Monday, August 22, 2011

What Price the "Free" Market?

What will it take to get us all to agree that "The Market" can't do everything? To admit that there are some things that the government is uniquely qualified to do?

We can agree on national defense -- and even there, well, don't get me started on private military contractors -- but after that?

Saturday's New York Times gave an excellent example.

Gardiner Harris reported that there are currently "critical shortages of drugs to treat a number of life-threatening illnesses, including bacterial infection and several forms of cancer."

These are not new drugs, but nearly 200 reliable, generally inexpensive, standards for the treatment of a wide range of diseases. As one oncologist quoted said, "These drugs save lives, and it's unconscionable that medicines that cost a couple of bucks a vial are unavailable."

When they are available at all, prices have risen dramatically (in some cases as much as twentyfold). And while the shortages are all of older drugs, they are affecting new-drug trials, as "some experimental cures have been delayed because the studies must also offer older medicines that cannot be reliably provided."

What is behind these shortages? In a majority of the cases, supplies have been disrupted because inspectors (internal or government) found contamination problems. Note that more and more of the production of these types of older drugs has shifted to a handful of generic-drug companies, many of whom manufacture overseas where they are never inspected by the FDA. In other cases, shortages "have occurred because of capacity problems at drug plants or lack of interest because of low profits, according to the FDA." (emphasis added)

These issues might all be important, but they don't help patients dying of childhood leukemia, colon or breast cancer, or bacterial infections.

As Harris wrote,
A crucial problem is disconnection between the free market and required government regulation. Prices for many older medicines are low until the drugs are in short supply; then prices soar. But these higher prices do little to encourage more supply, because it can be difficult and expensive to overcome the technical and regulatory hurdles. And if supplies return to normal, prices plunge.
...Some wholesalers buy certain drugs in large quantities because they are betting there will be a shortage. The excessive buying can help make their predictions come true.
I'm sure that some would say that the solution to the "disconnection" is less government regulation rather than more. But you know me -- while it's really tempting to rant about despicable war profiteers, that's not where I'm going to go with this.

The federal government, lawmakers, representatives of the pharmaceutical industry and doctors' groups are working on possible solutions, "which include a national stockpile of cancer medicines and a nonprofit company that will import drugs and eventually make them," that are still only in the planning stages.

Absent the national health-care system that I believe we have a moral responsibility to provide, we must at the very least not make it harder for Americans to obtain necessary care. A cancer diagnosis is always deeply stressful, no matter how treatable the particular form. We owe it to our fellow citizens not to make it more stressful by guaranteeing adequate supplies at uninflated prices.

Sunday, August 21, 2011

It's Amazing What $5 Can Buy You

Is a five-star review really better than a four-star one? What does "excellent" service (as opposed to "very good") mean anyway? And by how much does a rave review on Yelp affect your restaurant choices?

I wrote recently about "anonymous" Amazon reviewers, and about the gifts some receive for positive reviews. If you found that troubling, as I did, you'll find an article in yesterday's New York Times by David Streitfeld even more troubling. It appears that "[as] online retailers increasingly depend on reviews as a sales tool, an industry of fibbers and promoters has sprung up to buy and sell raves for a pittance."

Reviewers-for-hire may receive as little as $5 or $10 for a positive review, a "pittance" indeed, but if you churn out enough of them you can make enough to get by -- without wasting the time, effort, and money of actually reading the book or staying at the hotel.

Streitfeld continues,
The boundless demand for positive reviews has made the review system an arms race of sorts. As more five-star reviews are handed out, even more five-star reviews are needed. Few want to risk being left behind.
Does this sound familiar? We are all experiencing this "arms race", every day. I take my car for a regular service call and am told that the service team needs an "excellent" rating on my "anonymous" customer satisfaction survey call, or they will all be at risk of losing key bonuses. A friend, at the end of a cruise-ship vacation, is told that anything less than an "excellent" rating will ruin the careers of crew members. And, most egregiously, schoolteachers in Atlanta (and elsewhere) are encouraged to correct their students' standardized test scores in order to meet and exceed the No Child Left Behind goals.

Most anything can be measured. Some things should be measured. But before you go crazy on the measurement side, you might want to think about the unintended consequences. The more importance you place on a test, the more likely that you will see this kind of behavior. I am not excusing cheating, but I am explaining it. We should not be surprised by it. And maybe there are other ways of measuring that might provide more useful data -- but no doubt they'd be more expensive.

