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114,577 reasons to be fearful

Dear friend,

It seems the more closely you look at something the less you understand it.

With each passing day we look out of our electronic window on the world and find more and more that we fail to comprehend.

Take numbers; I can’t make head nor tail of them anymore.

When my 6-year-old son gets stuck on his maths homework I can still help him, but I am beginning to feel something of a fraud.

This is because I am starting to feel that in teaching him ‘correct’ logical maths I am failing to prepare him for life in the real world.

In the happy universe confined by his textbook, two and two still make four and if you have apples sold in packets of four and you want to know how many apples would be in 72 packets, you multiply 72 by four and come up with 288.

You get your gold star and go to the top of the class.

But in Munich Re’s renewal presentation you start with an €8.5bn book, you increase exposure by 12% and your overall premium drops 4% to €8.1bn, but somehow you say this means that your ‘pure’ pricing is only 2.8% lower!

I’m glad my son doesn’t have to read Munich Re’s renewals statements; he would look to me to explain their maths and I would fail hopelessly. And thus his slow process of disillusionment would begin!

(Note to Munich Re — please don’t write in —I’m sure your numbers are correct — it’s my fault for failing to understand them!)

Now on to the next number – 114,577 — this one is quite a biggy isn’t it?

Well, this is number of bonds whose ratings Fitch downgraded yesterday.

All at once, at a stroke.

What gives? Well, all of the bonds (114,560 municipal and 17 non-municipal) have the misfortune to be insured by Financial Guaranty Insurance Company (FGIC) which has also just been downgraded.

What amazing productivity! One hundred and fourteen thousand five hundred and seventy-seven bonds analysed and downgraded in a few hours.

It would take me a week just to write down the names of 114,577 bonds (114,560 municipal and 17 non-municipal), let alone begin to look at their creditworthiness.

When a call for rating comes in do these Fitch guys rush into the nearest phone box and change into red and blue capes, by any chance? Or do they have have a squadron of magical oopah lumpahs on their team?

I should get these guys to come round and fix my roof!

But has the underlying credit quality of all 114,577 IOUs really changed for the worse simultaneously? Of course not, no two bonds are quite the same.

And there is the point. Ratings agencies exist because of our need for simplification and categorisation of a complex world. If we didn’t have them it would be hard work having to analyse everything for ourselves, one by one — we’d probably give up and some US municipalities would be unable to raise debt finance on the markets (probably no bad thing, but that’s another matter).

It’s always far easier to get someone else to do the hard work and rely on their judgement. The trouble is that over time what starts as simplification always ends up as over-simplification.

And how else can the simultaneous downgrading of 114,577 individual deals be described if not as monumental ‘over-simplification’?

No wonder the politicians have the ratings agencies in their sights – none of this is their fault but they are an easy and obvious target — and an absolute Godsend for any populist faced with the prospect of fighting an election during a recession!

In many ways we have it easy in the reinsurance world. After all, we have only one AAA-rated reinsurer. For us it’s easy to see who to turn to in a crisis — dial Omaha 911 and ask for Buffett!

But what the unfolding monoline massacre is showing is that even the coveted AAA rating is inadequate.

It turns out there are triple-As and triple-As.

We need more shades, of grey and more complexity.

It turns out we need AAAA, and AAAAA!

Come on Fitch, S&P, AM Best and Moodys, get to work!

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