I hadn’t decided whether to bring “the design of government” to health care reform, but at the request of Anna D. (“Thanks, Anna!”) and having seen this WaPo article on Dr. Avarice J. Greed, M.D., P.C., and his confreres, and having received a long email from my sister, a retired nurse (see below), I think I’ll give it a shot.

Over the next few posts, I’ll comment on several issues:

1. Supply. The AMA (American Medical Association) closed half the medical schools in America about the turn of the last century. And, ever heard of “barefoot doctors”?

2. Demand. How much of obesity is due to low incomes? The Danes have a saying, “You have to be rich to be thin.” Would encouraging unions reduce obesity more than education? The GINI Index again.

3. System inefficiencies. Two flavors: Opportunities for information sharing and insurance company profits.

4. Medical mal-avarice. See below for starters.

My sister was first in her class in nursing school, and is now retired and raising show quality dogs. So she’s experienced hospital pricing from the inside and vet pricing from the outside. Her observations:

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I never had a job in any “company.” Obviously hospitals try to make money, and particularly in Union [SC] they invited the head RN’s to the top staff meetings. Such things as the base room rate being as low as possible-around $105 a day at that time — 1990 — because they said people call around if a procedure is non-emergency, and what they ask is the base rate. So then you just add higher prices for everything else, and I do mean everything.

At that time, a bag of IV fluid cost the hospital $1.00, we charged the patient $10.00. A foley catheter cost us $5.00, the patient paid $57.00. But then of course, they added for 1-1 RN care, etc.

Same basic thing at my previous job in Psych at MUSC, [Medical University of South Carolina, in Charleston] the base room rate was low, but they had at least 5 therapies for each patient, and I mean the group ones like physical therapy, music therapy, this isn’t counting the medical student seeing the patient, the intern, the resident, the MD, the staffing, etc, etc.

But what got me the most was in Union. I worked there about the time Office Max and that type of store opened. Of course they sent catalogs to everyone. I knew the prices we paid in Central Supply for packs of 3 x 5 cards, pens, all sorts of stuff, and of course there are hundreds if not thousands of those things. Some of the prices that hospital paid for office supplies were 10X what Office Max charged. So I went to the head of that department with the catalog in hand, marked, but he said they liked to order everything from one supplier, so paid whatever that supplier charged.

The darn vets are the same now. If I buy a bag of IV fluids from my vets, it is $35.00. They are exactly, and I mean brand, label, everything, the same as we used in Union, and every other job I have had. IV fluids are considered a prescription drug, whereas the tubing and the needles are not. I can get the identical fluids for $3.99 a bag from KV vet but the Vet has to call or fax the prescription in. They do allow for the vet to tell them what you can have in a year, and you can order it however you want. Of course the shipping is fairly high, so I order maybe 12 at a time, which that lasts me usually a year. And I can buy if from a site that is supposed to be for vets, but I have a password, every breeder I know uses it, for $4.99. The same stuff, Propofol, that Michael Jackson used IV, it is on that site.

The lady that is the financial head of my Vets’ 2 offices, told me the same identical thing, they want to order everything from one place. I have a catalog that the medicine for preventing the dog version of Alzheimer’s, called Old Dog Encephalitis, Selegiline, 5 mg twice a day, costs $5.99 for 500 tablets. The first time I had Huey, Andrew’s father, to the vet for confusion, maybe 2 years ago, the vet told me she had read it helped, but had offered it to 3 clients, but the $200 a month caused them not to get it. I had her write down the name and dose, (just so I could remember it) — the dose is the same for people – and when I went to Wal-Mart it was $46.00; I called Pet Care RX, it was $26.00. Then I saw it in a catalog for vets for $5.99 for a huge size. I can order anything from that catalog except for prescriptions. I got a box the size that a pair of high top sneakers would be shipped in, absolutely stuffed with IV tubings, for $4.99 the other day, 100 of them.

