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My perspectives as an investor and consumer

Take a look under that TARP

barsness_bigbluemountainIntimidated and confused by all the programs initiated by the government within the past 12 months?  Don’t beat yourself up.  We are in the majority.  Let’s try and shed some light on these programs and gain some understanding into the allocation of our taxpayer dollars.

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EESA) was signed into law amidst a tailspin in the financial markets.  The Troubled Assets Relief Program (TARP) was established under the EESA with the goal of stabilizing the financial system of the country and, hopefully, preventing a systemic collapse.  Under this law, the Treasury was granted authorization to spend up to $700 billion towards the purchase of troubled assets and the injection of capital into banking institutions.

The TARP has several programs under it:

  • Capital Assistance Program (CAP): to promote confidence in the financial system by ensuring that the nation’s largest banks have sufficient capital cushion against larger than expected future losses.  Financial institutions have to undergo a supervised stress test to be deemed eligible.  The stress test requires these institutions to make some assumptions. The banks would have to assume that the economy shrinks by 3.3 percent in 2009 and remains flat in 2010.  Assumptions will also have to include a decline in house prices by 22 percent this yearUnemployment should rise to 8.9 percent this year and reach 10.3 percent in 2010.  Big banks – those with consolidated assets greater than $100 billion – are required to carry out the test by the end of April.  If regulators assess that an institution does not have enough capital under these assumptions, they would have to raise the required capital either in the private markets or from the government.
  • Consumer and Business Lending Initiative (CBLI): a joint initiative with the Federal Reserve.  The goal of this program is to unfreeze consumer and business credit markets by providing financing to private investors willing to purchase assets backed by auto, student, small business, and credit card loans.  Under this plan the Federal Reserve will provide $200 billion in lending and the Treasury will support it with $20 billion in credit protection.
  • Making Home Affordable Program: an effort to stem the tide of foreclosures and declining home values through the employment of three initiatives:
    1. A refinance for 4 to 5 million people who took out loans owned or guaranteed by Freddie Mac and Fannie Mae
    2. A $75 billion loan modification program aimed at preventing foreclosures by targeting 3 to 4 million at-risk homeowners
    3. Support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac through increased funding commitments to the two entities
  • Public-Private Investment Program (PPIP): to repair balance sheets throughout the financial system through the Legacy Loan Program and the Legacy Securities Program.  The loan program will facilitate the purchase of troubled loans from banks while the securities program will attempt to move the highly illiquid securities (such as mortgage-backed securities and collateralized debt obligations) off the balance sheets of banks and into the hands of investors.  The PPIP is conducted in conjunction with the FDIC and the Federal Reserve.  $75 to $100 billion in TARP capital is combined with private capital.  FDIC and the Federal Reserve will provide leverage for the private capital thereby increasing purchasing power to $500 billion-$1 trillion.  Remember how excessive leverage was our financial system’s undoing?  Looks like we’re going back to the same well in order to rescue the selfsame.  I may have to post another article just on the intricacies of the PPIP.
  • Capital Purchase Program (CPP): created in October 2008 to provide immediate capital to stabilize the financial and banking system, and to support the economy.  It is a voluntary program in which the US Government, through the Department of Treasury, invests in preferred equity securities issued by qualified financial institutions.  The goal is to invest up to $250 billion.  As of the April 10th report by the Treasury, $198.8 billion has been invested.
  • Asset Guarantee Program (AGP): under this program, Treasury will guarantee certain assets held by systemically significant financial institutions. Assets to be insured are selected by the Treasury and must have been originated before March 14, 2008.  In return for this assurance, the government collects a premium from the financial institution, the value of which is determined through actuarial analysis.  Citigroup seems to be the only institution so far to have qualified, and tapped into, this program or forced to do so.  It has received a guarantee on up to $5 billion of its assets to date.
  • Targeted Investment Program (TIP): the goal here is to stabilize the financial system by reducing the chance that one firm’s distress will threaten other financially sound businesses, institutions, and municipalities.  The program is implemented through investments in these unstable institutions.  Citigroup and Bank of America are the lucky ones chosen for this program, each receiving $20 billion through investments in preferred stock with warrants.
  • Automotive Industry Financing Program (AIFP): instituted to prevent a significant disruption of the American auto industry.  Most of the aid has been through the issue of loans, which have so far totaled $24.7 billion.  $5.5 billion has gone to Chrysler Holding and Chrysler Financial.  $19.2 billion has gone to General Motors and GMAC.  The notable exception is Ford Motor, which stayed away from government support and has taken this opportunity to separate itself from the other two.  New York Times has an article on how this company managed to stay independent.
  • Systemically Significant Failing Institution Program (SSFI): to prevent disruptions to financial markets from the failure of institutions that are critical to the functioning of the nation’s financial system.  This domain is reserved for those rarest of institutions – ones that made the worst business decisions of, at least, the past decade, and threaten to cut us all off at our knees.  The lone inhabitant of this realm is American International Group, Inc. or fondly referred to as AIG.  The taxpayers have used $40 billion from this program to prop up this company.  This is in addition to the ~$90 billion it has drawn from the credit-liquidity facility created for it by the Federal Reserve.

Now that you’ve taken a look under the TARP what impressions are you left with?

Filed under: Economy, Government, , , , , ,

A glimpse into the future

dettmer3_1This is the debut of a weekly post, “A glimpse into the future” where I present five research findings as published in various scientific journals.  These projects represent the cutting edge of scientific research.

Advancements in science and technology form the foundation for future economic growth.  Many of these projects are a decade or two from producing applications or products for consumer use.  The ones that make it could significantly improve our quality of life.  As an investor, some of these may serve as candidates for sizeable returns.

