Guest post. Translated from the French by Tim Gupwell.

In the United States, bad news often arrives via the Congressional Budget office (CBO). Reputed for its analyses, this non-partisan Congressional body has just produced a forward-looking report on American debt. According to the CBO, if the tax cuts are renewed and public spending is maintained at the current rate, the debt will be around 200% of GDP by 2037. Measured in accordance with this same ratio (which is rightly contested) it currently stands at 70% of GDP. This kind of projection puts the European debt crisis – on which all the forecasters’ attention is currently fixed – back into perspective, as it is currently the weak link of the whole.

The global debt crisis dominates the horizon, but should not overshadow the other cracks in the financial system, which are just as serious, and which continue to worsen. The first of them, now known under the name of “currency wars”, has manifested itself in the form of persistent monetary instability and rising exchange rates for export countries like Japan and Brazil. As a consequence, the Yen and the Real continue to go through the roof, without the interventions from the Bank of Japan or regulation in Brazil seeming to have much effect. Jun Azumi, the Japanese finance minister, touched on the question during the G7 minister videoconference, in which the leaders of the central banks also participated: “I have told them frankly that current foreign exchange market conditions are very severe, and that it was having a very bad impact on the Japanese economy”.

The evolution in global bond market rates is another indicator of serious malfunctions. Investors are seeking refuge in American, British and German bonds, causing their rates to fall, whilst those of other countries are soaring as the market offloads them. In both cases, this creates a problem. The increase in risk associated with an increasing number of sovereign assets has obliged investors to pile into the safe havens (which are only relatively so), whilst the resulting drop in rates diminishes their investment returns. All in all, the market seems to obey a very simple logic, in which the returns are higher to the extent that the risks are greater. One of the major consequences of this polarization of the bond market is to weaken the system as a whole, since sovereign debt is the lynch-pin of it all.

The insurance sector, which (much to its satisfaction) is rarely discussed, is suffering too. Comparing the situation on a country by country basis, it can be seen that Italian insurance companies have been weakened by their possession of their country’s sovereign debt, their Spanish counterparts by their banking debt commitments, while the German insurers are seeing a worrying drop in returns from their assets, amongst which figure German debt. This is leading them to search for replacement investment solutions. The downsizing of bank balance sheets which is currently taking place with the objective of improving capital ratios and thus satisfying regulatory requirements, have offered some opportunities to insurance companies which they are looking into.

A transfer of bank loans, which have more favourable returns, has begun from banks to insurers. As a consequence, insurers have to face up to the same problems as the banks have had to come up against: how to assess the risk and how to re-securitize them so as to reduce the risk. The principle of the knock-on effect has just been illustrated yet again in financial matters. The Bank-Insurer concept having seen its hour of glory; it seems now that the pendulum has now swung towards the ‘Insurer-Bank’, a new concept. Insurance companies are now tempted to enter into the chosen domain of the banks, as financial intermediaries, arguing that their revenue structure – insurance policy contributions – is better adapted to the commercialization of long-term loans for chosen targets than that of the banks, which depend to a large extent on short-term financing. Yet this is how, under normal arrangements, banks earn their living when they are not speculating on their own funds. What will be left for banks to do if insurance companies encroach upon their traditional activities and if speculating on one’s own capital is restricted or forbidden? Will they become mere deposit-takers?

Fortunately, this is only the beginning of a process which will have to be confirmed. In the meantime, the International Association of Insurance Supervisors (IAIS), their regulatory body, is getting ready to designate 48 gropes of insurers in 13 different countries as systemically important institutions. For the happy chosen ones, this signifies the adoption of tighter supervision, although in its clemency the IAIS has announced that ‘incentive based measures’ would be privileged. Adopting an attitude common to financial circles, the insurers are attempting to circumvent these new regulatory constraints by emphasizing that their economic model is different to that of the banks, and that measures destined for the banks should not be directly applied to insurers. They are also fighting for the regulatory framework of the Solvency II directive (the insurers’ equivalent of Basel III for banks) to integrate the securitization products which they would like to issue so as to develop their activities more easily and thus kill two birds with one stone.

The insurance sector, which seemed to have come through the European crisis unscathed, has been contaminated and is preparing to be even more so. Slowly, in the core of the financial system, the cards are being re-dealt, but this will solve nothing since the rules of the game remain just as lenient, and in many cases non-existent. As the cracks continue to open up the financial system is becoming more and more fragile.