DATA & FIGURES
The fund-finance market is estimated to be between $1 trillion and $1.75 trillion, up from just a few hundred billion roughly a decade ago. The practice of using insurance guarantees to create highly rated securities could lead to a disaster, with 50% of the market potentially at risk. The resulting paper can then be marketed as investment grade, even though the assets underneath remain opaque, illiquid private-market investments, requiring less than 1% in regulatory capital.
THE SCENARIO
The current situation is reminiscent of the pre-2008 boom in structured subprime finance, where Wall Street packaged mortgages into residential mortgage-backed securities and collateralized debt obligations. The use of insurance guarantees and complex financial structures has created a situation where risk is being relocated and obscured, rather than eliminated. This has led to concerns about the potential for a catastrophic failure, similar to the $180 billion rescue of AIG in 2008.
DIRECT QUOTE
"We are not preventing the next crash. We are steadily assembling the mother of all crashes while congratulating ourselves for distributing the explosives more efficiently." — QTR's Fringe Finance, Author and Founder
BBN INSIGHT
The Positive Side: The use of insurance guarantees could provide a temporary solution for private-credit managers who need liquidity, as well as insurers and annuity companies looking for yield. However, The Negative Side: The practice of relocating risk and obscuring losses has the potential to lead to a catastrophic failure, similar to the 2008 financial crisis. This could result in severe losses for investors, pensions, and retirement accounts, ultimately affecting everyday people, workers, and immigrants who rely on these institutions for their financial security.
MARKET REACTION
The market reaction to this development has been muted so far, but experts warn that this could change quickly if the situation deteriorates. The VIX is still relatively calm, but beneath the surface, the picture is very different, with exploding single-stock volatility and deteriorating dealer gamma. As the situation unfolds, it is likely that we will see a significant impact on the prices of relevant assets, including stocks, fiat, crypto, and commodities.