Philadelphia Reflections

Benjamin Franklin: Chronology

Ben Franklin on the cover of Time magazine

January 17, 1706 Born in Boston, the thirteenth child of a candle maker; only went through 2nd Grade, Apprenticed to his brother as a printer, ran away to Philadelphia age 17 .
1723 Arrived in Philadelphia penniless, readily found work as a printer.

1725-26 First trip to England. Researched printing equipment, but probably lived a riotous life.

1726-1748 Returned to Philadelphia to found his own print shop and bookstore. Wrote and printed Poor Richard's Almanack organized local tradesmen into the Junto, formed partnerships with sixty printers throughout the colonies, obtained the print business of local governments, became postmaster. Able to retire at the age of 42 by selling his business for 18 annual payments, which offered him comfort and ease for considerably longer than his life expectancy.

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1751 Helped found Pennsylvania Hospital. Entered the legislature.

1751-1757 Active in legislature, rising to leadership during the French and Indian War, Pontiac's Rebellion and the uprising of the Paxtang Boys.

1757-1762 Second time in England. Acted as representative of both Pennsylvania and Massachusetts. After his electoral defeat, he returned to England for a total of eighteen years, suggesting hidden British sympathies may have been present. .

1762-1764 Returned to Pennsylvania Legislature, where his unpopular agitation for replacing the Penn Proprietors with direct Royal government led to his electoral defeat and the end of his elective career. The defeated but determined Quaker party sent him to England to lobby against the Penn family and for the rule of Pennsylvania by the King.

1764-1775 Third British visit. Although unsuccessful in his lobbying, his fame as a scientist made him welcome among the famous members of the Enlightenment, like Hume, Adam Smith, Mozart. Meanwhile, the colonies became considerably more rebellious than he was. His blunder with the publication of some letters gave the British Ministry an opportunity to humiliate and disgrace him in public, probably as a warning to the mutinous New England leaders. It irreconcilably alienated Franklin, who sulked, then packed up and joined the Continental Congress the day he arrived back home.

March, 1775-October, 1776 Brief but fateful return to America. Decisions were made in London to put down the colonists by as much force as necessary. Meanwhile, Franklin persuaded the Continental Congress they must declare independence from England if they expected help from the French.

July 4, 1776, Independence is declared within days after the arrival of a massive British fleet in New York harbor. Franklin dispatched to France to secure the assistance he was confident he could get.

1777-1785 France. Franklin served admirably as American ambassador, his wit and charm persuading the French to overextend themselves with ships, supplies, and money, and very likely contributing to the French Revolution by popularizing the American one.

1785-1790 Returning as a national hero for his final five years of life, Franklin loaned his personal influence to the constitutional convention, became President of Pennsylvania, worked for the abolition of slavery.

April 17, 1790 Died, probably of complications associated with kidney stones.

Bank Accounting Off the Books

Banking

Banks have long operated in a dual system of regulation, state and federal, which permits some shifting back and forth between regulators. Mergers sometimes confuse matters further, and a system of one-bank holding companies adds to the stew. Local banks, waving the red shirt of domination by Wall Street at their state legislatures, have resisted interstate banking in a wide variety of ways. Sometimes a customer finds that funds transfer between two branches of the same bank must be treated as out-of-state action, and so on. Inevitably there is a certain amount of dealing by subsidiaries which are not recorded on the books of the home bank of a bank conglomerate in ways prescribed by the subsidiary's regulator, or not recorded at all. Equally inevitable is the accusation of off-the-books illegality by competitors, politicians, or the merely captious. Fine points of these legal and accounting arguments must be left to experts, peer review, and courts. Muttering Enron at every opportunity, accusers may be right that some of these arrangements have stepped over the line; partisans in Congress and the legislatures, on the other hand, may be correct that existing law is bad law. This is not a good place to debate either point.

