Professor Paul Zipkin argues “regulation is a necessary element of the infrastructure of free enterprise,” in an op-ed published in the Sept. 24 edition of the Raleigh News & Observer.

Defective financial products can ruin lives just as surely as bad food and faulty electrical wires. Just ask the millions of borrowers who can never hope to pay their debts, the thousands of laid-off financial professionals and factory workers, and all of us taxpayers.

The Obama administration has proposed several initiatives to help our damaged financial system. One is the Consumer Financial Protection Agency. The CFPA aims to avoid some of the ill-conceived products, such as tricky subprime mortgages, that have played central roles in the financial crisis. It’s a good idea, and we should all support it.

Bankers too should support this idea, and some do, privately. Publicly, however, the banking industry has mobilized its considerable forces to oppose the CFPA. They argue that it will hamper financial innovation. Well, that’s sort of true – in a good way. Some innovations are valuable but some are not. Read the rest of this entry »

There is a lot of finger pointing going on one year after Lehman declared bankruptcy. Most of those fingers are pointing to Lehman and the way the bankruptcy was handled. However, that is a very simplistic view of what happened a year ago. The crisis was transformed into a panic — not because of the Lehman filing, but largely because of the bungling policy known as TARP.

Setting the Record Straight on Lehman

Lehman deserved to fail.

Here is the real story.

Then Treasury Secretary Paulson was getting a lot of pressure to help Lehman. Paulson wisely asks for the following information. He wants to know how they are valuing a list of illiquid assets. He requests the same valuations from Goldman and J.P. Morgan. The data come back quickly. The values that Goldman and J.P. Morgan are carrying on their balance sheet are deeply discounted and quite close to each other. The values that Lehman has on their balance sheet aren’t even close. Angry, Paulson is determined that the firm will go down. Why bail them out? It would be a colossal waste of taxpayer money.

This was the correct thing to do. Any bailout would have probably taken many rounds of taxpayer help.

Of course, the execution of the bankruptcy was a problem. Surely, arrangements could have been made for a more orderly transition. This would have given counterparties more time to unwind Lehman linked positions.

It is ironic that the disorderly bankruptcy of Lehman poisoned the possibility of the government letting other large firms file. As a result, the government adopted the terrible policy of “too big to fail.”

Trashing TARP

Let’s summarize the events:

• Paulson comes to Congress with a three-page term sheet asking for close to $800 billion
• The American people (rightfully) assume that the Treasury Secretary and Fed Chairman have inside information on the gravity of the financial crisis.
• They stoke uncertainty by their vague reasons for needing the $800B the apparent lack of strategy.
• They cause outrage on Main Street when it is revealed that toxic assets will be purchased at premium prices — essentially bailing out bad trades with tax payer money.
• TARP fails on first vote.
• TARP eventually passes.
• TARP is never TARP. That is, the money was not used for Trouble Assets. Instead, money was used to inject equity into big banks.
• Essentially, no questions were asked before the banks got the TARP money — remember the famous “Stress Test” came after the money was given to the banks.
• Government guarantees the big 19 banks.
• Good TARP money went to many firms that were essentially in Lehman’s situation. The TARP money was used to reduce risk rather than create new loans to pull us out of recession.
• Banks realize that they can’t pay bonuses at the same rate with TARP. As a result, they begin to give money bank. This results in even less money for lending – completely defeating the purpose of the original equity injection.

Now let’s speculate about some future events in 2010:

• Toxic assets still remain on the balance sheets.
• TARPless banks return to paying big bonuses.
• Defaults peak some time in 2010.
• Banks and policy makers are not surprised by the large number of defaults in Commercial Real Estate.
• Banks and policy makers are surprised by the large number of prime mortgage defaults.
• 1,000 banks are in trouble in 2010.
• Banks go back to the trough, err, TARP.

Already the FDIC is out of money — and they will need a lot more. 92 banks have failed this year and there are hundreds more to go. I made the 1,000 forecast last year. I noticed today that John Mauldin (who I high recommend reading) quoted some unpublished analysis from Institutional Risk Analytics that grades 2,256 banks in the “F” range. If less than half go under, you are at the 1,000 number.

There is more pain to come. Again, the decrease in new claims for unemployment insurance was spun as “good” news. Claims dropped by 12,000 to 545,000. However, to get the unemployment rate to meaningfully decrease, we need to reduce claims by about 300,000 — not 12,000. We are not even close to that. As I have written, the continued high umemployment will be the prime driver of prime defaults.

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See my appearance about 4 minutes into this BNN story.

As manufacturers race to test and deliver the H1N1 influenza vaccine by October, public health officials are working equally feverishly to determine how scarce doses should be allocated, and the U.S. has announced plans to donate 10 percent of its vaccine supply to the WHO.

