The Opaqueness of Structured Bonds: Evidence from the U.S. Insurance Industry

Abstract

It has been argued that the opaqueness of structured bonds, such as mortgage-backed securities, asset-backed securities and collateral debt obligations, was one of the major causes of the recent financial crisis that started in late 2007. We analyse the evolving nature of information asymmetry inherent in various types of structured bonds by examining the U.S. insurers' assets. We show that, prior to 2004, structured bonds were not associated with greater information asymmetry; however, holding more multi-class structured bonds, especially privately placed bonds, increased the information asymmetry when evaluating insurers' assets post-2004. The effect of information asymmetry was more significant with life insurers than with non-life insurers. In addition, by investigating the rating grades of such structured bonds, we find that the market views higher-grade, privately placed, multi-class structured bonds as having the highest information asymmetry among all types of structured bonds post 2004, an effect which is, again, more significant with life insurers. This result shows that structuring complexities and unreliable ratings make structured bonds more opaque than just securitisation itself. AbstractIt has been argued that the opaqueness of structured bonds such as Mortgage-Backed Securities (MBS), Asset-Backed Securities (ABS), and Collateral Debt Obligations (CDOs) was one of the major causes of the recent financial crisis that started in late 2007.In this article, we analyze the evolving nature of the opaqueness of structured bonds by examining U.S. insurers' assets from a capital markets perspective. We show that, before 2005, the market did not view structured bonds as opaque investments; however, after 2005, the market began to perceive multi-class structured bonds, especially private bonds, as opaque assets. In addition, by investigating the rating grades of such structured bonds, we find that the market views lower-grade, private, multiclass structured bonds as the most opaque assets. Additionally, publicly traded multi-class structured bonds with superior ratings are also considered opaque. This result provides a useful foundation for the reform of credit rating agencies.