Consider book reviews, for example. Fewer and fewer newspapers and magazines these days have reviewers on staff, but I value those reviewers' comments. Over time, I get to know their idiosyncrasies ("Oh, no wonder it's a negative review -- she hates hard science fiction."), and so know how to weight a positive or negative review. And I know that the critic's newspaper or magazine has paid for the book, not the reviewer herself. But with Amazon reviewers -- it could be the author in disguise, the author's best friend, the editor's husband, the publisher's enemy, or, in fact, a disinterested reader. But I don't have enough information to make a value judgment of the worth of the review. I don't even know if the reviewer has, in fact, read the book in question (I don't know it about the newspaper or magazine reviewer either, but I consider it far more likely).

"The whole system falls apart if made-up reviews are given the same weight as honest ones," says a Cornell University reviewer that Streitfeld quotes, who is part of a team working on an algorithm to detect fake reviews.

All those "personal" reviews give us a false sense of community. A book recommendation from a friend who knows me well is qualitatively different from a book recommendation in the New York Review of Books. A book recommendation from Amazon purports to be more like a friend's review... but in fact, it's not. Maybe "the whole system" should fall apart.

Friday, August 12, 2011

Ooooommmm. Trust. Ooooommmm. Transparency.

Anyone who's read more than two posts on this blog (maybe even more than one) knows my twin mantras: Trust & Transparency.

I don't believe in them just because they're the right way to behave -- although of course, given the title of this blog, I do think the ethics of such behavior is important -- but also because they're the smart way to behave.

As a result, I believe in strong regulation ("Trust, but verify", if you like). I believe in prosecutors' pursuing those who violate that essential market trust (which is why I keep wondering why we haven't seen a steady stream of go-to-jail-go-directly-to-jail following the 2008 market collapse).

Today's New York Times has a great article by Julie Creswell that illuminates the importance of trust and transparency.

"Small investors provide the bedrock for the United States stock market through their mutual funds, 401(k) plans and other company-sponsored retirement programs," she notes. In the current roller-coaster environment, what's a small investor to do?

Some will stay the course, because that's what their investment counselors have told them to do (or because they don't know what else to do). Some will pull out, because they've been spooked.

But some are heading for the exits because they no longer trust the markets' essential fairness:
Some investors fear that the markets have become dominated by high-frequency traders blitzing in and out of stocks, or by sophisticated hedge funds running mind-bending algorithmic trading programs that can outsmart the ordinary investor.

These people said they feel that the game is rigged and they are the fool.
Creswell quotes one retiree who sold out completely in the fall of 2008 to buy Treasuries: "I simply have no confidence at all that the markets are fair...."

In other words, Fool me once, shame on you; fool me twice, shame on me.

Investment professionals at all levels should be worried about that sentiment. The comments posted by readers reflect similar concerns. The very first comment reads,
I was a small investor and I am totally out of the market. There's no way for the little guy to respond fast enough to the computer programs that are set to kick in at various levels. Between that and the Hedge Funds, market manipulations and insider traders (yes, I know you are out there) there is no way I'm going to make any money in the stock market. There are going to have to be new rules and new ways of doing business before I will even consider it.
And there are many more in the same vein.

But if small investors get really spooked, there's no way that the stock market, which has indeed been an engine of wealth creation for many, will be able to sustain the draining downward pressure.

If the investment community is smart, and in it for the long term (as they always tell us small investors to be), they will get out in front of this and press Congress for tougher rules and greater transparency, to prove that the market can be trusted, that a small investor has a fair chance.

Do I think that will happen?

I'm not that naive.

Thursday, August 11, 2011

Wolves in Sheep's Clothing

At the best of times, I'm not a great fan of con artists. When they target the merely greedy, I can sometimes pause to admire the artistry of a con. But when they target the desperate, I go crazy.

Which is why I was so happy today, listening to Leonard Lopate's show on WNYC, to hear that the New York City Department of Consumer Affairs has issued subpoenas to 15 debt settlement companies (all chosen as a result of complaints by New Yorkers).

You know the companies I mean -- their advertisements are everywhere, promising to "cut your debt in half", and "negotiate" so that you end up paying pennies on the dollar.

It's easy for those of us who are fortunate enough not to be sinking under a rising tide of debt to wag a metaphoric finger, and say, "If it sounds too good to be true...." But when you're in that situation, and panicking, it's virtually impossible to think clearly. Someone offers to throw you a rope, you'll grab for it. Only to find out later that it's a noose.

“These so-called ‘debt settlement’ companies bombard New Yorkers with ads that fraudulently offer false hope, but instead deliver nothing but added fees and long-lasting financial ruin,” said [DCA] Commissioner Jonathan Mintz, in a press release issued today.

Speaking on the Lopate show, the commissioner went on to say that the best these companies do is take more of the indebted person's money, demanding an upfront fee, usually in the hundreds of dollars. The worst they do? Crater credit ratings, vastly increase penalties and fees, and push someone teetering on the edge right over the financial cliff.

