The Spymaster and the Economist

Jan Kmenta, Professor of Econometrics

The work of the best novelists and scholars burrow into the psyche. Peculiarly in my own mind the British intelligence officer and novelist David Cornwell (aka John le Carré), and Czech-born Jan Kmenta, the wry professor of econometrics, are inextricably linked. Both exemplify their generation's dedication to finding truth in ambiguous settings through careful application of craft.

Kmenta would begin his graduate course in econometrics with a set of definitions:

An Economic Historian goes into a dark room looking for a black cat.

An Economic Theorist goes into a dark room looking for a black cat that is not there.

An Econometrician goes into a dark room looking for a black cat that is not there and declares: "I found it!"

The rest of the course (and the three that followed) was devoted to an arduous study of the theory and practice that would keep us from making any such a mistake. With humor Kmenta could shoulder the futility of his quest, but he could not abide those who mistook shortcuts for progress.

John le Carré

These ruminations began when by some happy accident I picked up my decade-old copy of John le Carré's The Tailor of Panama. Writing in the mid-1990's, as the West was celebrating its accidental victory in the Cold War with the careless swagger of sophomores greeting the incoming freshman class, le Carré adapted his method to the times. Turning away from the earnest style of his previous spy novels, le Carré surprised his readers with a comic approach.

His unlikely protagonist, an expatriate tailor with a good heart and a questionable past, is recruited by a novice spy of uncertain virtue. Together they set out to prove the existence of conspiracy fabricated from whole cloth. True to his craft but inept in spycraft, the tailor weaves selective data with imaginative storytelling to flatter the careless and comfort the powerful. The institutions charged with analyzing and verifying his reports fail to question false information that suits their narrow interests. Let loose in a benign environment, the misdirected agents of change wreck havoc.

In the aftermath of the Western intelligence failures of this twenty-first century, John le Carré seems eerily prescient. By the same token, clients are advised to select their consultants and govern their projects with unusual diligence. It is all too easy to prove the existence of black cats that were never there.

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Timeline of Financial Bailout of 2008

Day	Date	Action
Q3-Q4: 2007		Subprime mortgage meltdown begins
Fri.	30-May-08	JP Morgan completes acquisition of Bear Stearns
Sun.	7-Sep-08	U.S. Treasury seizes control of Fannie Mae and Freddie Mac, government-sponsored mortgage guarantors
Sun.	14-Sep-08	Bank of America agrees to buy Merrill Lynch under terms set by the US Fed
Mon.	15-Sep-08	Lehman Brothers files for bankruptcy
Tues.	16-Sep-08	Treasury agrees to loan $85 billion to A.I.G.; takes control
Wed.	17-Sep-08	Treasury/Fed worry about runs on money markets and investment banks
Thurs.	18-Sep-08	Paulson and Bernanke present 3-page plan to Congressional leaders
Sun.	21-Sep-08	Morgan Stanley and Goldman Sachs become regulated bank holding companies, ending era of Investment Banking
Wed.	24-Sep-08	Economists submit letter in opposition to the original Paulson Plan, claiming it is unfair, ambiguous and short-sighted
Thurs.	25-Sep-08	Regulators seize Washington Mutual Saving and Loan and arrange sale to JP Morgan Chase
Sun.	28-Sep-08	First draft of Emergency Economic Stabilization Act of 2008 (HR 3997)
Mon.	29-Sep-08	HR 3997 fails to pass the U.S. House
Wed.	1-Oct-08	Senate passes HR 1424, a modified version of the bill
Fri.	3-Oct-08	Congress passes HR 1424 and President G.W. Bush signs it into law
Week ending 10/10		Dow Jones loses 18% of value in one week. Iceland seizes its banks. Britain proposes direct investment in banks
Sat.	11-Oct-08	G7 finance ministers, then Group of 20 meet at White House to coordinate policy
Mon.	13-Oct-08	Paulson and Bernanke meet with leaders of 9 largest banks. Get agreement on direct infusion of cash
Mon.	10-Nov-08	AIG bailout restructured to include $60 billion loan from US Federal Reserve, $40 billion in securities purchased by US Treasury, and credit lines of up to $30 billion backed by Credit Default Swaps and $22.5 billion against mortgage-backed securities

A collection of posts about the US Economy is maintained here.

