Wednesday, October 31, 2012

After The Storm.

After the devastation, the markets gave its best shot in a difficult situation. So far it is following the path written. If you remember, we expected the indices to move up and down this week and make a messy bottom. So far SPX has corrected only about 5% from its top but the downturn has persisted for over 40 days now. This in itself is something of a rarity. I see close similarity between now and last April.

And my call for a test of the high is consistent with that topping pattern.  Already some positive divergences are appearing.  Tradersu has forwarded the following link.

However, it would be good to remember that this rebound is going to be short term in nature and unless we see 1480 taken out with conviction and SPX stays above that range for a while, I would consider that as a part of topping process.

For the near term, I would like to share a chart of Presidential Election cycle sent by Tom McClellan.

Again, this chart fits perfectly with my cycle and call. I think Apple is bottoming short term and will test the 50 DMA in the coming days. Gold and silver made some progress from the base. All in all, I am of the opinion that a base of some sort is being built for the next stage of the rally. But for that, we may have to wait till next week.

I hope all you readers are safe and secure. Our good wishes to those who have been badly affected by this storm. At least it gave us respite from the 24 hour politics.

Thanks for sharing my thoughts. Hope you are in cash and cushy and ready for the opportunities ahead of us. 

Good and bad local news

Revealing bits of good and bad local news from the Chicago Tribune: Food trucks and congestion pricing.

Our city council is (finally) allowing Chicagoans to have food trucks. Sort of. They're restricted to special food truck areas, and have to follow a host of regulations, including gps trackers to make sure they don't spend more than two hours in one place.
One of the rejected locations is on Broadway south of Wellington Avenue. The East Lakeview Chamber of Commerce opposed it, saying the location would allow food truck vendors with lower overhead costs to unfairly compete with 20 restaurants that each spend at least $150,000 a year to maintain their storefronts. As a result, that location was removed, said Ald. Tom Tunney, 44th. 

.... "The businesses just don't feel that this is the right thing to do for them when they are trying to make a dime," Maureen Martino, executive director of the East Lakeview Chamber, told members of the License and Consumer Protection Committee..... she added. "And there is really not a need for more food."
Ah yes, as we all know, the purpose of regulation is to stifle competition, to keep prices up so that existing businesses can "make a dime." And I'm delighted that the Chamber can instruct the city council on the "need" for food.

In the good news category, Chicago may finally get congestion pricing on our freeways. This is, of course, an insanely good idea, that has only been sitting in introductory economics textbooks for 30 years or so.
The idea is being floated by the Chicago Metropolitan Agency for Planning as a way to pay for, and make the best use of, new lanes on six major Chicago-area roadways. These lanes would be "congestion-priced" in such a way as to assure that traffic would always flow at the posted speed limit of 55 mph.
Wait, you're kidding. We're not going to reserve them for carpools or electric cars like California does? Where is this sudden bout of sanity coming from?
Skeptics will see this as an excuse to gouge motorists who are already saddled with high gasoline prices, heavy fuel taxes and toll charges. Actually, one attraction of the idea is that if you would rather save the money, you'd have as many lanes available as you do now. Only the people who put a higher priority on their time would have to pay.
As nice a description of "Pareto Improvement" as I have seen in a newspaper. Yes, you and I might say "let's congestion-charge the whole thing, and tomorrow." But perhaps bundling it with new lanes and marketing it this way will get past the usual objections by people like, say, the City council (see above) and chamber of commerce. The cost is, of course, many more years of delay until the new lanes get built.
If you're worried about being gouged, it's reassuring to hear that the extra cost of a faster journey would not be prohibitive – $2.76 per trip on the Stevenson and $3.41 on the Eisenhower. Studies of congestion-priced lanes in other cities indicate that even low-income drivers find them worth the cost when time is short.

It's lovely to see a newspaper use the sensible words "priority on their time" rather than the senseless "can afford it" and an attack on "special lanes for the 1%, " and even document that view as in the last sentence.

I wish they had pointed out that the major substitution is simply time: To save money you simply schedule your trip off rush hour.

A minor complaint. We all know enough about economic modeling that $2.76 per trip is an impossibly precise estimate. I can't imagine that traffic engineers know elasticities with two orders of magnitude more precision than economists to.

