Published by clickbroker.blogspot.com.
What do you have when the smartest guys in the room engineer a financial product so complex that it blows up? Even smarter guys that pick through the ruble and steal the diamonds. Genius creates alchemy and alchemy creates genius.
Bloomberg’s “Citigroup Aims to Stop TPG Fund From Stripping CDO” reports the tables have once again turned on Citigroup (C) under the law of unintended consequences. Citigroup has already written down roughly $118B in CDO losses according to Bloomberg’s calculations. Now TPG Credit, separate but associated with private equity firm TPG, has dived deep into the esoteric trust structures to cherry pick some of the best CDO assets from the invalids.
Financial Reverse Engineering
Inflation and the Hierarchy of Needs
Published by clickbroker.blogspot.com.
Not to be outdone by Maslow, inflation has its own hierarchy of needs. Basic needs (physical survival) correlate to food and energy, safety (comfort) correlates to core inflation, and self-actualization correlates to asset inflation. The Federal Reserve admits that it has little influence on food and energy, believes that it can control core inflation, and says that it has no control over asset inflation.
I believe the Fed’s rhetoric is only partially truthful. I agree that the Fed has little control over the demand for survival needs. However, when it comes to core inflation (the safety teddy) General Electric (GE), Intel (INTC) and US Steel (X) have more influence on the overall price structure than the Fed.
The Fed is being outright disingenuous when it comes to asset inflation. This form of self-actualization is at the top of the inflation hierarchy of needs. Asset purchases are the most discretionary and the first place for excess liquidity to flow to. While professing the opposite, the Fed has maintained an active policy of promoting asset inflation.
After leaving office, former Fed Chairman Greenspan admitted that the Fed engineered asset bubbles to promote innovation. Even though the housing bust has proved much more difficult than Greenspan had imagined, Fed Chairman Bernanke has not changed policy. Every one of Bernanke’s “specialized” programs has failed to generate targeted core inflation because the Fed cannot really control the application of liquidity, only the intensity of the flow.
The Fed cannot even control which asset sectors get inflated. While the effort to inflate housing prices is failing, stock and even junk bond prices are rising. The question is does the Fed care about targeting asset sectors or just creating a general wealth effect? I believe the Fed’s focus is primarily on managing the overall wealth effect, not inflation in general and least of all the value of the dollar in foreign exchange.
Now we know that both Greenspan and Bernanke have reached self-actualization in the world of asset bubbles. Greenspan’s recent interview with Bloomberg’s Al Hunt was quite telling. He thought the banks could not make a profit and lend efficiently if they were required to maintain capital for long tail events. The role of government is to bailout black swans. Again, the Fed’s policy is to remove any obstacles to asset inflation.
Imprudent lending is Fed policy and that is why Bernanke is so opposed to the creation of an independent consumer protection agency. Protecting consumers from aggressive banking directly stands in the way of promoting the wealth effect. Both Greenspan and Bernanke aspire to see masses of self-actualized consumers.
Regardless of what you think of how inflation is calculated with “owner equivalent rent” and “hedonic” (constant value) adjustments, leaving asset inflation out of the calculation makes the inflation numbers meaningless. Don’t let the Fed tell us that we have no inflation when stocks are up 50% and the dollar is collapsing.
Finally, I am waiting for the Fed to explain in behavioral terms how businesses and consumers changed with each decrease in the fed funds rate. Was the change from 1% to 0% as effective as the change from 5% to 4%?
Wall Street Weather’s "Asset Inflation: The Missing Indicator In Economic And Monetary Policy" provides an excellent discussion of asset inflation and monetary policy.
Disclosures: Author is long GE and INTC.
Lessons of Medicare dis-Advantage
Published by clickbroker.blogspot.com.
The Washington Post’s “Hidden Costs of Medicare Advantage” reports seniors should beware; Medicare Advantage not only costs the government more but might cost seniors more too. The challenge to healthcare reformers is whether to consider Medicare Advantage an entitlement or an extra cost option for seniors. The opponents of reform are curiously framing Medicare Advantage as an entitlement, while professing opposition to the expansion of entitlement spending.
Let’s examine the pragmatist opponents of reform arguments: 1. Medicare Advantage provides choice, 2. Medicare Advantage improves the quality of care, 3. Medicare Advantage lowers costs for low-income seniors, and 4. raising Medicare Advantage premiums through lower subsidies effectively removes an existing benefit. The opponents don’t discuss the danger seniors face in restrictive provider networks.
