Healthcare Reform

I have spent the last few months trying to get information about the proposed healthcare reform from television media. Information and fact-based analysis has been completely absent from most media outlets. The media only reports on conflicts, without discussing underlying facts and analysis. While I still do not have a comprehensive understanding of the proposed reform, I have been able to get enough key facts to form a high-level opinion.

Health insurance companies are exempt from Federal antitrust laws

First, here is my general assessment of the current situation. Most healthcare in the U.S. is provided by private, for-profit companies. The McCarran-Ferguson Act of 1945 exempts insurers (with certain exceptions) from federal antitrust laws, severely limiting competition. Since insurance company revenue comes from premiums paid by the insured, and their cost is from claims paid to the insured, the incentive for the profit-maximizing insurer is to raise premiums and to limit claims paid. Due to their anti-trust exemption, competition, which is the natural free-market check on high costs and unfair practices, is limited.

Public option absolutely crucial since the government will mandate coverage

There are at least three healthcare proposals in the House and Senate, with differing components. However, the key components seem to be 1) new consumer protections, 2) a government mandate on citizens to purchase insurance and 3) a public insurance option.

Proposed consumer protections (which are long overdue and would end despicable practices by the insurance industry), include the following:
- no denial of coverage based on pre-existing conditions
- a ban on industry practice of collecting premiums until someone gets sick, then finding reasons to cancel coverage;
- no caps on benefits;
- better disclosure on costs

A government mandate without a public option would be a huge victory for insurance companies. Insurers would gladly trade the proposed consumer protections for the government mandate. A government mandate would give people no choice but to pay high costs of current insurers (who are exempt from antitrust laws allowing them to collude on pricing, which eliminates the need for companies to compete against each other). The government would essentially be forcing people to insurers with no limitation or monitoring of what the insurer charges. At least now, people have a choice to avoid the high cost of insurance by going without (self insuring). The government mandate would eliminate even this unsavory choice. This is why the public option is crucial. The bottom line is that, if the government forces people to get insurance, the government also has a similar responsibility to make sure that an affordable insurance option is available.

Public insurance options is the most capitalist and market-oriented approach

The government does not want to force individuals to buy insurance without making sure prices are fair. There are a couple of realistic options to accomplish this goal.

One, the government could control cost directly through regulation. Many industries in the U.S. have been regulated; it is not a radical idea. The government could directly control what insurers charge and incur in expenses to make sure that prices are fair.

Two, in a much more capitalist approach, the government could introduce competition into the market, which would provide an indirect yet effective incentive for insurers to control costs and expenses by introducing competition.

The Obama administration chose the second approach. By offering an efficient (low cost) alternative against which to compete, insurance companies would have to reduce cost, and become more efficient. This is why the public option is critical. Government mandated coverage without the public option is a windfall to insurers. A government mandate without a public option would actually penalize people by limiting their choice. At least now, one can chose to go uninsured (self-insure) if one feels the cost provided by private insurers is too high. With a government mandate, one would be forced to take whatever private insurance offers.

Final thoughts

Many question how insurance companies could make a profit if they have to compete with a public provider. I would turn this around to ask whether profit should be the sole goal of health insurance. The primary goal of health insurance should be to eliminate the financial risk to the population of catastrophic illness (see Appendix). In most industries, profit is the result of creating products or services that meet the demands of the consumer. Corporate and consumer goals are aligned. In certain industries this is not the case. Law enforcement, military, fire protection and utilities are a few examples. For a capitalist society to function, certain basic minimums must be met; the country must be protected from external threats (military); expectation of protection of our person and property from crime (police) and fire (fire department), etc. There is no value in providing these protections selectively, they must be provided comprehensively. But it may not be profitable to provide these protections to everyone. This is where the government steps in. Healthcare/insurance may, at least to a degree, be one of these areas. The current debate over insurance reform seems to value the profitability of insurers over all else. In most industries, profitability is and should be a primary goal. In my opinion, health insurance, like police and fire protection, falls in the basic protections to which everyone should expect access. The primary goal should be broad based coverage.

