Posts Tagged ‘Wall Street’

Volker’s Paradox

Wednesday, April 28th, 2010

In response to long-time commenter John Rose who asked for a link to some tangible data proving that profits for financial firms have increased markedly since deregulation began:

From the same paper as the above chart, comes the observation which prompted my post on how Wall Street’s enormous profits are evidence of a poorly functioning market:

In 1997, former Federal Reserve Board Chairman Paul Volker posed a question about the commercial banking system he said he could not answer. The industry was under more intense competitive pressure than at any time in living memory, Volcker noted, “yet at the same time, the industry never has been so profitable.” I refer to the seemingly strange coexistence of intense competition and historically high profit rates in commercial banking as Volcker’s Paradox.

Deregulation of the economy in general began in earnest under Jimmy Carter — but it wasn’t until the 1980s that the deregulation of the financial industry began to gain steam under Ronald Reagan. Then of course, in 1999 came the (in)famous Gramm-Leachley Act which seems to precede the sharpest rise in real profits of the financial sector.

[Chart from this paper by James Grotty (pdf) published by PERI.]

Wall Street’s enormous profits are evidence of a poorly functioning market (cont.)

Wednesday, April 21st, 2010

This is something that really needs to get more attention. William Cohan in the New York Times:

The easiest and most profitable risk-adjusted trade available for the banks is to borrow billions from the Fed — at a cost of around half a percentage point — and then to lend the money back to the U.S. Treasury at yields of around 3 percent, or higher, a moment later. The imbedded profit — of some 2.5 percentage points — is an outright and ongoing gift from American taxpayers to Wall Street.

H/t Ezra Klein.

I also came across this from James Kwak at the Baseline Scenario:

[I]f you see a company that has very high profits over a sustained period, there are two possibilities: either it is benefiting from a non-competitive market (e.g., it is a monopoly), or it is simply exceptional at innovating and staying ahead of the competition for years on end. If you see a whole industry that has sustained high profits, however, the latter explanation cannot hold, and you should immediately suspect a lack of competition.

[T]he thing that we should celebrate is not high profits, but competition. The pursuit of high profits is what motivates competition; but if a whole industry achieves high profits, then what you are seeing is not competition, but its opposite.

Must-Reads of the Week: Google/China, Liberal American Exceptionalism, The Failed War on Drugs, Defending the Individual Mandate, Counter Counter-Insurgency, Idiocrats, and Men Did It!

Friday, March 26th, 2010

1. Google v. China. I’ve refrained from posting on the Google v. China battle going on until now. So much of the praise for Google’s decision seemed overblown and I wasn’t sure what insight I had to offer, even as I read everything on the matter I could. But now, the wave of criticism of the company is pissing me off. I get the source of the criticism – that Google is so quickly criticizing other companies for staying in China after it left, and that Google’s partial exit may have made business as well as moral sense.  But motives are new pure – we’re human. Those who the critics accuse the company of merely using as a pretext for a business decision see the matter in other terms – according to Emily Parker of the Wall Street Journal, “Chinese twitterverse is alight with words like ‘justice’ and ‘courageous’ and ‘milestone’ “ and condolence flowers and cups being sent to Google’s offices in China.

What the Google/China conflict highlights though is the strategic incompatibility of a tech company like Google and an authoritarian state like China. One of James Fallows’ readers explains why Google and China could never get along:

Internet search and analytics companies today have more access to high quality, real-time information about people, places and events, and more ability to filter, aggregate, and analyze it than any government agency, anywhere ever.  Maybe the NSA can encrypt it better and process it faster but it lacks ability to collect the high value data – the stuff that satellites can’t see.  The things people think but don’t say.  The things people do but don’t say.  All documented in excruciating detail, each event tagged with location, precise time.  Every word you type, every click you make (how many sites do you visit have google ads, or analytics?), Google is watching you – and learning.  It’s their business to.  This fact has yet to sink in on the general public in the US, but it has not gone un-noticed by the Chinese government.

The Chinese government wants unfettered access to all of that information.  Google, defending its long-term brand equity, cannot give its data to the Chinese government.  Baidu, on the other hand, would and does…

The reader goes on to explain how China would slow down and otherwise disrupt Google services in China enough to ensure that Baidu would keep it’s dominant position. This, he explains is:

…just another example of the PRC’s brilliant take on authoritarian government: you don’t need total control, you just need effective control. [my emphasis]

Which is why it is so important that a country like China have constant access to search engine data. In a passage deleted at some point in the editing process from a New York Times story (which an internal Times search reveals to be this one), it was reported that:

One Western official who spoke on condition of anonymity said that China now speaks of Internet freedom in the context of one of its “core interests” — issues of sovereignty on which Beijing will brook no intervention. The most commonly cited core issues are Taiwan and Tibet. The addition of Internet freedom is an indication that the issue has taken on nationalistic overtones.