Medicare Advantage limits choice of doctors, hospitals and covered procedures. If virtually all doctors and hospitals accept basic Medicare, by definition each network can only be a subset. Whether the advice provided by primary care doctors in Medicare Advantage HMOs improves the quality of care is questionable. But the requirement for a separate referral for every single specialist, test and procedure is enough to weed out the more frail seniors from Medicare Advantage. How easy is it to get a referral if you can’t drive?
During younger seniors’ healthy periods, Medicare Advantage might substantially lower seniors’ medical expenditures. Providing the plans have no additional premiums and minimum “out of pocket” deductibles and co-pays, poorer seniors benefit. But like all private insurance, there of traps everywhere. There could be many situations when a senior actually pays more for the same test or procedure under Medicare Advantage than basic Medicare.
Seniors were never entitled to Medicare Advantage which costs the government an average of $850 per month, 14% more than traditional Medicare. With 25% of seniors on Medicare Advantage, it’s become too politically difficult to take it away. Once a senior starts having a serious or chronic medical problem, the government actually raises its payments to the private insurers. The risk exposure for private insurers is minimized; all upside with little downside.
The only protection seniors are provided is that they cannot be turned away during annual open enrollment periods. But at the same time they cannot change plans if they get sick and are not satisfied with the providers’ networks during the contract year.
The New York Times’ “Choosing a Policy to Cover What Medicare Doesn’t” reports on how expensive and complex the process of acquiring Medigap coverage is. After a 6 month open enrollment period, state insurance laws control whether policies are medically underwritten and other consumer protections. With a few exceptions open enrollment starts with Medicare eligibility and is never repeated. This leaves the Medigap route even more difficult to navigate than Medicare Advantage.
Medicare controls the minimum benefits for 12 model Medigap plans (A-L), but not the cost of premiums. Medigap “Select” plans restrict benefits to the insurers’ networks. Outside of networks, Medicare co-pays are not covered. But even with Select seniors are protected from the price gouging that can occur outside the Medicare Advantage networks. Given that Medicare does not allow balance billing, Medigap coverage might not make any economic sense anyway.
Pete Peterson’s (Blackstone Group co-founder) Financial Times commentary “Questions America must ask on health costs” states that 30% of Medicare expenditures are for end of life care. Regardless of whether public opinion feels this is justified, the real issue for Medicare Advantage providers is have they been able to eliminate seniors from their memberships before the final year of life?
Since I am not a senior, I have not experienced either basic Medicare or Medicare Advantage. But if I could buy my way into to basic Medicare, I would gladly surrender my private insurance.
Allowing private insurers to engineer their networks and benefits to exclude the worst risk seniors while costing the government more is no benefit to either the seniors or the government. The only reason that Medicare Advantage has any popularity at all is that a constantly growing population predicates a constant flow of younger healthier seniors.
My conclusion is that seniors should stick with basic Medicare and not purchase Medigap. Save the Medigap premiums to pay for Medicare co-pays and deductibles. Seniors – stay with the ultimate choice – virtually every doctor and hospital in the country. And to the health reformers in Washington, I say open Medicare to all so every American has the ultimate choice!
It’s time to sell Humana (HUM), UnitedHealth (UNH) and WellPoint (WLP) before this Medicare Advantage and overpriced Medigap Ponzi scheme comes to an end.
No Disclosures.
The Ultimate Story Stock: A123 Systems
Published by clickbroker.blogspot.com.
Short of Google (GOOG), IPOs don’t get any sexier than A123 Systems (AONE). No one disputes the potential of battery powered cars, massive storage of green energy from solar and wind, and having virtually every appliance from lawnmowers and vacuum cleaners to computers and entertainment cordless. But in the words of the internet, A123 is more eyeballs than monetization.
To be sure they have actual revenue, but they are running a negative gross margin on product sales. In essence the more they sell, the more they lose. And they predict the revenue from their largest customer Black and Decker (BDK) is expected to shrink considerably. No more revenue is expected from Mercedes-Benz (DAI) HighPerformanceEngines (Vodafone McLaren Mercedes Team). That leaves only BAE Systems (BAES.L) for growth.
The truth is in the prospectus. The only real-life applications besides power packs for hand tools have been: BAE Systems’ Hybridrive propulsion system for busses and a few Hybrid Ancillary Power Units for the AES Energy Storage unit of AES Corporation.