  1. Fluorescent cancer cells could guide brain surgeons. Gliomas are malignant brain tumors that arise from glial (supporting) cells of the brain. Gliomas are often resistant to chemotherapy. These tumors grow fine extensions that infiltrate normal brain tissue and, in addition, individual tumor cells can form satellites in surrounding tissue. Therefore, it is almost impossible to remove the tumor tissue completely by surgery. Yet, radical surgical removal of the tumor would substantially improve the prognosis of patients.  The scientists took advantage of the fact that tumors cover their increased energy needs, among other things, by taking up large amounts of the blood protein albumin. The researchers attached a fluorescent substance (5-aminofluorescein) to albumin, which is distributed throughout the body via the bloodstream and eventually accumulates in the brain tumor. Laser light causes the substance to glow and makes the fine extensions of the tumor visible.  The scientists tested the albumin method in thirteen patients with malignant gliomas. In nine cases it was possible to remove the fluorescent tumor tissue completely thanks to the intensive yellow-green light signal.  The researchers calculated that the probability of the glowing tissue being tumor cells is 97 percent.  Tolerability and effectiveness of the staining method will be validated next year in a larger study involving several hospitals.
  2. Worrying about hard drive failures may be a thing of the past. Physicists at the University of Leeds and scientists at IBM Research’s Zurich lab have made new advances in researching a new kind of memory, called  ‘racetrack’ memory, which could become the standard method of storing information on home computers. Racetrack memory, a concept invented by Stuart Parkin at IBM Research’s Almaden Lab, has no moving parts – instead it is the information which moves. Using a kind of physics called spin transfer, scientists use electrons (in the form of electrical current) to switch the magnetism of the domains, pushing them to a different location along a nanowire.  Racetrack memory looks to combine the benefits of flash – no moving parts, with that of a hard drive – low cost.  It is significantly faster than hard disks as there are no ‘seek’ times when the head has to search the disk for information.  Racetrack memory in a computer is estimated to be 100 times cheaper per bit than flash.
  3. A battery powered by viruses could help run your car or electronic devices. MIT researchers have shown they can genetically engineer viruses to build both the positively and negatively charged ends of a lithium-ion battery. The new virus-produced batteries have the same energy capacity and power performance as state-of-the-art rechargeable batteries being considered to power plug-in hybrid cars, and they could also be used to power a range of personal electronic devices, said Angela Belcher, the MIT materials scientist who led the research team.  The new batteries could be manufactured with a cheap and environmentally benign process: The synthesis takes place at and below room temperature and requires no harmful organic solvents, and the materials that go into the battery are non-toxic.Now that the researchers have demonstrated they can wire virus batteries at the nanoscale, they intend to pursue even better batteries using materials with higher voltage and capacitance, such as manganese phosphate and nickel phosphate, said Belcher. Once that next generation is ready, the technology could go into commercial production, she said.
  4. An important piece in clean coal technology – carbon sequestration – may have a sparkling future. New research shows that for thousands of years carbon dioxide has been stored safely and naturally in underground water in gas fields saturated with the greenhouse gas. The findings – published in Nature – bring carbon capture and storage a step closer. Politicians are committed to cutting levels of atmospheric carbon dioxide to slow climate change. Carbon capture and storage is one approach to cut levels of the gas until cleaner energy sources are developed.  Naturally-occurring carbon dioxide can be trapped in two ways. The gas can dissolve in underground water – like bottled sparkling water. It can also react with minerals in rock to form new carbonate minerals, essentially locking away the carbon dioxide underground.  Real studies to support either of these predictions had, until now, been missing.  This study showed that carbon dioxide has been stored naturally and safely in underground water in natural gas fields.  This new approach will be essential for monitoring and tracing where carbon dioxide captured from coal-fired power stations goes when we inject it underground – this is critical for future safety verification.
  5. World’s first nanofluidic device with complex 3-D surfaces. Researchers at the Commerce Department’s National Institute of Standards and Technology (NIST) and Cornell University have capitalized on a process for manufacturing integrated circuits at the nanometer (billionth of a meter) level and used it to develop a method for engineering the first-ever nanoscale fluidic (nanofluidic) device with complex three-dimensional surfaces. As described in a paper published in the journal Nanotechnology, the Lilliputian chamber is a prototype for future tools with custom-designed surfaces to manipulate and measure different types of nanoparticles in solution.  Among the potential applications for this technology: the processing of nanomaterials for manufacturing; the separation and measuring of complex nanoparticle mixtures for drug delivery, gene therapy and nanoparticle toxicology; and the isolation and confinement of individual DNA strands for scientific study as they are forced to unwind and elongate (DNA typically coils into a ball-like shape in solution) within the shallowest passages of the device.

Filed under: Health, Science, Technology, ,

Redefining the paradox of thrift

cycleschange41There is a story in The Scriptures about a man named Joseph, who had the gift of interpreting dreams.  One unfortunate event after another led him to the king’s prison where he had served for two years.  One night, Pharaoh, the king of Egypt, had two dreams both of which troubled him inordinately.  In one dream, seven healthy cows, standing by the river Nile, were devoured by seven sickly ones, which were none the better for it.  In the other dream, seven plump ears of grain were consumed by seven thin and blighted ones.

Of all the wise men in Pharaoh’s court, Joseph turned out to be the only one who could interpret the dreams.  He explained that both dreams referred to the same thing – two consecutive time periods, each seven years in duration.  The first seven years would be ones of plenty but they would be followed by seven years of hunger and famine.

