Medicare at 60

In the past I have pointed out that by getting rid of the third party payer (insurance companies) we could reduce health care cost. This is because administrative cost are 25 to 30 percent and this would eliminate 10 million jobs in the insurance industry. Medicare on the other hand has administrative cost of only 9%. While the total care cost per person in Medicare is high that is because of the ages of the patients. If we want to reduce the total health care cost to the country we should lower the Medicare age to 60 instead of raising it to 67. As more and more people are transferred to Obamacare the roll of private insurance will decrease and administrative savings will follow. When everyone is covered by government health insurance then there is a very real potential problem. Once the government has a monopoly then like all government programs inefficiencies will crop up and cost will likely get out of hand. Procedures to ration benefits will be introduced to help reduce cost. I have maintained from the beginning that the only long term solution to rising health care cost is to ration care and this is where we are heading as this is what happens in other countries that have national health care.

Party trumps country

When the founding fathers put in the first amendment they did so because they feared the power of the central government. They had just gone through a revolution to get out from under the king and wanted to make sure that would not happen again. The free press was the instrument to be used to reign in the federal government, to limit its power and to shine the light of day on all of its activities. This was the intended safe guard and so I pose the question, how did the todays government get all of its power? I maintain it started with a journalist named Dunne who in the early 1900’s wrote that the purpose of the journalist is to comfort the afflicted and afflict the comfortable. It was this attitude among writers that moved the emphasis from watching government to watching others. Soon the idea of protecting people from the misuse of power by government shifted to protecting people from powerful people not in government. Big business and by inference people who made lots of money from big business had to be exposed. Excess profits became and evil phrase. Fast forward to today and the whole concept has taken on political tones. Liberals often castigate large profitable business as somehow taking advantage of the ordinary citizen. During my life time I remember when AT&T was the big enemy and then it was McDonalds and then Microsoft and Walmart and big oil. On the other hand when it is Fanny Mae handing out loans to people who are not qualified to repay them the liberals back them by passing laws to make it easier to get loans. Using the cry that everyone has the right to the American Dream of home ownership they pushed the mortgage market to the point of collapse and the good citizens who were supposed to be helped ended up paying the bill for their misadventure. Conservatives seem to think the government regulators are only out to limit the growth of big companies and believe the free market will always act in the best interest of the public and they pass laws to encourage deregulation. What is wrong headed here is that the process has become politicized and this blinds both sides. The battle is no longer what is best for the people but what is best for the party.

Mayer glass ceiling

A big step was taken last year in the battle against the glass ceiling when Marisa Mayer was appointed as CEO of Google. It is significant in a number of ways including the fact that she is only 37 and Google is a hi-tech company. Today she announced that too much teleconferencing is bad for business even though her company is a big player in this method of communication. She said that talking on the phone isn’t nearly as good as meeting face to face when it comes to creative ideas. I bring this up because for most of my life I did not understand the value of small talk. I saw it as a waste of time. When I called someone on the phone I said what I called for and then hung up. What I didn’t grasp was what was being communicated between the words. People were developing emotional relations while talking about mundane everyday items of mutual interest. This bonding is what Ms. Mayer feels is important in creating an atmosphere of trust that leads to innovation and team work. I believe this is an example of the kind of change that women in high positions can bring to business. It promotes a desire to cooperate and share ideas in a relaxed setting. The productivity of good old boys sitting around the table can be increase with the addition of some good old girls.

Gain on sale

In 1998, ten years before the mortgage crisis hit the country, there was a mini crisis of the same sort that should have been a warning of things to come but was largely ignored. There is an old saying that love is blind but this episode assures us that love of profits is just as blind. Throughout the country there were small family owned mortgage lenders who specialized in high risk loans. They stayed in business by require large 50% down payments. Applicants with that type of cash and poor credit were not easy to find so these companies spent lots of time and money searching for eligible prospects. They looked for people without a credit history or people whose incomes were irregular because they were paid bonuses based on performance or seasonal business. Like all mortgage lenders as soon as they closed a deal they used the new found down payment money to finance the next loan. Beside the large down payment these companies hired their own appraisers so they could be sure the value of the property had not been tinkered with. In order to expand they needed more cash to make more loans so they combined the loans they had into bundles and sold them to investors. Sound familiar as this practice of securitizing loans would become the basis of the toxic mortgages that nearly brought down the country. Finding investors to purchase these bundles was labor intensive and costly so these companies began to look for other sources of cash. To the rescue comes Wall Street in the form of Bear Stearns and Lehman Brothers. These firms were willing to provide the cash since they could get interest from their cash and fees generated by the loans. They further envisioned incorporating these mortgage companies and selling stock in them thus generating additional fees. In those days there was an accounting rule called gain on sale which meant you could count as an asset the expected return on a loan over the life of the loan. It was left to the discretion of the mortgage lender to determine how much this would be and you can guess what happened. They projected the rosiest possible outcome. Next they expanded the concept to car loans and the race was on. Profits were pouring in and the business was growing faster than anyone had predicted. You could now buy a car, new or used and finance it on the spot. Don’t worry about the payback of the loan just make the sale. Then came the unexpected. In the summer of 1998 Russia had to devalue its currency and the whole house came tumbling down. Within a year most of these mortgage companies were bankrupt and as the dust settled the survivors began gearing up for the next big game, which would culminate ten years later with the big mortgage crisis that we are still suffering from and it looks like the survivors are once again getting ready for round three. Too big to fail is now too too too big to fail so the next unexpected problem should be a dandy.