Appendix

The purpose of insurance is to pool risk; too spread over a large group risk which an individual would deem to great to bear alone. Insurance serves a purpose in capitalism by freeing resources that would otherwise be put aside by each individual in case their individual risk is realized. Insurance becomes more efficient as the pool increases in size; the wider risk is spread, the lower cost to everyone. The incentive for a for-profit insurer may not always be to increase the pool. It may be in the best interest for the for-profit insurer to limit to pool, which, in the case of health insurance, could mean seeking only healthy individuals who would have the least cost burden on the insurer. The incentive for the for-profit insurer may differ from the need of society to insure against society’s risk. This is where government is required. Typically, the government has stepped into these types of industry with regulation.

Former Senior Interrogator in Iraq Dissects Cheney's Distortions

The article, reproduced below, was written by Matthew Alexander (as published in the Huffington Post), who led the interrogations that found Abu Musab Al Zarqawi, the former leader of Al Qaida in Iraq. He is a credible, first hand source, who directly contradicts the statements of the former Vice President. In fact, he concludes that the use of torture resulted directly in the death of Americans. The following is the word-for-word post by Matthew Alexander:

"As a senior interrogator in Iraq (and a former criminal investigator), there was a lesson I learned that served me well: there's more to be learned from what someone doesn't say than from what they do say. Let me dissect former Vice President Dick Cheney's speech on National Security using this model and my interrogation skills.

First, VP Cheney said, "This recruitment-tool theory has become something of a mantra lately... it excuses the violent and blames America for the evil that others do." He further stated, "It is much closer to the truth that terrorists hate this country precisely because of the values we profess and seek to live by, not by some alleged failure to do so." That is simply untrue. Anyone who served in Iraq, and veterans on both sides of the aisle have made this argument, knows that the foreign fighters did not come to Iraq en masse until after the revelations of torture and abuse at Abu Ghraib and Guantanamo Bay. I heard this from captured foreign fighters day in and day out when I was supervising interrogations in Iraq. What the former vice president didn't say is the fact that the dislike of our policies in the Middle East were not enough to make thousands of Muslim men pick up arms against us before these revelations. Torture and abuse became Al Qaida's number one recruiting tool and cost us American lives.

Secondly, the former vice president, in saying that waterboarding is not torture, never mentions the fact that it was the United States and its Allies, during the Tokyo Trials, that helped convict a Japanese soldier for war crimes for waterboarding one of Jimmie Doolittle's Raiders. Have our morals and values changed in fifty years? He also did not mention that George Washington and Abraham Lincoln both prohibited their troops from torturing prisoners of war. Washington specifically used the term "injure" -- no mention of severe mental or physical pain.

Thirdly, the former vice president never mentioned the Senate testimony of Ali Soufan, the FBI interrogator who successfully interrogated Abu Zubaydah and learned the identity of Jose Padilla, the dirty bomber, and the fact that Khalid Sheikh Mohammad (KSM) was the mastermind behind 9/11. We'll never know what more we could have discovered from Abu Zubaydah had not CIA contractors taken over the interrogations and used waterboarding and other harsh techniques. Also, glaringly absent from the former vice president's speech was any mention of the fact that the former administration never brought Osama bin Laden to justice and that our best chance to locate him would have been through KSM or Abu Zubaydah had they not been waterboarded.

In addition, in his continued defense of harsh interrogation techniques (aka torture and abuse), VP Cheney forgets that harsh techniques have ensured that future detainees will be less likely to cooperate because they see us as hypocrites. They are less willing to trust us when we fail to live up to our principles. I experienced this firsthand in Iraq when interrogating high-ranking members of Al Qaida, some of whom decided to cooperate simply because I treated them with respect and civility.

The former vice president is confusing harshness with effectiveness. An effective interrogation is one that yields useful, accurate intelligence, not one that is harsh. It speaks to a fundamental misunderstanding of interrogations, the goal of which is not to coerce information from a prisoner, but to convince a prisoner to cooperate.