Here’s where it gets interesting. A123 is designing and developing batteries and battery systems for BMW, Chrysler, GM, Shanghai Automotive (SAIC), Delphi and Better Place. While A123 invests in custom automotive research and development, they expect most of their revenue for the “foreseeable future” from very few customers. And none of the potential automotive customers have committed to long-term contracts or minimum production volumes. So far A123 is much more hype than substance.
I cannot judge whether A123’s technology is superior to its competition. But it has some fierce competitors: Bosch, Dow Chemical (DOW), NEC, Panasonic, Sanyo and Samsung. Nissan (NSANY), Toyota (TM) and Volkswagen have entered into joint ventures to produce batteries that don’t include A123.
A123’s major manufacturing facilities are located in China and Korea. Their key strategy is to reduce cost by starting to manufacture in Michigan. Makes sense to me; lower costs by moving production from low cost countries to a high cost state in a high cost country. It only makes sense when the government gets involved in this Ponzi scheme.
The US DOE Battery Initiative granted A123 $249.1M to build manufacturing facilities in Michigan. The company also believes that it will be able to borrow up to $235M from the Advanced Technology Vehicles Manufacturing Loan Program. The company expects to be required to invest 25¢ for each DOE Battery Initiative dollar. In addition, the Michigan Economic Growth Authority (MEGA) granted $10M and offered up to $4M in loans. MEGA is topping their deal with a 15 year tax credit. Even the government can’t resist something this sexy.
Product revenues were $53.5M in 2008 and $36.6M in the first 6 months of 2009. But cost of product sold was $70.4M and 39.2M respectively. Throw on operating expenses of $79.6M and $40.3M, and you get losses of $80.5M for 2008 and $40.7M for H1 2009. With no definitive volume automotive contract in the near future, it looks like A123 is a pipe dream.
It might be helpful to view a speculation on A123 like a small biotech. Though, I take A123 more seriously than the ethanol debacle. No doubt green energy needs smoothing and electric cars will be a reality. But will A123 survive long enough to benefit? While automotive is the highest profile application, it is too much like what General Electric (GE) calls “long cycle businesses.” A123 will need to concentrate on less sexy applications to keep the company going until the brass ring comes in.
I might speculate on A123 when they break even on a gross margin basis and the hype in the stock is deflated. The trick is to enter when the fundamentals start to look like a viable business, but before the first major automotive and power grid deal is announced.
Disclosures: Author is long GE; GE has made an investment in AONE.
Both Health Insurers and Consumers will Cherry Pick under Reform
Published by clickbroker.blogspot.com.
The Washington Post’s “Discrimination by Insurers Likely Even With Reform, Experts Say” subtitled “Economic Pressure Could Give Rise to New Biases Against Prior Conditions” sites many distinguished academics warning of cherry picking continuing under health reform. The professors predict that private insurers will employ a series of creative carrots and sticks to achieve the most favorable risk pool composition within the umbrella of guaranteed issue and no exclusions for preexisting conditions. I will argue that these practices might actually benefit the astute consumer.
Insurers are currently paid between approximately $800 and $2000 per month for Medicare Advantage seniors according to discussions in the recent Senate Finance Committee healthcare markup. Insurers are reimbursed the most for chronically ill seniors, but they cannot turn any senior away. The insurers maintain profitability charging a premium seniors are willing to pay by maximizing reimbursements and minimizing their actuarial risk. Humana (HUM) said during its most recent earnings call that they have to do a better job of identifying seniors in their risk pools that qualify for higher government reimbursements.
The professors predict that by offering gym memberships and limiting network doctors that specialize in high cost oncology and cardiology, insurers are able to encourage and discourage participants in their risk pools. In Florida, all Medicare Advantage recruitment events are in drive-to locations. The insurers never visit senior communities or nursing homes. The insurers recruitment skills honed in Medicare Advantage will now be applied to the general public.
The key to survival of the private insurers is to create generally affordable products and avoid or limit high cost consumers. If their risk pools are too high, the premiums will be unaffordable. So even though the goal of healthcare reform is to spread risk, the goal of the insurers is still to segregate risk. Karen Ignagni, president of the insurer lobbying group America’s Health Insurance Plans, is trying to promote a diversity of benefit products to segregate the population into multiple risk pools.
The next step is for the insurers to market to the best risks. This is the most subtle form of cherry picking. The consumer’s job is to buy insurance from the lowest actuarial risk pool and secure the lowest premium. The maximum out of pocket will be held to between $5000 and $6000 per individual and double that for families. But the composition of network providers, deductibles and co-pays will drive the risk pool for each plan.