Credit Crunch

It does seem appropriate to notice that banking has long been massively inefficient and that much of this inefficiency has been imposed by regulators. Regulators represent the public, more or less, and the public is rightly nervous about stewardship of its assets. Dual regulation offers refuge from the ancient fear of confiscation by the sovereign and is worth a certain amount of inefficiency if it works. But it does create loopholes, and it does impair transparency. In the case of the credit crunch of 2007, it sequestered bad debt in off-the-books ways, perhaps creating tax avoidance, but mainly creating distrust among counterparties. In those days of awful turmoil, no one knew what was going on, multi-billion dollar losses were being confessed by premier institutions, so transactions were delayed, avoided, or rejected. Transactions with anybody. When the time comes to reconsider regulations, it should be emphasized that by far the most damaging component of the whole mess was lack of transparency. Once more, a massive computer programming effort is entirely capable of restoring transparency to the existing regulatory structure, highly pigglety though it may be. After we achieve transparency we might consider achieving efficient transparency, and after that perhaps ponder fairness in transparency. When a trader calls another and asks to buy a zillion shares, the happy recipient of the call likes to glance up at his screen to see what the other fellow is worth, before he shouts, "You got it!"

What the Federal Reserve might well call the highest priority calls for respect, as well. Ever since we began the century-long transition from a gold standard for money, there has been a concern that the Fed might not be able to determine how much money, or credit, or liquidity -- is actually in existence. We have reached a point in this process where the Fed has largely stopped trying to measure monetary aggregates, and merely adjusts its tools to keep the money supply sailing between the rocks of inflation and recession; if neither rock is in sight, the amount of money is about right. That system has served us for eighteen years, long enough to spark hope that it can be permanent. But when a rocky shore does make an appearance, the Captain of the ship must know how much slack he has, and how reliable his sonar. For huge sums to be obscured within bank subsidiaries or delayed marking to market, is to increase the chance we will run up on the rocks when it might have been avoided. He too needs transparency, but he also needs prompt obedience to his orders. The rest of us passengers are rightly concerned when he appears before Congress and admits he is not sure what the situation is. As long as that is the case, fairness -- and dogma -- be damned.

Taking a step backward, the whole credit crunch has brought to the world's attention that real estate transactions are both immense, and immensely inefficient; a great deal of money is to be made if any step in the chain can be streamlined. Therefore, real estate agents, real estate lawyers, title insurance, surveyors, advertisers, inspectors and everyone else who makes a living from real estate sales -- can expect to be drawn into an annoying process of inspecting the premises, promises, kickbacks, referral fees and marketing costs of a whole expensive process, first blasted open to inspection by implementation defects while computerizing the mortgage step. It appears to be high time for it.

Second Mortgages Want to Be First

Chrysler Logo

In a bankruptcy proceeding, there has long been a traditional conflict between the holders of first mortgages and the holders of second mortgages. It goes like this: since the holder of a first mortgage gets paid first, his incentive is to hurry up the process and get the money. The holder of a second mortgage, however, only gets paid what is left, so this party will normally wish to stall proceedings in the hope the market will improve and give the second mortgage a better payout. Normally, this sort of predictable dispute is covered by contracts, and in any event, most banks hold both kinds of mortgages and are neutral about what is just and fair. In the current banking crisis, however, the major banks have developed an incentive to favor the second mortgage, so they have a new view of what is just and fair. Four of the largest banks hold a total of $440 billion of second mortgages but have very few first mortgages because they were sold off in the securitization process. The banks mostly retained the function of servicing first mortgages, however, so they now have quite a conflict of interest.

Something like this seems to be going on with the resolution of the Detroit auto makers, with the difference that politicians tend to favor the interest of the auto workers in the bankruptcies because there are more voters to be influenced. And in the case of the auto companies, there are stockholders who will be wiped out by a bankruptcy unless the liquidation of the company assets produces enough cash to satisfy the creditors, secured and unsecured. After all, stockholders aren't creditors at all; they are owners of the company. No matter how things turn out, however, the secured creditors would normally have the first call on whatever is salvaged. So, it's one class of secured creditor against another, or else it is the secured creditors against the "stakeholders", employees or any other unsecured creditor. If the government intervenes, there is the additional issue of the Fifth Amendment of the Constitution, which prohibits the government from the "taking" of private property without just compensation. Representative Conyers of Michigan, whose political allegiance is not in doubt, has introduced legislation to prohibit lawsuits in these matters. So now, the prospect grows of a constitutional clash between Congress and the Supreme Court, over the Constitutionality of such a law which denies due process. So that gets us into the fourteenth amendment, too. If we look beyond the technicalities, the looming clash is between President Obama and Chief Justice Roberts. One of them wants to take money from secured creditors and make it available to someone with more political clout; and the other surely wants to preserve the sanctity of contracts, the rights of property holders, due process, and the right of the Supreme Court to declare contrary laws to be unconstitutional.