Not only did Joseph have an interpretation, he also had a plan to address the inevitable downturn.  For the first seven years, the time of abundance, the Pharaoh was to collect 20% of the harvest throughout the land of Egypt and save them in storehouses.  These “savings” would be used to feed not just the people of Egypt, but also of neighboring lands who were going to be affected by the dearth during the subsequent seven years.

As the story goes, Joseph’s interpretation of the dream was accurate and the implementation of his strategy positioned Egypt to not only survive the famine but to provide for her neighbors.

I am reminded of this story every time I hear the phrase, “the paradox of thrift” in the media.  Paradox of thrift is also referred to as the “paradox of saving” and was presented by the economist, John Maynard Keynes.  According to this paradox, if everyone saves more during times of recession, then aggregate demand will fall resulting in reduced savings by the population as a whole because of decreased consumption and economic growth.

Here is an example of the paradox in microcosm.  When you save more now than you did last year (as a percentage of your income), you do so by reducing spending because the chances of one’s income rising in a recession are low.  One of the ways you reduce spending may involve cutting expenditure on dining out.  As a result, your local restaurant feels the pinch.  It responds to the altered environment by cutting pay for its employees, reducing work hours or laying some of them off.  Regardless of the nature of the restaurant’s response, the employees’ incomes are reduced.  They, in turn, spend less.  When taken in aggregate, this could lower economic growth as represented by Gross Domestic Product (GDP), because 70% of GDP is based on consumer spending.

Economists of the Keynesian vein believe that spending needs to come from somewhere to stimulate the economy during a recession.  If the consumer has decided to clamp down on spending, it’s the government’s responsibility to pick up the slack.  Herein lies the impetus for the American Recovery and Reinvestment Act of 2009.

I don’t dismiss the paradox outright as do economists that follow the Nobel Laureate, Milton Friedman.  However, the context seems to be turned on its head.  There are certain principles in the story that I recounted earlier that seem to have been abrogated by our society:

  • Always remembering that nothing continues in perpetuity i.e., there is a cycle or season to everything.
  • Times of recession follow periods of growth and vice versa.
  • Preparing for famine needs to be a part of living in abundance.
  • If you have prepared during good times, then you will be in a position to support your community during tough times.
  • If you are in a position to help others during the community’s or nation’s dearth, then you ought to do so.

To me, this is how the paradox should be played out during a recession.  The key is for us to act from a position of strength, not weakness.  A strong position would mean low or no debt and cash reserves sufficient not merely for ourselves but also to support others.  Unfortunately, most of us find ourselves in the contrasting position – that of minimal cash reserves and a mountain of debt.  Opportunities for investment, career advancement or change, societal impact, etc., are all presenting themselves, yet we feel impotent.

However, our story need not end there.  That is the beauty of cycles.  When one passes, another one arises.  What is required of us is a reaffirmation of the principles we once abrogated – to build towards a position of strength and then, operate from that position.

If you are operating from a position of weakness, don’t allow economists to guilt-trip you into spending under the guise of saving the rest of the population.  You can’t help anyone when you are withering.  If, however, you find yourself in a strong position these days, then use this opportunity to impact your community whether it be through investments, doing business with local establishments, or supporting your favorite charities.  Those of us who are not in your position will be inspired by you and aspire to join you in these efforts during the next cycle.

Filed under: Economy, Government, , , , , , ,

So you’re saying, “There’s a chance.”

zebraOne of the many funny scenes in the movie, “Dumb and Dumber” involves an exchange between Lloyd (Jim Carrey) and Mary (Lauren Holly).  Lloyd is wondering about the probability of a future with Mary:

Lloyd: What are my chances?

Mary: Not good.

Lloyd: You mean, “Not good” like one out of a hundred?

Mary: I’d say, more like one out of a million.

Lloyd: So you’re telling me there’s a chance.  Yeah!

The reaction of investors on March 18th seemed similar to that of Lloyd’s as they digested the statement by Ken Lewis, the CEO of Bank of America.  He stated that his company could pay back the $45 billion it received from the Troubled Assets Relief Program (TARP) by the end of 2009 or early 2010.  The price of the stock shot up 22% that day.

This got me thinking about “rhetoric” and the perception it creates in the minds of the audience.  Notice the use of the phrase, “could pay back.”  The intended effect here was that of using the phrase, “will pay back” without the negative legal and psychological ramifications of actually making such a definitive statement.

The reaction that such a statement generated in the stock price of Bank of America is what elicited this post.  Executives of corporations and politicians see it as their job to put as positive a spin on an issue as possible while staying within the legal bounds.  Corporate and political public relations (PR) departments are in the business of using the imagination of the audience and causing them to project what is possible as something that is probable or even highly probable.

What does this mean?  There is a distinction between possibility and probability.  Simply put, that which is possible may not be probable, while that which is probable has to be possible.  In other words, the likelihood of an outcome increases when you move it from the realm of the possible to that of the probable.

What does this have to do with rhetoric?  The intent of rhetoric in the world of business and politics is two fold:

  1. To get people to perceive that which is merely possible as actually being probable
  2. To minimize or eliminate liability from the statements that are made

Let’s take a look at a couple of examples, one from the corporate world and the other from politics:

Corporate.  Ken Lewis, the CEO of Bank of America says that the company could pay back $45 billion by the end of 2009.  This is actually within the realm of possibility.  But things that are merely within this realm do not provide enough actionable information for an investor.  I cannot make an investment decision based solely on this information because the company could just as well not pay back the money.  However, if the executive can make me think that this is highly probable, then I have something to build an investment thesis on.  It would go something like this…

The company pays back the TARP money.  They are excluded from discussions about banks that are going to be nationalized.  Management is, therefore, free to run the company in a manner that’s in the best interest of the shareholder as opposed to the government.  Bonuses for highly talented people are dictated by the company’s compensation committee, not the government.  This becomes a tool for poaching talent from other nationalized or semi-nationalized banks.  The company, as a result, is able to run a business that is more efficient than their nationalized counterparts.  As an investor, this would make the company a candidate for my investment dollars.  Therefore the spring-loaded effect on Bank of America’s stock price on March 18th.

