of the premiums than the risk. By doing so, the issuing companies sometimes made money on business that was distinctly unprofitable for the issuing and reinsuring companies combined. (This result was not necessarily by intent: issuing companies generally knew no more than reinsurers did about the ultimate costs that would be experienced at higher layers of risk.) Inequities of this sort have been particularly pronounced in lines of insurance in which much change was occurring and losses were soaring; e.g., professional malpractice, D & 0, products liability, etc. Given these circumstances, it is not surprising that issuing companies remained enthusiastic about writing business long after premiums became woefully inadequate on a gross basis.

Sound familiar at all ?

Turns out that political activism in favour of misguided and ill considered "social justice" projects has twice in thirty years sunk the economy of the United States : once in the 80s, when a changing legal professioni prototyped the mechanism that eventually led to coffee cup millions ; then once again in the 2000s, when Clinton's notions about how everyone should "own" their own house even if they don't have the intellectual wherewithal that'd allow them to collect the resources that'd allow them to own their own house resulted in the end of the United States as a going concern.

Remember kids : history does naught but repeat itself, and social justice kills.

———
  1. In the sense of, intelligent, educated men going out, to be replaced by less intelligent, less educated ninnies. To quote John Hasnas' excellent The Myth Of The Rule Of Law :

    In fact, however, the law is not truly stable, since it is continually, if slowly, evolving in response to changing social mores and conditions. This evolution occurs because each new generation of judges brings with it its own set of "progressive" normative assumptions. As the older generation passes from the scene, these assumptions come to be shared by an ever-increasing percentage of the judiciary. Eventually, they become the consensus of opinion among judicial decisionmakers, and the law changes to reflect them. Thus, a generation of judges that regarded "separate but equal" as a perfectly legitimate interpretation of the Equal Protection Clause of the Fourteenth Amendment gave way to one which interpreted that clause as prohibiting virtually all governmental actions that classify individuals by race, which, in turn, gave way to one which interpreted the same language to permit "benign" racial classifications designed to advance the social status of minority groups. In this way, as the moral and political values conventionally accepted by society change over time, so too do those embedded in the law.

    The law appears to be stable because of the slowness with which it evolves. But the slow pace of legal development is not due to any inherent characteristic of the law itself. Logically speaking, any conclusion, however radical, is derivable from the rules of law.

    []

Comments feed : RSS 2.0. Leave your own comment below, or send a trackback.
Add your cents! »
    If this is your first comment, it will wait to be approved. This usually takes a few hours. Subsequent comments are not delayed.