Insurance for fire, flood why not recession

Washington | Updated: Dec 31 2008, 07:12am hrs
Mortgage lenders often require homeowners in flood-prone areas to carry special insurance. Should banks make companies buy recession insurance from governments before they can borrow

That is one idea proposed by the International Monetary Fund on Monday as a way to help situations like the current one where economic uncertainty is so high that companies and consumers put off spending, deepening the downturn.

The proposal was tucked into a 37-page paper on fiscal stimulus, and an IMF official said it was merely a topic of internal discussion for now.

The Fund has not yet broached the subject with any representatives of any government, said Carlo Cottarelli, director of the IMFs fiscal affairs department.

In essence, governments would be providing insurance against extreme recessions. They would offer contracts that pay out if economic growth falls below some threshold level. Banks could make buying the insurance a condition for loan approval.

Widespread use of such contracts would provide an additional automatic stabilizer because payments would be made when they are most needed, namely in bad times, the IMF said.

Cottarelli said it was premature to think about exactly how the contracts would be structured or what sort of premiums would be charged, noting that the idea was included in a section entitled Some proposals for discussion.

Kenneth Rogoff, an economics professor at Harvard University and a former IMF chief economist, said the idea could backfire because governments would be sorely tempted to underprice recession risk, which could exacerbate crises rather than ameliorate them.The government is already absorbing a significant amount of recession risk through the tax system. When output tanks, the governments tax revenue also collapses. Many governments would end up just defaulting. That said, it is healthy to try to advance new ideas.

The IMF acknowledged the risk that the government may not be able or willing to honor its obligations, and said countries offering such insurance would need to budget accordingly.

U.S. officials have been struggling to find a way to break a self-reinforcing cycle of economic fear and paralysis that has contributed to a yearlong recession.

Consumers worried about losing their jobs or losing their money in the housing and stock market slumps have curbed spending dramatically. Companies worried about getting caught with too much inventory when demand is falling have cut production, jobs and investment.

That in turn leads to more credit defaults, and banks hit by heavy losses respond by restricting lending.

Simon Johnson, a professor at the Massachusetts Institute of Technology who stepped down as IMF chief economist earlier this year, said it was not clear whether such an insurance plan would have paid off this time because the economic data has yet to show a severe recession.

Reuters