The bright side, and my only original two cents in this post: The uncertainty is win-win.  One of two things will happen with congestion pricing. People might be willing to pay astounding amounts of money to get to O'hare at 9 am Monday morning, so the costs skyrocket to $10 or $20. Great.   Our city, state, and federal governments are broke. Congestion taxes are as non-distorting as they get. Or, people turn out not to be willing to pay much, and voluntarily reschedule or reroute to stay off busy roads. Great, we voluntarily eliminate congestion. We can't lose.

Tuesday, October 30, 2012

Sandy is a Negative

Don't believe the argument that natural disasters fuel economic growth.  That argument is only true if what is being destroyed is something that should have been demolished in the first place.  Otherwise, things like "Sandy" should be viewed as a net wealth loss.  So, who steps up to make up for the wealth loss....the government?

Governments at all level are broke.  Sandy will only exacerbate the problems of state and local governments and everyone knows the federal deficit is on a path to disaster.  So, there is no silver lining here.

The loss is not confined to destruction.  Shutting down New York City and much of the East Coast for two days is not going to be completely made up later.  Some substantial loss is inevitable from the shutdown.

Sandy is a reminder that bad things can happen randomly. It is also a reminder of why people and governments should save for a rainy day.  Sometimes it rains.

Sunday, October 28, 2012

Nassim Taleb on Antifragility at Princeton


Nassim Taleb discusses the concept of Antifragility at Princeton. 

If you want to understand the long-term consequences of market interventions and other attempts to delay or remove stressors from real-world systems, watch this video. 

Taleb also makes clear that we are at an unprecedented point in history, in which those in power benefit on the upside while having no real risk (no "skin in the game") on the downside. In other words, our supposed "leaders" hold their positions and accrue benefits from them without having to display courage or face the consequences of their actions and decisions.

You can hear more from Taleb on this topic in an excellent econtalk interview from earlier this year. 

His new book, Antifragile: Things That Gain from Disorder is available on Amazon.   

Saturday, October 27, 2012

Messing Up With The Brain.

That’s what the market is doing with bulls and bears. The bottom is in sight but it is going to be a messy short term bottom. I would not be surprised at all to see the markets up one day down the next for the whole of next week.

So far the important support level has held but it is still too early to do bottom fishing. As I had mentioned in my email, till cash SPX closes above 1420 in a convincing manner, there is no reason to go long for even one day. Even after that, if you want to go long, I would recommend that you weigh all the benefits against risks.  Most likely we will see a retest of the earlier high and may even have a higher high but just. I would think that the risk is more to the downside, both fundamentally and otherwise.  We have been here before.

(H/T: Lance Roberts)

I do not normally believe in analogs. Analogs are fun while it works but we cannot make investment decisions based on analogs. But there are other factors like money flow through the banking system, the coming fiscal cliff and even cycles indicate that there are dangers ahead.

One of the respected chart analysts, Peter L Brandt has this chart to show:

The caveat is that this theory is invalid if SPX closes above 1480.

By Mid-November, I expect SPX to push above 1470 but whether it will stay above is the million dollar question.

We will take it one day at a time but now is not the time to be cute or smart. The topping process is on and even if the mid-November top comes by end November, it does not change anything.

That’s all I have for this rainy weekend. For those of you living in the path of the storm, hope you are well prepared. If we have to err, better be on the side of caution, be it a storm or stock market. Stay safe friends.

NBER Asset Pricing conference

I spent Friday at the NBER Asset Pricing conference in Palo Alto. All the papers were really good, and the discussions were especially thoughtful. Here are a few highlights that blog readers might like.

There's no better way to wake up than with a good puzzle. Emanuel Moench presented his paper with David Lucca,The Pre-FOMC Announcement Drift.(If these links don't work for you, most papers can be found with google.)

Here are average cumulative returns on the S&P 500 in the day preceding scheduled FOMC announcements (when the Fed says what it will do with interest rates). The grey shaded areas are 2 standard error confidence intervals. The S&P500 drifts up half a percent in the day before FOMC announcements!  In fact, 80% of the total return on the S&P500 over this period was  earned on these days.