2. Liberal American Exceptionalism. Damon Linker of The New Republic responds to critics:

[T]he most distinctive and admirable of all [America's] qualities is our liberalism. Now let me be clear: unlike Lowry and Ponnuru, who identify American exceptionalism with the laissez-faire capitalism favored by the libertarian wing of the Republican Party, I do not mean to equate the ideology that dominates one of our country’s political parties with the nation’s exemplary essence. On the contrary, the liberalism I have singled out is embraced by nearly every member of both of our political parties—and indeed by nearly every American citizen. Liberalism in this sense is a form of government—one in which political rule is mediated by a series of institutions that seek to limit the powers of the state and maximize individual freedom: constitutional government, an independent judiciary, multiparty elections, universal suffrage, a free press, civilian control of the military and police, a large middle class, a developed consumer economy, and rights to free assembly and worship. To be a liberal in this primary sense is to favor a political order with these institutions and to abide by the political rules they establish.

3. The War on Drugs Is Doomed. Mary Anastacia O’Grady of the Wall Street Journal echoes me saying: The War on Drugs is Doomed. (My previous posts on this topic here, here, here, here, here, here, here, here, here, here, here, here, and here.)

4. Defending the Individual Mandate. Ezra Klein explains why the individual mandate is actually a really good deal for American citizens:

The irony of the mandate is that it’s been presented as a terribly onerous tax on decent, hardworking people who don’t want to purchase insurance. In reality, it’s the best deal in the bill: A cynical consumer would be smart to pay the modest penalty rather than pay thousands of dollars a year for insurance. In the current system, that’s a bad idea because insurers won’t let them buy insurance if they get sick later. In the reformed system, there’s no consequence for that behavior. You could pay the penalty for five years and then buy insurance the day you felt a lump.

Klein also had this near-perfect post on our unhinged debate on health care reform and added his take to the projections of Matt Yglesias, Ross Douthat, Tyler Cowen on how health care law will evolve in the aftermath of this legislation.

5. Counter-Counter-Insurgency. Marc Lynch describes a document he recently unearthed which he calls AQ-Iraq’s Counter Counter-insurgency plan. Lynch describes the document as “pragmatic and analytical rather than bombastic, surprisingly frank about what went wrong, and alarmingly creative about the Iraqi jihad’s way forward.”

6. Idiocrats Won’t Change. Brendan Nyhan counters a point I (along with many other supporters of the health care bill) have been making (here and here for example) – that once the bill passes, the misperceptions about it will be corrected by reality. I fear he may be right, but I believe it will change opinions on the margins soon and more so over time.

7. Theories of the Financial Crisis: Men Did It. Sheelah Kolhatkar looks at one theory of the financial crisis some experts have been pushing: testosterone and men.

Another study Dreber has in the works will look at the effects of the hormones in the birth-control pill on women, because women having their periods have been shown to act more like men in terms of risk-taking behavior. “When I present that in seminars, I say men are like women menstruating,” she says, laughing…

Positioning himself as a sort of endocrine whisperer of the financial system, Coates argues that if women made up 50 percent of the financial world, “I don’t think you’d see the volatile swings that we’re seeing.” Bubbles, he believes, may be “a male phenomenon.”

His colleague, neuroscientist Joe Herbert, agrees. “The banking crisis was caused by doing what no society ever allows, permitting young males to behave in an unregulated way,” he says. “Anyone who studied neurobiology would have predicted disaster.”

A very interesting thesis. And one that strikes me as broadly true. I previously explored other theories of what caused the financial crisis:

[Image by me.]

Rothkopfian Aphorisms

Monday, November 2nd, 2009

Although the conventional wisdom holds that blogging and the internet is leading us to become cretins who cannot compose full sentences (lest they run longer than 140 characters), there is reason for hope. And not just because Twitter and Wordpress have made more prolific writers out of all of us. I have never read the news as intensely as I have this past years, so I cannot judge from even the limited perspective of my life, but there is some great prose written on blogs. I’ve found though, that when reading on a computer screen, I “read/skim” and don’t notice the finer sentences as I jump about the piece searching for the most interesting bits. However, I have taken to printing out substantial entries from blogs, and found much of the writing is in fact quite good.

One of the writers who has consistently drawn my attention with his witty aphorisms is David Rothkopf. His blog is well worth reading, for the insight, yes – but also for the wit.

On diplomacy:

In marriage, a lack of intimacy usually means you are not getting fucked… but in diplomacy, it means you almost certainly will be.

On the advantages America has over most other potential great powers:

We’re also protected by two great oceans and our neighbors are fairly easy to get along with. (Mexico is a bit of a concern at the moment but Canada lost its last remaining offensive capability when Wayne Gretzky moved to the United States.)

