Tuesday, October 12, 2010

Memo to Ben Bernanke: Listen to a Conference Call Once in a While

The September employment report “is simply a signal, a strong, strong signal for Fed QE2,” Gross said….

—‘Gross Says Employment Report Signals More Fed Easing,’ Bloomberg, October 8, 2010

"The business traveler is back. We're excited to see demand so strong in so many places with prices moving up. But we know what you want to know, essentially where do we go from here? According to the National Bureau of Economic Research, the recession officially ended in June 2009. Notwithstanding that, many seemed to wonder whether the economic recovery has any strength and about the risk of a double dip.

"Let's be clear. There is nothing in our business which indicates that sort of weakness. Both business transient and leisure travel remain strong."

—Arne Sorenson, President & COO, Marriott International, Earnings Call, October 7, 2010

There’s something about Washington DC that saps people’s brains of all reason, sense and intellectual honesty.

How else to explain the process by which Congress and the Administration undertook to restructure the entire healthcare system of the United States without asking a single insurance company for advice on how to improve the system?

Before you spit out your coffee and scream, in the manner of our President and any random Congressperson running for reelection, “hey, the insurance companies are the bad guys of healthcare,” sit back and think what insurance companies really are: they’re the canaries in the healthcare coal mine.

They gather cost data, put a mark-up on it, and negotiate with their customers the delivery of their services—i.e. the parsing and paying of healthcare claims. As a result, no part of the healthcare chain knows more about the actual costs of trial lawyer abuse, hospital waste, insurance fraud, drug company price hikes, and the staggering inefficiency of a Balkanized, paper-based delivery system than the insurers.

And if anybody had bothered to ask where to find and how to prevent inefficiencies, fraud, abuse, and inflation exist, the so-called healthcare “reform” act might have managed to do a thing or two to reform our healthcare delivery system.

But, of course, Congresspersons don’t like to be confused by the facts.

Neither, apparently, does the White House. Bloomberg recently reported that IBM offered to analyze the healthcare system, free of charge. You might think the offer would have been snapped up—but, then, you would be a rational human being:

IBM said it would analyze health-care spending, at no cost to the government, to hunt out fraud, Sam Palmisano, the company’s CEO, said at a conference in New York on Sept. 14. The White House wouldn’t sign on to the plan.

“We offered to do it for free to prove a point, and they turned us down,” Palmisano said. “Our recommendations weren’t aligned with the priorities of the administration. Their priority was not to reduce fraud and improve productivity. It was to increase coverage.”

— ‘Obama May Try to Woo Business as P&G, Blackstone Blister Moves,’ Bloomberg, October 8, 2010

Sure, nobody likes the cost increases insurance companies pass on, and nobody likes the impersonal, bureaucratic decisions they make when it comes to healthcare coverage, or when they make mistakes. Indeed, some people find it offensive that many insurance companies are for-profit enterprises.

But taking out anger at the lousy healthcare delivery system in the US on the insurance companies the way Congress and the Administration did was more like shooting the mailman who delivers the eviction notice than dealing with the actual problem that caused the eviction notice to be sent by the bank.

Consider for ten seconds the mark-up on an insurance company’s services versus that of one of the drug companies on whose behalf the insurers collect much of our hard-earned premiums: United Healthcare’s gross markup (i.e. before administrative and selling costs as well as taxes) on its services is 23%; its net after-tax margin is 4%.

Pfizer’s gross markup on its products is 85%; its net margin 17%.

How, exactly, are the insurance companies the bad guys here?

Of course, people in Washington DC consider nothing for ten seconds unless it involves the prospect of getting reelected, or getting reappointed.

Look at Ben Bernanke and the panic-stricken reaction of the Federal Reserve to the recent employment data. So freaked out is the Fed by the lackluster hiring that it is preparing something called “QE2”—Quantitative Easing, Round 2—by which the Fed will buy government debt (at record, all-time high prices…hardly the time to buy anything) in order to keep the economy from stalling.

The Fed’s reaction to unemployment data, unfortunately, ignores a simple fact: nobody hires new employees because interest rates go down.

They hire when they are confident of their future.

Thus, the weak employment data are not telling the Fed that business stinks—in fact, business is actually fairly healthy. Indeed, if Bernanke listened to an actual company talk about business, he’d hear some interesting stuff.

Take the above-quoted commentary from Marriott International, and think about what it means that both business and leisure travel are “strong.”

It means companies see deals that can be done, so they’re sending people on the road. And if hotels are filling up, it means that airplanes are flying full, rental cars are being rented, restaurants are being booked and cabs are being hailed.

It also means that city hotel room taxes and airport gate fees and sales taxes are being paid, and waiters and waitresses and cabbies and bellmen are being tipped.

Travel is one very important canary in the economic coal mine, and it’s telling us that business really is getting better.

So we have a suggestion for Ben Bernanke, and, for that matter, Bill Gross, ace bond king of PIMCO who seems to manage PIMCO from within a CNBC studio, so frequently do his musings on the state of the economy appear on that TV channel, and a cheerleader of the Fed’s impending QE2 campaign: listen to a few conference calls some time.

If they listened, they’d know that companies aren’t holding back on hiring because business stinks: they’re holding back because they see tax hikes and healthcare cost increases coming, and they’re not sure adding a new FTE is a smart thing to do.

And no amount of “QE2” or QE3, 4, 5 or 6 will change that.

Ah, but who in Washington needs facts to make up their minds?

Jeff Matthews
I Am Not Making This Up

© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.


Anonymous said...

your "markup" analysis of pfizer vs. united healthcare is not exactly a fair comparison because pfizer spends on R&D that is expensed in operating expenses, not cogs.

Sean said...

