Financial Guarantee Insurance and the Failures in Risk Management

The financial meltdown that began in 2007 revealed problems with the financial guarantee insurers and regulation of these insurers. Financial guarantee insurers, with business models dependent on AAA-credit ratings, were exposed to risks that threatened those ratings. These insurers had four primary sources of risk: the proportion of structured finance in the insurance portfolio, the proportion of structured finance in their investment portfolio, selling credit default swaps, and providing guaranteed investment contracts. These exposures provided a toxic mix once the structured finance market faltered and credit ratings fell. We examine these risk exposures and the failings of the regulatory framework of these insurers.