The companies' "advice" is generally: Stop paying your debts. Wait 'em out. Eventually they'll be so exhausted, they'll let you off the hook, or nearly so. We'll talk to you for them.

That's not just bad advice; it's almost criminally bad. The creditor will sell the debt to a collection agency, and add fees and penalties. Monies that an indebted person puts into escrow with the settlement company are nearly impossible to retrieve, in part because the companies change names frequently. And there's little indication that these companies actually do contact the creditors.

This isn't a new story. The New York Times, as part of its "New Poor" series, ran an article by Peter Goodman more than a year ago about this nationwide scourge, preying on the vulnerable:

In the Kansas City area, Linda Robertson, 58, rues the day she bought the pitch from a debt settlement company advertising on the radio, promising to spare her from bankruptcy and eliminate her debts. She wound up sending nearly $4,000 into a special account established under the company’s guidance before a credit card company sued her, prompting her to drop out of the program.

By then, her account had only $1,470 remaining: The debt settlement company had collected the rest in fees. She is now filing for bankruptcy.

A number of state attorneys general have been investigating these companies (now represented by their own trade association, the genteelly-named United States Organizations for Bankruptcy Alternatives), but I have yet to hear of significant criminal proceedings.

Commissioner Mintz said that about 18% of New York City households are carrying credit-card balances in excess of $10,000 (compared to about 13% nationwide). With an economy that continues to sputter, and jobs few and far between, it's easy to understand how that kind of debt could lead someone to jump for a proffered out. It's much harder to understand how people could choose to defraud the desperate.

Monday, August 8, 2011

Would the Hens Hire a Fox to Value their Eggs?

Let's say that you're in the business of rating products and services. Investors rely on your ratings to decide whether to buy a product, or whether to demand more return for greater risk. Now imagine that you're paid for this work by the companies whose products and services you rate. Can you say, "conflict of interest"? Sure you can.

Remember all those junk-quality mortgages that got split up and repackaged and sold as AAA-rated bonds? Sure you do.

That explains why, when Standard and Poor's downgraded US debt to AA+ (from AAA) status on Friday, I was less than impressed. As Paul Krugman wrote in today's New York Times, Standard & Poor's is "the last place anyone should turn for judgments about our nation’s prospects". (Full opinion piece, here)

S&P is, after all, the company that "gave Lehman Brothers, whose collapse triggered a global panic, an A rating right up to the month of its demise. And how did the rating agency react after this A-rated firm went bankrupt? By issuing a report denying that it had done anything wrong."

It didn't help S&P's case that the administration immediately pointed out a $2 trillion error in S&P's math. The rating firm argued briefly, conceded the error, and went ahead with the downgrade.

Just how good at their jobs are the rating agencies? In his Times "FiveThirtyEight" blog, Nate Silver calls S&P country ratings "substandard and porous", noting that, for example, their egregious $2 trillion error in the US downgrade came from "their lack of understanding of the way that bills are scored by the Congressional Budget Office". Not a way to engender trust in their acumen, wouldn't you say?

I'm not suggesting that we aren't facing serious financial and economic difficulties in this country; of course we are. But this blog isn't about economics -- it's about ethics.

I find it ethically troubling that S&P (and Moody's and Fitch) are primarily paid by the very companies whose products they are reviewing.

There isn't any question that a great deal of, um, questionable behavior was going on, at the banks, at the ratings agencies, and no doubt at the accounting and law firms that served the banks as well. Much of it is coming out in private suits. An article by Louise Story and Gretchen Morgenson in today's Times, for example, reports:
One case against Bear Stearns indicates that its employees put troubled mortgages into securitization trusts that it sold to customers, while simultaneously receiving reimbursement — known as apology payments — from the companies that originated the loans.

And a recent case against Morgan Stanley cited a witness saying that the bank would receive mortgages with documentation of a buyer’s income and then shred that documentation so that it could call it a “no doc” loan and pay less for it. Those banks dispute the accusations.

If these allegations are true, then I'm glad that lawsuits are uncovering it.

But can we pause for a moment here and wonder why the Justice Department hasn't gone after these firms? Or Moody's? Or, for that matter, Bank of America, which is likely to be sued by still-largely-taxpayer-owner AIG? (Story and Morgenson's article in the Times reports that AIG will claim that BoA "misrepresented the quality of the mortgages placed in securities and sold to investors.")

Perhaps AIG has the wrong target in mind for its suit. If they bought BoA mortgage bonds in part because they were AAA rated... maybe the rating agencies should be held accountable, too. The agencies would no doubt claim that BoA and its subsidiaries provided falsified data, and that they're just victims here too. I'm not buying it. What about you?