underwriting loans

I’m going to just copy/paste this one.

From the WSJ:

The thrust of the mortgage section would require lenders to make sure that borrowers can repay any home loans they are sold. It puts limits on the ability of lenders to offer loans without documentation from borrowers, and has rules regarding the way loans can be refinanced.

Then, Arnold Kling comments:

Making a loan that subsequently defaults is known as a Type I error. Turning down a loan that will subsequently be repaid is a Type II error. In the past, the Congressional harpies have gone nuts over type II errors, accusing lenders of denying loans to minority borrowers and ruining the American dream. Now, they are going nuts about Type I errors.

Basically, there needs to be a balance here. With the new rules, there may be an overshoot of now denying some deserving people loans in the rush to caution.

Financial Regulation

As a finance person, I assume some may wonder what I think of the financial regulation bill meandering through Congress. As it is a lazy holiday weekend, I’ll outsource it:

In two weeks, I am supposed to speak on a panel entitled “Financial Re-regulation.” My question is, what re-regulation? To me, re-regulation means you would reverse some step that you took toward deregulation. But the new financial reform bill does not reverse any of those steps, as far as I know.

For example, the new bill does not repeal Gramm-Leach-Bliley, a 1989 law that ratified the de facto breakdown of the separation between commercial banking and investment banking, which is often blamed for the crisis. You would think that for symbolic reasons, if nothing else, you would repeal that law and go back to Glass-Steagall. Of course, I do not think there is much connection between GLB and the crisis, so I am not advocating repeal. I am just pointing out an inconsistency between one narrative of the financial crisis (it was caused by GLB) and the actual response.

In fact, if you wanted to restore the distinction between commercial banking and investment banking, you would need an entirely new law. That is because Glass-Steagall did not contemplate money market funds (are they commercial banking or investment banking?) or mortgage-backed securities (same question) or credit default swaps (ditto). There is no clear-cut inherent distinction between commercial banking and investment banking. It is true that some folks have a reasonable intuition that combining certain functions may be anti-competitive or unsafe and unsound, but that intuition needs to be articulated in a way that speaks to the modern financial world.

Back to the main point–if we are re-regulating, then what was deregulated? For example, where did subprime mortgages come from? Can anyone point to a particular legal or regulatory barrier that was removed in the last two decades? If so, has the new legislation restored this barrier?

When banks created structured investment vehicles (SIVs), collateralized debt obligations (CDO’s), and other innovations, did this require a specific deregulation? Were the actions of the credit rating agencies a result of their becoming deregulated in some way? In my own analysis of the crisis, I point to capital regulations that rewarded CDO’s, SIVs, and the manufacturing of AAA-rated securities. But that was not deregulation. And it was not reversed by the legislation.

Perhaps the centerpiece of the new legislation is a consumer protection agency for financial products. But if the core problem was a lack of consumer protection, what we should have seen was banks extracting profits from loans and foreclosures. Instead, banks got wiped out by losses. As Tyler Cowen points out, given where the losses took place we should be talking about predatory borrowing.

As I have said before, there is no coherent narrative that connects an analysis of the causes of the crisis to the financial reform legislation as written. Rather, the bill serves to deflect blame from government’s role in pursuing housing policy through dubious mortgage market intervention and from the mutual overconfidence of large financial institutions and their regulators.

The new law is not re-regulation. The regulations it contains are largely irrelevant to financial stability. And potential regulations that would improve financial stability (such as increasing the use of subordinated debt to discipline banks or requiring sizable down payments on mortgages) are not in the bill.

To sum up: The bill is largely an effort by politicians to say they “did something” without really doing anything.

Senate planning to regulate health insurance premiums

From the New York Times:

Fearing that health insurance premiums may shoot up in the next few years, Senate Democrats laid a foundation on Tuesday for federal regulation of rates, four weeks after President Obama signed a law intended to rein in soaring health costs.

