People insure themselves against many types of potential catastrophes: a house fire, a car accident, the untimely death of a spouse, a serious health problem. For other unexpected expenses, prudent people, as we say, save money “for a rainy day.” For some reason people and governments have chosen not to insure themselves (individually or collectively) against two catastrophes that have been much in the news lately: pandemics and large investment losses.
There is a connection, of course, for the two are tightly coupled. Here are some of the similarities between the two:
- Both occur at irregular and sometimes very long intervals.
- Both require careful thought and regular financial outlays to hedge against.
- Despite persistent warnings from experts, most people (and governments) did not act on such warnings.
- Now that the worst has occurred, many investment advisors and governments say, “No one could have seen it coming”—even when such a statement can be proven immediately false with easily obtained video evidence!
Will we learn from our current experience?
The answer in some cases will certainly be no because the incentives in our system encourage those in high places to act imprudently. Executives of publicly traded companies have spent trillions of dollars buying back shares of their own companies in order to goose stock prices and make their stock options more valuable—without regard for the need for cash reserves to make it through a recession.
One case that’s making the news is that of the U.S. airline industry. In the past five years the industry as a whole spent $45 billion on stock buybacks in order to enrich top management and shareholders. Now, the industry is asking for $50 billion from taxpayers to bail out profligate managers and their companies. Wouldn’t it be nice if they were asking for only $5 billion instead?
Aerospace giant Boeing has spent $43 billion on stock buybacks since 2010 and is now seeking $60 billion in public funds.
Of course, the executives seeking those public funds will never offer to give back their bonuses or return the profits they made from their stock options. They will instead keep all that money and their jobs despite their reckless financial management. Unless the law changes to force executives to act differently, they will do the same thing the next time around.
How about individual investors? The stock market crash led to a decline of 35 percent in the S&P 500 Index in the space of about a month, the swiftest decline on record. As of Friday, those losses had been trimmed to just 16 percent. Perhaps all will be well though the reason for the rebound seems to have been the belief that the the trillions of dollars injected by the U.S. Federal Reserve into financial markets (mostly bond markets which were breaking down everywhere) has led to what will be the first leg of a recovery.
To show you what insuring oneself against a decline can do, it is worthwhile to examine the record of people who do just that for a living. In March, the Universa Investments, a fund designed specifically to hedge against large market disruptions returned 3,612 percent. That’s NOT a typo. For the first quarter of this year the return is 4,144 percent.
Universa recommends that clients put 3.33 percent of their portfolio in the fund as a hedge against just the kind of disaster which has now unfolded. Universa didn’t know ahead of time that the coronavirus was going to strike. It simply knew that large market disruptions take place more often and are more severe than most people believe. The fund itself has now returned an average 76 percent per year since its inception in March 2008, far above the 7.9 percent per year return on the S&P 500 during the same time period. And, it’s a fund that can only be categorized as bearish. Contemplate that for a bit!
If you are one of those who hung on to your stocks during the crash and are now patting yourself on the back for not panicking, contemplate further the words of Universa’s chief investment officer, Mark Spitznagel:
Looking ahead, the world remains very much trapped in the mother of all global financial bubbles. This is obvious, a given. Markets were priced for “perfection,” and now, following even more of the greatest monetary stimulus in human history (much of it in the span of just the last few weeks), they’re still priced for “really good”—still very expensive.
So this is far from over; the current pandemic is merely threatening to pop the bubble. (And, as we all can plainly see, the powers that be are likely running out of ways to keep the bubble inflated.) Make no mistake, it’s the systemic vulnerabilities created by this unprecedented central-bank-fueled bubble, and the crazy, naïve risk-taking and leverage that accompanies it, that makes this pandemic so potentially destructive to the financial markets and the economy.
Okay, that’s a short peek at the financial damage and possible mitigation strategies. How about insuring against a pandemic? Well, doing so in a way that would have avoided the catastrophe we’ve experienced would have cost money, lots of money. I have no way of knowing what adequate preparations would look like that might have enabled a real-time containment of the virus when it first appeared in China. Nor am I versed in a strategy that would NOT involve lockdowns of entire societies when containment failed.
However, such a strategy might have required extensive recruitment and training of contact tracers who trace every contact of an infected person and seek to test them and treat them while advising quarantine until the infection has passed. This would have to be done in every community.
Proper preparation would also have involved holding large inventories of medical supplies just in case. It might have entailed maintaining significant excess hospital beds, intensive care beds in particular, that would go unused for years. It might have meant boosting the salaries of nurses, improving their working conditions and recruiting many more to be in the profession both full-time and part-time so as to have a workforce flexible enough to respond to a pandemic. It might have involved researching the best ways to help patients survive severe respiratory infections, rather than waiting until a pandemic occurs and learning on the fly.
I am certainly missing many elements of such preparations. But even my small list gives you the idea of the scope and possible costs of such an effort. Let’s assume that the cost of such an effort over the past 10 years would have been $2 trillion worldwide or about $200 billion per year. Would that have been worth it?
The most recent estimate of worldwide damage to the economy I could find is this April 3 assessment by the Asian Development Bank which puts the cost this year alone at between $2 trillion and $4.1 trillion in lost Gross Domestic Product. How much would you be willing to bet that that is an underestimate for the year? And, how much would you wager that once we’ve finished 2021, we’ll find that the cost for 2020 through 2021 will be far higher than these numbers? And, will you be surprised if we continue to suffer losses beyond 2021?
Now, the cost of insuring against such losses would have been substantial. It would have been difficult for politicians to explain such lavish expenditures for something that “might” happen versus the daily needs of their constituents. And, it would have been difficult for hospital administrators, both nonprofit as well as for-profit, to justify extra beds and nursing staff just in case—unless governments would have been willing to pay (which would put the problem back in the laps of the politicians).
In retrospect such an investment would have paid handsome dividends both in money and lives saved, especially if it had been able to bring about complete containment of the disease in China. But the problem with insurance is that you cannot wait to buy it until after the event you are insuring against.
Insurance in this case is a political problem. And, political problems are a reflection of the problems inherent in the culture. We have a modern global culture that simply could not accept the inevitability of large disruptions to our fragile system. At this writing, most people still believe that we will return more or less to conditions as they were before the coronavirus—if not by the end of this year, at least by some time in 2021. They have not yet assimilated the idea that we may have gone through a phase change in global society that will lead to many more knock-on effects in the economy and society that will mire us in economic stagnation and social disruption for years to come.
We can hope that won’t happen. But hope is not a strategy. If we want a more robust world for ourselves and our children, we will have get involved to create that world. The blind acceptance of or least acquiescence to what elites tell us is good for us will only come to an end if we choose to end it. That will take foresight, creativity and involvement. But those are qualities that often make themselves abundant when circumstances force us to adapt to vastly changed environments.
Image: Shadow of a man gambling online (2014) by kalhh. Wikimedia Commons https://commons.wikimedia.org/wiki/File:Online_problem_gambling.jpg