Amity Shlaes dismisses the idea of a federal safety net for firms hit by terror claims.

Last autumn, the White House started ringing the bell to alert the nation to (more) disaster. After September 11, it said, there would be an insurance problem. Insurers wouldn't want to insure companies against the uninsurable - terror. So Washington needed to pass legislation to back the industry up with a public emergency fund, the sort that might help firms out in the face of future attacks. If the government fund didn't become law by the new year, the advocates of federal help said, the economy would grind to a halt. Seven in ten reinsurance policies would lapse.

The legislation didn't make it through. And the economy didn't grind to a halt either. Rather the opposite, or so the econo-scribes tell us. Nonetheless the White House is once again making insurance one of its big priorities, and hoping it can push it past "the Daschle obstacle" - the Senate led by Tom Daschle's Democrats.

Not so fast. While there are good reasons for federal terror insurance, there are even better ones for no federal safety net.

The good reasons are obvious. Damage from terror already has already cost big firms $40bn, quite a hit to the economy. And the costs are continuing to mount, even excluding terror insurance. Terror does not fit easily into actuarial tables, so companies have a hard time translating its cost into premia. When they do quantify terror's cost, it turns out to be really expensive. Too expensive, perhaps, for small businesses. So it is the fledgling firms, the one who may be the economy's next big leaders, who will suffer the most.

There are big terror costs and little terror costs - what of the costs to a firm that must shut down because the nation goes to Defcon 1 (but not, it turns out, nuclear war)? This is so called "business interruption" - costly. Then there is the problem that some states mandate coverage of uncoverable terror by barring insurers from writing in a standard clause that would exclude coverage of such incidents.

Additionally there is the general uncertainty argument: uncertainty is bad, and generates unnecessary panics. A government that is big and present - as Washington wants to be with its terror insurance - serves to calm things down and reduce needless costs. This is the same argument that says the Fed can rectify things by pumping a little extra liquidity into the system - or even merely announcing it is ready to pump - at moments like September 11, or in the near-panic over the Y2k computer bug in late 1999.

But the arguments against some form of federal safety net are also compelling. Federal insurance can be a sinkhole: just look at the history of deposit insurance. After it was increased, back in the 1980s, US savings and loans felt they had the license to do what they like - the classic example of moral hazard. So they started acting like chaebol bosses, investing in a whole lot of improbable projects that made sense only to their political cronies - and that only after four glasses. The result was a lot of empty shopping malls, the credit crunch and the savings and loan crisis of George Bush senior's presidency.

The White House argues its project is important because it would also contain elements of tort reform, limiting the liability of companies to the awful sort of suits terror targets are now beginning to file (see this week's news of the first such suit, filed against American airlines by the husband of a woman who was killed in the World Trade Centre bombing). Litigation after the downing of Pan Am's Flight 103 over Lockerbie actually killed off the airline. The loss of this great American brand was a tragedy all of its own, and didn't bring any of the passengers on that flight back to life either.

Still, the insurance component of the White House plan remains questionable. Along with the airline bailout, the energy bill, the larger military budget, and so on, does the US economy really need fresh exposure to waste and moral hazard courtesy of a government insurance fund? After all, the US already has nominated an agency to be responsible for reducing the cost of future terror attacks to US businesses, as well as returning the nation to peacetime stability. That agency is called the Defence Department.

© Copyright 2002 Financial Times