Finally, the point that is most absent is that our greatest success in this conflict was achieved without torture or abuse. My interrogation team found Abu Musab Al Zarqawi, the former leader of Al Qaida in Iraq and murderer of tens of thousands. We did this using relationship-building approaches and non-coercive law enforcement techniques. These worked to great effect on the most hardened members of Al Qaida -- spiritual leaders who had been behind the waves of suicide bombers and, hence, the sectarian violence that swept across Iraq. We convinced them to cooperate by applying our intellect. In essence, we worked smarter, not harsher."

U.S. Government Debt Projection

According to recently released White House projections, U.S. government debt will reach $15,370 billion by 2019! Keep in mind, White House budget projections are typically optimistic; less optimistic projections put this amount at $23 trillion. Here is the link to the website with the budget numbers:

http://www.whitehouse.gov/omb/assets/fy2010_new_era/Summary_Tables2.pdf

At the end of 2008 foreign nations (governments and individuals) held $3,077 billion, or 53%, of the total $5,893 billion national debt. Here is a break down of foreign holdings by country ($ billions, source: U.S. Department of the Treasury):

China (excl. Taiwan) 727
Japan 26
Oil exporters 1/ 186
Caribbean banking centers 198
Brazil 127
UK 131
Russia 116
Other countries 966

1/ Includes Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Saudi Arabia, UAE, Algeria, Gabon, Libya and Nigeria

The U.S. has become dependent on foreign purchases of U.S. treasury notes and bonds at continually increasing levels. To date, this has not been a problem given the U.S. status as, by far, the safest credit in the world. But, the amount of credit the world is comfortable extending to the U.S. has a limit; and we may be approaching that limit. Recently, the Premier of China (a major creditor as can be seen from the chart above), made public statements implying some concern about the safety of its investment in the U.S.

The high level of debt, and the increasing dependence on foreign buyers, worries me, but not for obvious reasons. What if nations, such as China, decide they do not want to hold so much U.S. debt, and sell significant portions? I do not think the likelihood of this happening is very high. Selling a significant portion of its U.S. bonds would flood the market, causing the price to decline significantly, which would result in a significant loss in value to the Chinese on the bonds it continued to hold. By doing this, they would hurt themselves as much as they would hurt the U.S. Another unwarranted fear is that we will not be able to repay our significant debt if the amount gets to large. Again, this should not be a concern. Treasury bond obligations are repaid with U.S. dollars, which essentially can be printed by the U.S. government.

However, the U.S. dollar is itself a note; an obligation of the Federal Reserve. In my opinion, the only way to ultimately satisfy the obligation represented by the U.S. dollar in the long term is by transferring goods and services of the same value. Put another way, eventually, U.S. production of goods and services (gross domestic product) will have to grow to a level sufficient to satisfy our debt in the long run. If not, there will be negative consequences in the form of inflation, high interest rates, or both.

As stated above, treasury bond obligations can be satisfied by paying dollars (Federal Reserve notes). However, Federal Reserve note obligations must be satisfied, eventually, by production of real goods and services. If U.S. production of goods and services is less than the amount of its obligations (as represented by its currency), the result will be inflation. The prices of goods and services will rise due to greater demand caused by greater amount of currency in circulation. The second concern is that our excessive levels of debt will lead to high interest rates. To entice investors to continue to loan money, especially if the perceived risk of lending increases, the U.S. may have to increase the interest it pays for these loans. This has a direct impact on you and me. Rates on mortgages, credit cards, auto loans and other consumer loans are directly related to rates on U.S. government debt. Government bond interest rates also influence the rate business can borrow; higher rates (cost of capital) make it more difficult for business to expand.

The U.S. has experienced periods of high interest rates and high inflation in the past. For example, during the early 1980s, interest on the ten-year government bond rose to over 15%. This was most likely due to the inflation rate at the time, which rose to over 14%. Given the projected need for the U.S. to borrow at unprecedented levels, a return to high interest rate/high inflation environment is likely. Keep the possibility of this happening in mind when planning your long term financial strategy. Also, much of the U.S. borrowing will need to come from foreign countries such as China. It is interesting to see how this fact has, and will continue to, influence U.S. foreign policy.