So what the heck is this? Obviously, there was some disssection that it is spurious. Stocks are so volatile that it's easy to find 3 days that account for 80% of its total return, let alone a few hundred. But they did not fish.

I am still a little worried -- there are two big positive outliers in the distribution of returns (Figure 2) and a missing left tail. If we had two more such outliers on the negative side, would those confidence intervals get bigger? Did options markets know that the left tail is missing?  The pattern is there for international stocks before US announcements, but not in bond markets. But Annette Vissing-Jorgenson, setting the style for the day, dissected it every which way and didn't get rid of it, so discussion moved on.

It's not volatility (higher volatility might generate a higher mean return) -- realized volatility is lower in these periods than other periods. And volume is lower too -- see at left.

This observation generated what I'll call the consensus of the room: Lots of equity traders sit out or hedge their positions in advance of this day. (Confirmed by people in the room who talk to such traders.) Anyone trading on the morning before an FOMC announcement is suspected of being "informed," which makes markets less liquid. So the risk is concentrated and held by a narrower group.

Emanuel answered that they did regressions including these and all sorts of liquidity measures, which didn't get rid of the puzzle. But when you do that, you assess how much expected return premium corresponds to illiquidity by the correlation of returns with liquidity on other days, and there are all sorts of reasons to think this measurement underestimates the effect. Anyway, as a fan of facts linking trading to pricing, it's a great paper. (And a good hint to PhD students: make sexy graphs like these.)

Annette also brought up the issue, should journals publish papers that just pose well-documented puzzles, without offering (usually lame -- my view) theory or explanation? I think this paper makes a hearty case for "yes!"

Xiaoji Lin presented his paper with Jack Favilukis Wage Rigidity: A Solution to Several Asset Pricing Puzzles. How can I make a general equilibrium model with adjustment costs and wage rigidity sexy for a blog?

Well, this one is. "Standard" real-business cycle models drive the economy with productivity shocks. When there is a good such shock, investment and output go up, and people work harder. But, the marginal product of labor goes up (that's why they work harder), so wages go up. Since wages go up, profits don't go up that much, and equity isn't that risky. By putting sticky wages in the model, now wages are like a bond payment, so the firms profits are leveraged, making them more risky. This helps to fit a broad range of asset pricing facts. I'm especially impressed that the model generates a spread of value vs. growth firms (hard to do) and a value premium.

The impulse-responses at left show the basic idea. You're looking at responses to technology shocks (growth in technology follows an AR(1), so there is some technology momentum.) You see wages rising quickly in the "standard" model to match the higher productivity. You see profits much more affected in the middle when wages can't adjust.

Lots of discussion here. Of course "stickiness" is an abstraction for all the interesting things that labor/macro people put in their models. One good comment, wages are not "smoothed," they're "screwed" -- workers don't get the present value of the  marginal product increase (or feel it if a decrease) as they might under an intertemporal smoothing contract. That likely has a big effect on the value of stocks.

The last one I'll mention (they were all great, just running out of steam here) Erkko Etula and Tyler Muir presented their paper with Tobias Adrian on "Financial Intermediaries and the Cross Section of Asset Returns"

They construct shocks to broker-dealer leverage from the flow of funds, and then construct a single-factor asset pricing model, expected excess return = beta on broker-dealer leverage shocks times lambda. Here it prices the  size and value portfolios, momentum portfolios, and bond portfolios! All with a single, economically motivated factor!

 Much discussion (of course). One possibility, which I called the "AQR theory of asset pricing." Suppose you look at the portfolio of one trader, who is invested in value, momentum, small, and term risk. The the wealth, and (if borrowing is pretty constant) leverage of that agent will be a good pricing factor for those anomalies.  So just because leverage works well does not necessarily prove the usual causal story, that these broker-dealers are "marginal," they get in to trouble sometimes and then start selling securities in "fire sales," etc.  If they sell, after all, someone else must buy, so they're "marginal" too. Much good discussion on the facts too, with great graphs by Bryan Kelly showing that it is a bit unstable over different samples.

Lubos Pastor presented his paper with Pietro Veronesi "Political Uncertainty and Risk Premia" with a great discussion by Nick Bloom showing us the latest of his uncertainty index. Welcome to the Krugman-thinks-you're-a-moron club, Nick.