On Venezuela’s announcement of a nuclear program:

I’ve been predicting this problem for so long that it gives me a little lift even if it is a potential calamity for millions of others. Take note: that’s what narcissism makes possible.

On Eliot Spitzer’s desire for publicity:

The A.I.G. scandal and the collapse of Wall Street could have been [Spitzer's] apotheosis, the moment the howling dogs of ambition in his breast might have finally gotten enough red meat of press exposure.

On the mania of the government for ensuring constant economic growth, specifically of GDP growth:

Didn’t our founders specify that the purpose of our country was to guarantee the right of all of us (well, white men anyway) to life, liberty, and the pursuit of constant growth in “the total market values of goods and services produced by workers and capital within a nation’s borders during a given period (usually 1 year).”

Commenting on GQ’s “50 Most Powerful People in Washington” edition:

If you follow Washington without losing your appetite, you’re not paying attention.

On the relationship between capitalism and Wall Street:

Because 21st Century Wall Street is to capitalism as Pope Alexander VI was to the teachings of Jesus Christ. There was a connection but it was remote and observed more in the breach than in the honoring of the essentially good underlying ideas.

On why Wall Street will finally be reformed:

Personally, I think they miscalculate. They finally may be undone by their greed. Except it won’t be because they stole too much or blew up the international economy. It’ll be because they stopped paying off the people who set the rules. And nothing puts a politician back in touch with his principles like a failure to keep up payments by the banker to whom he has mortgaged them.

Describing the dust-up between Kim Jong Il and Hillary Clintons:

No doubt drawing on his extensive training in rhetoric and stand-up comedy at the University of Malta (training ground for all of Malta’s best comics), Kim fired back with the tell-tale wit that once had him referred to as “the anti-factionalist Oscar Wilde of Baekdu Mountain” until someone discovered who Oscar Wilde was and the guy who invented the nickname was dropped out of a Russian helicopter into the Amnok River. (Wilde, meanwhile, might have called North Korean official efforts at humor “the unspeakable in pursuit of the unattainable.”)

Comparing America’s hegemony with Microsoft’s monopoly:

In the mid-90s, America and Microsoft were clearly the future of the world. Then both started to abuse their power. America, in the wake of 9/11, undercut the international system it built, rhetorically flaunted its hallowed values and then crudely and repeatedly undercut them in its behaviors. Microsoft went from a symbol of the garage-launched entrepreneurial energy of the tech revolution to being a ruthless crusher of competitors. In fact, it became so dominant, that it felt it could foist on the American public products that didn’t work, were full of bugs, were vulnerable to security breaches and, as in the case of Vista, should never have been released in the first place.

Defining the foreign policy precept, the law of the prior incident:

A reason for the swift action on Honduras is that old faithful of U.S. foreign policy: the law of the prior incident. This law states that whatever we did wrong (or took heat for) during a preceding event we will try to correct in the next one … regardless of whether or not the correction is appropriate. A particularly infamous instance of this was trying to avoid the on-the-ground disasters of the Somalia campaign by deciding not to intervene in Rwanda. Often this can mean tough with China on pirated t-shirts today, easy with them on WMD proliferation tomorrow, which is not a good thing. In any event, in this instance it produced: too slow on Iran yesterday, hair-trigger on Honduras today.

I had also accidentally included this Paul Krugman quote in the mix of Rothkopfian aphorisms – because it seemed so like something he’d say. Only on searching for the quote did I find its true author, but I’ll include it here anyway:

Serious Person Syndrome, aka it’s better to have been conventionally wrong than unconventionally right.

[Image adapted from a photograph by the New America Foundation licensed under Creative Commons.]

Our Wall-Street Run Health Care

Friday, July 24th, 2009


There are quite a few ways to explain what is causing our health care and health insurance costs to skyrocket, but in terms of crude political terms, there are really only two possibilities: either health care costs are skyrocketing because the government is involved in a major way – with Medicare, Medicaid, the prescription drug benefit, the subsidy for employer-based coverage, etc.; or the market for health care and health insurance is inefficient independent of government interference.

I don’t have the expertise to resolve the issue – but to me it is telling that the costs of health care and health insurance began to rise exponentially not shortly after Medicare and Medicaid were begun, but during the early years of the Reagan administration with his derogatory fervor. Then the medical loss ratio began to decrease – as health insurance companies began to squeeze as much profit as they could from their businesses. In other words, the prices for health care and health insurance began to rise precipitously as Wall Street began to take a more assertive role in running the economy including health insurance. At the same time, the costs of government insurance has risen slower than that of private insurance companies.