AIG Counterparties List

Was the AIG bailout used by the Treasury Department as a way to get more funds to financial institutions and avoid public scrutiny, which continues to turn increasingly negative toward such activity?

American International Group Inc. (AIG) disclosed its list of counterparties who received $95.9 billion of the reported $160 billion in government bailout funds received by the company. I was very surprised to see Goldman Sachs at the top of the list, especially considering that the Treasury Secretary at the time was the former CEO of Goldman Sachs.

AIG was a traditional insurance company that moved aggressively into the business of issuing credit default swaps. A credit default swap, in very simple terms, is insurance provided to a holder of a certain security against default or loss in that security. For example, if I own a security, and purchase a credit default swap from AIG protecting me from loss on that security, I can recover my loss on that security from AIG. With respect to many of the banks on the list of counterparties, the securities protected by AIG through the credit default swap market were, most likely, bonds backed by subprime mortgages (such as collateralized debt obligations). As we have all heard in the news recently, collateralized debt obligations have suffered significant losses due to the decline in the housing market. These losses triggered equally significant claims on AIG to the extent covered by AIG. These claims, in turn, caused the approximately $62 billion dollar AIG fourth quarter loss (the biggest loss in history!), and the need for cash from the government.

AIG was given money under the Treasury's Systematically Significant Failing Institution Program. Basically, the Federal Reserve (chaired by Ben Bernanke), the New York Federal Reserve (headed by Timothy Geithner at the time), and the Treasury Department (headed by former Goldman Sachs CEO Henry Paulson at the time) agreed that AIG's failure would pose a systemic risk. In other words, AIG's failure would likely have severe repercussions for global financial markets and the economy.

I have listed, in the chart at the top, banks who received funds under the Treasury Departments Troubled Asset Relief Program (TARP). Next to this, I have listed AIG's counterparties. A number of key names, such as Goldman Sachs, are prominent on both lists.

Eliot Spitzer, in his article for Slate Magazine, raises some very valid observations and key questions related to the just-released list of AIG counterparties. Spitzer states that, in his opinion, "AIG was just a conduit for huge capital flows to the same old suspects, with no reason or explanations." Given the now apparent conflict of interest with regard to Henry Paulson, key questions need to be answered. Did the Treasury and Federal Reserve already know the counterparties and exposures of each when they made the decision to fund AIG? Why weren't the names of the counterparties disclosed immediately?

I am still forming my opinions on all of this, but right now, I think that there was an obvious conflict of interest due to the Treasury Secretary's relationship with the largest counterparty. However, I also think that the failure of AIG truly represented systemic risk to the global economy. The credit default swap market had grown to $70 trillion (to put this amount in perspective, it is roughly five times the amount of goods and services produced by the U.S. in a year, or, put another way, it is almost nine times the amount of the total currency and bank deposits held by all Americans!). Given the effect of the Lehman Brothers bankruptcy, it is not hard to imagine how the collapse of AIG could shock the market; an important market if not only based on its size. But, the Treasury Department should have compelled AIG to release the list of counterparties before any bailout funds were disbursed. This would have caused some uproar at the time, but it would have increased transparency and reduced the appearance of favoritism among Wall Street and former Wall Street folks in the government.

Obama's Tax Plan Consistent with Economic Growth

Some elected officials are making ridiculous statements about President Obama's tax plan. These people are making irresponsible comparisons to Lenin and Marx, and using terms such as "socialist" and "class warfare" when describing the plan. It is important to look beyond these misleading statements and focus on the facts.

President Obama intends to let the Bush tax cuts expire, which means that the top two marginal rates (the rate taxed on the last dollar of earnings) will return to 36% and 39.6% from the current levels of 33% and 35%. Because these rates are at the top of the tax brackets, they will only impact people earning more than approximately $200,000 per year. The marginal rates of 36%/39.6%, which will exist once the Bush tax cuts expire, are the same rates that were in effect in the mid to late 1990's under President Clinton.