Would it not pay a hospital or a busy vets’ office, really 2 offices with 7 vets, one full time person’s pay to check prices and order things from different suppliers? In IV fluids alone they could pay that person a week’s salary a month. They even order packages of sweetener and sugar and instant coffee from the same place!

 How do things like this fit into the direction of having a great company? And of course I only see a few things!

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And all I’ll add is that (a) if you can pass on all your costs to the patients (customers) AND add a percentage for profit, who cares what things cost? And that (b) when your customers or patients have no idea of your costs, you can charge them whatever you like!

When I worked for DOD, back in the 1960’s, we had both “cost-plus contracts” and “contractor-furnished lunches.” I loved CFLs – can you guess who paid? It was you, the American taxpayer!

Both are now outlawed in DOD – now how about health care? Duh!

Do you think that our current economic mess is more like the age of the Robber Barons of the late 1800s, the Great Depression of 1929, or the nuclear power plant accident at Three Mile Island on March 28th, 1979?

Regardless of YOUR opinion, don’t you think that the government’s response(s) to the crisis should be based on thorough analysis? The best theories available? Diagnosis before prescription?

I. Let’s look first at the oligopoly thesis.

The theory here is that market concentration often generates behavior that’s at odds with the general welfare. Does the name OPEC ring a bell? Worldwide, the four firm concentration ratio defines “oligopoly” as existing when four firms have more than 60% of their market. The Big Four banks in America are the Bank of America, JP Morgan Chase, Citigroup, and Wells Fargo. Does anyone know of any other banks? Of course, the big investment banks like Goldman, Sachs have had their rivals, like Bear, Stearns just “disappeared” by the Federal government. Can it be long before there’s just one brokerage, following the path shown by Morgan Stanley Smith Barney?

In the olden days, the Federal Justice Department had an Anti-Trust Division that was charged with policing anti-competitive behavior, and indeed breaking up firms with undue market concentration. That was long ago, before economic theory (especially the Chicago School) bowed to industry practice. The ideological shift happened between the 1982 breakup of AT&T and the 1999 settlement allowing Microsoft to continue as one firm.

It would appear obvious on its face that the salaries and bonuses paid on Wall Street demonstrate oligopolistic profits. The “value-added” simply isn’t there. In 1979 Ezra Vogel published his book “Japan as Number One: Lessons for America” which notes that at that time Japanese CEOs took home salaries only ten times those of their shop floor workers. Can you imagine?

An argument can be made that the societal concern about the increasing concentration of Wall Street’s financial institutions is not their unwarranted profits, but the systemic risk associated with having so few firms. That is, if we had more firms, we could allow a few to fail without inviting disaster. This in turn could reduce the moral hazard associated with the Federal government backstopping them.

So, if you believe that today’s problems are due at least in part to oligopolistic behavior or its associated risks, you might recommend breaking up the large (and growing larger) financial institutions on Wall Street.

II. A Reprise of the Great Depression?

If upon reviewing the history of the years after the Great Depression, in which the business cycles were substantially dampened, you might (A) associate those successes with the government policies responsible, and (B) wish those policies to be continued in the future. Most economists DO associate the dampened business cycles with government policies.

Sadly, much of the Federal government’s economic policy was degraded over time, due perhaps to people saying “Look, we haven’t had more economic crises, so we don’t need those policies!” Doesn’t there seem to be a logical fallacy in there somewhere?

A good start towards reimposing controls on the markets would be to reinstate the Glass-Stegall Act and reinstitute serious margin requirements, among other actions. After all, “If you want to keep the economy between the ditches, you may have to impose some speed limits.” Been there, done that. Worked for three generations.

