Management Indemnity

As the credit market continues its see-sawing, some home truths are finally surfacing. One of the most bizarre trends in the past few years was the insatiable appetite of large institutions for structured investment vehicles, particularly CLOs and CDOs. I saw this at first hand, as I used to work for an insurer who bought inordinate amounts of this stuff, as it offered the magic combination of relatively high investment income with investment grade credit (or so S&P thought), as well as the "right accounting" treatment.
Now, I'll confess I didn't foresee how bad the underlying loans could go. The issue is only now beginning to surface, and will probably get far worse. However at the time I did wonder that this might be too much of a good thing, and suggested a minimal ticket in CDOs and CLOs. Unfortunately, Investment Committees in insurance firms are refugee camps for the financially inept. At best they are people who couldn't hack it in asset management, and at worse actuaries or accountants without a clue about how markets really operate. Dull, backward-looking and technically naive: a car crash-inducing combination.

The end result was that I was overridden, and seduced by those juicy (and quarterly results-friendly) returns, my employer invested ten times the recommended amount into structured vehicles. I soon after, and have watched the sorry tale unravel from afar over the past year. And yet, just like Citi, the management that got the firm into this mess are still in place.

The obsession with accounting results is bizarre. My opinion has always been that investment should be seen as an economic proposition - pushing it into accounting buckets merely creates perverse incentives to either trap liquidity or take inappropriate risks. This is a particular sin of insurers - most of the time they actually lose money underwriting insurance, and it's the investment income that comes to the rescue of the P&L. It's a pretty dicey bit of financial brinkmanship, and the sector is now reaping the results of that bet.