A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Tuesday, September 1, 2009

Health Care and Games on Wall Street

On the podcast today, some short takes on the health care debate from angles off the norm, more evidence that Wall Street is playing games, not helping recovery, and a deeper look at the 70-30 labor-capital split.

Alex urged us to do a health care special on the podcast, and provided me with some grist for the mill. Today is not that. These are just some observations from left field, where sometimes you have a cooler head than when you're in the batter's box.

First, the greatest part of the problem and the key to the solution with health care is not entwined with its delivery, but in its financing. Rather than treat it as a simple public good available to all, we have allowed an insurance model and the segmenting of the covered population and the treating of health care as a private good. This means we now need to collect from the user of services and that suppliers make their money by maximizing the services that are provided to paying users.

Of course, it is not quite that simple, because health care resists being treated as a private good. Attempts to insure only the healthy and dodge as many liabilities as possible create a whole industry that is more accounting and actuarial than health care delivery, which functions net about thirty cents of each private dollar spent. At the same time it produces an outcome that taken as a whole is worse than in nations where health care is a public good.

Still, there are profits to be made. Demand is very inelastic. You need it, you pay.

Our second angle from left field is that we have a wonderful example of health care being a public good in the impending swine flu epidemic. It takes no great imagination to realize that the population that has no health care coverage is a wonderful culture for incubation and transmission of the disease as it gets going. We can imagine that many without the foresight or fortune to own health insurance will show up at emergency rooms carrying advanced symptoms or will work through their milder symptoms in the restaurants and retail establishments that commonly provide less coverage. Of course, these folks themselves will likely pay a steep price for their inadequacy, but many others will be unwilling and unwitting fellow travelers and many of these will have health coverage.

Bottom line, the total costs will be much greater than were health care delivered and received as the public good it is.

Finally, although we are mercifully ignorant of much of the popular media's coverage of the current debate, we understand that much of it has been selected for its theatrical rather than its informational value. Nothing new there.

But the increasing incoherence and bellicosity of the Right on this matter, we feel, reflects nothing at all about health care. It reflects instead the deterioration of the Reagan agenda, as one after another -- deregulation, tax cuts, favoritism to corporate interests, anti-governmentalism -- have led to collapse and destruction. There are fewer and fewer rational arguments for the Right that are not frustrated by the facts on the ground. Consequently the argument shifts from head to fist, from evidence to volume control, from building consensus to us versus them.

It is not strictly a matter of what the best thing to do is. If it were, the public option would be viewed as nothing more than a strategic experiment. No. It is a matter of who is right. We suggest that the entrire foofaraw is parallel to the "If we leave there will be a bloodbath" line of argument in Iraq. Yes, there will be problems, but there is no other good solution.


We don't want to sound like we've fallen in love just because Jamie Galbraith sent us another nice note, but we do think his book is a tremendous overview and expose of economics. Exposing not only the many shiboleths and errors that are incorporated into economic conventional wisdom -- a phrase Galbraith's father John Kenneth coined, "conventional wisdom" -- but also exposing the skeleton and circulatory avenues of the economic system as it exists.

The book is much more broad and much less a polemic against the corporate oligarchy than its title, "The Predator State," might suggest. To lead into today's critique of the financial markets, here is an exerpt from the audiobooks version of The Predator State


We hope this comes under the category of brief quotations in review and not of copyright infringement. Available from Blackstone Audio, Inc. Nine hours on eight discs, reader William Hughes.

The financial sector in the current downturn is doing few people good and many people harm. The argument that we first have to salvage the financial sector in order to go to recovery is becoming more and more hollow as profits return to Wall Street and Main Street goes begging.

Credit is still not flowing, as much for want of borrowers as for want of lenders. Another counter-conventional recommendation from Demand Side follows below, on the other side of a look at the profit centers of derivatives trading and commodity speculation. On both, there is a move afoot to regulate markets.

We posted a good Bloomberg piece yesterday as a primer on derivatives.

Half of the Big 5's trading earnings come from unregulated derivatives. The AIG bailout was the government backstopping CDS's, but they're still not regulated. Even if regulated, they are a speculative tool with hundreds of trillions in notional value. The Administration and Treasury Secretary Geithner seem to be ready to standardize them and put them onto exchanges, but this does not eliminate the government's implicit guarantee. It may make it more explicit. Beyond this, Geithner has decried efforts to ban "naked" CDS's, whose value is simply as a gaming tool. Derivatives and commodity trading, activities of extremely questionable value to the society, are now the center of Wall Street's profits.

The Bloomberg article from Christine Harper, Matthew Leising and Shannon Harrington begins

"Wall Street is suiting up for a battle to protect one of its richest fiefdoms, the $592 trillion over-the-counter derivatives market that is facing the biggest overhaul since its creation 30 years ago. Five U.S. commercial banks, including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Bank of America Corp., are on track to earn more than $35 billion this year trading unregulated derivatives contracts. At stake is how much of that business they and other dealers will be able to keep.

“Business models of the larger dealers have such a paucity of opportunities for profit that they have to defend the last great frontier for double-digit, even triple-digit returns,”

said Christopher Whalen, managing director of Torrance, California-based Institutional Risk Analytics, which analyzes banks for investors.