Research from Duke and the European School of Management and Technology (ESMT) demonstrates why, in some cases, countries would be best served by giving their drug supplies to another country.

Duke Professor Peng Sun, Duke PhD student Liu Yang, and Professor  Francis deVericourt  of ESMT created a model based on game theory  to test how countries with adequate drug supplies should react to an epidemic affecting a neighboring country with little or no supply of vaccine or treatments.  Their findings indicate that countries possessing treatments are sometimes best served by donating their treatments to the first country afflicted by an epidemic, instead of using the drugs on their own citizens.  In game theory, this situation is referred to as a Nash Equilibrium, the combination of actions by different players that results in the best outcome each player can expect, given the other players’ moves.
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Is it easier to lie when you’re hiding behind knockoff sunglasses?  Dan Ariely explains how small acts of dishonesty can lead to more serious changes in behavior.

DURHAM, N.C. — A group of leading research universities has launched Futurity (www.futurity.org), an online research channel covering the latest discoveries in science, engineering, the environment, health, and more.

The site offers direct access to research news posted by Duke University and 35 partners supporting the project.

Futurity cofounder Michael Schoenfeld, vice president for public affairs and government relations at Duke, says the site allows the public to see how federal, state, and private funds are being put to use by universities to address critical challenges.

“It’s not often you see high-powered universities working together in such a collaborative way,” says Schoenfeld. “That fact alone indicates the project’s significance. Universities are the world’s laboratories. They host the brightest minds working to answer some of today’s most urgent questions. The breadth and caliber—and the collective force—of the research featured on Futurity is truly extraordinary.”

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By Kevin Schulman, M.D.

Duke Medicine has just announced a $700 million expansion of its physical plant to add 847,000 square feet, including adding 16 operating rooms and renovating 160 beds (that’s over $800 per square foot if you’re doing the math).

This will add a new cancer hospital facility within the Duke campus, and expand the number of intensive care rooms at Duke Hospital. This is a significant investment in infrastructure for the health system, but how will this investment impact the care delivered to patients by Duke Medicine?

Duke Medicine is a fee-for-service hospital system and physician network. This is one of the oldest forms of a provider organizational structure in existence, and pre-dates the development of health insurance in the US. This model is managed to allow patients access to high-end specialty and hospital services. Within this model, hospitalization is not considered a failure, but rather a core service offering. Competition between Duke and other providers is on the basis of technology and specialty service offerings. This type of competition can lead to improvements in the performance of specialist physicians, but can also lead to a phenomena described as a “medical arms race” where hospitals “must” acquire certain technologies to remain attractive in these specific markets.

Hospitals like to point out that their high-tech facilities and services are better than those of competitors (see Robinson and Luft JAMA 1987). This type of competition has been criticized as driving to higher investment in technology, overcapacity, and higher health care costs. There’s some local evidence of this arms race concept with UNC’s investment in a similar cancer facility only nine miles from the Duke campus.

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Courtesy of AI Roofing Company, LLC Houston

 Given the decrease job losses and other favorable (or less bad) news, it appears as if the economic storm is abating — or is it the calm that you feel when the eye of the hurricane passes over?

There is unambiguous information that the rate of job losses is decelerating. “Only” 216,000 jobs were lost in August. The unemployment rate increased due to three reasons: (a) the job losses in August; (b) a revision upwards in the job losses in July; (c) and new people entering the labor force – perhaps reentering after a prolonged period of unemployment.

However, in my opinion, there is very little to call “good news” here.

Let’s summarize:

• We have lost 5.02% of the labor force to unemployment during this recession, over 6.9 million jobs
• This is now the worst episode in the post WWII period (this month it became worse than 1948).
• This is not the end. Remember the government stress test has the “worst case scenario” of 10.3% in 2010. We are getting close to that now.
• This is the time of maximum government spending. Just as the clunkers program has ended, the amount of government spending will begin to decrease.
• We have yet to see the peak in foreclosures and defaults in both residential and commercial real estate. That should happen sometime in 2010.
• We will see surprisingly positive growth in Q3 and people will declare the recession over.
• Even if such declarations are true, we are not out of the woods. The combination of three economic forces will slow growth in 2010.
  • A new wave of stress on the financial system due to surging defaults on prime mortgages and commercial real estate.
  • The continued constraints that small and medium sized businesses face in getting credit. These businesses drive employment growth.
  • Little or no action from consumer spending – which represents 70% of GDP. Consumers need to protect themselves by saving. No job is safe right now.

The Consumer’s Problem

Let me comment a bit on the consumer. The consumer has taken multiple body blows.

