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Prevention Guide
How to crash an economy: Underestimating the value of a disaster
Our economic crash can be found in the winds of a hurricane
By Don Elzer
It really has become easy to hide the real reasons behind an economic collapse.

When there’s a problem with the economy, it truly is remarkable how easily we accept the quick answers we get from economists. It seems that we just don’t want to get past the sound bites and two-minute interviews.

As a result we get general, superficial answer as to why the largest investment banks and mortgage brokerage houses are failing, why interest rates and insurance premiums are going up, and why foreclosures and bankruptcies are on the rise.
One would think that in the middle of an election campaign in both Canada and the US that we would demand to know more about the details of the problem and how it began.

Not so.

We have in fact become quite satisfied in putting our trust in people and systems, which would in a heartbeat, place their own interests ahead of the common good.

It is the way of the free marketplace, that has as it’s war cry, “Let the buyer beware”.

So as we on mass, buy the reasons for this most recent and major economic upheaval, allow me to at least expand the news clip ever so much, so that further pondering can occur even if it borders on speculation, which I might add is a common instrument used when explaining most of the forces within our economy.

Just two days after the Bush administration refused to help Lehman Bros. avoid bankruptcy, the Federal Reserve began finalizing plans for an $85-billion bailout, and takeover, of insurance giant American International Group (AIG). The bailout marks a stunning reversal of the administration's weekend insistence that Wall Street use private money to solve its own problems.

A precursor to AIG’s plunge into collapse happened earlier this month as Hurricane Ike, which blasted the densely populated Texas coast and swept through Houston, triggered yet another spike in insurance claims of between $8 billion and $18 billion, according to early estimates of the damage.

Based on those estimates, Ike will not be anywhere near as costly for insurers as Hurricane Katrina, which happened three years ago, but at the high end of the estimate it could rank as the fourth most expensive disaster in US history.

How the Americans manage their disasters, has a direct impact on Canadians and our insurance premiums and availability. Disaster also has a direct impact on the North American economy.

Today, insurers across North America are scrambling as they face a wave of claims from businesses and homeowners in the low-lying areas around Houston, the fourth-largest city in the US.

Windows in Houston high-rises blown out by Ike's strong winds were alone expected to result in costly claims. According to one insurance adjuster, "It’s expensive, it is a significant cost once salt water gets into the buildings," he said.

Most standard homeowners policies exclude flood damage, and many homeowners across the US and Canada do not opt for separate coverage. However, commercial properties do generally carry it.

However, when a house with a mortgage is destroyed and the owner walks away from their debt. It’s the bank or the mortgage company that’s on the hook for the loss, foreclosing on property, that has no replacement insurance thus no longer has value.

While Hurricane Ike was a big storm, it’s a dwarf compared to Hurricane Katrina the most costly U.S. catastrophe on record, causing damage that at the time was estimated at more than $80 billion, about half of which was covered by insurers according to the New York-based Insurance Information Institute, a trade group funded by insurers.

After Katrina, which cost insurers $41.1 billion, 1992's Hurricane Andrew and the 2001 attacks on the World Trade Center in New York and the Pentagon rank as the No. 2 and No. 3 most-costly U.S. catastrophes, according to the institute. Insured losses from Hurricane Ike would have to top $17 billion to rank fourth.

Katrina ended up costing almost as much as two wars. Lining those disasters up in a row and squeezing them into an eight year time frame is proving to be much too costly for the North American economy.

The weekend after Hurricane Katrina hit Florida, Alabama, Mississippi and Louisiana, the US government was writing checks for close to $2 billion per day on items such as the 17 million meals ready to eat, tens of thousands of trailers to house refugees, and contracts to rebuild highways and bridges.

At least 1,836 people combined lost their lives in the actual hurricane and in the subsequent floods in August 2005. Initially the storm was estimated to have been responsible for $81.2 billion in damage; but costs have climbed with present accounting estimated at more than $300 billion and a rival to the costs of fighting wars in Afghanistan and Iraq.

Three years later, thousands of displaced residents in Mississippi and Louisiana are still living in trailers and the winds can now be felt swaying the towers on Wall Street. The collapse of the subprime mortgage market have lead to record losses for insurance companies, overtaking Hurricane Katrina, as the worst disaster ever to hit that industry in the US. But now there is reason to believe the two costly disasters are linked.

The amount of asset write-downs and credit losses reported by the industry has reached at least $40 billion, just short of the reported $41.1 billion in claims paid out as a result of Katrina, which left more than half of New Orleans homeless in 2005.

What’s interesting to note, is that the value of claims reported by the industry isn’t necessarily the real value of claims, such figures represent the value of claims paid out not the value of claims made by disaster victims.

In short, there may not be enough money in the vault to pay out all of the claims that deserve to be paid. If in fact $100 billion is yet required to replace losses as a result of Katrina, that figure is equal to the value of the slowdown in US building starts for the entire country over this past year. In other words the value of the construction slow-down in the US which impacts the Canadian economy, is equal to the value of replacement construction that should have taken place in New Orleans and the southern states.

The question remains, why didn’t the rebuilding of New Orleans cause an economic boom in the US? Certainly, rebuilding one of the largest cities in the US, is a project that which might compare to staging 30 or 40 Olympic Games. The answer is simple, it wasn’t rebuilt. It remains an anomaly in US history, and one that we’re all paying for today. The decision will eventually prove to be negligent on the part of  policy-makers and the insurance industry.

Clearly, there is not enough insurance money to pay out claims and many of those payouts needed to be paid to banks and mortgage holders themselves. Over the past three years many homeowners have walked away from their debt, leaving mortgage companies and banks foreclosing on equity of little or no value.

So why were the claims not paid? Because insurance premiums were invested in subprime mortgages and elsewhere.

The statistical data associated with the damages caused by the hurricane remains eerily unavailable; as does any important details regarding why the rebuilding effort is so slow to happen. Presently, federal aid for most homeowners without any insurance assistance is being used by many to pay monthly mortgage payments on home that are not livable, This federal assistance is about to run out, which will result in the next wave of homeowners walking away from their mortgages, leaving lenders with the next wave of losses.

My guess is that historians will be able to link the sub-prime mortgage crises in the US directly to Hurricane Katrina. The losses that occurred for banks and mortgage companies required an increase in interest rates across the nation, which in turn had a ripple effect leading to an increase in foreclosures nation-wide and removed many Americans out of the home marketplace.

Disasters of any kind all have something in common. They all have a beginning, a middle and an end.

For this latest banking crises, the beginning was Hurricane Katrina.


Economic Bad Karma
A grave on a once busy street in New Orleans,
a disaster ignored by all of us now haunts the global economy.