46r

Continuing my rehash of the mortgage crisis, I want to discuss an accounting rule known as FIN 46r. That rather innocuous sub-section tells the story of why a big company like Citigroup got in trouble. The centerpiece of this relates to SIV’s or structured investment vehicles. I just love the way they name these things. It sounds so mundane it couldn’t possibly cause any problems. 46r laid out the guidelines determining whether a company had to include SIV’s on its balance sheet. In other words the current value of the SIV had to be part of the companies report. As a person interested in investing in a company you would like to know about such things but the company might prefer to keep them secret. Citigroup was accumulating large amounts of mortgage bundles and attempted to hide them inside of SIV”s. Citigroup like many others large banks sold paper certificates to investors who wanted to buy into these mortgage bundles. Since these bundles offered a handsome return they had lots of buyers. Citigroup transferred these bundles to the SIV’s and they no longer appeared on the Citigroup company statement. When asked about these SIV’s Citigroup responded by saying they had no explicit obligation to back these certificates, meaning they had no contractual arrangement to back them. What was not said is that they may have an implicit obligation. That question was answered when the mortgage crisis began to unfold and people began to sell the certificates they had in these SIV’s. Citigroup was forced to sell off the mortgages to pay back the investors and as they sold the prices began to drop and they took huge losses. As these previously unreported debts began to appear, the investors in Citigroup were astounded. The company began massive layoffs and its value shrunk from 300 billion to 6 billion and it was ready to go under. The government stepped in with a 300 billion bail-out and the company was saved from bankruptcy. Their deceptive accounting practices were revealed but no one was prosecuted even though it caused their investors to lose millions.

Mortgage crisis

As the dust from the mortgage crisis slowly dissipates we can use the gift of hindsight to try and make some sense out of the whole mess. Since there are many things that went wrong and many of those are quite complicated, I will zero in on one small aspect, that being the rating agencies. The big three are Standard and Poor’s, Moody’s and Fitch. My first encounter with S&P came 40 plus years ago in the financial planning business. I worked for Equitable of New York and would proudly tell my clients that my company was rated triple A by the rating companies. I investigated to find out just what this meant and very quickly realized that the whole rating system was flawed. S&P would ask The Equitable for important data they needed to evaluate the strength of the company so they could select a rating. Talk about the fox guarding the hen house! The weakness of this approach is further exaggerated when you realize that the rating companies get their fees from the companies they evaluate. Fast forward to the recent mortgage crisis and while there are many mortgage companies, concentrate on Fanny Mae which is the largest. The executives at each company were intertwined in such a way that they both benefited when the volume of home loans grew. In the scheme of things the quality of the loans had no bearing on the push for more loans. As Fanny Mae grew the fees paid to S&P grew and it was a carbon copy of the relationship between the insurance companies and the rating companies. The most amazing part is that this same incestuous relationship still exist to this day and no one seems to care.

Economics

We learn in Econ 101 that risk is directly related to return. When the mortgage loan giant Fannie Mae was started in 1938 it had a built in advantage over other mortgage lenders. While it was not a government agency it was a Government Sponsored Agency (GSA) and that meant that if things went bad the government would come to their aid. Investors were aware of this and thus were willing to receive a lower rate for the safety of their investment….risk/return. While this difference was only a quarter to a half percent it was a leg up. Everyone knows how much a half percent can make on a thirty year loan. In the 60’s and 70’s rumors spread about how Fanny was using its interest advantage to promote its own business to the detriment of the private market. Fanny would always respond to threats to remove their quasi government status by bragging about how they helped many people get homes. In the 80’s the precursor to the mortgage crisis was born. Some small local mortgage companies realized there was a market for people with bad credit