Lessons from the Financial Crisis (2)

It must be ok if everyone else is doing it – Banks were unwilling to miss out and not take part of this lucrative idea. In the past insurers have been caught up in this approach to business as well. The presence of a well respected firm in a market does not make that market good for everyone.

THis factor was so strong that one bank CEO suggested that if he did not allow his bank to continue in the lucrative sub prime business, that he would start to lose key employees and eventually would lose his job to someone who would participate in that business.

That must be one of the last stages of a bubble, when markets become so profitable that many feel that they have to participate.

In this case, the very low interest rates and spreads for almost any other type of risk helped to feed the situation. The sub prime market was one of the only place where there was any spread to be had.

And a major flaw with the “everyone is doing it” motivation is that some things only work if a small fraction of the market is doing it and fall apart when everyone jumps on.

Just like the ferry. A few people can stand on the edge looking at the shore, but if everyone on the ferry stands along that same edge and looks, the boat may dip and might even capsize.

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Explore posts in the same categories: ERM, Hedging, Reinsurance, Risk Management, risk transfer, Sub prime

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