The Washington fight, conducted mostly behind closed doors, has been overshadowed by the noisy debate over health care. That’s fine with investment bankers, who for years quietly wielded their financial and lobbying clout on Capitol Hill to kill efforts to regulate derivatives. This time could be different. The reason: widespread public and Congressional anger over the role derivatives such as credit-default swaps played in the worst financial crisis since the Great Depression. “Public sentiment isn’t very much in their favor,” said Richard Lindsey, a former director of market regulation at the U.S. Securities and Exchange Commission who worked at Bear Stearns Cos. from 1999 to 2006, referring to Wall Street firms. “In some places, they’re not going to have anybody who wants to listen to them.”

In a bad omen for the industry, the Obama administration kept the details and timing of its plan to regulate the derivatives markets under wraps before making it public earlier this month. Robert Pickel, head of the International Swaps and Derivatives Association, and Scott DeFife, chief lobbyist for the Securities Industry and Financial Markets Association, were meeting with Deputy Treasury Secretary Neal Wolin on Aug. 11, when Wolin mentioned that the proposals would be sent to Congress in 60 minutes, according to a person familiar with the meeting. The sudden notice was not what they were used to.

and the article continues

But the point we continue to make is that regulating these derivatives, even putting them on exchanges, while continuing the implicit backstop, is profoundly unstable.

Credit default swaps have a limited use, to hedge against loss in an asset you own. This use accounts for a fraction of the use of CDS's. Most of them are speculative, or even manipulative tools. Backstopping a market this size , well, wow. Impossible.


One more clip

Wall Street is accustomed to getting its way with derivatives legislation. The last major congressional action, in 2000, was designed to exempt over-the-counter derivatives from government oversight. Commodity Futures Act Lawyers for Wall Street’s largest banks initiated and shepherded the 2000 Commodity Futures Modernization Act through Congress because they were concerned the business was in jeopardy from reforms proposed by Brooksley Born, then chairman of the Commodity Futures Trading Commission, according to two lawyers involved in the process who asked not to be identified. The market has swelled more than sixfold since then, according to industry data.

“The Street does make money on this, so it tends to be pretty important to them,” said Lindsey, the former Bear Stearns executive who now works as an adviser to hedge funds and institutional investors at New York-based Callcott Group LLC.

Analysts can only estimate how much revenue the big banks make from over-the-counter derivatives because the banks provide little disclosure in their quarterly 10-Q and 10-K filings, said Portales Partners’ Charles Peabody.

“I’ve been in the business for 30 years, and I read these 10-Qs and 10-Ks, and I still walk away not understanding how they’re conducting their business, how profitable it is."

Derivatives is part of it, but surely not the only profit center in the big banks.

Well, there's commodity speculation.

Tomorrow we put up a treatment of a new paper by Kenneth Medlock and Amy Myers Jaffe of Rice University’s Baker Institute for Public Policy. Medlock and Rice blame the Commodities Futures Modernization Act of 2000 for today's oil market woes, and say the government should crack down on the non-commercial oil market speculators.

Here from the first pages

Early reports indicate that the CFTC, in its new study, is likely to pin oil price swings more squarely on speculative index trading. The Obama administration has already indicated that it will pursue greater regulation of the market and is negotiating with the United Kingdom about possible coordination.




noncommercial traders -- who the CFTC designates as any reportable trader who is not using futures contracts to hedge -- have increased their footprint in the marketplace dramatically since the late 1990s. Hedgers are typically producers and consumers of the physical commodity who use futures markets to offset price risk. By contrast, noncommercial traders seek profits by taking market positions to gain from changes in the commodity price, but are not involved in the physical receipt or delivery of the commodity. These financial players -- generally referred to as "speculators -- have come to account for a significantly greater proportion of activity in the U.S. oil futures markets than physical players in the oil industry in recent years. In addition, trading strategies of some financial players in oil appear to be influencing the correlation between the value of the U.S. dollar and the price of oil. Moreover, we contend that the observed trading behaviors were supported during the 2000s by the policies surrounding the way governments approached the use of strategic government oil stocks.

Oil up or the dollar down?

Commodity price manipulation is much more directly observable than the OTC derivative games, and also more directly costly to the real economy. Say hi to it at the gas pump.

Demand Side has a new out of the box recommendation to offer here. The weak of heart should cover their ears.

We start with the observation that the low interest rate, easy money policy of the Federal Reserve is not working to get credit flowing again. Again and again we hear that the Fed will keep interest rates low because credit is not yet flowing. The unspoken and unbreakable conviction is that it will eventually work.

We continue with the observation that in February 1994 Alan Greenspan raised short-term interest rates in similar conditions, with many banks in similar states of quasi-insolvency. Greenspan acted basically to follow up the long-term rates that he had no control over. What arguably happened then was the beginning of a strong recovery.

Why? Because banks who were previously happy to make their money on the margins between low short-term rates and other unnamed here activities now were forced into making more risky business loans in order to stay afloat. Banks today are happy to make their money on the margins between their low borrowing and their speculative activities combined with the interest from the toxic securities still on their balance sheets. Perhaps a higher short-term rate would force them out into the real economy.

Just a thought.

1 comment:

  1. Hi,
    It seems strange to see the games on Wall street.The health care debate is necessary on the money crazy Wall street.Nice movements on the market.
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