Saturday, September 12, 2009

Spend your weekend reading

Must read health care reform proposals: I haven’t had time to go through all of the details but this proposal by Senator Ron Wyden (linked to by David Brooks of the NY Times) may have some merits. That is, if the only option for reform is to tweak the current system.

The plan, known as the Healthy Americans Act, would:

  1. guarantee private health care coverage for all Americans and allow them to choose the health insurance that is right for them;
  2. provide health benefits equal to those that Members of Congress now enjoy;
  3. modernize the employer-employee relationship regarding health care benefits making health care portable from job to job and even allow Americans to keep it between jobs;
  4. provide incentives for individuals and insurers to focus on prevention, wellness and disease management rewarding Americans for maintaining healthy lifestyles;
  5. establish tough cost containment measures that save $1.48 trillion over 10 years;
  6. as demonstrated by the Congressional Budget Office, the plan would pay for itself once the act is up and running by eliminating administrative costs and changing the outdated tax code that gives businesses write-offs for even the most lavish designer health plans; and
  7. return surpluses to the government after the first two years of implementation.

However, after going through the absolutely must read article in the Atlantic entitled “How American Health Care Killed My Father,” I am not sure if any plan that just modifies the current system makes sense. If you read nothing else for the rest of the year, I suggest reading this article. It turns everything we know about health care delivery and payment for care on its head and asks the important question of why. Why do we get so much of our health care from hospitals? Would smaller, more efficient clinics be better? Why do so many people die from infections they receive in hospitals? Why is it that the hospitals can charge 6 figure bills to treat people for infections obtained while in the hospital? That’s kind of like an auto shop charging you (or your car insurance provider) for damage done while changing your oil.

Or, why do we even have insurance that pays for health care services? If you went to the grocery store, did your shopping, and then sent the bill to an insurance company (for which you paid only a deductible) you would not care at all about price. That’s precisely how we pay for non-catastrophic health care. No wonder routine services are so costly. The consumer never even looks at the actual price! In almost all other situations insurance is used to cover against unexpected or catastrophic events: life insurance, flood insurance, fire insurance, car insurance, etc. When it comes to these forms of insurance we do not pay premiums to cover routine services. Could that mean that it is the payment mechanism that prevents costs from going down?

And finally what about technology? Why does the price of health care technology continue to go up while the price of TVs, DVD players, and video game players continuously go down? Why is something akin to Moore’s Law and the associated drop in prices not applicable when it comes to health care devices? Maybe it’s because the receiver of the services does not pay for them. They pay the middle man or even worse, the government pays for the services. In either case the patient may never even look at the actual cost. That sure is a great way to keep down costs.

Look, I don’t know if all of the suggestions in the article will work. The author literally calls for what would amount to a revolution in health care that could take a full generation to play out. I know I disagree with some of his assumptions about the benefits of health care savings accounts. But, if you ever want to read an out of the box, but amazingly practical solution to our health care dilemma then spend the time on this article.

Goldman wants to profit from your death: I know the subject of securitizing life settlements has gotten a reasonable amount of press recently. But I had to highlight this article in the NY Times because something about bankers selling products in which investors make money when people die as soon as possible is just perfectly fitting. Some of the excerpts from the piece are absolutely precious, especially when taken out of context. I know this may sound sick and twisted but you have to admit that the irony is somewhat amusing and is so poignant given the recent actions of the Wall Street banksters:

The bankers plan to buy “life settlements,” life insurance policies that ill and elderly people sell for cash — $400,000 for a $1 million policy, say, depending on the life expectancy of the insured person. Then they plan to “securitize” these policies, in Wall Street jargon, by packaging hundreds or thousands together into bonds. They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.

The earlier the policyholder dies, the bigger the return — though if people live longer than expected, investors could get poor returns or even lose money.

Boy would I be afraid of Goldman owning an asset that paid off if I died prematurely. That would be like Helicopter Bernanke having a stake in a company that profited if the Fed created rampant inflation. Talk about skewed incentives for dubious actors.

Either way, Wall Street would profit by pocketing sizable fees for creating the bonds, reselling them and subsequently trading them. But some who have studied life settlements warn that insurers might have to raise premiums in the short term if they end up having to pay out more death claims than they had anticipated.

Indeed, what is good for Wall Street could be bad for the insurance industry, and perhaps for customers, too. That is because policyholders often let their life insurance lapse before they die, for a variety of reasons — their children grow up and no longer need the financial protection, or the premiums become too expensive. When that happens, the insurer does not have to make a payout.

But if a policy is purchased and packaged into a security, investors will keep paying the premiums that might have been abandoned; as a result, more policies will stay in force, ensuring more payouts over time and less money for the insurance companies.

As usual, the Wall Street players win due to the fee generation and Main Street could potentially lose as a result of higher premiums. Heads they win, tails we lose. How familiar does that sound?

Goldman Sachs has developed a tradable index of life settlements, enabling investors to bet on whether people will live longer than expected or die sooner than planned.

Somehow the vampire squid comparison doesn’t even do that passage justice. I’m sorry but after everything that has happened over the last 2 years the unintentional comedy of that statement is literally off the charts. But there has to be some benefit of all of this, right?

Defenders of life settlements argue that creating a market to allow the ill or elderly to sell their policies for cash is a public service. Insurance companies, they note, offer only a “cash surrender value,” typically at a small fraction of the death benefit, when a policyholder wants to cash out, even after paying large premiums for many years.