Unless someone backs off, the situation would seem to be as monumental as Franklin Roosevelt's Supreme Court-packing proposal. Because -- there is every reason to anticipate a 5-4 vote by the Supreme Court, a 5-3 vote if Justice Souter is not replaced by that time, and strenuous efforts to alter the balance.

Federal Reserve Rolls the Dice

Lehman Brothers

For the year preceding, it was general opinion that the financial crisis was caused by $100 billion or so of mortgage-backed securities, mostly California and Florida home mortgages. But around Labor Day 2008 Lehman Brothers collapsed, and the problem became twenty times as large. What that was about is unclear, but seemingly had to do with money market funds being treated as "funds in transit" in consequence of the international monetary agreement known as Basel I, and thus not requiring bank reserves to be maintained for them. It will take time to unravel the intricacies of, and assign the blame for, this mess. However, the markets responded by refusing to trade at now uncertain prices, thus "freezing up". The response of the Federal Reserve was to double the money supply through international markets, mostly using "Central Bank liquidity swaps". The participation of various countries in this action has not been made public.

The doubling of the money supply required borrowing between one and two trillion dollars. After five months, or just after the inauguration of the new Presidential Administration, the markets had seemingly started to function more normally, and the stock market had rallied somewhat. The obviously bewildered leadership of both political parties agreed to the proposal to purchase $1.75 trillion of the troublesome assets, taking them off the market and presumably hoping the markets would function as if they did not exist. By July 2009 this operation was only about half completed. Not only was there disagreement about what these securities were really worth, but the banks which held them were reluctant to allow prices of what they continued to hold to be driven down by comparison with these forced transactions.

Federal Reserve Bank of Philadelphia

In any event, the second stage of this huge government bailout of the banking system is projected as follows: The portfolio of assets would be worn down, either by allowing debts to mature, or by selling them at what is hoped will be advantageous prices. Who will buy them is to some extent dependent on the state of the economy, and to some extent on the perception of the fairness of the pricing. The Federal Reserve Bank of St. Louis has been assigned the task of designing a public formula for how much to buy or sell, depending on selected indicators of the economy. A public formula is felt to be necessary in order to reassure the markets that purchases and sales are not being made in response to secret information or unsuspected problems.

The reasoning would be that if these assets are sold to speculators at fire-sale prices, the money supply will shrink inappropriately, and the recession will be prolonged by the need to borrow replacement reserves for the monetary system. Unduly profitable sales would probably lead to inflation, since the present level of monetary reserves is twice as large as was thought appropriate, as recently as a year or two ago. But this maneuver by a central bank has never been tried before, and the results may well differ from present predictions. The Federal Reserve is prepared to take as long as ten years to accomplish the complete maneuver, but that plan presumes ten years of recession and five congressional elections. It also implies that the economy could swing between 7% annual inflation, and 7% annual deflation, in the two worst cases, and assuming nothing extraneous happens to the economy.

President Barack Obama

In the meantime, two other ominous notes. Although the nationalities of the lenders have not been made public, one can safely assume the Chinese are a major component. Since they are refusing to lend us money beyond two, and at the most five, years, we would be indefinitely in the position of borrowing short and lending long. In other situations, that imposes a risk of depositors starting a run on the bank. And secondly, it is hard to imagine that Mr. Obama's presently ambitious programs in healthcare, environmental protection, two wars and several election cycles, will be allowed to proceed without enormous public resistance to even further fiscal deficits.

Looming Early Issues in Obamacare

Obama Care

The Attitude of Big Business. In order to preserve maximum flexibility as long as possible, many important features of the Affordable Care Act (Obamacare) remain unrevealed, and some are perhaps still unsettled. Furthermore, attitudes change with experience. At the formation of the Obamacare idea, the leaders of big business (at the time) were more concerned about foreign competitors than about employee attitudes. The traditional goal of a "level playing field" led them to favor an employer mandate to provide employee healthcare. It probably was presented to them that they could only have their desires by agreeing to a universal individual mandate for everybody. Although it was uncertain whether the employees would agree, universal was the price to be paid, and they paid it. Whether new leadership supports this compromise or not, it is generally assumed that big business feels obliged to support Pete Stark's universal mandate until it is tested. Only time will tell whether businesses will withdraw their support in the face of events, but fragile beginnings certainly do not assure permanent support. Since it was the withdrawal of this group's support which destroyed the Clinton plan in 1994, a significant issue hangs in the balance. Therefore, when conflicts were discovered with the ERISA laws under which big business works, the inclusion of big businesses in the framework of the Affordable Care Act was postponed for a year. How it will emerge next year or whether the ACA can survive for a year without major business inclusion, both remain to be seen.

