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Monthly Archives: January 2009

I attended the West Chamber of Commerce Health Care Community Forum as part of the Obama-Biden Transition Project. It got me thinking about the cost of health care.

Here are some of my findings:

1. Based on my experience, between 2001 and 2008 employer’s healthcare payments have gone up by 2.2x in just these last 6 years. (This figure correlates with other people’s findings).

2. In real dollar terms this is around $1,350 per employee (with a family of three) or $16,200 per annum.

3. The 2006 Average Median Household Income was $49,568 (more).

4. COBRA is ineffective. See Washington Post article, COBRA Too Costly for Many Unemployed, Report Finds.

5. Small businesses accounted for 99.7% (2006) of US employer companies, and 50.9% of the US non-farm private labor force of 58.6 million people (more).

6. In 2006, the estimated average annual salary of a small business employee was $31,049.

7. The average US household size is 2.6 and average family size is 3.19 (more). For rough calculations we can continue to use a family size of 3.

8. Between 1997 and 2006, the proportion of the uninsured US population has hovered between 14.2% (1999) and 15.4% (1997). more 

9. Between 1997 and 2006, however, the proportion of under 65 insured by private insurance has steady gone down from 73.1% (1999) to 66.5% (2006). That is approximately a whopping 10%.

10. The usual trends presented tend to be related to age (CDC Data), that younger people tend to be uninsured.

Here are my thoughts:

1. The 2008 health insurance costs to the small business employer is on the order of 30% of an employees’ salary.

2. Cobra is ineffective, because almost no small business employee who has been laid off can afford it. This is because as soon as the employee is laid off his expense burden increases by 30% if he or she want to continue with the medical benefits.

3. We have to ask oursleves some very hard questions:
3.1 Was there a 2.2x increase in accidents or diseases in the US to account for this 2.2x increase in health costs? No.
3.2 Was there a 2.2x increase in the non-employable senor citizen population in the US? No.
3.3 Did the number of uninsured in the US increase by 2.2x over these last 6 years? No.

The politically incorrect & uncomfortable answer is that health insurance costs increases were not due to the underlying population demographics or the economic condition of the US in general.

4. More and more Americans are opting out of private health insurance plans, at the rate of 1.5% per annum, not taking into account the effect of the 2007-2009 recession, which should substantially increase the uninsured in 2009.

5. Though age trends are very interesting they miss a very important underlying correlation, that income is highly correlated to age. Quite possibly the age correlation is symptomatic of earnings, and not an independent factor in itself.

6. If age is not the right factor can income be correlated to proportion of insured? I could not find this data, but looking at incomes as a ratio of poverty levels, there is an important relationship. The average private insurance level between 1997 and 2006, by poverty category shows that there is a strong relationship between income and proportion insured. The CDC data shows the proportion insured, of Poor (23.5%), Near Poor (47.2%) and Not Poor (86.5%).

7. That is private health insurance only works in a society when this insurance is not a significant chunk of disposable income. That means we have to get back to affordable health insurace costs. Say $100 per month?

8. The opt out rate is an exponential function, and therefore it would be reasonable to expect, that this 1.5% per annum rate, will substantially accelerate with the passage of time if nothing is done to address runaway health insurance premiums.

9. Don’t be surprised if the proportion of Americans below 65 yrs. with private medical insurance drops below 50% by 2020.

10. I suspect that the private medical insurance industry is therefore in a bubble of it own making.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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As simple as it will sound there is a fourth requirement for good regulation that we always overlook in the heat of formulating regulation.

The fourth requirement of good regulation is that it needs to facilitate market forces.

This is not as easy to do as it sounds. Take for example currency bands. Once a country set currency band limits, than all a currency investors has to do is buy low and sell high. How quickly you get rich depends on how quickly you can move the currency across the band.

Where does the investor’s profits come from? From the taxpayers of the currency-banded country as their government tries to prevent the currency moving outside the band. Currency bands are wealth pumps siphoning wealth out of a country.

So the lesson here is that good regulation fosters economic forces while reducing the potential for market players to game the system.

Benjamin t Solomon
QuantumRisk LLC

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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In my previous posts When to Expect a Recovery in the Mortgage Market, I had anticipated that banks would rework failed mortgages because that would be in their long term interest, as the penalty for not doing so would be an additional 20% loss in the loan principal writedowns.

I’d like to say my forecast was correct. Per Reuters’ Citi backs measure to help avoid foreclosures, CEOs like Citi’s Pandit concur that it is better to modify mortgages then to face the writedowns. Expect more banks to fall in line.