• A dramatic wealth hit due to degradation in the value of their main asset — housing. Indeed, for most homeowners with mortgages, their equity has been wiped out (or negative).
• A wealth hit due to a drop in the value of other holdings (like 401Ks).
• Unemployment and fear of potential future unemployment.
• Unease over future obligations as the government racks up record deficits and debt.

You put this altogether and it seems unlikely that the consumer is going to be the engine of the recovery. Savings rates were driven to very low levels during good times. This recession is shockingly bad and it caught most consumers by surprise. Indeed, we really haven’t had a deep recession in almost 30 years — people forget.

The result is caution. Consumers will build their savings for three reasons. First, many fear losing their jobs — or being paid less in the future. Second, the savings were close to zero to start with. Third, they want some insurance for the future.

All of this spells slow growth.

I am not sure when they will officially date the end of the recession. I had originally forecast the end of 2009. However, the more important issue has to do with growth prospects going forward.

Interpreting the Data Going Forward

The data will be difficult to interpret. We will see strong Q3 growth which is really due to government spending (which cannot be indefinitely maintained) and some inventory adjustment (firms have let inventories run so low that there needs to be some production to restock). Neither of these positive forces is sustainable.

While I am more pessimistic than most, let me say something optimistic. The Unites States is in far better shape than European countries or Japan. So, while this might seem for the U.S. to be a painful period of slow growth, we will gain ground globally with respect to other developed countries.

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See below my monthly employment graph that standardizes the job losses (based on the size of the labor force) across different recessions.

By Kevin Schulman, M.D.

Ted Kennedy passed away this week at age 77 of glioblastoma (he was treated surgically here at Duke for his disease last year; Duke has the best program for this disease in the world, but the prognosis for people diagnosed with glioblastoma remains grim).

Kennedy spent more than 45 years in the US Senate, and during that time he championed both liberal causes and bipartisanship. Orrin Hatch, a conservative Senator from Utah, has said publicly that Senator Kennedy was the only Democrat he could work with in the Senate. That’s quite a statement.

In the politics of health care reform, there are two committees in the Senate with jurisdiction. Senator Kennedy was chairman of the Health Education Labor and Pensions Committee (HELP), which has passed a version of the health reform legislation. Democratic Senator Max Baucus is chairman of the Senate Finance Committee, which has jurisdiction over entitlement programs (including Medicare and Medicaid). The Senate Finance Committee has not passed a bill, as Senator Baucus and his committee appear to have some substantial disagreements with the House and HELP committee versions of the bill — as they work to craft a bipartisan piece of legislation.They have tentatively committed to reporting out a bill by mid-September.

I was on a panel earlier this week with a major health insurance executive. I was asked about the status of health reform. I suggested that there are three issues that need to be addressed as part of reform: 1) access to health insurance, 2) the costs of health care, and 3) the future solvency of Federal health programs.

Currently, the debate seems to be limited to access to insurance. The second and third issues are more problematic and look like they will remain despite health reform (or may even be exacerbated by the reform).

The insurance executive suggested that access was relatively easy to solve. In fact, he suggested that their trade association, AHIP, had agreed publicly with a reform plan that included market reforms including removal of underwriting from small group policies in return for a mandate for coverage (as we teach in health economics and strategy, in the absence of a large group or mandates, insurers would face adverse selection without underwriting since only the sick would be interested in an expensive insurance policy).

The executive suggested the debate was really over the public option. Here, the debate spills over from access to costs. Health insurance costs include medical loss (payments to doctors, hospitals and pharmacies), a sales charge, a “risk” premium, overhead, and margin.

United Healthcare, for example, reports a medical cost ratio of 82% for 2008. This leaves 18% for these other categories. An argument for the public plan is that Medicare’s medical cost ratio is 96-98%. Thus, a public plan would be cheaper. This is an apples-to-oranges comparison, since Medicare doesn’t have huge expenses for marketing, risk and administrative expense that a public plan would obviously have to bear.

There are other hidden costs of a public plan as well. While most seniors support Medicare, Medicare’s low payments for primary care physicians and the overpayment of specialty physicians has been acknowledged for 15 years, yet Medicare has been politically powerless to change its payment system even as physicians leave primary care in droves. A public plan could face the same risk.

Healthcare, however, is a local monopoly in many places. Hospitals or physicians that are required to be included in provider panels have the ability to set their own prices. The ability to use a public plan to set rates for providers with monopolistic market power is an attractive feature that private health insurance plans cannot match (and thus oppose).

So where does this leave us in the reform process (it’s not really a “debate” since all of the shouting means there is almost no discussion of the three core issues I raised)?

Senator’s Kennedy’s death is significant. Will it inspire a sympathy effort to have the “Kennedy reform bill” in his honor, or will his death remove the last hope for compromise in the Senate?
We’ll find out over the next few weeks.