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Health Care Reform Takes Shape

image from http://www.PiperReport.com


With the final markups of the Affordable Health Choices Act now clearing committees in the U.S. House of Representatives, the potential scope of the legislation is becoming clear. And, while the American Medical Association is on board with H.R. 3200, the House version of the bill, the insurance industry is coming out swinging.

Doctors have to appreciate several aspects of the bill. First, the bill would extend insurance coverage to tens of millions of Americans who currently are denied coverage by insurance companies or who simply can not afford it. (See An Explanation of the Health Care Bill.) Second, the bill enhances the role of the primary care physician in determining the effective course of treatment and offers economic incentives for doctors and medical students to take on this role. The bill also addresses flaws in the Medicare reimbursement mechanism and includes measures to promote wellness and disease prevention.

Insurance companies seem most concerned about the introduction of a government-operated insurance plan, which they view as unfair competition. Health care economists argue that a government plan is required in order to:

• Ensure access to affordable care
• Provide market leadership in setting standards and negotiating prices for medical services, which currently vary widely by market
• Develop (and share) processes and information systems for accurately assessing and paying claims
  

The legislative history of the bill, a work in process, demonstrates considerable cooperation between and within the Congressional chambers. The Senate had split the bill into two components. Sections of the bill relating to reform of insurance and other mechanisms for funding health care were drafted by the Senate Committee on Health, Education, Labor and Pensions (H.E.L.P.). That Committee completed its work on the bill on July 15, 2009 and submitted it to the full Senate for consideration after the August recess. The Senate Finance Committee, which took responsibility for drafting legislation governing the cost of health care, has not completed its work.

In the meantime, the U.S. House divided its work among three committees, all of which have completed markup of H.R. 3200. That version of the bill closely mirrors provisions of the bill passed by the Senate H.E.L.P. Committee, but also covers areas still under debate in the Senate Finance Committee. Having effectively taken the lead in the legislation, the House of Representatives is expected to pass H.R. 3200 following the August recess, perhaps with amendments taken from the floor of the House, and submit it to the Senate. At that point the Senate may choose to accept it as it stands (which is unlikely) or continue work on its own version of the legislation. If the Senate passes a bill that differs from H.R. 3200, the House and Senate leadership would then create a Conference Committee made up of representatives from each chamber to negotiate a bill that would be acceptable to both the Senate and the House of Representatives.

Important provisions of H.R.3200 that have not been cleared by a Senate Committee would empower the government plan to aggressively negotiate prices, delivery methods and standards of service with providers. The debate about the government's role in determining what kind of care is most efficient and effective is bound to be most contentious.

Expecting a fight in the Senate, the Administration has already begun to telegraph its fallback position by referring to the bill as "insurance reform." In other words, having gotten similar insurance reform provisions through committees in both the Senate and the House, the Administration is confident that at least those aspects of the bill will become law. And, while they would like to adopt stronger measures to accelerate cost containment, those more controversial measures could be sacrificed in the interests of getting insurance industry restructuring underway.

Businesses large and small should be prepared to reevaluate their health care policies, providers and pension plans in light of this new legislation. Economic effects are likely to be profound.

The American College of Physicians has published three white papers: A Public Plan Option in a Health Insurance Connector; Reforming the Tax Insurance Exclusion; and Individual Mandates in Health Insurance Reform.

A collection of posts about the US Economy is maintained here.

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Businesses Going Shopping

Mr. Monopoly

Economic crises beget struggle and restructuring and renewal.

When the housing market collapsed and the banking system all but failed, our present became divorced from our future. Corporate planning has been replaced by cash control; investment by saving; loyalty by expediency. Without faith that tomorrow would be at least as good as today, corporations have been reevaluating every asset, obligation and commitment, seeking every opportunity to convert capital into cash.

This market, like all before it, will turn. Shortages of inventory are creating needs for production. By liquidating unproductive assets and renegotiating future obligations businesses are improving cash flow. Drops in commodity prices are boosting profitability. Excess government spending is creating demand, often in new sectors. Some of the people freed from unproductive employment are inventing new technologies, products and services more appropriate to the needs of their times.