III. Or Is Wall Street really like Three Mile Island?

Wikipedia has a good account of the Three Mile Island (TMI) accident. In part, it states:

“The Three Mile Island accident of 1979 was a partial core meltdown in Unit 2 of the Three Mile Island Nuclear Generating Station in Pennsylvania. It was the most significant accident in the history of the American commercial nuclear power generating industry.
“The accident began on March 28, 1979, with failures in the non-nuclear secondary system, followed by a stuck-open pilot-operated relief valve (PORV) in the primary system, which allowed large amounts of reactor coolant to escape. The mechanical failures were compounded by the initial failure of plant operators to recognize the situation as a loss of coolant accident due to inadequate training and ambiguous control room indicators.
“The scope and complexity of the accident became clear over the course of five days, as various officials tried to understand the problem, communicate the situation to the press and local community, decide whether the accident required an emergency evacuation, and ultimately end the crisis.
“In the end, the reactor was brought under control, although full details of the accident were not discovered until much later, following extensive investigations by both a presidential commission and the NRC. The accident was followed by essentially a complete cessation of the start of new nuclear plant construction in the US.” [as abbreviated]

In fact, the “scope and complexity” were not so clear. Charles Perrow, now an emeritus professor at Yale, spent years researching the TMI accident, and created a theory about highly complex and interrelated entities or systems.

His book, Normal Accidents, was published five years after TMI. His conclusion was that if a system’s components are both highly complex and tightly interrelated, failure is inevitable. That is, a system’s structure and design determine whether it will (not whether it may!) fail.

Most recently, Perrow wrote an Op-Ed for the Washington Post about the system failures involved in the fatal Metro crash in June, 2009.

Perrow has also contributed to the study (and theory!) of High Reliability Organizations (or HROs). HROs have both a wikipedia entry and a website.

HROs have things in common, per the Wikipedia entry: “There are 5 characteristics of High Reliability Organizations that have been identified as responsible for the “mindfulness” that keeps them working well when facing unexpected situations:
– Preoccupation with failure
– Reluctance to simplify interpretations
– Sensitivity to operations
– Commitment to resilience
– Deference to expertise

Does “mindfulness” sound like Wall Street to you? Not to me! And what’s sauce for stand-alone organizations must be sauce for tightly coupled groups of organizations – as in a 21st century financial system, with information and money sloshing around at the speed of light!

So if the structure and design of the financial system will determine whether it will (not whether it may!) fail, and if failures of the financial system cause major societal crises, then either (A) those in the financial system must show the rest of us that their system is a highly reliable system, or (B) the government must assure that the financial system is so designed and operated.

We now have the government involved in redesigning the financial system and its controls. What troubles me is that there has been NO discussion of the theory and practice of designing High Reliability Organizations in the public discourse, and I’m not convinced that it’s being discussed in private either!

So as far as the design of the Federal government’s response to the financial crisis is concerned, what we’re seeing is not transparency as promised, but “translucency.” Translucent means “permitting light to pass through but diffusing it so that persons, objects, etc., on the opposite side are not clearly visible.”

And given the influence of Wall Street veterans in the governmental design process, I’m worried that not only are ‘persons and objects not clearly visible,’ but that they’re really ‘on the opposite side’ – from the rest of us.

(I am indebted to The Teaching Company and Michael Roberto’s magnificent course, The Art of Critical Decision Making for introducing me to Charles Perrow and High Reliability Organizations)

From the first posting on this blog, excerpted from a paper I wrote in 1977:

“An example closer to home was the surprising preference of the local powers in some unreconstructed rural Southern counties for the food stamp program over the old commodities distribution program. Most people in the North thought the food stamps far more liberal and humane.

In 1968, while travelling in upstate Louisiana for the Office of Economic Opportunity, I found out that the food stamp program (a) enriched the local storekeepers, (b) permitted both the hiring of white clerks and the firing of Black warehousemen, and (c) was driving the poorest of the poor out of the state. They could not afford the minimum cost of the food stamps, and their source of commodities was shut off.

I dare say that few of these consequences were uppermost in the minds of the major sponsors of the food stamp legislation.”

If Wall Street is going to run the economy into the ditch every once in a while, then government is going to have to impose speed limits or hire some more cops. The Administration’s plan is to hire more cops. I’m for more speed limits.
Even Alan Greenspan is in “a state of shocked disbelief” at the consequences of “the self-interest of lending institutions.”  So once again the debate is about the speed limits and the cops. We’re not hearing so much about the glories of the open road.