Your markup comparison is sort of bizarre. It doesn't make sense to compare gross markups from two different industries. Wouldn't it make more sense to compare the gross markup of Medicare to that of the average insurance company?

Of course if you did that you'd have an entirely different thesis...

Anonymous said...

How about a Christie/Matthews ticket in 2012?

But What do I Know? said...

Wow, the pharma guys are up early this morning! If I can elucidate what I think your point was, it's that PFE and MRK et al. pay enormous salaries and spend enormous amounts of money on marketing which are simply unnecessary costs that they can pass on. The difference between gross and net margins is hardly, or even nearly, all R&D.

I agree with you that QE2 is stupid--but what I don't understand is why the Fed thinks it will work. I mean, you could make the argument that QE raises bond yields--have you looked at the 30-year lately, and at what happened to it after the last QE announcement? As for stock prices, a continuation of the strong Mar09-Apr 10 rally was not unexpected (and we haven't even reached new highs yet on the S&P 500 or Russell 2000). All the Fed seems to have done is cause commodity prices to go parabolic--or hasten the dollar's slide, whichever way you want to look at it.

Jeff Matthews said...

Sean asks why we didn't compare private insurer markups with Medicare. Medicare, of course, pays what it covers, at taxpayer expense, without a profit markup even as low as the 4% United Healthcare earns.

That public sector function is a business model that does not promote efficiency, as anyone who uses the Post Office recognizes.

We'll bet $1,000 to Sean's favorite charity that United Healthcare delivers services more efficiently than Medicare.

As for the Anonymous suggestion of a "Christie/Matthews" ticket in 2012, it brings to mind the Jack Nicholson line from 'Terms of Endearment': "I'd rather stick needles in my eyes."


Gho said...

Would the Medicare patient base be more efficiently serviced by UNH? This that what you're asking Jeff.

Because comparing UNH and Medicare efficiency to their respective patient bases is apples to hand grenades.

BTW, when hedge fund managers gush about Wellpoint or UNH they don't gush about their profit margin but their FREE CASH FLOW generation. It seems like both do a lot of padding of capex/R&D to lower their profit margin to a more acceptable level. Does anyone really think that 15% profit margins for UNH would be looked upon kindly by Congress?

Anonymous said...

I always love reading your reality- and evidence-based analysis for a breath of fresh air. In this case, though, I've seen business survey data that indicates the problem really is lack of demand and not fear of taxes or regulations. This post by Krugman was fairly convincing to me. I curious what your thoughts are:


brenda said...

I would like to hear President's Obama's response to your accusation that the administration didn't care to take IBM up on its offer of a free analysis. I find so often that on CSPAN I listen to Obama and he knows exactly what he is doing- he has reasons for things that are sound, intelligent, and fair. I trust him and I don't like accusations like these that don't offer his response. I trust that if I had a chance to put this to him he's have an appropriate and meaningful response.

Anonymous said...

Interesting way of finger pointing. And what would the party not in the White House say if the QE2 was thrown out as a bad idea? Looking at history, something about the majority not caring for the "little" people. Damned if you do...

Anonymous said...

Dude, need to check your facts. Health insurance industry was very involved in drafting health reform legislation (which Obama was criticized for, btw) - and the White House meets w/ industry frequently. In fact, President met with CEOs in July for an extended meeting. Don't know about IBM complaint, but sounds fishy. Government hires many contractors to root out Medicare fraud.

Jeff Matthews said...

Anonymous 1, accusing us of "finger-pointing," is Exhibit A for why thin-skinned non-financial people shouldn't read financial blogs: the White House has nothing to do with QE2.

QE2 is a Federal Reserve plan, which the title of this piece ('Memo to Ben Bernanke...'") makes rather clear, since Ben Bernanke is Chairman of the Fed.

The reason we dragged the White House and Congress into the discussion is that neither proved themselves capable of letting the facts get in the way when they set out to "reform" healthcare...and Bernanke seems to be incapable of letting the facts get in the way of Fed policy. So there must be something in the water in that town.

As for Anonymous 2, this demonstrates that any comment starting out "Dude..." is not going to add much value to the discussion.

Indeed, no facts are presented here to discuss, except the rather sad notion that the Government hires contractors to root out Medicare/Medicaid fraud...which demonstrates that only that those programs fail utterly to do what they are supposed to do.


Sean said...

This is getting good! No time to respond now, but I'll have something to say before the end of the weekend. I promise to keep it shorter than your original post, Jeff.

bobble said...

anon 7:50 ". . . the problem really is lack of demand and not fear of taxes or regulations"


jeff, i think your personal distaste for taxes and regulations is warping your thinking on this.

for example, did companies hire in 1960 when the top marginal tax rates were 90%? yep!

Jeff Matthews said...

"Bobble" is a great handle for the last poster, conjuring up as it does the image of "Bobble-head" dolls.

While accusing us of letting personal prejudices get in the way of straight thinking, "Bobble" simply makes up a false tax rate to attempt to validate his or her argument.

The top corporate tax rate in 1960 was not 90% as Bobble states. "Bobble" must be confusing personal tax rates, the top bracket of which was indeed 90% back then, with corporate tax rates. The top corporate tax rate was 52% back then.

And personal tax rates have nothing to do with whether corporations hire or not.


bobble said...

JM:""Bobble" simply makes up a false tax rate to attempt to validate his or her argument."

nope. that's a real rate. since small business does most of the job creation, i used the individual tax rate.

JM:"And personal tax rates have nothing to do with whether corporations hire or not."

my argument works just as well with corporate rates. the 52% corporate tax rate in 1960 was the highest corporate rate going back to 1901 (it was briefly exceeded at 52.8% in 1968-69) and has been going down since then.

the corporate rate is now 35%. why were corporations hiring in the 60's when the corporate tax rate was 52% and not hiring now when the rate is 35%?