Used to be, bankers were the makers of loans. The steely eyed loan officer would examine the borrower and his business and decide if the loan, if made, would get paid back. Then some of the steel went out of the bank backbones, and they started buying bonds. Then a bond or two defaulted, leaving the bank out of money. So the banks started buying "bond insurance". Pay a small premium, and the bond insurer would promise to make the bond good even if the bond issuer fled the country. The bond insurers only insured state, country, or municipal bonds which are incredible safe. The state, county and municipal governments have taxing power, they can always raise taxes to pay off the bonds and they cannot flee the country to avoid payment. Nice safe business for the insurer, you just collect the premiums and keep them. You never have to pay anything out.
Then the bond insurers started to insure sub prime mortgage bonds issued by brokerage houses. The steely eyed loan officers didn't have clue as to what such a bond was worth, but if they could insure it who cares? The bond insurers wrote trillions of dollars of such insurance, even though they only had millions of dollars to pay off claims. Now that the sub prime bonds are defaulting left and right, the bond insurers will be broke in another week or so.
Did the premiums paid on sub prime bonds do any good? If you are Merrill Lynch, worth trillions, why are you buying insurance from a smallish insurer with much less money than you have?
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