Not sure how this will work. If the underlying health care costs continue to rise, but the amount of money insurance companies collect is capped, then that seems to me to be government mandated bankruptcy. Perhaps this is a hidden way to cap health care expenditure without directly taking on doctors. Normally, I’d say “Price caps lead to scarcity” which they do in a normal market, but since the government now mandates coverage and mandates benefits, I’m not sure how this will turn out.

But make no mistake, this bill, if it passes, will mean the government runs our health care. You may like that or not, but it is. And, as many have said so far, the health care bill just passed is the beginning, not the end.

How health care might evolve beneficially (in my opinion)

1. Business mandates are not strong enough so more and more business drop health care coverage and more people are put on the exchanges. This weakens the employer-provided healthcare problem.

2. Individual mandates are not strong enough either, which means the young and healthy pay a fine instead of joining up.

3. This creates a large market of individuals who are potentially profitable customers. Insurance companies innovate by creating new types of less expensive plans to get them to join. This likely will happen first at the state level if a few states change insurance regulations such that minimal insurance is pretty minimal and individuals can choose their coverage. Currently, most states mandate large, expensive and comprehensive coverage. If those states allow that innovation and see prices drop with more customer satisfaction, we’re in business.

4. I imagine this innovation only works if people voluntarily submit to health screening which means those who don’t get screened are assumed to be sick and pay higher prices.

5. Guaranteed Issue (where insurance companies cannot deny coverage) starts to be more expensive, perhaps the answer is more subsidies or a government backstop for the sickest (i.e. those who refuse to be evaluated). If it is subsidies, they are likely never enough and this group continues to pay a lot for health care. If a government plan, it is less expensive/free but not very good, along the lines of public education.

6. Those currently healthy don’t want to get stuck paying huge claims when they are sick (or in a government program) so they opt for something like health-status insurance which pays the difference in premium for comparable coverage in the event of a major health status change (i.e. you get cancer).

The key step is 3. If insurance companies lobby government for higher fines or more subsidies instead of innovating and creating new insurance products to win customers, then we head toward socialized medicine. This is also true if the government continues to mandate thorough, comprehensive coverage as a baseline, which is common now.

And I’m not sure there is a good outcome here for people who are currently low income and quite sick. I think they get a baseline of affordable coverage but again, the metaphor would be the type of education low income kids get at public schools – and this to me will be the case regardless of whether the larger market becomes more private or more public.

Congress is also baffled by health reform!

From the NYT. Priceless.

It is often said that the new health care law will affect almost every American in some way. And, perhaps fittingly if unintentionally, no one may be more affected than members of Congress themselves.

In a new report, the Congressional Research Service says the law may have significant unintended consequences for the “personal health insurance coverage” of senators, representatives and their staff members.

For example, it says, the law may “remove members of Congress and Congressional staff” from their current coverage, in the Federal Employees Health Benefits Program, before any alternatives are available.

The confusion raises the inevitable question: If they did not know exactly what they were doing to themselves, did lawmakers who wrote and passed the bill fully grasp the details of how it would influence the lives of other Americans?

Egad. If you read a bit deeper, it is all based on a provision that Congress should use the exchanges “just like all other Americans” or something like that, which is fine. It just appears to have been hastily written and really vague, such that even though the exchanges don’t come online until 2014, many congressional staffers are required to buy from the exchanges effective immediately. Hmm.

In addition, the report says, Congress did not designate anyone to resolve these “ambiguities” or to help arrange health insurance for members of Congress in the future.

Now, to be fair, there has been a trend in the last 10-15 years of Congress drafting laws that are pretty high level and allowing the necessary agencies to put the details in place – I heard an NPR story on that recently. But this seems to be an extreme version of that trend with lots of missing details. I guess that means it will be hard to really know what health reform act will actually do until it is in place.

mandates again

Everyone who advocated for coverage of everyone with no regard to pre-existing conditions always included an individual mandate. I’ve blogged on this before, but can’t find it now. The idea is that if you don’t allow an insurance company to charge people different rates for varying health conditions, you must have the whole population in the insurance pool to keep the average cost down. This is because the healthy, who are by definition charged more to pay for the sick, won’t do it otherwise. So keeping them insured and paying premiums is vital to keeping costs from ballooning. More on that effect here.