Economists long ago discovered that health care markets are not efficient on their own – as most individuals do not treat health care as a typical service. Rather if people have a choice, they avoid using the service until they absolutely need it – and then are willing to pay whatever is necessary to get better. This also is demonstrated by the fact that despite the fact that America spends far more on health insurance than nations with similar health care systems, statistics show our overall level of care is generally lower than in these countries (fewer doctors per patient; a lower life expectancy; etcetera). At the same time, most individuals treat some level of health care as a right. Even right-wingers – as they decry the attempts to make health care a right in America – implicitly treat it as one when they tell the anecdotes about the 21-year old alcoholic who was denied a liver transplant under Britain’s system because the bureaucracy in place required him to prove he would not endanger his new liver. But unless getting medical treatment to extend this young man’s life is a right, why would anyone be outraged over it?

Because of these various factors, health care operates as an inefficient market as demand does not appreciably respond to changes in price. This helps explain how the health insurance industry began to fall under the sway of Wall Street and take on the telltale characteristics of a Wall Street-run corporation that exists primarily to generate exorbitant profits instead of to provide a service or product. When Wall Street focuses on an indursty, there follows certain predictable steps:

  • as a precondition, there needs to be a market inefficiency that Wall Street can exploit; for example, the inflexibility of demand for a product or service allows the creation of a rapidly inflating bubble in costs;
  • the pay of top corporation executives rises exponentially above that of most employees;
  • increasingly, these executives began to make decisions that benefit their shareholders in the short-term so as to maximize their paychecks and keep their jobs;
  • the product or service is degraded as corporations turn their focus to creating mass short-term profits;
  • the inefficiences present initially are exacerbated;
  • most important, many major risks and costs are deliberately externalized to the public so as to maximize private profits;
  • at some point, this becomes unsustainable and the bubble bursts.

This is exactly what we saw in Exxon’s massive profits during the surge in oil prices in 2008; and it is very similar to what we saw in the housing market; and it is also clearly what we have seen with health care in America for the past twenty to thirty years as the inflation in health care costs far outpaced all else.

I actually don’t like the idea of blaming everything on Wall Street – but the telltale signs are here:

  • health care demand is generally inflexible, although when costs are paid can be shifted as most people see health care as a right and medical facilities and doctors swear an oath to provide care to everyone;
  • health insurance companies – rather than maintaining their large dollar profits as prices skyrocketed in the 1980s and 1990s instead began to increase their percentage of the profit – as a Wall Street-run company always does, thus exacerbating the inefficiencies already present;
  • rather than seeking to reduce the costs of care while providing the best service possible, they sought to exclude as many sick individuals as possible and to cancel coverage for as many individuals who got sick as possible and to use other means of artificially lowering their costs without lowering the price of their service;
  • by refusing to pay for so many sick individuals, many of these costs are externalized to the public; by refusing to cover those who have preexisting conditions – and thus those who are more likely to need to use health care resources – the costs of taking care of these individuals is put upon hospitals and the public; while doing all of this, the insurance industry sought greater and greater government subsidies.

The toxic effect of this inflating cost bubble coupled with the attempts to externalize as many costs as possible have created the twin problems of a growing number of uninsured Americans and rapidly growing federal deficit fueled almost entirely by health care costs.

This is the status quo that we need to change. As Steven Pearlstein explained:

Among the range of options for health-care reform, there’s one that is sure to raise your taxes, increase your out-of-pocket medical expenses, swell the federal deficit, leave more Americans without insurance and guarantee that wages will remain stagnant.

That’s the option of doing nothing…

Doing nothing means leaving our Wall Street-run health care in place; and while right-wing critics focus on the specter of rationing by government bureaucrats and government bureaucrats in between you and your doctor and complain about the complex system the Democrats are proposing – they fail to acknowledge that this Wall Street-run health care rations care by cost and interjects bureaucrats reporting to CEOs imbued with the culture and ethos of Wall Street as they attempt to exploit every inefficiency in our current extremely complex system as much as possible, externalizing as much cost to the public as they can.

If the problem with our current system is not that the government is too involved – as right-wingers assert – but that the market is inefficient in providing health care – and that these inefficiencies are being exploited by Wall Street-run health insurance companies – and if with the economy still fragile from the bursting of the bubble in home prices and with radical changes not feasible or desired – then you turn to the various plans that the Obama administration and Democratic Congress are looking at which attempt to introduce various processes and incentives that will gradually shape the health care system into a more rational market – creating regulated markets for individuals to buy health insurance; eliminating abusive practices that artificially decrease medical costs for insurance companies; creating a public option to compete with these private companies; empowering an independent body (MedPAC) to regulate Medicare prices and practices; creating a body to look at and disseminate information on the comparative effectiveness of treatments and medicines.

It’s clear that our Wall Street-run health care industry isn’t working. More of the same – more deregulation as the Republicans propose – isn’t going to fix this problem. We need change. We need to take back our health care from Wall Street and make it responsive to consumers again. Our system won’t be perfect – and it won’t happen overnight – but the Democrats are clearly working to reform this system. The Republicans are merely seeking to obstruct.