If this does not pan out and the company is unable to pay back the money, they minimize their liability by saying that they never made a definitive statement to that effect.  It was only a possibility.  The company has succeeded in capturing current upside and minimizing future downside.

Politics.  Here is a case with similar intentions but contrasting results to the corporate example.  I remember even when the recession was underway, President George W. Bush and Senator John McCain were sounding like a broken record emphasizing that the fundamentals of the economy were strong.  Their intention was to keep the country, as a whole ,from going into panic mode.  It is possible that the country would not go into a deep recession, but probability showed otherwise.  They were trying to get the American people to project what was possible as that being highly probable.  If called to account, they would try to minimize liability by saying that the “fundamentals of the economy” actually referred to something like the integrity, optimism, entrepreneurial spirit, and work ethic of the American people.  However, as the popular saying goes, “The road to hell is paved with good intentions.”  The administration and Senator’s intentions were instead seen as ignorance, arrogance, and subterfuge and contributed significantly to the results of the subsequent elections.

Here are the lessons for consumers/citizens/investors:

  • Realize that it is the job of corporate executives and politicians to present any situation in a positive light.
  • It is not your job to receive it at face value.
  • The explicit statements may not contain much actionable material.
  • The interesting material is implicit as is the case with the work of art shown above by Victor Vasarely, considered by many to be the father of Optical Art (Op-Art).
  • Learn to read between the lines and be diligent about it.
  • Ask yourself questions like, “What is the real information here?” and “What is intended merely as a projection?”

“One in a million” could mean that you have a chance or very little chance.  Which one, as a consumer or investor, are you going to pick as being actionable?

Filed under: Business, Politics, Psychology, , , , ,

To the creditor go the spoils

spinning_into_debt_by_m0nk3y504Through my earlier post, “Do you know where your money is?”  you were made aware of the amount of federal debt our nation has accumulated ($10 trillion) and the alarming rate at which it is projected to grow over the next ten years (60%).  As you know, debt does not exist in a vacuum.  Every dollar of debt has to be financed by someone.  I can only get a mortgage if a creditor (bank, mortgage originator, etc.) is willing to  finance the desired amount.  Each dollar spent beyond my means has to be facilitated by a credit card company, a bank, a family member, etc.  The creditor or lender expects the borrowed amount (the principal) to be paid back with interest.  Such expectations are based on the creditor’s understanding of my credit worthiness or my ability to pay back the borrowed amount.   The creditor is taking a risk in lending me the money since there is always a possibility that I won’t be able to pay back.  This risk usually comes at a price for me and a reward for the lender.  The price/reward typically takes the form of interest.  Therefore, the more credit worthy I’m deemed, the lower the risk for the lender and lower the interest I’m charged (usually) for the benefit of credit.

Same is the case with the federal government.  The $10 trillion in debt has to be financed by someone1.  About $6 trillion of it is financed by the public and is referred to as public debt.  The public constitutes states, corporations, individuals, and foreign governments.  The rest (~$4 trillion) is in intragovernmental holdings, a vehicle by which the federal government borrows money from other governmental agencies.  The largest borrowing of this kind (56%) is from the Social Security Trust Fund.  I can see some eyebrows being raised as you read this.  However, the story gets even more interesting.

Public debt can be broadly classified as marketable and nonmarketable securities.  Marketable securities can be resold by whoever owns them.  These are made up of Treasury Bills, Treasury Notes, Treasury Bonds, and Treasury Inflation Protected Securities (TIPS).  Marketable securities represent 90% of public debt.  Nonmarketable securities cannot be resold and are primarily consisted of savings securities, special state and local government securities, and Government Account Series securities.

Majority of public debt (52%) is held by foreigners.  China is the largest of these creditors with $740 billion in US Treasury securities (as of January 2009).  The creditor always holds the upper hand in a relationship.  The more I owe someone, the more they are in a position to exert control over my decisions.  Such exhibition of control doesn’t always have to be overt.  Merely an unspoken threat will suffice.  China’s latest inferences to the quality of US credit is but one example of the poor ramifications of ever increasing federal debt in the hands of foreign governments.  Their negotiating leverage as a trading partner gains power with each passing year.

There is another issue to consider.  Additional debt will have to be issued in order to fund all the stimulus packages.  This debt will need financing from foreign creditors.  As I mentioned earlier, an entity’s credit worthiness plays a big part in the kind of financing deals it can garner.  Both Standard & Poor’s and Moody’s have raised concerns over the ability of the US to maintain its triple-A rating in the long run.  If the quality of US sovereign debt is in question, we may have to pay higher rates in interest to find enough buyers.  These buyers could also seek additional benefits, such as trade deals that are skewed in their favor, a bigger say in international policy, etc., in order to continue financing our debt.

So no matter what our government says about trying to exact trading concessions from partners like China, remember this – it’s the entity that holds the debt that always controls the board.

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1 GAO-08-168 Financial Audit: Bureau of the Public Debt’s Fiscal Years 2008 and 2007 Schedules of Federal Debt

Filed under: Economy, Government, , , , ,

Use leverage to transform health care in the US

ailing_healthcare_by_frantzwahWe all understand to some extent that our health care system is in dire need of reform.  Do we know what its condition really is?  Allow me to paint a picture.