Enter life settlement companies. Depending on various factors, they will pay 20 to 200 percent more than the surrender value an insurer would pay.

But the industry has been plagued by fraud complaints. State insurance regulators, hamstrung by a patchwork of laws and regulations, have criticized life settlement brokers for coercing the ill and elderly to take out policies with the sole purpose of selling them back to the brokers, called “stranger-owned life insurance.”

The answer is a definite maybe. Sure, if all of the participants act in good faith and the regulators have the competency and resources to protect people, then everything will be fine. Just like Madoff’s investors. Or the millions of victims of predatory lending. Or the constantly manipulated equity markets.

Just when I thought this whole thing was going to create terrible conflicts of interests and possibly lead to nefarious activity, some silver lining appears. Need some diversification in your portfolio? Bet on the premature death of your fellow Americans!

Some academics who have studied life settlement securitization agree it is a good idea. One difference, they concur, is that death is not correlated to the rise and fall of stocks.

Can higher education tuitions grow to the sky: I have been highlighting the rising costs of higher education a lot recently. One of the more interesting arguments I have read concludes that the availability of student loans actually has driven up the price of attendance, similar to how easy mortgage credit drove housing prices up to an unsustainable level. But fear not. These are prestigious universities. There is an endless demand of students who can pay for their educations without the need for easy credit that will keep the bubble from popping. So, at no point will schools have to worry about a drop in demand that could potentially offset their everlasting pricing power. Not even the implosion of the private student lending business can stop these costs from growing right to the sky. My advice: beware of the argument that in this case things are different. I’m not saying fees will go down necessarily but the constant rise in prices likely cannot be sustained.

Tuition and fees at Harvard jumped 67.8 percent over the decade; at Princeton, they increased 43.4 percent.

That hasn’t dented demand. Freshman applications at Harvard in Cambridge, Massachusetts, rose by 60.9 percent over the last 10 years. At Princeton in New Jersey, which started accepting the Common Application standardized form for admission in 2005 (Harvard did so in 1994), demand rose by 47.7 percent.

The two Ivy League schools haven’t been entirely immune from the recession. Harvard this year reported that its endowment fell an estimated 30 percent; Princeton’s, 25 percent.

“They say trees can’t grow to the sky, but apparently there’s no stopping college tuitions,” said Jay Diamond, a managing director at Annaly Capital Management, a New York real estate investment trust with total assets of $86 billion, and member of Princeton class of 1986.

The reason the stock market continues to rally: Guess what? People think positive events are more likely to occur than negative outcomes. Now you can see why so many are willing to overlook the structural imbalances and imperiled financial institutions to pour money into stocks:

One of the most basic findings in behavioral economics is what’s called the “optimism bias,” also known as the “positivity” illusion.

The basic idea is that when people judge their chances of experiencing a good outcome–getting a great job or having a successful marriage, healthy kids, or financial security–they estimate their odds to be higher than average. But when they contemplate the probability that something bad will befall them (a heart attack, a divorce, a parking ticket), they estimate their odds to be lower than those of other people.

This optimism bias transcends gender, age, education, and nationality–although it seems to be correlated with the absence of depression.

Seriously, let’s give the Fed more things to potentially mishandle: This op-ed from the Wall Street Journal makes a simple argument about why the Fed should not have additional responsibilities. In short the author asserts that Fed has enough trouble focusing on price stability AND FULL EMPLOYMENT already.

But piling yet more responsibilities on the Fed raises the question of whether we are serious about discovering incipient systemic risk. If we are, then an agency outside of the Fed should be tasked with that responsibility. Tasking the Fed with that responsibility would bury it among many other inconsistent roles and give the agency incentives to ignore warning signals that an independent body would be likely to spot.

Unlike balancing its current competing assignments—price stability and promoting full employment—detecting systemic risk would require the Fed to see the subtle flaws in its own policies. Errors that are small at first could grow into major problems. It is simply too much to expect any human institution to step outside of itself and see the error of its ways when it can plausibly ignore those errors in the short run. If we are going to have a systemic-risk monitor, it should be an independent council of regulators.

It is one thing to set a thief to catch a thief—as President Franklin Delano Roosevelt is said to have done when he put Joe Kennedy in charge of the newly created Securities and Exchange Commission in the 1930s. But to set a thief to catch himself is quite a different matter.

Damned if they do, damned if they don’t: Hat tip to the King Report the link to this article from Bloomberg. Regardless of what you think of John Hempton’s fantastic multi-part analysis of Fannie and Freddie, the larger question is if these two entities could ever actually leave the government’s nest. The answer from the GAO is a resounding no:

“Credibly” privatizing Fannie Mae and Freddie Mac, the mortgage-finance companies seized by U.S. regulators last year, may be too difficult given the precedent set by the Treasury Department’s financial assistance, according to a Government Accountability Office analysis.

“The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency,” the GAO said in a report today from Washington. “Consequently, such privatized entities may continue to derive financial benefits, such as lowered borrowing costs, resulting from the markets’ perceptions.”

In other words, even if the government made an all out effort to distance itself from FNM and FRE, the market would still assume that in a crisis the US would bail them out. With all of the agency debt that our foreign creditors hold, this conclusion is not a surprise at all. Of course, the problem of moral hazard and too big to fail will persist and in the meantime FRE and FNM will benefit from lower borrowing costs than otherwise. Everyone is a big winner!

(Picture courtesy of