Theories of the Financial Crisis: Hubris of the Bankers

Wednesday, July 15th, 2009

No list of theories of causes of the financial crisis that almost destroyed the fabric of the world economy (as opposed to the slow-motion disaster unfolding now) would be complete without listing hubris, that most Greek-mythical of faults.

Hubris clearly isn’t the only reason. There was greed – we all know that. There were various incentives that distorted the system as a whole. There was an enormous imbalance between East Asian countries and America that assisted in producing unmooring our financial industry. There was government intervention. There was a shift in the animal spirits. There was a profound miscalculation of risk. There were assets bubbles, Goldman Sachs, deregulation, new financial instruments, and a subservience of politics to finance.

But how can one explain how far out on this limb all of these venerable institutions went – how they thought they would be able to leverage themselves 33 to 1 – how they took on so much risk they almost brought down the financial system built over centuries in a week. Bankers didn’t take to calling themselves “Masters of the Universe” because they were being ironic. No – at the heart of this crisis – and reasserting itself now as they try to restore “normalcy” to their profession – was hubris.

Michael Lewis – who worked on Wall Street as a young man – described this hubris brilliantly in an essay published in the immediate aftermath of the financial collapse for Portfolio. He described how countless warning signs were ignored – because the money and the success had gone to the heads of these titans of Wall Street. (He steers away from the more high profile Cassandras from Nassim Nicholas Taleb to Nouriel Roubini to Brooksley Born.) After all, how had they gotten so much money if they didn’t know what they were doing? Lewis, unable to make that “logical” leap himself, had left Wall Street in the late 1980s, expecting the whole house of cards to fall at any moment:

To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital—to decide who should get it and who should not. Believe me when I tell you that I hadn’t the first clue…

In [the past two decades], I had been waiting for the end of Wall Street. The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management: Over and over again, the big Wall Street investment banks would be, in some narrow way, discredited. Yet they just kept on growing, along with the sums of money that they doled out to 26-year-olds to perform tasks of no obvious social utility. The rebellion by American youth against the money culture never happened. Why bother to overturn your parents’ world when you can buy it, slice it up into tranches, and sell off the pieces?

At some point, I gave up waiting for the end. There was no scandal or reversal, I assumed, that could sink the system.

Michael Osninski – who wrote programs creating derivatives – explained his rationalization for why he was able to make so much money:

[E]ven then, I was wondering why I was making more than anyone in my family, maybe as much as all my siblings combined. Hey, I had higher SAT scores. I could do all the arithmetic in my head. I was very good at programming a computer. And that computer, with my software, touched billions of dollars of the firm’s money. Every week. That justified it. When you’re close to the money, you get the first cut. Oyster farmers eat lots of oysters, don’t they?

Everyone seeks to claim credit for the successes that they benefit from – so, as the money flowed into Wall Street and all together people who didn’t quite understand what they were doing worked together and together inflated the prices of assets they didn’t know enough about to value – everyone got rich.

Contributing to this sense of unreality – and this hubris – was the culture that grew up around these people. They learned how to manipulate the programs written by the lowly programmers that created derivratives and other complex assets – and created a language that was opaque to those outside the club – of super senior risk, of CDS, CMS, and sundry other financial products. They sealed off their world from outside inspection, blocked regulation at every turn – and came to believe they understood the system. Though many must have understood their ignorance going in – as Lewis did – their success washed away their concerns. A gambler doesn’t need to know how roulette works if everyone who is playing the game is winning.

But hubris always leads to a downfall – and so, in the fall of 2008 2009, the house of cards created by these “Masters of the Universe” collapsed – and with it, the life savings of millions who trusted the brash bankers.

In the end it seems, no rational analysis or argumentation could convince these titans of Wall Street that their success was based on luck rather than knowledge or skill. And they ignored or marginalized who demonstrated otherwise – until it was too late. Too many seemed to have believed their own hype. It was as if they truly thought they were “Masters of the Universe.”

And now that the financial system has gotten back on its feet – and as the rest of the economy is still suffering – this hubris, which seemed to have fallen with the stock market, has reinflated. As a top Goldman Sachs official said commenting on the high levels of risk the firm was taking on – and the best-ever profits they were generating from that:

Our model really never changed, we’ve said very consistently that our business model remained the same.

The near-collapse of the financial industry is apparently no match for the hubris of bankers.