What is the current and projected state of health care in the US?

National Health Expenditure (NHE) is defined as the total health care spending in the United States.  According to Centers for Medicare & Medicaid Services (CMMS), which quantifies health spending on an annual basis, the NHE grew 6.1% to $2.2 trillion in 2007, or $7,421 per person.  In comparison, this cost was $75 billion or $356 per person in 1970.  Health care spending currently accounts for 16% of our Gross Domestic Product (GDP) and is projected to grow by an average of 6.2% per year between 2008 and 2018.  At that rate the NHE will have reached $4.5 trillion in ten years and account for 20% of our GDP.  Healthcare spending has exceeded overall economic growth (GDP) annually by an average of 2.5 percentage points since 1970.

80% of health care spending goes to hospital care (37%), physician and other professional services (29%), and drugs (14%).  Many doctors complain that the system is now turned on its head where more and more of each healthcare dollar goes to cover administrative costs associated with the first two categories than to pay professional fees.  The facilitator of the doctor-patient relationship has become the principal entity.  Meanwhile, the doctor-patient relationship is now there to support the facilitator.

Private health insurance and out-of-pocket payments accounted for the largest part of health spending (55%) in 2007.  Public programs like Medicare, Medicaid, etc., comprised 45% of NHE.  While worker’s earnings and overall inflation has increased ~30% since 1999, health insurance premiums have grown 119% during the same period.  This usually means that workers have to spend more of their income each year on health care to maintain coverage.  These effects may either be direct – through increased worker contributions for premiums or reduced benefits, or indirect – such as when employers forgo wage increases to offset increases in premiums.  I gather you’ll agree with me that neither of these options is ideal.

Due to the influence of the recession and the leading edge of the Baby Boom generation becoming eligible for Medicare, average annual spending growth by public payers is expected to outpace that of private payers.  As a result, CMMS projects that public programs will overtake private insurance and reach 51% of NHE by 2018.  Not only will it be necessary for us to allocate greater portions of our income to employer-covered insurance premiums and Medicare, there is no guarantee that it will be sufficient to bear the imminent burden on our health care system.

How can this problem be addressed?

Victor Fuchs, Professor of Economics and of Health Research and Policy at Stanford University, proposes tackling health care reform around four essential principles: coverage for the uninsured, cost control, coordinated care, and choice1.  According to him, any reform which does not cover these essentials is doomed to fail.  In addition, any reform plan that is not controversial is certain to be inconsequential.

Dr. Benjamin Carson has one such controversial and ambitious plan.  Dr. Carson, who has served in a medical advisory role for both President Clinton and President Bush, suggests the idea of a medical endowment where ten percent of the cost of health care be set aside annually in an endowment fund2.  The interest from the endowment would be used initially to cover health care expenses for the uninsured and underinsured, the first C of Prof. Fuchs principles.  He envisions growing the fund to such a size in 15-20 years that it can cover most of the country.  He has initiated a pilot program at Johns Hopkins Medicine.  The fund, called the Benevolent Endowment Network fund, will be started off in pediatric neurosurgery, expanded to all of neurosurgery with the hope of eventually covering the entire hospital.

On the corporate side, Wal-Mart is slowly positioning itself to be a force in health care through a controversial plan for tackling the second C – cost control.  I call it controversial because Wal-Mart tends to elicit a visceral reaction from many people, who view the company as “pure evil.”  I merely present the company as one of the potential forces necessary for true health care reform to be accomplished.  In September 2006, the company introduced $4 30-day prescription pricing for 291 generics in the Tampa Bay, FL area, which was available to the uninsured.  It has since expanded the program to 49 states covering 350 generics and 1000 over-the-counter medications.  Pricing now includes an option for a 90-day prescription for $10.  Several pharmacy chains, including Target and K-Mart, were forced to follow suit.  Anecdotal evidence from my pharmacist friends, who work for other chains, suggests anger at this move.  Meanwhile, many consumers applauded the move.

The company is now looking to shake up Pharmacy Benefits Management (PBM).  It announced a pilot with Caterpillar to provide 2500 prescription drugs to 70,000 of its employees, spouses, and retirees.  If successful, it is sure to try expanding the deal with other employers.  This, in turn, could help employers cut their costs related to prescription drug coverage.

The third leg in Wal-Mart’s stool is electronic medical records (EMR).  According to an article in the New York Times, Wal-Mart has decided to team its Sam’s Club division with Dell and eClinicalWorks to market hardware, software, installation,maintenance, and training to physicians’ offices.  They will be mainly targeting small physician groups where 75% of the nation’s physicians practice.  Another initiative in the works for Wal-Mart is telemedicine in collaboration with NuPhysicia, LLC.

Michael Porter, University Professor at Harvard Business School and Director of the Institute for Strategy and Competitiveness, has a plan for tackling the third and fourth C’s – coordinated care and choice.  He proposes a value-based health care delivery system where players strive to create value for patients rather than capturing more revenue, shifting costs, and restricting services.  The centerpiece of this strategy involves bundled reimbursement for an entire care cycle instead of individual services like doctor visits, MRI scan, radiologist consultation, biopsies, etc.  He provides examples of institutions such as The Cleveland Clinic and MD Anderson Cancer Center where disease-based integrated practice is bearing fruit.