Of course the bad news for other investors is that their coupon payments will be reduced (it already is), but that still is better than loan defaults that would reduced the value of their original investments.

We are moving a step closer to a 2009 recovery. Remember that it is the real economy that matters.
 

Benjamin T Solomon
QuantumRisk LLC

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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If you had studied finance in Europe in the early 1990s you would be aware of two raging topics in academia. First, was the how much regulation was required for efficient markets? Second, was dividends paid from profits or from cashflow?

Today, we know the answer to the second question, i.e. from cashflow, but only have a partial answer for the first question. The partial answer is that the 2008 Wall St. ‘mess’ clearly shows us that no regulation or little regulation is definitely a bad thing. That was an expensive lesson, not just for Wall Streeters, but for the investing American public, too.

In today’s New York Times editorial Starting the Regulatory Framework, the following paragraph caught my attention:

“In addition to explicit regulation of derivatives, those rules must include limits on the amount of money that financial institutions can borrow in order to boost returns — and higher requirements for the amount of capital they must hold to support their activities and cushion their losses.”

A friend of mine told me that here in the US regulation tends to be short but in Scandinavia it tends to be long. I think we miss the point when we focus on ‘explicit’ regulation or even the length of a regulation as a measure of ‘explicitness’.

I do believe that good regulation must have three properties.
1. Instill Clarity. It should be clear from the wording of the regulation what the spirit of the regulation is, even to dissenting stakeholders. Clarity discourages people from gaming the system.
2. Promote Transparency. Regulations should promote open and full disclosure of what a company is doing. For example if something is outside the books, for example off balance sheet, regulation should require that this be made visible (amount, timing, penalites, exposures, and historical trends) even if auditors, accountants and internal parties believe otherwise.  This would include trading and derivative exposures, in a manner that would facilitate public scrutiny because markets are only as efficient as the information they have available to them.
3. No Exceptions. Everyone lives by the same spirit of the regulations. This ensures that market players do not arbitrage off an unregulated segment of the market when a regulated segment would not allow them to make similar profits.

Benjamin T Solomon
QuantumRisk LLC

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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The New York Times article Risk Management is one of the better articles I have read on the big picture of risk management.

I would definitely recommend you reading this article.

Benjamin T Solomon
QuantumRisk LLC

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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In my previous post Mortgage Spreads too High? I had used the formula: 

53% * 2,000,000 * $250,000 * (35% + 20%) = $145.75 billion

Let me explain. This is a standard expected loss formula adapted to our current situation. It takes the form:

Expected Loss = Prob of Default *  Severity of Loss

Given no reworking of loans, the probability of a default is 53%. The Severity of Loss is the average loss as a percentage of the loan, in this case 35%, multiplied by the average loan value. Depending on which paper you read, the average residential mortgage loss varies between 20+% to 60+%. The generally accepted figure is 35%. 

Given that a very large proportion of the loans are subprime, one can expect a Loan-to-Value (LTV) ratio of 100%, i.e. the average loan amout was the value of the property or $250,000.

I added an additional 20% to the loss as on a 100% LTV the unrecoverable loss needs to include the depreciation in house prices of 20%. This is appropriate as average losses are monotic and subadditive.

There is an important lesson here.

The formula tells us that if banks foreclose on a property they will have to realize the additional loss from the 20% house price depreciation. If banks have the capital to hold on to these foreclosed properties until the economy revives and house prices appreciate, then these banks do not require the government bailout funds, and should not be allowed access to the bailout funds.

This raises the question, how are banks using the bailout funds? If the bailout funds are being escrowed into reserve accounts for when a foreclosure is realized, then expect further deterioration in the mortgage markets in 2009; because the bailout funds are being used to stopgap bank losses but not to address the cause – the real economy.

If the funds are used to rework and rewrite mortgages so that 85% of the toxic mortgages are now viable, then we can expect a recovery in the mortgage market in 2009, because banks are addressing the problems in the real economy.

Now we know why Sheila Bair of the FDIC proposed a workout of 2,000,000 residential mortgages. In the long run it will actually help save the banks.

Unfortunately, as Paul Kruger pointed out in his New York Time’s blog, the spreads have increased to unprecedented highs. So don’t expect a recovery in the real economy of the mortgage markets until mortgage spreads come back down.

Benjamin T Solomon
QuantumRisk LLC

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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