(more…)

The Medical Loss Ratio

Tuesday, July 14th, 2009

In most industries, when a customer pays for something – and then asks to get what they paid for – it’s not considered a big deal. It’s the basic transaction that the business engages in. The health insurance industry works differently. You make regular payments so that the insurance company will pay your irregular medical bills and so that they will protect against the possibility that you will be one of the unlucky few who has some serious condition which requires extensive medical treatment. Most people aren’t – and so they just give over money regularly and receive very little in return. But a few people end up needing serious medical care. That’s the purpose of insurance – to distribute the risks and costs more evenly. This is what it was designed to do – this is why people buy it – it is what they are paying for. But the health insurance industry sees their role differently. They’re in it to make as much money as possible – not to provide a service for a fee and make a profit from this. Thus, when anyone who has duly paid for health insurance for years makes a claim for a condition that requires serious and expensive medical treatment, they try to find every possible basis to deny and revoke their coverage. It would be as if – after I had paid for a soda – the store then tried to deny me the right to open the soda and leave the store.

Obama’s attempt to reform health care is partly about reforming the way we provide care (with electronic records, comparative effectiveness studies, etc.) – but it is mainly the way in which we provide health care insurance. In this fight, there is one statistic we have not heard enough about but which critics of the current system should bring up whenever they can: the medical loss ratio. This statistic describes the percentage of dollars that a health insurance company takes in from its premiums that it uses to actually pay for medical services. For example, back in the 1990s – when the health care insurance industry was quite profitable – the figure was generally in the mid-90s. In other words, about 95% of all dollars collected in premiums were used to pay for medical services. Since then, structural changes in the health insurance industry have led it to focus more on profits – as a Wall Street mentality took hold. Since the 1990s, the medical loss ratio has dropped significantly. Today it is in the mid 70s to low 80s – meaning $20 to $30 of every $100 paid in insurance premiums is not used to provide the services paid for. These profits – and the quest to increase such profits – has led to the health insurance industry becoming more like a Wall Street financial firm – with massive bonuses to its top executives and large dividends to shareholders as they skim greater profits from a rising bubble in the field in which it operates in. Our health insurance system is run by Wall Street tycoons.

How does this affect the quality of the service that health insurance companies provide? It forces them to reduce their medical loss ratio as much as possible. Wendell Potter, a former executive at CIGNA, explains several ways:

Rescission is one thing. Denying claims is another. Being, you know, really careful as they review claims, particularly for things like liver transplants, to make sure, from their point of view, that it really is medically necessary and not experimental. That’s one thing. And that was that issue in the Nataline Sarkisyan case.

But another way is to purge employer accounts, that – if a small business has an employee, for example, who suddenly has have a lot of treatment, or is in an accident. And medical bills are piling up, and this employee is filing claims with the insurance company. That’ll be noticed by the insurance company.

And when that business is up for renewal, and it typically is up, once a year, up for renewal, the underwriters will look at that. And they’ll say, “We need to jack up the rates here, because the experience was,” when I say experience, the claim experience, the number of claims filed was more than we anticipated. So we need to jack up the price. Jack up the premiums. Often they’ll do this, knowing that the employer will have no alternative but to leave. And that happens all the time.

They’ll resort to things like the rescissions that we saw earlier. Or dumping, actually dumping employer groups from the rolls. So the more of my premium that goes to my health claims, pays for my medical coverage, the less money the company makes.

The health insurance industry uses any possible reason to revoke coverage that an individual has been paying for as soon as they actually need the service they have paid for – for example, they will point to some minor preexisting condition that was not disclosed when they agreed to provide the insurance as an excuse to cancel coverage. Robin Beaton of Texas had her policy revoked as her doctors were scheduling her double mastectomy for her breast cancer because she had failed to disclose to her insurance company that she had the pre existing condition of acne and a rapid heartbeat.

So – essentially, these organizations accept contracts to provide health insurance in the event someone needs it. But as soon as a significant claim is made, they try to find a reason to deny it. And the executives at these companies have refused to say that they will not continue these practices.

Our system of health insurance has created a Wall Street-run health care business. For all the worry Republicans are trying to gin up about government bureaucrats reporting to Congress or the White House being in between you and your doctor – what we have now is a system where faceless corporate bureaucrats are making medical decisions reporting to Wall Street tycoons. Like the Wall Street firms, health insurance companies have driven up prices exponentially, creating a bubble; the CEOs take enormous salaries; they are accepting money for insurance from anyone, but will look for any way out of any of their commitments if they can get away with it. In normal businesses, profits are the primary side-effect of providing a product or service; in a Wall Street style corporation, profits are the sole and only goal – with the product or service they are selling merely a means to this end. This is what our health insurance industry has become.

This is the royally fucked system we have today. This isn’t the only issue health care reform needs to address – but it is a major one.

(more…)

Theories of the Financial Crisis: Greed

Thursday, May 21st, 2009

George Will may seek to defend greed (Or maybe not – it’s actually kind of hard to tell.) – along with Ayn Rand and other market fundamentalists.