Snehal Banerjee presented his paper with Jeremy Graveline, "Trading in Derivatives When the Underlying is Scarce", really interesting (especially to me, given writing on the 3 com / palm issue) with Nicolae Garleanu discussing.

 Chris Polk, presented his paper Dong Lou "Comomentum: Inferring Arbitrage Capital from Return Correlations" with a great discussion by Robert Novy-Marx. They find that momentum works when the pairwise correlations of momentum stocks are low, indicating the trade is "less crowded," and conversely.

All cool stuff, but but the plane is landing. (Thanks to glamorous Southwest airlines for onboard wifi.)

Thursday, October 25, 2012

Apple Fell From Tree.

Story of the night is the earning miss by Apple. And the cherry on the top is the disappointing results by Amazon. SPX futures (/ES) again tested 1400 after hours and Nasdaq futures (/NQ) tested 2600. Both bounced back from the lows but we have to wait and see the action overnight.

Trading of Apple shares were halted in the after-market when it traded below $600. But the market was not expecting anything great from these two, if I have got the pulse correctly. Right at the point of writing this post Apple was trading at $ 607. There was no dumping as such.

I wrote in the past that once Apple closed below $640, it had more to fall. I think we will not see a trade-able bottom for Apple before the end of the year. This is consistent with my view of the general market. For now, despite the disappointing results, it is poised for a bounce soon. So are the futures.

Today the markets messed up with both the bulls and bears and end of the day both group were confused as hell. The short term cycles are all mixed up and it is going to be a messy bottom in a day or two.  

These days I look at 4 hour chart to get a little bigger picture. The 4 hour chart of /ES is showing 4/5 touches around 1400 level and bounce from there. Obviously this is an important support. As time passes and bears are unable to convincingly break this support, it becomes stronger. Having said that, market always surprises and inflicts maximum pain on maximum number of people. If folks did buy more puts of Apple, we can be sure that Apple will close higher. As per option pain calculator, November Max.pain for Apple is $ 635, which is higher than where it is now. Go figure.

I still think a short term bottom is around the corner. Let us see what the overnight actions and tomorrow bring. And I am still waiting to see whether Nat.Gas gives the sell signal. Today it broke below $3.40 but closed above that line. If there is no sell signal in a day or two, then it will be time to pile on to Nat.Gas.

Sentiments have turned south for gold and silver. Today one newsletter writer bailed out of gold and that may be a good contrarian indicator. My take is that we will see a re-test of the last high by mid-November and if the re-test fails, then we bail out and re-enter by end of the year.

That’s all for tonight. I made some changes in the Ad program. Now we only have Amazon link at the top and no other Ads except the in-line text ads. Hope you will remember the blog if and when you use Amazon.

Thanks for sharing my thoughts. Patience is required for few more days.

Wednesday, October 24, 2012

"Are We There Yet" Redux.

There were some questions from readers about the stock market performance vis-à-vis Presidential elections cycle. The theory goes that price movement in stock market predicts the winner. Logically the incumbent wants to spread the feeling of well being before the voting and “O” has done his best to goose up the stock market with endless liquidity flow. And barring the 50-60 point sell, we are actually closer to the top end of the range. And yet every drop in market is cheered and end of the world is eagerly anticipated. We never believed in this rally (including me) and many have stayed away from the melt up from June. But someone made money and I bet that someone belongs to the Boyz club. With this month long chopping and grinding down, sentiments are bearish. But if the COT EuroDollar chart as shown yesterday is any indication, we should follow the money flow of the TBTF banks.

Today Stock Trader’s Almanac had this chart:

It compares two past Presidential election when the challenger defeated the incumbent. I do not care much about who wins but what I wanted to point out from the chart is that in both cases the market has gone up from this point.

Is it any wonder that cycles are calling for a rally soon?

Today /ES (SPX Futures) tested the 1400 line twice during the day and so far it held. The 1st rebound from here, if it comes tomorrow will fail. And at that point we have to see whether it makes a higher low and whether there is a positive divergence in RSI. I think we will again test this level in a day or two. By that time we will be in the last week of October.