There are both theoretical and practical problems with just hiring some cops. There are several practical problems.  Some of the cops just hang around fruit stands eating the apples (see: Bernie Madoff and the SEC). Sometimes the word from headquarters is to spend more time polishing the patrol cars (see: Christopher Cox and the SEC). And sometimes budget cutbacks reduce the cops to invisibility (see: CPSC and Chinese toys).
The theoretical problems are far more serious. They stem from Ashby’s Law of Requisite Variety, a fundamental proposition in cybernetics and systems theory. Ashby’s law states that “only variety can absorb variety.” More simply stated, three basketball players will never be able to outscore five players. Just ain’t gonna happen.

Regulations and regulatory agencies are the cops in this story, and Ashby’s Law applies in both (1) space and (2) time. First, there are a lot more folks on Wall Street (read: the financial sector writ large) than regulators, and ‘twill be ever thus. The regulators can’t be everywhere.

Second, regulation as a ‘tool of government’ is effective only until the regulated evolve enough to evade the regulations. This happens quickly. In today’s world of instant information, we’ve even seen the financial markets evolve ahead of our imaginations. So today’s regulations can never prevent tomorrow’s problems. A recent Tom Toles’ cartoon captures this well.

This would be true even if we truly understood either (a) the financial system or (b) the governments’ interactions with it. Only a certified system dynamics simulation model would show we understand the financial system itself. And even though the Clinger-Cohen Act of 1996 mandated enterprise architecture for federal programs, there’s been no attempt to apply this form of systems analysis to the many and varied governmental agencies, taken together, that touch the financial system.

So that leaves “speed limits,” defined as any controls built into the system that don’t require cops (regulators) for enforcement.

All the attention has been on “executive pay caps” and whether these will destroy the motivation of the Masters of the Universe, and on and on. This is a wrong-headed approach.

Back to the highway analogy. Imposing executive pay caps is like putting a governor on a rental car driven by a teenager. It’s not his car, and he’s still out looking for thrills.

We need to have bankers act like a new father out driving with his baby daughter in a car seat in the back. We need them to have some ‘skin in the game.’ We need them to retain substantial personal liability so they act (drive) more cautiously. We need to add some fear; reducing greed alone won’t cut it.

Joe Nocera’s entrancing New York Times Magazine article, “Mismanaging Risk,” goes on for 7500 words about investors’ risks and firms’ risks but never imagines that risk might apply to the people running the firms.

Corporations are creations of governmental laws and regulations. So are partnerships, limited liability companies , and limited liability limited partnerships. It would not take “rocket surgery” to create and mandate a form of entity for firms capable of causing “systemic risk” that would retain personal liability for managers whose actions could put either their firms or the economy at risk.

Median annual household income in America was $50,223 in 2007. I think someone gunning for one hundred times that should be willing to put his Manhattan apartment, his house in the Hamptons, and both yachts at risk until he’s been out of the game for, say, ten (10) years.

Give me my choice of three Harvard professors, throw in one from MIT, and I’ll have a solid draft for you in a weekend.

Letter to the Washington Post:

Max Stier (June 8th: “The Flow-Chart Fallacy”) is half right. We don’t need to reorganize and layer the regulatory communities around food safety and the financial system. We’ve had our Katrina on Wall Street. Building a bigger financial regulatory structure won’t prevent another dangerous recession, just as creating the Department of Homeland Security certainly didn’t help with hurricane recovery.

But improving the leadership of the regulatory community won’t help if a future Administration’s policy is to turn a blind eye to abuses, or if agency budgets are continually reduced. And useful measurement tools won’t correct the fundamental flaw of regulation: Regulations are great for controlling old problems, but they seldom if ever prevent new problems from emerging or control them when they do.

We need some fundamental changes to “the way the game is played” in capitalism, akin to those that restrained monopolies a century ago. Surely the maintaining the health of the financial system today is at least as important as restraining Standard Oil was then.