But just about everyone else lists it as a fundamental cause of the financial crisis. Will tries to make the case that free markets punish greed. But what Will presumes is that an unregulated market is a free market – and on this fundamental point he is wrong. The market Will describes is not one heavily regulated by the government – but it is regulated by ebay which in this instance takes on the role of the government for this small market. The financial markets on Wall Street though were largely unregulated – especially the shadow banking system (which was created in such a way as to be unregulated) – and they were in this sense free from government interference. But they were controlled by a small number of individuals – and in this sense were part of a world where freedom was available only to a princely few. Will makes the point that greed is an immutable human characteristic – and thus does not account for the booms and busts of our business cycle (and of financial crises such as this.) But what does is the combination of perverse incentives for short-term profit (indeed a form of legal fraud), a relaxation of the regulations designed to keep the markets stable that tends to occur when Republicans have power, and greed.

There has always been an historical wariness in America about the combination of greed and concentrations of wealth – focusing on a national bank, on various financiers, on “the malefactors of great wealth” and indeed, on Wall Street. The people, in their wisdom, could see that this concentration of financial power undermined the democratic distribution of political power. But by the 1980s, there was an additional reason to be wary – as Ronald Reagan unleashed a money revolution. This money revolution – like all revolutions – was the commingling of many forces – globalization, the ad-hoc Bretton Woods II agreement, and the relaxation of regulations and reduction of taxes. This revolution helped to concentrate an increasing percentage of the world’s wealth in the hands of a small number of Wall Street (and also London) bankers. The function of these bankers – their expertise – was to balance risk and profit to their customers’ satisfaction – to maximize profit for themselves and their customers while minimizing (or controlling for) risks. As a small percentage of individuals accumulated more and more wealth around the world, these individuals entrusted more and more of this wealth to Wall Street bankers – and the more money the bankers controlled, the bigger their cut. As Michael Osinski explained in a piece for New York magazine:

When you’re close to the money, you get the first cut. Oyster farmers eat lots of oysters, don’t they?

This closeness to the money created an easy money culture – in which enormous sums money were distributed whether they was deserved or not and the culture began to prize attempts to satisfy the bottomless desire that is greed. Wall Street bankers took on the culture of gamblers – except with the market going up, everyone made money. The long boom began to create perverse incentives – as risks began to seem safer, as luck and a rising tide and short term profits made everyone seem like geniuses, they all became accustomed to a certain lifestyle. Financial innovations sought to overturn many of “the fundamental rules of banking” including “that default risk is an inevitable liability of the business.” The combination of innovation and the culture of greed and gambling led to greater and greater risks being taken.

As steady foundations of banking – both as a business and as a culture deteriorated – and as the cautionary tales of Oliver Stone’s Wall Street and Liar’s Poker morphed into guides – a new culture of excess developed – excessive greed, excessive pay, excessive drinking, excessive spending, excessive personal risks, and eventually excessive professional risks. Wall Street bankers began to betray all the symptoms of the easy money culture – like gamblers whose knew their earnings were ephemeral and that every up would be followed by a down to be followed by an up – as long as they could stay at the table. But as Matt Taibbi wrote,  ”this was a casino unique among all casinos, one where middle-class taxpayers cover the bets of billionaires…”

Osinski tells a story of how this easy money culture affected the individuals:

Now that I was spending more time on the floor, I wondered why the men’s room always stank. Then one afternoon at three, when I was in there taking a leak, I discovered the hideous truth. Traders had a contest. Coming in at eight, they never left their desks all day, eating and drinking while working. Then, at three o’clock, they marched into the men’s room and stood at the wall opposite the urinals. Dropping their pants, they bet $100 on who could train his stream the longest on the urinals across the lavatory. As their hydraulic pressure waned, the three traders waddled, pants at their ankles, across the floor, desperately trying to keep their pee on target. This is what $2 million of bonus can do to grown men.

This easy money culture warped the incentives at Wall Street firms as well – as they were structured in such a way as to generously reward short-term success (without controlling sufficiently for long-term failure.) Rather than being paid large salaries, most of a banker’s income was handed out in enormous bonuses based on yearly performance. As long as fees were generated, as long as this quarter’s profits were growing – bankers would be rewarded with enough profits to last a lifetime. This alone is enough of an incentive to cause massive fraud. But at the same time, the culture of Wall Street ensured that money would be spent ridiculously, ostentatiously, and quickly. 

Perhaps no one has been more articulate in his visceral disgust for the excesses of Wall Street than Matt Taibbi of Rolling Stone

[I]t’s time to admit it: We’re fools, protagonists in a kind of gruesome comedy about the marriage of greed and stupidity. And the worst part about it is that we’re still in denial – we still think this is some kind of unfortunate accident, not something that was created by the group of psychopaths on Wall Street whom we allowed to gang-rape the American Dream.