So, the efficacy of mandates is quite important. Of primary importance is the individual mandate – this is getting the young and healthy individuals who are not currently insured into the pool. Austin Frakt has done some in depth analysis and thinks the mandates are sufficient. I hope he’s right because if not, this thing is going to come apart fast. He compares the mandates to Massachusetts where they seem to be effective (in the sense that north of 97% of the population has insurance and people are not gaming the system).

Tyler Cowen rightly brings up the enforcement issue – i.e. how will it be enforced. It seems that it will be tied to your tax return, but will not have the same collection mechanisms (i.e. wage garnishments, interest payments, etc.) as tax payments. That seems pretty strong. Then, finally, there is the cultural issue – i.e. does skipping the mandate somehow become a cultural norm (i.e. ‘cool’) or does it become looked down upon. The mandate is strong enough, that if there is cultural pressure as well, then it might just work.

Now, even this is no paradise. Massachusetts, even with it’s mandates “working” has seen it’s health care costs rise faster than the national average since it’s reform packages was passed.

Now, the business mandate is another story. It seems totally inadequate, according to John Cassidy:

Take a medium-sized firm that employs a hundred people earning $40,000 each—a private security firm based in Atlanta, say—and currently offers them health-care insurance worth $10,000 a year, of which the employees pay $2,500. This employer’s annual health-care costs are $750,000 (a hundred times $7,500). In the reformed system, the firm’s workers, if they didn’t have insurance, would be eligible for generous subsidies to buy private insurance. For example, a married forty-year-old security guard whose wife stayed home to raise two kids could enroll in a non-group plan for less than $1,400 a year, according to the Kaiser Health Reform Subsidy Calculator. (The subsidy from the government would be $8,058.)

In a situation like this, the firm has a strong financial incentive to junk its group coverage and dump its workers onto the taxpayer-subsidized plan. Under the new law, firms with more than fifty workers that don’t offer coverage would have to pay an annual fine of $2,000 for every worker they employ, excepting the first thirty. In this case, the security firm would incur a fine of $140,000 (seventy times two), but it would save $610,000 a year on health-care costs. If you owned this firm, what would you do? Unless you are unusually public spirited, you would take advantage of the free money that the government is giving out. Since your employees would see their own health-care contributions fall by more than $1,100 a year, or almost half, they would be unlikely to complain. And even if they did, you would be saving so much money you afford to buy their agreement with a pay raise of, say, $2,000 a year, and still come out well ahead.

Now, this could also be a feature, not a bug. Basically, what this means is that for most firms, starting with the smallest, will have pretty strong economic incentives to drop their health coverage and put people on the exchanges. What this does is create an individual market for health care insurance. Since, the employer-based care was one of the biggest problems with the system, this could be a pathway out.

Things to like in the health care bill

1. The Independent Payment Advisory Board (IPAB). This was set up as a part of the Affordable Care Act (The official name of the Health Care Reform bill). What it does is set up an independent commission, separate from Congress which will make recommendations on how to save money on Medicare. Ezra Klein has more here. He’s soul-searching a bit because it seems that it takes removing this sort of thing from Congress to get it done. I’m not surprised, he seems a bit disturbed.

Anyway, he is right that the IPAB has a lot more power than anyone would have thought it could have – an interesting product of the way this bill was passed. Basically, if the IPAB makes a recommendation to cut some price or remove some coverage from Medicare (politically unpopular, no doubt) then it automatically becomes law. Congress has to act in order to stop it. And then the president has to sign it. This is a really, really high threshold because basically it means that a Congress has to pass a law, signed by the President, to stop it.

Now, do not underestimate the political power of seniors. They care, they are active, and they vote. So I’m sure there could be broad, bipartisan support for emasculating the IPAB on an annual basis – it could end up just like the annual repealing of the 20% Medicare reimbursement cut we already have. But I like this a whole lot better than other options.