Liquidity + Good Plan = Opportunity

Investment bargains abound. Suppliers are willing to renegotiate long-term contracts in order to secure base business. Technology companies using the most flexible and open platforms have learned how to manage developers from low-cost regions. Empty condominiums can house a new generation of renters. Highly trained and experienced managers are seeking new opportunities.

Virtually every corporation must realign its assets, obligations and capabilities to position itself for healthy growth. Now, while assets are undervalued, is the time to engage in long-term planning. Relatively small outlays today to bring in experienced, independent consultants can help time-strapped executives plan tomorrow's investments without taking management focus away from achieving liquidity.

A collection of posts about the US Economy is maintained here.

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Architecting the Retail Enterprise

Architects Stephen Kieran (left) and James Timberlake (right)


In their path breaking work, Refabricating Architecture: How Manufacturing Methodologies are Poised to Transform Building Construction, Stephen Kieran and James Timberlake argue that the architect of a complex structure must reassert the role of conceptual leader of designers, builders, product engineers and materials scientists. Too often, they argue, architects are relegated to the role of designer, as commercial builder/contractors have taken the lead in bringing cookie-cutter structures from design to completion. The cost of this abnegation of control to project engineers has been a failure to innovate and acceptance of a false choice between usefulness and artistry.

Similarly, our Retail Lifecycle Management model requires that the developer of the retail enterprise define and guide the physical design of store formats that connect the firm's commercial vision with its marketing message, operations capabilities and target customers. We see Store Development, the management of investment in retail structures across time and geography, as the purview of general management, an integrative function drawing as much on the disciplines of economics, organizational development and information management, supply chain strategy and contract law as on architecture, design and construction.

Since publishing our newsletter on Restaurant Lifecycle Management, we have tested these concepts with leaders in chain restaurant, architecture, software and design firms. Surprisingly few restaurant chains can answer a simple question: "Who is responsible for managing investments in restaurant design, construction and remodeling." Generally management admits to being frustrated by an inability to influence store design, while architects complain that management is unwilling to fund investment in the innovative technology that would help them become more integral to the business. Having long ago decided to leave design to the experts, management complains that its design process seems mismanaged.

Bridging this management chasm requires not an architectural solution, but an organizational one. Retailers are advised to establish store development organizations with full responsibility for managing their investments in store design, site development, construction, and equipment. Just as the Operations Group is responsible for managing store profit and loss, so should a Store Development Group control the substantial budgets for design, construction and remodeling. At the same time, retailers should go about reclaiming the intellectual properties tied up in their designs, CAD drawings and layouts that have been scattered among their many contractors, agencies and franchisees.

There are a couple of hopeful signs. One fast-growing restaurant chain where the store development function is managed by an attorney stipulates in its franchisee agreement that contractors of franchisees work from corporate prototype designs and then submit "as built" designs to corporate upon completion. At another equally fast-growing chain, a staff designer lists Refabricating Architecture on his on-line list of recommended reading.

For related posts see Retail Lifecycle Management and Chain Restaurant Development.

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An Explanation of the Health Care Bill

Senators Chris Dodd (D-CT, left) and Mike Enzi (R-WY, right)

The system of U.S. Health Care is now so thoroughly inefficient and inadequate that virtually no serious participant in the debate argues that reform is unnecessary. Partisans disagree about the desirable extent of government involvement in the outcome, but all agree (though not always explicitly) that government involvement is necessary. After all, according to the Congressional Budget Office, government currently regulates the medical insurance, health care and pharmaceutical industries and funds some 60% of health care costs through the Medicare and Medicaid programs, other programs that insure veterans, government employees and retirees, tax subsidies for health care insurance, and subsidies for various health care initiatives.

Many in the U.S. receive exceptional health care and few are denied emergency care, even if they are not able to pay for it. However, with U.S. collective expenditures on health care now amounting to more than 16% of Gross Domestic Product we should expect better performance, including:

• More universally available access to services that promote health and prevent disease
• More efficient allocation and selection of medical services
• Greatly reduced cost of administering and financing medical services

Comprehensive health care reform must address three key areas:

• How is care allocated and provided?
• How and to what extent is health care subsidized?
• How is insurance provided and regulated?

