David Sandham analyses the current financial crisis.

I am very proud to become Editor of this magazine, especially after such an excellent predecessor. We wish a fond farewell to Helen Yates, who was with the magazine for three years, two of which were as Editor. A month after she was into the job, Helen was in Monte Carlo shortly after Katrina struck the United States. Katrina was later estimated to have caused $81bn in damage, making it the most costly hurricane in U.S. history. Overnight, it changed the industry that Helen had only just started reporting on. But that baptism of fire was perhaps why Helen became so fascinated by reinsurance. I am very pleased to say she remains in close contact with the magazine, and I think you will enjoy her article on Surviving Monte Carlo on page 14.

Time will tell whether the present hurricane season holds any similar surprises in store for us during this year’s Monte Carlo Rendez-Vous. But over recent months, the financial community has been struck by a storm of a different kind, though just as difficult to predict: the hurricane force volatility of the capital markets, and the rotting flood of bad credit.

If Katrina was the worst that Mother Nature could throw at the U.S., then the Credit Crisis is the worst financial crisis since the Wall Street Crash of 1929.

The Credit Crisis began with the bursting of the U.S. housing bubble in 2007. Arguably, that bubble was itself in part the consequence of a preceding bubble: too much cheap cash was available to be thrown at the housing market because, at the time of the bursting of the technology bubble in 2000, interest rates were cut in order to stave off recession. Bubble begets bubble.

The Credit Crisis is often called the Subprime Crisis, referring to the subprime mortages that were so vigorously sold to those who had so little ability to repay. But it would be a mistake to think of the problem as limited to housing debt alone. It is also a crisis in securitisation, in which the bad loans were repackaged, and then repackaged again. Securitisation, and the flourishing of synthetic securities, spread the problems far and wide. The market in credit default swaps, a form of debt insurance, has ballooned to $62 trillion, a staggering figure equivalent to double the size of the total capitalisation of all the companies listed on the world’s largest stock exchange (NYSE Euronext); or, to put it another way, equivalent to 15 times the world’s total annual insurance premium income.

The Credit Crisis is hitting banks more than insurance companies, but the latter are not immune. Over the past three quarters, AIG has lost $25bn on credit default swaps. Swiss Re, which last year lost $1bn on two credit default swaps, has $10bn direct debt exposure to troubled U.S. mortgage lenders Freddie Mac and Fannie Mae. XL Capital had to pay almost $2bn cash, plus shares, to disentangle itself from bond insurer SCA, which had eight credit default swap agreements with Merrill Lynch. Allianz is hemorrhaging cash to its Dresdner Bank unit, which no doubt it would dearly love to sell. Bear Stearns was, last March, sold for a song to JP?Morgan, but who knows what would have happened had it been allowed to default.

Many who have lost money in the Credit Crisis are looking for someone to blame.?If just a few of those hundreds of legal suits succeed, the insured losses could be considerable. Gavin Coull, partner at law firm Steptoe & Johnson in London, recently told me: “It would be naïve in the extreme to ignore the fact that, with the U.S. litigation kraaken already awakened, a tidalwave of claims (but will these translate as losses?) will wash through the insurance and reinsurance D&O and E&O markets.”

Thomas Hess, Swiss Re’s chief economist, told me that he estimates D&O and E&O credit crunch related losses, “at between $3bn to $9bn, roughly equivalent to a medium size natural catastrophe in the U.S.”

Not all storms can be blamed on Mother Nature.

David Sandham, Editor

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