The Rising Voice of the Uninsured. A financial recession usually increases the number of health uninsured, but at present unemployment is slowly falling. However, decades of scientific medical advances are not only extending longevity but reducing non-fatal illness among the young and uninsured. Although it is unclear whether youthful perceptions match the actual changes in their morbidity, young healthy people who rebel at paying health insurance premiums may actually increase in number substantially during the coming decade. Although overall inflation has been moderate, discomfort from competing costs of college debts and items such as gasoline have escalated. When the Affordable Care Act is fully implemented, youthful perception may make the first serious test of its usefulness. Those among them who actually get sick may get an opportunity to sample Medicaid and report their experiences to their friends. To some extent, this will be a race between efforts to improve Medicaid in order to forestall complaints, and the tendency of young people to try to get their way by pounding the table with their shoe. If successfully managed, it could promote some badly needed improvements in Medicaid. Handled poorly, however, it could bring the program down.

Cost of the Program. The fact must be squarely faced that insurance almost always increases costs. That is true of all casualty insurance, whether auto, homeowners, or maritime. Correctly applied, it can indeed redistribute costs, but insurance imposes extra administrative expenses, and it produces "moral hazard", so total costs are increased by insurance. Moral hazard is a term of art, signifying that nobody spends someone else's money as carefully as his own. Actuaries calculate the extra cost imposed by present American forms of health insurance to be at least 30% of the total service, and arguments can be made it will be so much more, that level historical costs cannot conceal the appreciably higher premium level. Longevity is improved by reducing the number of brushes with life-threatening illnesses in a lifetime; costs go up because prices go up.

Universal coverage now introduces its own uniquely unwelcome issue, that eliminating non-insurance market benchmarks for medical prices also eliminates the cost guidance they formerly provided. Crippled though it may have been, the partial cash market did set benchmarks, if not prices, which insurers then had to match -- and those benchmarks will possibly soon be seriously diminished. That development will be welcome to those who wish to receive higher prices, but cause dismay among those who have to pay for them. The result is predicted to lead to price controls, which will, in turn, provoke shortages, possibly demonstrations or worse. Matters may not follow that path, but it is hard to see why not. As to any reduced overhead like marketing costs, employer-basing has already reduced them to a small opportunity for streamlining. In the past, a resort to price controls has almost invariably led to shortages. Even in 2013, there have been shortages of cancer drugs, an almost unheard-of event in the past century.

To put it mildly, rationed healthcare is politically disadvantageous for those who attempt to enforce it. The most conservative projections now suggest that Obamacare will increase healthcare costs by 22%. Since the following proposals would by contrast almost surely reduce costs by a conservative 30%, it is not impertinent to suggest that no matter remains closed while a 50% overall cost swing remains credible. That would be particularly true when it concerns 17% of gross domestic product (GDP) during a recession. In fact, no one has even contemplated what it would mean to inject 5% of American GDP back into the world economy, especially by the mechanism of releasing a paralyzed medical system.

Patient Participation

Patient Participation in Claims Costs, Generally Speaking. For the insurance industry, this is an old story. Industry survival has depended on success in answering it effectively. In health insurance, the traditional approaches have mainly been 20% co-pay and about $500 annual deductible. The first means 20% of all benefits cost, the second means the first $500 of benefit costs in a year. These figures evolved out of countless negotiations between labor and management, or within legislatures, are now accepted as traditional, and are accepted by the public. These figures also represent how much each side thinks it can afford since they see themselves as ultimately paying the bill. Until recently, however, patient participation at such small levels has not reached a point where it significantly influences patient behavior, which is set by entirely different forces and is now the main long-term cause of healthcare cost inflation. As mentioned above, business negotiators seldom pay much heed to imposed costs, just so long as their major competitors must pay the same costs; in fact, that is one of the flaws in our corporate system. However, governments as third-party payers enjoy no such luxury, and most of the complaining about healthcare cost inflation has originated with governments. Consequently, businesses not infrequently drag governments to higher cost levels, and this must be recognized as a reality of entitlement programs. Furthermore, attempts at raising patient cash contributions have always had political rather than economic origins, usually loudly characterizing any cost constraints at all as crippling the intent of insurance, making false promises, and depriving the poor of humane treatment. If patient contribution ever reaches 50% of costs, the program will likely be called a failure (Insurance exchanges please take note.).