2. The Cadillac Tax. Now, as I said before, this could end up applying to a large number of people. But that could be a feature, not a bug. If expensive health care plans end up being taxed, then we may get pressure to deliver cheaper health care plans. Those may end up being more targeted with more consumer choice (Does every 40 year old woman need comprehensive pregnancy coverage? Even if she’s had her tubes tied? Right now, she does and pays for it.). Basic economics says if you tax something, you get less of it. So this may be one dampening force on the ever rising costs of health care.

Again, don’t hold your breath. The politics of this may be that this tax never actually happens – unions oppose it vehemently and the right seems to be against anything remotely called a ‘tax’ so it could also be removed before it goes into effect in 2018  with broad, bipartisan support and little debate.

The evolution of health care: a less optimistic take

By Bryan Caplan. His concern is with problems around fines and mandates, and his source is the 7 page summary document put forth by the White House.

Issue 1: “Immediate Access to Insurance for Uninsured Individuals with a Pre‐Existing Condition.” Most see this as a benefit, but it may not be so. If insurance companies cannot use your health information to set premiums, then rates go up for everyone. Imagine if the car insurance company was not allowed to pull your driving record to set your car insurance rates. They’d have assume you were an average-to-bad driver (health) and charge you accordingly. Then what? Since the good drivers (health people) are overcharged, they are the most likely to try to go without (they are, after all, good drivers). So, the healthy opt to pay the fines. That means the average population seeking insurance are actually more sick the the population at large. As the insurance company figures this out, they charge higher premiums. Now, the moderately healthy are getting a bad deal, so they opt out and pay the fine. Repeat. This is a classic adverse selection problem which people claim was present in the insurance industry, but it is only present when you cannot (or are forbidden to) determine the actual health of the insured (or driving ability of the driver). Note that while the coverage is mandated in 2010, the fines for not buying health insurance don’t arrive until 2014. So, the healthy are actually incentivized to skip insurance now (too expensive), pay no fine, and once/if  they get sick, and then get it, since they can’t be denied.

Issue 2: The fines are not high enough. The bill:

Requires most individuals to obtain acceptable health insurance coverage or pay a penalty of $95 for 2014, $325 for 2015, $695 for 2016 (or, up to 2.5 percent of income in 2016), up to a cap of the national average bronze plan premium. Families will pay half the amount for children, up to a cap of up to a cap of $2,250 per family. After 2016, dollar amounts are indexed. If affordable coverage is not available to an individual, they will not be penalized.

I guess we’ll see if these fines are enough. I’m guessing that $95 per year is not likely going to do much. 2.5% of income sounds closer, but it depends on how much the alternative costs – i.e. how much health care costs (even with the subsidies).

Issue 3 I let Bryan take:

3. While new regs penalize firms that don’t offer insurance, the penalty seems to asymptote to $2000/employee:

Requires employers with 50 or more employees who do not offer coverage to their employees to pay $2,000 annually for each full‐time employee over the first 30 as long as one of their employees receives a tax credit. Precludes waiting periods over 90 days. Requires employers who offer coverage but whose employees receive tax credits to pay $3,000 for each worker receiving a tax credit up to an aggregate cap of $2000 per full‐time employee.

I have a feeling that post-recession jobs are going to be a lot less likely to offer health insurance.

Remember, employers don’t get subsidies. So, assuming annual premiums costs something like $12,000 for a business to provide, even with the tax deduction, I don’t think it will compare with paying a $2,000 fine for not providing it. Now, I doubt large businesses will opt out en masse, but I do expect firms in the 50-500 employee range to seriously consider simply dropping coverage and paying the fine.

