The Bank of England's knack for looking behind the curve is uncanny. Just as it finally gets around to recognising the severity of the banking crisis, investors are distracted by the next financial car crash: insurance. Results from Aviva today have sent the market into a tailspin almost alarming enough to overshadow the Bank of England's dramatic decision to shower us in new money.
As I warned a few weeks back, insurers are uniquely exposed to the latest phase of our financial horror story because they own lots of company debt, particularly bank debt. With shareholders all but wiped out in many companies, the next in line to feel the pain will be anyone who has lent them money. Default is a dirty word, even in the bombed-out banking industry, but the fear of bankruptcy is rising by the day.
Even if we miraculously keep the show on the road, the fear of default can hurt insurers because it drives down the price of corporate debt in the market. There are endless debates about whether to pay attention to market prices, but the bottom line is that investors do look at them and it makes them nervous.
This is where quantitative easing comes in. By buying up corporate debt, the Bank of England not only makes it easier for companies to borrow money directly (thus circumventing the broken banking industry) it also drives up the price of existing corporate debt trading in the market. Purists may argue this will make no difference to the long-term solvency of insurers, but it should at least help things look better.
