Tuesday, 3 March 2009

Backstopping systemic meltdowns

Various government agencies such as the FDIC in the USA and in more general terms elsewhere, governments(i.e. taxpayers) are underwriting the fallout from a systemic financial breakdown.
But it is worth pointing out, contrary to comments being made by some bloggers that the kind of protection being provided is of a very different nature from the risk/reward matrix of a seller of puts. A seller of puts, at least as traditionally understood, has a finite and measurable amount of risk in that the asset can at worst go to zero in value. But the asset that could be put to us as taxpayers as a result of the current crisis has no initial value and a highly uncertain terminal value.

Underwriting the fallout from systemic financial accidents is much more like the risk undertaken by an insurance company which specializes in high risk catastrophes, where the magnitude of the exposure is potentially without definable and imaginable limits.
It might be better to think of the current risk exposure, when all is said and done, as comparable to the claim for damages that might follow an event such as a Yellowstone super volcano eruption.

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