Finally, issue 4:

4. The “Cadillac tax” doesn’t kick in until 2018.  But given the regulation-induced adverse selection problem, plus many other provisions to hobble discount insurance, I wouldn’t be surprised if half of the insured ended up paying it:

based on this from the White House doc:

Tax is on the cost of coverage in excess of $27,500 (family coverage) and $10,200 (single coverage), increased to $30,950 (family) and $11,850 (single) for retirees and employees in high risk professions. The dollar thresholds are indexed with inflation…

The key thing is that the tax is indexed to inflation but health care costs have been rising much, much faster than inflation. Inflation is typically 2% per year, health care costs have been rising at close to 10% per year (loose estimate. A lot more than 2%). Either way, what this means is that more and more plans will be considered “Cadillac” plans and be taxed even as these “Cadillac” plans become the average coverage most Americans use.

How healthcare will evolve – an optimistic take

We all know that even though we often analyze things as if other things are held constant (for simplicity), those other things will not, in fact, be constant. So, what are the dynamics likely to be? Tyler Cowen, assuming that the fines/penalties are sufficient to induce everyone (or most everyone) to be insured, has the following take:

Many Americans will receive subsidies for insurance, from what I understand roughly in the range of 6k to 12k.  Many other Americans — namely those who already have health insurance — will not receive direct subsidies of this nature.  Yet the subsidy-receiving and non-subsidy-receiving Americans will very often belong to the same income classes.

This is because some will be employer-insured (no subsidy) while others will be self-employed or employed by a small business and thus get a subsidy and use the insurance exchanges. He continues:

This disparity does not bother me personally (I have other worries about the subsidies), but I believe it will be very unpopular once it is publicly understood.  One way or another, the “firewall” between the exchanges and the employer-supplied system will break down.  Some people will want to spread the subsidies, others will want to limit them.  Yet the former is budgetarily problematic and the latter will be politically difficult.

Now, he continues to address the reality that we have three systems of healthcare:

A second and related issue is that the differences in reimbursement rates — across private insurance, Medicare and Medicaid (highest to lowest) — will become a more pressing issue.  For one thing, Medicaid patients will be crowded out by those buying private insurance on the exchanges, plus they will be crowded out by the growing number of Medicaid (and Medicare) patients.  There will be pressure to fix this problem and the difference in rates will lead to growing supplier gaming, queues, quality differentials, and so on.

Reimbursement rates are what insurance pays doctors. What he means when he says “Medicaid patients will be crowded out” is that since they have the lowest reimbursement rates, they will (on average and over time) have a harder time getting healthcare – longer waits, more distant appointment times. Some doctors will decline to accept Medicaid (some do already).

Over time, reimbursement rates across programs (insurance subsidies, Medicare, Medicaid) will converge to an increasing degree.  Subsidies will be increasingly determined by income class rather than previous insurance history.

In the limiting case (I’m not suggesting we will get there), everyone will receive means-tested subsidized vouchers for regulated private insurance.

I also think a limiting case could be one of government provided insurance – the “socialized medicine” everyone fears along the lines of the public school system. I prefer the vouchers.

In this strange way, Medicare and Medicaid could end up partially privatized and Ezekiel Emanuel — a voucher advocate — will end up being more influential than his brother Rahm.  We will have to live with the problems of means-testing to a higher degree than today, but we will have something closer to a unified system, as do most other countries with universal coverage.  There will be political pressure for compulsory health care savings, as they have in Singapore, to lower costs of finance.It would be good if such vouchers could evolve in the direction of emphasizing catastrophic care and eventually they will have to.

Massive pressure will be put on such vouchers if either health care consumes 30-40 percent of gdp or income inequality continues to rise.  In the former case, subsidies become increasingly expensive and involve extraordinarily high implicit marginal tax rates (earn more, your subsidy declines in value).  In the latter case, it becomes increasingly difficult to ensure “near-equal” levels of health care access at feasible subsidy levels.  Those pressure points are not unique to the Obama bill, but they become especially critical under the evolutionary scenario I am outlining.  Perhaps we would give up the ideal of near-equal access, but that day is a few decades away.