Despite the various forces working to address the four C’s, one important issue that I see missing is that of preventive medicine.  I proffer this as the most important piece for the long term viability of any health care reform that’s implemented.  Most reform ideas center around the reduction of current health care burden which are all remedial in nature.  In fact, our entire nation’s health care focus seems to be on treating the disease.  Even the preventive measures mainly target regular screenings.  The assumption here is that some type of disease is inevitable; so let’s try to nip it in the bud through screenings.  What about the notion that many diseases may be prevented if we actively engage in a lifestyle that’s healthier this year than it was the last?  A friend of mine (hat tip CJC) made a statement recently which I believe to be true:

No health care reform or plan in the world can bear the burden of overweight and obesity and the complications that arise from it.”

According to the National Institutes of Health, two-thirds of us are overweight and one-third are obese.  Overweight and obesity are known risk factors for several diseases.  Certain diseases can trigger other complications and multiply the cost associated with treating them all.  For example, people with diabetes spent $190 billion for health care in 2004, nearly seven times the $28 billion they spent specifically to treat diabetes.  A sizeable portion of the total spending for these people went to the treatment of conditions that are common complications of diabetes3.  So leverage, in this case, works against us and multiplies the burden on the health care system.

However, leverage may be employed to our advantage, as well.  What if we take personal responsibility for our long term health through healthier eating and more physical activity?  We may be able to reduce conditions of overweight, and obesity and diseases like diabetes, heart attack, stroke and other related disorders.  As a result, we will find ourselves making fewer doctor visits outside our regular check-ups.  Fewer complimentary services are ordered by our primary physician.  All of this reduces the burden on our health care system.  Health care providers can, in turn, focus on patients with diseases that are out of their control and provide better value.  Meanwhile, consumers may be willing to apply some of the savings from their reduced insurance premiums to cover the uninsured and underinsured.  The four C’s have a better chance of success in providing coverage for all of us because less strain is put on by each of us.  And the best part: this leverage monetarily costs us next to nothing.

All it requires is one question and small steps to answer it: How can I live healthier this year than I did last year?

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1 Health Reform: Getting the Essentials Right by Victor R. Fuchs

2 The vision of the Benevolent Endowment Network fund by Dr. Ben Carson

3 Roehrig C., et al. National Health Spending by Medical Condition, 1995-2005.  Health Affairs.  Volume 28, Number 2 (2009): pp 358-367.

Filed under: Business, Economy, Government, Health, , , , , , , , , ,

Do you know where your money is?

paper_money_macroOn February 26th, President Obama laid out his administration’s budget proposal for 2010.  The entire document, with a great marketing title of “A New Era of Responsibility,” contains 112 pages of words and an additional 21 pages of tables.  Believe it or not, this is actually a summary of the detailed version that will be released in April.  Ironically this administration makes it no easier to understand how our government is spending our money.  In fact, the US Government Accountability Office has complained about this ambiguity in budget proposals for the past twelve years.  I point this out to you because we should not confuse strategy with ineptitude.  I would probably employ ambiguity as well, if I were they.  In the chapter, “On Military Strategy,” the Huainanzi has this to say about the use of ambiguity:

“It is important that strategy be unfathomable, that form be concealed, and that movements be unexpected, so that preparedness against them is impossible.  What enables a good general to win without fail is always having unfathomable wisdom and a modus operandi that leaves no tracks.”

Unless someone knows clearly what you are up to, they cannot hold you accountable.  When it comes to the democratic process, an uninformed electorate is one that can be easily swayed.  Rhetoric is a politician’s friend, whereas clearly delineated items in a financial statement are not.  This is not to say that financial statements are immune to manipulation but the task is more cumbersome than the spin of a wordsmith.

I looked around the web to see if anyone had succinctly presented all the information contained in the budget proposal.  I could not find any that were comprehensive enough.  So I decided to undertake the task.  My goal was to distill everything down to two or three tables which can be understood by anyone within a few minutes.  I must confess that this task took me days to reasonably connect the dots.

The federal fiscal year starts on October 1st and runs through September 30th of the following year.  The budget has a spending side (outlays) and a tax revenue side (receipts).  There are two basic categories of spending: mandatory and discretionary.  Mandatory spending contains entitlement programs, such as Social Security and Medicare, which are provided by law.  This accounts for approximately 60% of annual outlays.  Discretionary spending is appropriated annually by Congress and can be split into defense and non-defense spending.  Defense spending typically absorbs 50-60% of the discretionary outlays.

Table 1 itemizes federal outlays by governmental agencies.  obamabudgetoutlays2009Click on the table to see it in detail.  The agencies are listed in decreasing order of the amount allocated to them annually.  Federal spending is projected to be $3.9 trillion in 2009, an increase of ~$1 trillion from 2008.  $497 billion of it is allocated to the Treasury Department for the Troubled Asset Relief Program (TARP) and a placeholder for potential financial stabilization.  Even after the one-time allocation to the Treasury expires, federal outlays only settle to the ~$3.6 trillion level for the remainder of President Obama’s current term.  The slack is going to be picked up by mandatory spending for the departments of Health and Human Services, Social Security Administration, and “Other Mandatory Programs,” which are conveniently not listed.  The Department of Defense will see spending levels drop from ~$700 billion (including the cost of Iraq and Afghanistan war) to $670 billion in 2010, a decrease of less than 1% of total federal spending.

Actual spending amounts for “Other Mandatory Programs” are not listed anywhere.  obamabudgetmandatory2009The best I could do was look at the contribution of mandatory spending by various agencies to the budget deficit.  Table 2 lists these contributions.  This is an example of the ambiguity that I am referring to.  You’ll notice several agencies with “No Significant Change.”  From a strategy perspective, this looks much better than listing the actual amounts of spending.  Spending cuts can be made to look rather large when actual spending amounts are not given.  For example, a $500 million spending cut seems large but is insignificant if the reduction comes from an agency that sees $500 billion in annual spending (0.1% spending cut).  The biggest contributor to the increase in 2009 deficit, from the mandatory spending category, is the Department of Treasury.  Notice how convoluted this statement sounds.  Ambiguity.  The less we know, the fewer questions we ask.