I have two suggestions for starters. First, I would limit the market share of any bank, hedge fund, etc., so that individual failures would not threaten the overall system. We’ve had banks get bigger, not smaller, since last year. And of course I’d reinstate Glass-Steagall (1933) in a Wall Street minute!

Second, I would mandate that large financial entities be licensed and managed as “limited liability partnerships” rather than corporations. (A hybrid form to include shareholders is not beyond the imagination of policy-makers and law school professors.)

Such an entity would require that the senior staff, those making more than, say, $1 million per year in salary and bonus combined, would be personally liable for any losses and any damages and remain so for a period of perhaps ten years after leaving the firm.

Rather than fight a losing battle over executive pay caps, I’d like to see the Masters of the Universe have some “skin in the game.” A lot of skin.

One of my father’s favorite stories – meant to instruct as well as entertain – was about the Irish lord interviewing candidates for coach driver. He asked each, “And if the English were coming, and you had my family in the coach and had to hurry down the mountain, how close to the edge of the road would you drive?”

The first man said he’d drive as close as a yard to the drop-off below. The second man, wanting the job, said he’d drive to within a foot. The third man said, “Sure, and I’d be drivin’ as close to the mountain side of the road as I could, yr Lordship!”

The third man got the job.

This came to mind yesterday when listening to Marketplace on NPR. Tess Vigeland said, “Three hundred and forty-five thousand people lost their jobs last month. Now the pace of layoffs is slowing, but the Labor Department reports the unemployment rate now stands at 9.4 percent. Want to hear the scary part? Well remember those bank stress tests? The unemployment rate used in their so-called “Worst Case Scenario” was a mere 8.9 percent. Oops.”

That raised a flag for me, because for months unemployment has been predicted to rise to over 10 percent in 2009.

Then I read a story on Bloomberg News, Bank Profits From Accounting Rules Masking Looming Loan Losses, that included the following:

“Treasury Secretary Timothy Geithner, after “stress testing” 19 banks on their ability to withstand a worsening economy, declared in early May that Americans can be confident in the banks’ stability and resilience. Wells Fargo & Co. and Morgan Stanley were among banks raising $43 billion in new capital since then through share sales…

“… Janet Tavakoli, president of Tavakoli Structured Finance Inc. in Chicago, says the government stress scenarios underestimate how bad the economy may get…

“The Federal Reserve, which designed the stress tests, used a 21 percent to 28 percent loss rate for subprime mortgages as a worst-case assumption. Already, almost 40 percent of such loans are 30 days or more overdue, according to Tavakoli, who is the author of three primers on structured debt. Defaults might reach 55 percent, she predicts.”

The last “stress test” that I had involved a treadmill and a lot of heavy breathing. I was wired up with a heart monitor and under the close supervision of several folks in white coats.

It’s beginning to look like the “stress tests” those nineteen banks passed were more like a walk in the park!

How can the government claim it’s measured something – say the safety of banks – if the yardstick isn’t both (a) clearly marked and (b) open to inspection?

Almost as troubling but more obscure are some of the rules of the (banking) game that the Feds have changed recently. I remember the discussion of “mark-to-market,” but some are far more arcane. The Bloomberg article includes this:

“Along with that change [mark-to-market], FASB also let companies recognize losses on the value of some debt securities on their balance sheets without counting the writedowns against earnings. If banks plan to hold the debt until maturity, they can avoid hurting the bottom line.

“Another $2.7 billion before taxes came from an accounting rule that lets a company record income when the value of its own debt falls. That reflects the possibility a company could buy back bonds at a discount, generating a profit. In reality, when a bank can’t fund such a transaction, the gain is an accounting quirk, Weiss says.”

Such rules raise two ‘governance’ issues. First, and foremost, what are the possible unintended consequences of hurried rulemaking? Second, what is the likelihood that such rules, of obvious benefit to the industry, will ever be rescinded?

Aren’t we getting closer and closer to the edge of the mountain?