The story of AIG – in its way – symbolizes better than anything else what this culture did to Wall Street. Back to Taibbi:

AIG is what happens when short, bald managers of otherwise boring financial bureaucracies start seeing Brad Pitt in the mirror. This is a company that built a giant fortune across more than a century by betting on safety-conscious policyholders – people who wear seat belts and build houses on high ground – and then blew it all in a year or two by turning their entire balance sheet over to a guy who acted like making huge bets with other people’s money would make his dick bigger.

A culture of greed and excess – a lack of respect for tradition – a market free only to a princely few – negligence bordering on fraud with regards to the evaluation or risk – and an increasing percentage of the world’s wealth concentrated in the hands of a few. Together, these were the recipe for this financial disaster. 

The problem with greed is that it is unsustainable. It exists in a cycle, like all unsustainable desires. Government regulation, like morality, seeks to control and channel greed in less destructive ways – to mitigate the effects of this cycle. The true cause of this financial crisis was not greed – but the ideology that held that finally the immutable human vice of greed had been overcome with clever financial innovation and the magic of the market.

(more…)

Profiling Holy Cross Grad Mark Walsh

Wednesday, May 6th, 2009

Devin Leonard for the Times wrote this weekend about Mark Walsh, formerly of Lehman Brothers. The article portrays him as one of Wall Street’s top deal makers whose decisions were one of the major factors that led directly to the fall of the bank. Yet the article is also strangely positive in describing Walsh. 

What stood out for me most were the numerous connections Walsh has to me. As the article describes his brief biography:

Mr. Walsh grew up in Yonkers, the son of a lawyer who once served as chairman of the New York City Housing Authority. He attended Iona Preparatory School in New Rochelle; the College of the Holy Cross, where he majored in economics; and, finally, the Fordham University School of Law.

And then a bit later:

He bankrolled Tishman Speyer in its purchase of the Chrysler Building in 1997.

I am a fellow alumnus of Holy Cross – a fact which by itself causes me to be irrationally positive about individuals, from Chris Matthews to Bob Cousy to Obama speechwriter Jon Favreau. He also went to Fordham Law – which is one of the schools I am considering. And I currently work in the Chrysler Building. All tenuous connections, but enough to make me root for the guy.

Of course, it’s hard to get around the damning nature of this reporting:

[I]t wasn’t long before Mr. Walsh found a way to do an even bigger deal with Mr. Speyer’s company. In May 2007, Lehman and Tishman Speyer offered to buy Archstone-Smith Trust, a $22 billion deal struck at the peak of an already dangerously frothy market. Tishman Speyer put up a mere $250 million of its own equity. Lehman, in a 50-50 partnership with Bank of America, put up $17.1 billion of debt and $4.6 billion in bridge equity financing.

The most enlightening aspect of the article were the way in which it spotlighted the oddness of what was going on. Leonard describes one of Walsh’s biggest clients pulling out his money saying that:

 [T]he real estate market — and, indeed, the entire financial system behind it — was becoming increasingly bizarre.

In an example of this from 1997 – well before this observation – Leonard describes one of Walsh’s coups – how he managed to steer Lehman clear of the financial crisis resulting from the failure of Long Term Capital Management that Nassim Nicholas Taleb had predicted at the time:

On the eve of the financial crisis brought by the near collapse of Long Term Capital Management in 1998, Lehman flushed $3.6 billion in commercial real estate loans through its securitization machine, avoiding some of the losses that crippled other firms, including Nomura and Credit Suisse.

I hate to say it – but I have no idea what that means. And that’s not unintional – at least according to a lecture given by Financial Times reporter Gillian Tett at the London School of Economics. (A lecture very much worth listening to – and which I will blog about later.)

But to demonstrate the oddly positive take on Walsh, here’s how Leonard concludes his piece:

His friends say they believe that Mr. Walsh will eventually emerge from the rubble of Lehman’s collapse and return to deal-making.

“Guys like this are very rare,” says Mr. Rosen, the developer. “He’ll be back. He picked up the phone and people listen. Nobody can take that away from him.”

Back in the game perhaps – but hopefully a bit wiser.

Wall Street Exec: “I’d almost rather say I’m a pornographer.”

Wednesday, February 4th, 2009

David Segal of The New York Times interviewed a former Wall Street executive who wished to remain anonymous for his article on how “Wall Street” has become a financial epithet. The executive said:

I’d almost rather say I’m a pornographer.  At least that’s a business that people understand.

The self-pity is unbecoming – and the lack of an acknowledgement of responsibility is not surprising. After all – it was indecent greed and irresponsibility that got Wall Street into such trouble.

What’s funny is – I think this anonymous executive is right. Whether in New York or Topeka, a pornographer is now held in more esteem than a Wall Street banker.