$250 billion is allocated to the Treasury in 2009 as a placeholder for the potential stabilization of financial markets.  The Department of Education will see some changes, as well.  Pell grants will be converted from the discretionary category to the mandatory.  Entitlements for financial intermediaries under the Family Federal Education Loan Program will be eliminated.

Health reform initiatives will begin in 2011 and be ramped up during the President’s second term (2013-2016).  During this period savings will be wrung to the tune of $75 billion annually through Health Savings and limiting tax liability from itemized deductions to 28 percent.

Table 3 summarizes the Federal Budget and compares it with the last two obamabudgetsummary2009years of the previous administration.  The revenue side of the budget (receipts) comes mainly from taxes of various forms.  Individual income taxes (45%), Social Insurance taxes like Social Security and Medicare (36%), and Corporate taxes (12%) contribute the bulk of receipts.  They are estimated to decrease this year and the next primarily due to job losses and shrinking of corporate profits.  Couple that with increased federal spending and deficits are projected to increase almost four fold to $1.7 trillion in 2009 and settle around $600 billion by 2012.  Even more shocking are the numbers associated with our federal debt, which is projected to increase by 60% from $10 trillion in 2008 to $16 trillion in 2012.

If I told you that my personal financial plan over the next four years is to live increasing below my means (greater deficits) and increasing my debt by 60% would you consider this era of mine as being responsible?  If a publicly traded corporation told you that it is going to be losing money on its operations at a greater rate and increasing its debt load by 60% over the next four years, would you consider this management to be responsible and the company to be a highly attractive investment?  Yet our government considers this to be “A New Era of Responsibility.”

My advise to you would be to pay NO ATTENTION to the words.  Follow the numbers instead and let them narrate the true story.  At least you will be in a position to decide whether you like the story or not.

Filed under: Economy, Government, , , , , , ,

As the pendulum swings…

the_pendulumThrough my experience as an investor, I’ve learned to look at the market as a collective expression of fear or greed. Webster’s dictionary defines greed as a selfish and excessive desire for more of something than is needed.  Fear, on the other hand, is an unpleasant often strong emotion caused by anticipation or awareness of danger.

The market tends to swing between these extremes in reaction to various factors.  What’s peculiar to me is the timing of these emotions.  We are most fearful when we should be aggressive and most greedy when we should be cautious.  I use the words “aggressive” and “cautious” purposefully because I don’t think we should ever be making decisions based on fear or greed.

Part of the reason for collective emotion is due to the human tendency for groupthink.  Groupthink is an exhibition of consensus without critical thought or analysis.  It requires minimal effort, is not caustic, and appeals to our desire for a comfortable buffer.  If an idea fails, at least we’re not the only ones failing.  There is a certain level of comfort in failing or being mediocre as a group.  Unfortunately a successful idea under groupthink does not bear a lot of fruit because the participants, by design, are too late to the game.

Independent thought, on the other hand, requires maximal effort.  You find yourself having to do most of the research and analysis, and drawing your own conclusions.  These ideas differ from the “group;” so criticism is inevitable, which over time, can wear emotions down.  Besides, there is always the danger of failing miserably with no one to fall along with you. Once we take these factors into account it’s no surprise that many of us unintentionally pursue the path of least resistance.

The emotional pendulum had swung to the side of greed during the historic housing boom:

  • as home values appreciated, the idea of quick and large profits gained momentum
  • our wrongful association of material wealth with happiness found new life
  • homes inappropriately became ATM’s due to easy access to home equity loans
  • financiers saw an opportunity to take advantage of groupthink participants to juice up their bottom lines
  • as our perceived “ATM’s” got bigger, we allowed ourselves to suspend the simple, yet profound, notion of spending less than we earn

Kyle Bass serves as an example of a person who resisted groupthink during the greed phase.  Mr. Bass runs a hedge fund out of Dallas, Texas.  In 2005 he started doing his own research into the mortgage-related securities that were being packaged by Wall Street and sold worldwide.  He asked the tough questions.  According to him, Wall Street was putting lipstick on a pig and selling it to people who did not understand what they were buying.  The lynchpin to the groupthink assumption was that home values would never come down.  Bass came to the conclusion that the trend was unsustainable and the unraveling would be vicious.  He and his partners predicted early on that the amount of troubled loans would hit $1 trillion.  He even shared his concerns with risk managers on Wall Street.  No one wanted to listen.  He then made the tough decision of putting a substantial portion of his own capital and that of his investors behind his conclusions even as the herd was thundering the other way.  His fund reported a return of 400 percent in 2007.

The pendulum now finds itself swinging to the other extreme — that of fear:

  • people are pulling out of the stock market after seeing half the value of their portfolios vanish into thin air
  • those nearing retirement are worried that they will have to work much longer to make up for the lost value in their retirement accounts
  • the housing-led recession is fully afoot
  • those who have lost jobs are wondering if they’ll find one soon
  • those who still have their jobs are fearful of losing it any day
  • the decline in home values hasn’t abated yet (remember the lynchpin?)
  • the foundations of many banks are crumbling leaving people wondering if their money will be safe
  • ……….