The premiums within each product can vary by only by age, location and a few other criteria; not the medical condition of applicants. However, there are no limits to premium differential between products. Consumers who were previously either rejected or up-charged for minor infractions such as slightly elevated cholesterol or blood pressure will now be able to buy their way into the lowest risk pools and pay the lowest premiums.
Whether the government tightly controls benefit packages or not, consumers can seek out products marketed to the healthiest applicants. Insurers won’t be able to turn them away. This is where the cat and mouse games begin.
Obviously, lower deductible plans would be more appealing to sicker patients as would more compressive networks. To avoid gaming the system, consumers might be limited to changing products only during open enrollment periods like Medicare and Medicare Advantage. But given that the maximum out of pocket risk would be relatively low in all products, consumers can buy cheap now and switch when they need to.
The biggest risk to consumers is balance billing for out of network providers. This is where an out of network provider charges consumers the difference between their retail rate and whatever the consumer’s insurer chooses to reimburse. A limited network increases the risk of needing such a provider and there are no government plans to limit balance billing. This is why a government option for all based on the Medicare model is best. Medicare forbids balance billing.
I think the insurers will be pretty good at estimating the risk pools of each of their products. But outliers such as a high deductible consumers costing over $100K in medical expenses will exist.
In summary, both sides will be cherry picking. With guaranteed issue consumers are close to but not quite being equal warriors. Let the games begin.
No disclosures.
GE CEO Jeffrey Immelt Misdirected
Published by clickbroker.blogspot.com.
The New York Times’ “G.E. Chief Sees India Helping Cut Costs of U.S. Health Care” reports that Jeffrey Immelt predicted that India’s role in reducing US healthcare costs will be significant. The comments were made by General Electric’s (GE) CEO during a news conference related to GE’s healthcare business restructuring in India. He predicted that India’s healthcare industry will grow to $75B by 2012.
Given that GE’s healthcare business is still way too dependent on the medical imaging “big-iron”, it is not surprising that Immelt’s comments focused on outsourcing the interpretation of these images. Creating a cheaper operating infrastructure to support the big-iron is favorable to selling more machines. Obviously, GE wants to do whatever possible to sell more machines and lowering someone else’s revenue will not affect GE’s profits.
GE continues to be shortsighted and selfish in its view of healthcare. I am disappointed as a shareholder that GE is not exiting or substantially shrinking their imaging business. GE’s imaging business is as over reliant on government subsidizes for senior care as Humana (HUM). It is just that Humana’s subsidy is direct Medicare Advantage revenue and GE’s subsidy is revenue to their doctor and hospital customers. These companies should heed what happed to the banks, for they might get feathered without even being TARPed.
Trouble with healthcare is not that the US is undersupplied with medical technology, doctors, hospitals and drugs; we are too far oversupplied. And seniors are no different than street drug addicts, they can never get enough doctoring – whether it’s beneficial or not. What Americans need more of is unbiased advice. Is a cancer patient better off suffering for 2 to 5 years under chemotherapy or living his remaining life peacefully with just pain therapy?
America’s addiction to healthcare is often justified in rhetoric about rationing, waiting lines and technology. As long as the arguments continue; companies, doctors and hospitals will continue to avoid preparing for a reduction in demand. Pfizer (PFE), Merck (MRK) and others will seek mergers, GE will do nothing and demand will start shrinking. The bill for healthcare reform will force us to break our addiction and rational use of healthcare will emerge.
Breaking any addiction is difficult and going cold turkey can be devastating. The Genentech-Roche model is going to be just as obsolete as GE’s. In addition to a newfound emergence of cost-benefit will be patient centric suffering-benefit. Are multiple years of suffering under the breast cancer drug Herceptin worth a short life extension?
Government’s role is to fill in the gaps left by the absence of profit motive. The suffering-benefit equation has not been well balanced by either the private sector or the FDA, and doctors are biased toward extending life at any dollar or suffering cost. Doctors’ role as scientists often conflicts with the patient’s desire for wellbeing. Government needs to fill this void. While choice would definitely encourage substantial cost savings, unbiased advice by government should not be interpreted as “death panels.”
GE must understand the shrinking healthcare demand will not be based on the economic cycles alone. The next generation of seniors might not take every treatment just because it’s free and the government will encourage this new refreshing attitude.
Disclosures: Author is long GE and PFE.
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