He mentions “high implicit marginal tax rates” which is the same thing I discuss here. The idea is that if you get a large subsidy due to your low income, if your income rises and you lose your subsidy, you could actually be worse off in terms of net benefit= (higher salary – subsidy you lost).  This effect is a disincentive to attempt to move up in terms of salary, job, etc.

I’ll post again on a scenario where the fines/mandates are not enough to induce the healthy to get insured and employers to provide healthcare. This scenario is less optimistic.

Health Care – Economic Implications

$800B of the $900B cost of the health care bill is subsidies – i.e. payments from the government to individuals or families to help pay for health care. This is necessary for the mandate part of the bill to be remotely feasible. Most people want health care, they simply can’t afford it, so fining them won’t help. They need subsidies to pay for expensive health care.

The problem is that subsidies cause higher spending on the thing subsidized as we all worry about the burden of higher health care costs. We’ve done nothing to lower costs, we’ve simply shifted them from the uninsured and underinsured to the government (i.e. all of us taxpayers who fund the government’s operations).

Remember Cash for Clunkers? How about the first time homeowners tax credit? Both are subsidies – the government handing out money to assist people in buying cars and houses. What was the goal? To increase purchases of cars and homes. So, we now subsidize health care without cost controls means we ease the pressure on doctors and hospitals to lower costs: the government is now helping all sorts of folks get health care. But this was the point, wasn’t it?

The problem is that by releasing this pressure, we will see costs rise again. Markets work like this: if prices rise, many people get priced out of the market, which causes demand to drop. This drop in demand means that less gets sold at those higher prices. Competition then rewards the innovator who can provide the same service for less – they get no only those who have exited the market due to higher costs, but will also get some switching who were paying more. Thus prices go down. This competition mechanism is what is broken in the current system – we only see the cost of healthcare via monthly or annual premiums, not each time we go to the doctor, so the cost-consumer link is separated by space and time. And this bill continues to separate them for those who are assisted by it:

The second part of the subsidies, estimated to cost $466 billion during the next decade, would limit out-of-pocket expenses for deductibles and co-payments. This help, for individuals with salaries of $27,000 and families with income of $55,000, would be significantly more generous than any version of the legislation Congress has considered.

What we now know is that 50 million uninsured and premiums at $10-12K per year (or whatever they are now) is a socio-political breaking point. The current legislation will provide subsidies to ease this tension by reducing that annual cost with subsidies and reducing the uninsured to about 20 million or so. But, what happens now? With no cap on the cost and no incentive with copayment or coinsurance to say ‘no’ to procedures, the cost of healthcare will continue to rise until the costs after subsidies are once again $10-12K per year and we again have 50 million uninsured, but now we’re spending billions each year, let’s say the subsidy is $8K per family, so now the total cost is $18-20K. What happens now? Those same folks are again priced out of the market, and Congress is forced to increase the subsidy. Or, perhaps, they do this:

One part of the subsidies would consist of tax credits to help Americans afford insurance premiums, guaranteeing that they would not spend more than a specific portion of their income for them, ranging from 3 percent to 9.5 percent.

Which guarantees that nobody is priced out of the market, but guarantees that as the costs continue to skyrocket, the government picks up the increase, year after year.

And then what? Remember, Medicare and Social Security are mandatory spending on entitlements, just like this health care bill. In 1965, they accounted for about 25% of federal expenditures, now they are around 55% of spending and growing. Defense spending? About 50% in 1965 and about 20% now.  All other spending has been basically flat.

The problem is that Medicare, Medicaid, Social Security, and now this Health Care entitlement are all mandatory (in that no politician will touch them), mostly tied to an aging baby boomer population, and highly linked to rapidly escalating health care costs. I do not see how this ends well for us as a country. If the debt markets start losing faith in the US and the interest we pay on our growing debt starts going up, this will go from ‘bad – we should do something’ to ‘terribly awful – our government may default on it’s debt’ really fast. Things like hyperinflation or a massive dollar devaluation (both basically the same thing) follow. We are not that different from Greece.