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liquidity reserve


ERICOPOLY
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As Prem points out in the latest annual report, most of the debt is merely a liquidity reserve to be tapped reliably even if the overall financial system is under severe stress, offset by an equal amount of cash and securities at holdco.  This debt is not used to achieve returns, but rather used to REDUCE overall risk.  It is a hedging strategy against systemic risk.

 

I was primarily involved in stress testing when I was employed, and I designed and implemented a stress automation system for user-mode Windows applications.  My automation framework allocated a very large (200mb) chunk of virtual memory as a reserve for the error reporting.  When an application crash was detected, I would then free the reserve, collect some data, and send the reports to the database.  The data reporting and such required system resources (virtual memory) -- however, under stress the virtual memory may not be available for dynamic allocation... in other words, when the system is under stress everybody else may have already claimed all available virtual memory.  So by pre-allocating a large chunk of memory I reduced the risk of being unable to grab system resources when the system was under severe stress (at the very time that the apps I was testing tended to being crashing).  

 

In short, Prem seems to be doing the same.  

 

This makes Fairfax less risky than the business model would otherwise suggest, because even the best underwriter can be wiped out if the unthinkable claims come in at a time when the capital markets are frozen.

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It won't freeze until people really forget about what just happened. I'd say we won't see the same type of crisis before another 10 years.

 

Right now everybody is looking for:

 

"The next bubble (China, Canada's Real Estate)"

"The next big failure(Greece, Portugal, US...)"

"The next derivative problems"

 

Because that's just what we got... it's funny how people tend to discard the years 1780-2006 when looking for troubles! Thunder never hits twice at the same place.

 

BeerBaron

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