Fear seems to control our decisions these days.  Unfortunately, the economy will not see an improvement until this emotion subsides.  One thing I know for sure…this too shall pass.  As Solomon, the wise man, once said, “To every thing there is a season, and a time to every purpose under the heaven.”   There are enormous opportunities for people who recognize this, resist groupthink, make tough decisions, and take some risks.  As sure as Kyle Bass earned his profits working against the market’s greed, there will be those who reap great rewards working against the market’s fear.  Sadly, most of us will only hear about it after the fact.

Filed under: Business, Economy, Psychology, , , ,

Gifted Hands

brain_neurons_medLast week TNT aired an original movie, “Gifted Hands,” based on a book of its namesake. The book is a memoir of Dr. Ben Carson, a man I greatly admire.  Dr. Carson is the world’s foremost expert in pediatric nurosurgery.  The movie reminded me of why his life and book have been such an inspiration to me.  Coming from an impoverished background in Detroit, with the nickname “Dummy,” it was no small feat for him to reach the pinnacle of medicine.  His body of pioneering work includes the first successful separation in 1987 of Siamese twins joined at the head.

He credits his success, in large part, to his mother.  As a single parent, she had to work two or three jobs to keep from going on welfare and to provide for the family.  She accepted no excuses for poor work and insisted that as long as Dr. Carson had a brain, he could find a solution to any problem.  One of her statements has stayed with me:

“You’ve got all the world inside your head.  You’ve just got to see beyond what you can see.”

I have long been fascinated with the scientific and metaphysical aspects of the brain; this serves as another reason why Dr. Carson’s story resonates with me.  The brain is probably the most complex biological structure known.  From a scientific perspective, it is seen as generating behavior that promotes the welfare of the animal.  Philosophically speaking, however, it may be the physical structure supporting the mind.

I am not a neuroscientist but I believe our brain and our mind to be powerful enough to meet greater demands than what most of us normally place on it.  According to Dr. Carson, we don’ t use all of our brain but the more it’s challenged, the more it delivers.  Imagine how the remaining half of a child’s brain that has undergone hemispherectomy adapts to take over many of the functions of the resected portion.  Many neurologists, neurosurgeons, and psychiatrists attribute this to neuroplasticity, the structural and functional adaptation of the brain to various stimuli.  Recent school of scientific thought claims that neuroplasticity is not merely relegated to the developing brain of a child but can occur in the adult brain, as well.

The exciting implication for me as an adult is the realization that I can continue to develop new skills, increase in knowledge and understanding, and add even more shades of color to my experience of the world.  Dr. Carson would say that it is not so much about an innate intellectual ability as it is about the target of our concentration.  It is about raising expectations.

In 2008 Dr. Ben Carson was awarded the Presidential Medal of Freedom, the highest civilian award presented annually by the President of the United States.

Filed under: Books, Inspirational, , , , ,

Mr. Softy’s becoming a retailer?

apple_store_smallMicrosoft is pursuing its ambitions in retail by planning store operations of its own.  It has hired David Porter to spearhead its efforts.  Mr. Porter was most recently the head of worldwide distribution for DreamWorks Animation SKG.  He also brings 25 years of experience from Wal-Mart.

Critics are already shoveling dirt over the perceived grave of said effort.  I’m withholding  judgment till I see it played out.  Their reasoning behind such a push is really what piques my interest.  As you may recall, Microsoft had once ventured down this path in 1999 through a large store in the Metreon center in San Francisco.  The doors were quietly shuttered within two years.

Fast forward ten years and we have another effort by Microsoft to operate its own stores.  Why does a company that has 90+% of the worldwide PC market need to enter into the brick-and-mortar retailing business?  How much more can it gain through sales at these stores?

I think discussions around marketshare miss the point.  The real issue is consumer mindshare.  Although Microsoft has tried to expand into areas such as search, gaming, music, mapping, etc., its cash cow still remains the operating system and Office suite of applications.  The latest incarnation of its operating system, Vista, has not received the acceptance that Microsoft had hoped.  When it comes to innovation, companies like Apple and Google are capturing consumers’ attention.  Microsoft, although ubiquitous, finds itself falling off consumers’ radar.

Here are a couple of charts to illustrate my point:

The first chart was produced using Google Trends.  aaplvmsft_search_volumeYou can use their tool to compare the frequency of occurrence of your term/s relative to the total number of Google searches.  The results are expressed as “Sales Volume Index” which is the volume of your search term relative to total search volume.  Although these results would not pass the test of scientific rigor, they do provide interesting insight.

I compared the terms “Apple” and “Microsoft.”  The green line represents Microsoft while the orange line represents Apple.  The chart shows results of  searches conducted worldwide over the past five years.  Of interest here is the steady loss of mindshare, expressed through search, that Microsoft has suffered relative to Apple.

Now take a look at the second chart which compares the relative market cap of the two companies.  aaplvmsft_mkt_capThe numbers are normalized to Apple’s market cap in January 2004 of $8.4 billion.  Microsoft’s market cap in 2004 was 36x that of Apple’s.  You’ll notice that the general trend since then has been similar to that of the Sales Volume Index.  While Apple’s market cap has increased 1000% in the past five years, Microsoft’s relative market cap has seen a 50% decline.  One of the reasons for the decline is the steady erosion of Microsoft’s traction with the consumer.

With the next version of its operating system, Windows 7, Microsoft wants, and needs, to prove to the consumer that they can have a better experience with its products than they do with Apple or Google.  Maybe getting them into a  vertically integrated store is the solution.  Microsoft would control all aspects of the store and the experience.

Whether successful or not, Microsoft feels that it needs to try because consumer confidence, once lost, is enormously difficult to regain.  Just ask the Big Three auto makers.

Filed under: Business, Technology, , ,