Gold tested 1700 level and held so far. Same with Nat.Gas. It did not go below $ 3.40. If it does not break through $3.40 in a day or two, I will anyway take a long position with  Nat.Gas. The COT positions are bullish.

Although I plan to take a long trade by end of October, I am hesitant to long equities. I think it may be a good idea to Short VIX. Again this would be a trade for 15 days or so and not an investment. I think we will get a decent correction after mid-November, not an itsy-bitsy 50-60 points correction which is about to reverse any-time now.

So we wait for another day and in the mean time day traders pile up on short trade only to be squeezed. Thanks for sharing my thoughts. Remember, cash is also a position.

The Fiscal Cliff

The President, in the third and final debate with Governor Romney, said that sequestration was "not going to happen."  Wonder what he knows that we don't?  In any event, it has already happened in some sense.  The expectation of increased tax rates and of sequestration are already playing into the economy.

Business folks don't wait until January to make decisions.  They are making them now.  Business has ground to a halt in the US, excepting a spurt in housing and the buoyant energy sector.  The combined impact of Dodd-Frank, of Obamacare, of the expiration of the Bush tax cuts, and of the coming sequestration are enough to scare any self-respecting entrepreneur about America's future.

We are already careening down the fiscal cliff. 

The question is, if the President loses his re-election bid, can we climb back out of the abyss.  That depends upon what a President Romney would prioritize.   In the short run, the economy needs the government to step back.   Rolling back some of the draconian measures at the EPA would be a start.  Giving the green light to the Keystone project would be a dramatic symbolic gesture that would also create a lot of high paying jobs almost immediately.

But, to get real prosperity, we will need real tax reform that lowers marginal rates, the repeal or gutting of Obamacare and the repeal or gutting of Dodd-Frank.  Absent these items, the economy is not likely to ever be what it once was.

We've been going through one of the most anti-free market periods in American history (there have been others).  Do Americans still believe in free markets?  Does Romney?

Even a Romney presidency may not reverse the tide against free markets, but who knows?  We can and should hope for the best.

Tuesday, October 23, 2012

Demise Of Financial Bloggers?

Josh Brown ran an article today as to why financial bloggers have gone down in numbers. I found it quite funny and could not resist quoting it here:

“There seem to be fewer regularly-updated, high quality financial blogs these days. Many have simply disappeared or have gone inactive. And very few new ones of note have come along to replace them.
But why?”

 Then he goes on to give some theories:

Many bloggers have simply been so completely dead wrong about the post-crisis period we've been in (Hyperinflation! Depression! Social Unrest! Hoard Water and Dry Goods!) that they simply have no audience left. Keep in mind that many of the 2008-2010 generation of bloggers were misanthropes who had been rooting for a collapse all along. They came out of the woodwork and began blogging motivated by a mixture of I-Told-You-So schadenfreude and the desire to predict the next crisis, which was obviously an imminent thing. Only it didn't happen (I know, I know, any day now). And having blown all of their personal credibility on failed Cassandra-ism, having recognized what a horrendous disservice they've done to those who've heeded them, they've simply moved on. Many went to Twitter instead where there is a less permanent record of their bullshit.

But the biggest rant blog is still going strong.
That brings me to my post. The collapse of USA is not yet imminent. And come to think of it, so far it is just a 50 point correction in SPX. But already folks are behaving as if the end is near. And when the real stuff comes up, there would not be many to take advantage of it.

We all know the fundamentals sucks and earnings are crappy. And retail has started buying puts like never before. It happens without fail. Retail will sell at the bottom and buy at the top. The equity put/call volume ratio across all 10 options exchanges ended at 1.05, with roughly 7.46 million calls and 7.86 million puts traded.

My 2 cent contrarian thinking:
VIX closed outside its BB today , 1st time after April 2012.

And SPX closed 2 Standard Deviation below mean, outside BB.

If we see a green day tomorrow, it might be considered as a VIX buy set up.

I do not expect a rally from tomorrow; rather I expect a sideways movement from here till end of the month.
One of the things I follow with interest (apart from my cycles) is the COT Eurodollar indicator as shown by Tom McClellan. He has some complex formula whereby he moves the whole thing ahead by 12 months. I do not understand how it works, except it gives a clue to what the Banksters are thinking and where the money is going. Few days back,the following chart was shared in SHJ’s blog by one of his readers.

