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CDS Trading at ALICO

|Includes: American International Group Inc (AIG), MET

The New York Times today reported on CDS trading at AIG subsidiary ALICO, which MetLife is reportedly thinking about buying.  The article's title "At AIG, Risky Trading Wasn't Just on the Fringe", was a little more incendiary than the content, wherein the ALICO CDS portfolio is described as being pretty well diversified and never a big risk to anyone, except perhaps ALICO.

The interesting bit comes, however, in quotes from various insurance regulators in Delaware, where ALICO is domiciled:

“I don’t think an insurance commissioner should tread on the toes of the banking industry,” said Karen Weldin Stewart, the commissioner in Delaware. “This started out as a bank product.”

Fair enough, but if it's a bank product shouldn't it be subject to bank regulators?  Not content to have one goofball quote in a paper of record, a direct report of Stewart continues on.

Her special deputy for examinations, John Tinsley, explained the reasoning. “In insurance, you’re putting  together a pool,” he said. Each customer would be charged a premium based on the total risk of the pool.

A credit-default swap cannot be insurance, Mr. Tinsley said, because it does not involve a pool. There is just one seller and one buyer for every contract.

“It’s an investment product,” he said. “It’s closer to buying an option.”

So banking and bank underwriting don't use pools, I see.  So how do banks measure credit risk and decide to whom they should issue loans and credit cards? By studying the payment and default behavior of large numbers of people sharing demographic characteristics, "pools", if you will.  It's not much different.

This kind of simplistic logic demonstrates that the continued state-by-state balkanization of insurance regulation benefits few except the insurers themselves, who easily overmatch their would-be watchdogs. Quis custodiet ipsos custodes?, indeed.

Disclosure: Only index funds: FUSEX, FSTMX