However, it would appear incentives cannot affect overall patient behavior very much until patient payments to reach a much higher point, and we may well see some experiments to test what that level may be. (As it is argued here, this dilemma need not be completely dispositive.) More recently, steadily rising healthcare costs have actually led to employer increases in co-pays and deductibles, and the Obama administration has been giving signs of yielding to the behavior modification argument. However, these approaches cannot be called a success until they seriously reduce long-term healthcare cost inflation, and that remains a doubtful outcome.

In fact, no desperately sick patient should ever be expected to pay much attention to costs. The restraint of partial cash payment should be reserved for lesser conditions, and even provider discipline should be reserved for what are provably individual provider decisions, whether at the institutional level or the professional one. There are certainly broad areas where no patient cost restraint whatever can be justified, and program design should recognize that premise. Nevertheless, much more could be done with patient participation in costs than is done at present.

Cost Restraint

Targets for Cost Restraint Requiring Two Distinctive Approaches. There are two factors in overall medical costs: the item price, and item volume. Above a certain level of sickness severity, only item prices can be legitimately constrained, not the volume of service. Before any of that happens, of course, all published prices should be audited and forced to conform to standard cost-to-price ratios, because cost-shifted indirect costs are so prevalent. For minor conditions and illnesses, volume control on the patient remains legitimate, particularly for conditions where patients are usually responsible for inciting them. Patient cost-sharing is, therefore, a legitimate out-patient approach. Officials given the right to set such boundaries will almost surely be assailed as having a conflict of interest, or untrained for the decisions; it is an unpleasant role, attractive only to unpleasant people.

The healthcare market segments itself into two quite different approaches and successful administration consists of accurately distinguishing the two. As soon as the patient enters a hospital, his control of cost creation is taken away along with his clothes. Therefore, payment by diagnosis is a sensible approach for inpatients and could be even more effective if the diagnosis codes were revised to include greater stratification by the additional use of laboratory and other billing sources as confirmatory evidence. An argument can be made that fee for service to a helpless patient operates without cost resistance. But having removed incentives for abuse, the laboratory data becomes even stronger evidence of underlying diagnostic distinctions. Since Obamacare has apparently not fully examined such distinctions, there remains hope it can be persuaded to see the codes need expansion. At present, DRG codes are very crude and rely heavily on errors on the high side canceling out errors on the low side. Furthermore, they are derived from (ICD), the International Classification of Disease, which identifies individual diseases only if they are common, responding to the needs of medical records librarians who complained that usage did not justify the effort of coding every case. This combination of short cuts and errors is too crude for the advanced use now planned for them and would benefit from substituting the coding system called SNOMED3. A case can be made for both lumping and splitting; perhaps two codes are required, a crude one derived by computer-lumping precise ones of the same average cost -- rather than by similar etiology. As matters now stand, teaching hospitals have no way to assert a need for greater reimbursement for greater case complexity, specialty hospitals are able to select inexpensive cases within expensive categories, and rural hospitals are left without satellite cash cows.

However, this is tinkering around the edges of volume measurement. Much greater savings are immediately possible from attention to prices, through billing for direct and indirect costs separately, recognizing indirect costs as the present main locus of cost-shifting. Some serious thought should be given to the growing shift of profitability to the outpatient area, with inpatient care transformed into a loss-leader. As that is increasingly true, it becomes wiser to shift attention to the prices of outpatient and emergency room services. Going all the way to Health Savings Accounts would be ideal because it enlists patient incentives to the side of prices restraint. HSA also comes inherently segmented, between outpatient and inpatient hospital. Beyond segmenting price and utilization controls, however, consideration should also be given to segmenting health insurance itself, to match natural cost segmentations. Prison inmates, persons mentally impaired, and illegal immigrants account for nearly 30 million persons, and require specific ministrations, not patchwork exceptions to what the rest of the population requires.