So the Boyz have planned all the ups and downs all along!

What I like most about this chart is that it matches with my cycle analysis. It also agrees with the Bradley dates. So we may have to wait a bit more for the Armageddon. Don’t buy the dry foods yet.

At least I have no emotional trauma to bear because I am on the sideline.  So I leave you with some thoughts and cautions. It’s raining here in Toronto. The fall leaves are almost gone. They say that winter will be difficult this year and I still have not been able to get in Nat.Gas. It refuses to give a sell signal. But I am patient.

Thanks for sharing my thoughts. Stay frosty folks. 

Monday, October 22, 2012

Christina Romer on Stimulus

(Small update to clarify in response to early comments)
Christiana Romer has an important column in Sunday's New York Times on the stimulus. You will recall that as chair of the Council of Economic advisers, she played a big part in designing the stimulus, and forecasting its effects. She also is one of the preeminent academics who have done empirical work evaluating the effects of stimulus programs. You expect a thoughtful essay.

She explains how cause-and-effect empirical work in economics is hard
To understand what’s wrong with that reasoning, think of someone who’s been in a terrible accident and has massive internal bleeding. After lifesaving surgery, the patient still feels rotten. But we shouldn’t conclude from this lingering pain that the surgery was useless — because without it, the patient would have died.

Without knowing where the economy was headed in the absence of the stimulus, it’s impossible to judge what it contributed just from what happened afterward. That’s why empirical economists rely on other approaches.
This is really good compared to the usual "of course it worked you blockhead" sort of argument from stimulus sympathizers (you know who, and "blockhead" is being polite).

Of course I might have used the image of doctors bleeding the patient, applying poultices or voodoo, and then claiming great power when the patient heals on his own, but the principle is the same.
A growing literature examines the effects of such tax cuts and increases in government spending over history and across countries, and the overwhelming conclusion is that fiscal stimulus raises employment and output in the near term.
Wow, that's strong. .
..states that received more money [for random reasons] fared substantially better. This is the strongest direct evidence that the Recovery Act contributed to employment growth. Based on the estimated size of the effect, the studies suggest that the act created more than three million jobs. 
This does not follow at all. I don't think anyone disagrees with the proposition that if the government takes money from residents of state A and splashes them on state B, the economy of state B improves.  But this totally evades the whole issue: what about state A? This is the entirety of the stimulus debate: The government can transfer resources, but not get resources to fall from the sky. (Whether it taxes or borrows form the residents of state A, it's still transferring resources.) Stimulus is  supposed to raise aggregate demand, not transfer demand from state A to state B.  Yes, if the government builds a military base in the desert, GDP in that desert goes up. From this, stimulus raising the whole country does not follow.

The web version cites the studies. I've read about half of them, and they are careful not to jump to this conclusion. (This is about cross-state studies. There is another industry of time-series studies, trying to see if times when the US overall has stimulated it did any good. That's another issue, which Romer doesn't talk about, so I will also put off for another day.)

She goes on,
In addition to its near-term jobs effects, the Recovery Act may also be having more lasting benefits. It’s too early to measure the value of the roads, bridges...
Fine, but that's not the issue either, and never was. Sure, if there is a positive rate of return investment, make it, and a recession is a good time to do it. But the argument for Keynesian stimulus is that spending money helps the economy at that moment, whether or not it does any long run good. Paul Krugman is admirably honest by  advocating we fake an alien invasion so we can build useless defenses. (I'm not sure why he's not for building useless ships and submarines, but that's for another day.) Whether that works is the issue, not whether the money turned out not to have been totally wasted.

She discusses some faults of the stimulus, finishing with
Finally, there’s little question that policy makers — myself included — should have worked harder to earn the public’s support for the act.
Well, I might say, now is a good time to start. The question for our time is whether stimulus was a great tool rediscovered or a grand failure waiting the ash heap of history. If its central architect, and a noted scholar, has to stoop to such illogical arguments to summarize our experience, I'd say earning support is unlikely.

