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Financial Perversions Sold During Credit Boom

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By: Floyd Norris | February 11, 2010

Would you buy a “XXX” security?

Those securities do exist, providing evidence of the perversion of finance during the credit boom that ended so abruptly in 2007 and 2008.

That perversion was not of the type you might associate with the label XXX. The letters instead refer to the number of a regulation that insurance companies found inconvenient, and wished to get around.

Here are some of the features that make XXX securities memorable:

They were based on the assumption, endorsed by the bond rating agencies, that insurance regulators were requiring life insurers to retain too much capital.

Therefore, investors could take on a large part of the risk of the insurance with complete safety. That would be only the “excess” part, as calculated by the insurance company.

The securities were sold as virtually risk-free cash equivalents, enabling the investor to get out, at par, once a month. Supposedly sophisticated investors sank more than $30 billion into them.

The securities were explained in complex prospectuses that almost nobody even obtained, let alone read.

They were guaranteed by bond insurers, like Ambac, further persuading people there was nothing to worry about. There was, it turns out, plenty to worry about.

Espen Robak, the president of Pluris Valuation Advisors, says some of the securities are trading from 5 to 28 cents on the dollar.

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