Howard Marks, Oaktree Capital — 2025-06-18
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Memos from Howard Marks 2025-06-18T07:00:00.0000000Z" pubdate title="Time posted: >6/18/2025 7:00:00 AM (UTC)">Jun 18, 2025
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Last September, I wrote a memo titled Shall We Repeal the Laws of Economics? in which I described economies as organic entities that operate on their own pursuant to some underlying laws. The best known is the law of supply and demand: in general, people will buy more of something as the price goes down and produce more of it as the price goes up. Another has to do with incentives: in general, people will allocate resources (such as their labor) to the activities for which they will be best rewarded. These and the rest of the rules are straightforward, and it doesn't take a Ph.D. to understand them. In fact, they're part of human nature.
But governments sometimes want outcomes different than those a free-functioning economy will produce. To that end, they enact rules and regulations designed to override the laws of economics. Some governments even go so far as to adopt socialism or communism, creating economies where government commands take over entirely from the laws of economics.
Rent Control
A prime example discussed in my September memo was rent control. When demand for apartments exceeds supply, it's only natural that rents will rise, perhaps eventually to the point where people who live in a given location can't afford to continue doing so. But elected officials typically want to preserve neighborhoods. They want their constituents to be able to continue renting apartments in their districts and not lose out to others who can pay more. To deliver on this aspect of constituent service, they pass laws to limit rent increases. Now people who otherwise couldn't afford to live in the jurisdiction can do so. Those tenants are happy, and that makes the elected officials happy, as happy constituents tend to vote for incumbents.
But not everyone is happy. Landlords are unhappy about not being able to charge the full rent they could charge in a free market, so they stop investing in their apartments and sometimes take them off the market. Developers who might be interested in building new apartments refrain from doing so out of concern that they won't be able to earn a sufficient return. Also unhappy are people who would like to live in that location and can afford to pay market rents but are unable to find vacant apartments because they're occupied by people paying below-market rents.
There are at least two things wrong with this situation. The first is that governments are choosing winners and losers, rather than letting market forces do so. In the case of rent control, the people who occupy apartments (and potentially political incumbents) are the winners, but landlords, developers, and people looking for apartments are the losers. The elected officials enacting rent control will say they're only trying to produce fairness for existing occupants, but they're obviously treating others unfairly.
In addition, there are negative implications for society overall. Tenants living in rent-controlled apartments enjoy a very valuable asset: a bargain-priced place to live. But there's no way to monetize that asset; they can only enjoy the benefit by continuing to live there. For this reason, they tend not to move, reducing mobility for themselves and everyone else. Rent control also discourages the upgrading of existing apartments and the construction of new apartments, so the housing stock fails to keep up with the needs of the community in terms of both condition and quantity. In other words, governments can limit the rents landlords can charge for their apartments, but they can't make developers build new ones. These things can reduce overall societal welfare and interfere with the movement of resources to the use where they're most productive.
Fire Insurance in California
Most unfortunately, earlier this year, in the aftermath of the Southern California wildfires, we witnessed an extreme economic consequence of overriding the laws of economics. When fires decimated the communities of Pacific Palisades and Altadena, thousands lost their homes, including a dozen Oaktree employees. On top of the severe disruption of all aspects of their lives, many of them are suffering extremely negative financial consequences. This is because many were uninsured or underinsured, often as a result of actions taken by California insurance regulators.
Most of California's government is firmly under the control of the Democratic party, which generally leans toward a high level of activism in general and intervention in economic matters in particular. Notably, because the Democrats hold a super-majority in the state legislature and have little fear of potential Republican opponents, Democratic elected officials don't have to moderate their behavior to pass legislation or hold on to their seats. And just like the support for rent control – there's a lot of that in California, too – the government sought to help out homeowners by limiting the premiums companies could charge for fire insurance.
In a sign of the times, I'll let my new (and AI-powered) editorial assistant, Perplexity, fill you in on the background. I've simplified the format and added emphasis, but I haven't changed a word. What follows below is pretty close to what I would have produced in an hour or two:
Before the devastating fires of 2025, California's fire insurance market was already in a state of crisis, shaped by a combination of regulatory constraints, insurer withdrawals, and mounting wildfire risk.
Insurers were prohibited from using forward-looking catastrophe models to set rates for wildfire risk. Instead, they were required by law to base their rates on historical average losses over the previous 20 years. This approach became increasingly problematic as wildfires grew more frequent and severe, making historical data a poor predictor of future risk. Regulations also prevented insurers from raising premiums to reflect increased reinsurance costs, further limiting their ability to price policies according to actual risk.
Major insurers began withdrawing from the California market or ceasing to write new policies in fire-prone areas. Chubb stopped writing new policies for high-value homes in 2021, Allstate followed in 2022, and State Farm, the state's largest home insurer, stopped writing new policies in 2023. In 2024, State Farm announced non-renewals for over 70,000 policies statewide, including thousands in high-risk areas like Pacific Palisades and Altadena, just months before the 2025 fires. Other insurers, including Tokio Marine America and its subsidiaries, also exited the market in 2024.
Homeowners who managed to keep their policies often faced dramatic premium hikes. For example, some saw their annual premiums rise from $4,500 to $18,000. As a result, many property owners either lost coverage or could not afford to insure their properties, leading to widespread underinsurance. By the time of the 2025 fires, fewer than a quarter of affected properties were insured against fire.
The state-backed FAIR Plan, intended as a last-resort insurance option, saw a surge in enrollment as private insurers withdrew. However, FAIR Plan coverage is limited and more expensive than private insurance, often requiring supplemental policies to achieve adequate protection. The FAIR Plan's exposure to wildfire risk increased dramatically, raising concerns about its solvency in the event of a