It's derivatives. It is what it is. Marking everything to market all the time isn't a great answer either.
It's possible that our particular implementation of the insurance markets is deeply flawed, but a general concept of 'Pay X now to be backstopped in the event of catastrophe' is incredibly useful.
I also think that a lot of people pay for insurance that doesn't make a whole lot of sense though. If you could afford to replace the thing you're insuring out of pocket, you probably shouldn't be insuring it.
I only pay for third party car insurance because I can just buy a new car if I total it, but I can't buy a new Lamborghini for the person I crashed into. I don't pay for contents insurance at all because I can buy a new bed and laptop if my house catches fire.
Insurance companies have done the math, your EV for insurance is always going to be negative (on average), you should only insure against costs that you can't afford to pay in one big lump sum if they happen.
Insurance is effectively a loan for things you already own, just put that money in a savings account instead.
It’s the pension fund take on overpromise and adultery.
This is misunderstanding BIS's point. The BIS is talking about the size of the market - ie they are concerned about liquidity and system wide risk. They are not saying the pension funds are short trillions via FX swaps.
maybe accounting standards should be updated to record derivatives risk to take into account interest rate and counterparty risk.
The reason for this is that fx swaps dont create exposure to fx or credit swings the way that fx trading or borrowing against future cash flows do because they are fixed rate contracts.
There is counterparty risk but a) that is typically mitigated much more cheaply and us generally less risky and b) you’d move the loss “on book” if the counterparty risk shapes up.
Imagine you go to the bank to get a loan for a new tractor for your business. They ask to see a list of your assets and liabilities (your balance sheet).
You own a house worth $1 million with no mortgage. You have an insurance policy. You have nothing else.
If bushfires start right next to your house as you are meeting the bank manager, you don't say to him/her: I have a house that is worth 900k marked to market because of the bushfire risk, and I marked my insurance policy to be worth $100k.
You have a house worth $1 million. The insurance policy is "off balance sheet" despite the fact it could be worth a lot of money.
No. Insurance is subject to the "insurable interest" doctrine, which generally prohibits using insurance as naked speculation. There are also far more backstops, reserve requirements, government guarantees, etc., designed to prevent this kind of implosion. Not saying it doesn't happen, but we've had since the South Sea Bubble to learn how to regulate insurance to prevent this kind of thing.
The key difference is that insurance is generally regulated from a consumer protection perspective, since many insurance lines are sold directly to unsophisticated consumers. CDSs are, by contrast, sold primarily these days to sophisticated financial speculators, who are presumably fully aware of the kinds of risk involved.
Regulation doesn't get rid of the risk. And it's got zero to do with naked speculation. We simply cannot make risk disappear. Contracting with someone else to eat the risk creates a new risk. Counter party risk just doesn't go away, despite our hopes and dreams.
"South Sea Bubble to learn how to regulate insurance to prevent this kind of thing." - AIG (at the time the biggest insurance company in the US) went down in 2008 during the Great Financial Crisis because they insured sub-prime loans (CDS again).. So I guess there are lots of holes regulators still need to learn....
This is why flood and earthquake insurance often end up being (underfunded) and run by the state.
These are run through clearinghouses in most money centre jurisdictions.
I've yet to find a solution that tracks down every dependency from a call made inside an application that crosses many platform boundaries. There are dependency mapping "solutions" but they all are incomplete inventories at best, and I've yet to find one that acts as a metadata repository for distributed tracing solutions.
I would really like an AOP-style way of attaching code, turtles all the way down as much as possible, that shows me all dependencies and each of their various affiliated sensors and probes that get automatically called for known failure modes whenever there is an unexpected value, and when an unknown failure mode happens dumps all the sensors and probes instead of just a stack trace. I want to be able to attach such tracing code to third party code without causing their support teams to suck in their breath through their teeth and with a grimace tell me they can't support that "modification". These days, I not only need a call graph, I need the exact state of everything when something broke because I increasingly see Heisenbugs in environments due to various pressures in software development, and most vendor support teams' way of collecting data is woefully inadequate in cloud/distributed ecosystems.
The issue that BIS is raising isn't the mere existence of derivatives. It's both the scale of debt and the lack of public visibility into it.
The concern BIS has is basically that policy makers are making decisions that can have major impacts on price of the dollar and global interest rates. Given both the scale of this debt and it's lack of visibility, BIS is pointing out that policy makers might not have all the information they need to make safe decisions.
It's neither a case of "the sky is falling" or "it is what it is". This is absolutely something that should not be shrugged off with a "meh" which is why BIS wrote the report in the first place.
So, they look at the ones that have historically caused the biggest issues and are causing the most obvious pain right now, make changes that hopefully give others time to adapt to without catastrophic issues, and cross their fingers.
If the things that explode are within the scope and scale expected? Then success.
If not? Try to figure out what happened, and try to do better next time.
There is no ‘good’ decisions in these situations, even doing nothing has major costs. It’s about the least bad decision, and trying to avoid taking on unnecessary risk and hence unnecessary pain.
so far CDS’s are a potential problem, but not as big of a known historic problem as economy wide out of control inflation.
So, off we go.
And then the reuters report lede makes it sound like pension funds are short $80 trill. People on this thread think it's what is being reported.
It's awful.
In an ideal world sure, yet naked shorting and similar practices are rife. There are ways around these things.