The table at the top lists tax rates, government budged deficit and economic growth (as measured by gross domestic product, or GDP) during the Clinton and Bush presidencies. It is worth noting that: 1) Clinton raised the top tax rate dramatically, from 31% under the former president to 39.6%; 2) economic growth was stronger under Clinton, even though the top tax rate was higher; 3) government budget deficits declined every year under Clinton, and turned to surpluses during his last two years.
Economic growth was very strong during the Clinton administration. At the same time, budget deficits were turned into surpluses. President Obama is proposing to return tax rates to the same level as existed during Clinton's presidency. Based on the evidence, the theory that strong economic growth cannot occur under Obama's tax plan is false.

Stimulus Bill - Spending vs Tax Cuts

Many conservatives have criticized the approximately $800 billion economic stimulus bill, charging that it is merely a spending bill. Their remedy for the current situation is tax cuts. To many conservatives, tax cuts are the answer for everything. We are currently in a severe economic downturn. The economy contracted by a 6.2% annualized pace during the fourth quarter of 2008. Generally, one would like to see the economy stimulated by the private sector. However, this is not happening, and with job losses (measured by initial jobless claims released by the Department of Labor) running at a rate of over 600,000 per week, the likelihood of this is lessening. The government can attempt to fill in for the private sector by increasing spending, reducing taxes or a combination of both.

The table above shows the dollar increase in economic activity per one dollar of a given activity. It is noteworthy that this table was put together by an economist for Moody's who was an advisor to the McCain presidential campaign. A key conclusion from this table is that, generally, the spending items listed have a greater impact than the tax cut items. The biggest impact to the economy, according to the economist, is an increase in food stamps. For every $1 increase in food stamps, the economy grows by $1.73. Extending unemployment (UI) benefits is a close second, with an impact of $1.64 for every $1 spent. This makes sense to anyone who has had basic economics; an economically poor person with an extra $1 will on average spend more of that dollar than a wealthy person, out of necessity. Much of the extra dollar going to the wealthier person is likely to end up in savings (not necessarily bad, just not immediately stimulative). Notice the least stimulative item, making the Bush tax cuts permanent; followed closely by a cut in corporate taxes and making dividend and capital gains taxes permanent. There are some stimulative tax cut items, such as the payroll tax holiday, since it benefits a wide economic spectrum, not just the wealthy.

To criticize the stimulus bill by saying it is just a spending bill is silly. Government spending is the more efficient method for the government to stimulate the economy. And, if the spending goes towards areas that benefit the country in the long run but have been neglected (infrastructure, alternative energy), even better.

LA home price update

Home prices have declined significantly this year. The median price in the Los Angeles area has declined over 26% during 2008 according to the S&P/Cash Shiller index.  As a result, prices are getting closer to their historical relationship to median income. This can clearly be seen in the NAHB/Wells Fargo Housing Opportunity Index, which measures home affordability. This number is basically the percentage share of homes that are affordable to people earning a median income. The index rose to 26.9 last quarter for the Los Angeles area (it reached a low of 1.9 during the second quarter of 2006!). My rough estimate of an average during normal times (pre-bubble) is around 43. So, affordability is getting back to historical average, but it is not quite there yet.

Despite significant declines, prices may have farther to go. Goldman Sachs, for example, recently said that even though national home prices are back to pre-bubble norms, there is still downward pressure on prices. Inventory is still high, and completed homes are outpacing sales, which does not help matters. Adding to the supply of homes on the market, Goldman Sachs expects that 25% of all mortgages will default. That's just astounding.


A more immediate factor for me personally is the continually-deteriorating economy. The U.S. economy is in a free-fall, and we have not seen the worst yet. The employment picture is particularly troubling. Some economist expect unemployment to reach just below 10%.

Given the underlying economic picture, still high inventory levels and still lower-than-average affordability, there is little reason to think that home prices will go up in the near future. I do not expect any help from interest rates, which are already at historical lows.

My conclusion is that it may be a good time to start looking for "too good to pass up" deals, but err toward waiting a bit longer.