Title I of the bill now in committee in the U.S. Senate, the Affordable Health Choices Act (Bill), provides one solution. Its major provisions would:

• Forbid private insurers from denying coverage based on a patient’s medical history
• Eliminate annual and lifetime limits on insurance coverage
• Require employers with 25 or more employees to provide subsidized insurance to those employers (or face a tax penalty)
  
• Subsidize insurance to low-income individuals
• Require individuals to obtain medical insurance (or pay a government penalty)
• Establish state-level "Health Benefit Gateways" to assist individuals and employers in selecting appropriate insurance policies
  
• Establish a government-run health insurance organization to compete with private insurance companies
• Establish a national voluntary insurance program for purchasing community living assistance services and support (by incorporation of the CLASS Act)
  

As the Bill moves through the Health, Education, Labor and Pensions (HELP) Committee and onto the floor of the Senate, it is likely to be amended. Some will challenge the limits and taxes it imposes on employers and insurance companies and others will be disappointed by the way in which its various subsidies are distributed and funded. However, in its current form the Bill is estimated to extend coverage to an additional 20 million uninsured Americans without fundamentally restructuring the insurance, pharmaceutical and health care provider industries.

Nonetheless, the Bill would alter the functional nature and competitive environment of the medical insurance industry. State-run Gateways would be able to appoint either public or private "navigators" who would essentially act as insurance brokers. Also, by simultaneously eliminating discrimination against individuals with preexisting conditions, eliminating plan limits on annual and lifetime payouts, and limiting the degree to which insurance premiums can be based on age, the Bill is intended to redirect underwriters away from the task of evaluating the risk posed by applicants and toward the task of evaluating the costs and benefits of procedures. In combination these provisions would directly address a major, under-reported, and increasingly troublesome segment of the under-insured, that is middle-aged individuals who are privately employed or out of work and whose previous medical history includes any number of risk factors (however well managed). Among the list of risk factors are treatment for chronic disease, skeletal injury or disease, depression or other mental illness or disorder. Ironically and perversely, the current system penalizes those who have sought medical attention and are taking preventative measures, while favoring those who have avoided medical care. With unemployment growing and hitting middle-aged workers especially hard, the number of people unable to find affordable health insurance of any kind is expected to grow alarmingly unless today's underwriting policies and their underlying causes are corrected.

Title I of the Bill is focused on extending access to health care to more Americans. As such it does little to address issues with the dominant fee-for-service nature of the U.S. health care system. The primary charge leveled against the fee-for-service approach is that it rewards providers for gaming the billing system, but not necessarily for getting efficient outcomes or encouraging wellness. By favoring certain treatments, specialties and procedures, this incentive system keeps various forms of government in the position of determining what kinds of care are administered. The incentives baked into the system encourage doctors to specialize and encourage specialists and health care facilities to recommend courses of treatment that play to their strengths, even when more efficient modes of care might be available elsewhere. An excellent treatment of the fee-for-service issue can be found in the CBO's letter to the Senate Budget Committee of 16-Jun-09.

Paul Krugman puts the public cost of Title I in the range of $1.0-$1.3 trillion over a 10-year period, including the cost of subsidizing insurance for the poor (a topic not addressed in the current form of the Bill). The President has floated at least two vehicles for funding the bill: (a) eliminating the subsidy paid to private Medicare insurers through the Medicare Advantage program; and (b) eliminating the deductibility of insurance premiums under the corporate income tax. At the same time, the Administration is bargaining with health care providers and pharmaceutical companies to hold down the cost of care.

Those interested in learning more about this topic can find the Bill and the Congressional testimony that shaped it on the Senate website at http://help.senate.gov/. See especially the testimony before the Senate Committee on Health, Education, Labor and Pensions of Karen Pollitz, Research Professor, Georgetown University Health Policy Institute, and that of Janet Stokes Trautwein, Executive Vice President and CEO, National Association of Health Underwriters. A partial estimate of the cost of Title I to taxpayers (which excludes the cost of the subsidy to the poor) can be found on the Blog of the Congressional Budget Office at http://cboblog.cbo.gov/?p=315.

See also Health Care Reform Takes Shape.

A collection of posts about the US Economy is maintained here.

To learn more about our work in consulting, please see our Profile, download a brochure about our Practice, or check out our Case Studies.

Contact JP Farrell & Associates, Inc.