Pile of paper

In response to my long health-care essay, a friendly doctor sent me the image at the left, with an explanation:

"You want to talk about filling out forms? Here are two hospital privilege renewal applications. Most of my info - such as where I graduated from, where I trained, license #, etc - has not changed. That includes my face, yet they want a new photo. My staff tabbed all the places where I have to sign or initial. This is a standardized form, yet I have to fill one out for every hospital and they all want extra information (including a copy of my signature on a check made out to the hospital)."

Comment: And, amazingly this is all on paper!  

Indices Dig Out Of Hole.

The selling momentum of last Friday continued for better part of today but the last hour was a good turnaround. DOW covered more than 100 points to close in green. In terms of chart pattern let us see the favourite of the Boyz, /ES or emini (SPX futures).

The following is a 4 hour chart of /ES

This is the 2nd time /ES has bounced from 1420 level which is a good support and the last breakout happened from here. The next line of defence is 1400 level.  And the indices still held the low of 10/12/2012. The cash SPX actually bounced off the lower BB and is sitting just above the 50 DMA. Possibly the bears are allowed only up-to this much for now.

The fundamentals are not that great. With corporate profits down and fiscal cliff hanging in front, there are quite a bit of distributions going on for the last many trading days. Most likely smart money is getting out before the uncertainty hits home. But the last bit of shenanigan is still ahead of us and the Boyz will melt up the market for at least one more time. Therefore it is time for patience and not the time for taking positions. I plan to take a long position by end of October but not in any stock or indices. In my view, the least risky trade would be short bond and therefore TBT.

As you know I am long term bullish on Gold and Silver. But if Gold and Silver do not make new highs by mid-November, it may not be a bad idea to step out for a short while. However, if you are not checking your investment portfolio everyday and are comfortable to hold it for a long term, then there is no need to hop in and out.  In fact every weakness is an opportunity to scale in.

Nat.Gas did sell off today. From $3.65, it closed at $3.44. Yet it has not given the sell signal. It has to close below $3.40 for a meaningful correction. I am waiting for it to correct some more for a good entry.

Coming back to short term equities cycle, the 1st reading had bottom around 24th October. Subsequently, 24th October inverted to top and cycle bottom moved to end of October. In situations like these, it is screaming confusion and the best course of action is no action at all. The crystal ball is fairly clear after 29th/30th October till mid- November and that is when I plan to take a long shot for a short while.

Hope you have been in cash and cushy. Cash is the king in times like these. Good opportunities are ahead of us and we have to keep our emotions in check. If you were long, hope you did not close your position because it will turn around very quickly. Problem is, none of these turn around are for real.

We may see some more selling in a day or two but it does not matter. Unless the bears break down 1400 with conviction in the coming few trading sessions, we are looking for a swing high around 1480-1500 range by mid-November.

That’s all for this Monday evening. Thanks for sharing my thoughts. Be safe out there please.  

Sunday, October 21, 2012

Tips For Investors.

I have couple of tips for Relaxed Investors:

1.       Remember that Investment if different from TradingThe successful investment strategy differs markedly from trading.  It is especially important to establish good, long-term positions when prices are favorable. Most individual investors seriously underperform long-term results by selling low and buying high.  Most successful professionals, of course, do the opposite.
             Even successful years have significant drawdowns.  15% is not unusual.  The investor needs to   expect this.  If it feels stressful, then your asset allocation is wrong.
(H/T Jeff Miller)

2.       Realize that we are no expert on world events: However much ZH or some such blog or various talking heads on TV explain why the world is going to end soon, world is not going to end that easily. Investing based on bear talk can be harmful to the portfolio. World may or may not end tomorrow but investing based on personal belief is not a good strategy.

One of my favourite strategy is to have patience and remove the fear of missing out from the mind. I have not been active in the market for the last few months. During these times, market has gone up and down many times in the most unpredictable fashion. Nothing and nobody can say with any degree of certainty which direction the market will move next. Why take the burden of emotional pain in such a market? So I am looking for what would be a long term trend and trying to get in slowly for a long haul.

For next week, my 2 penny advice would be the same. Patience and do not chase either way. Monday we may see some more selling to start with but an eventual bounce. The market would chop around till end of October. Gold most likely would form a bottom around 24th-25th October. And thereafter a longer term up trend (relatively speaking) for equities till mid-November.  Let us see how things develop.

Thanks for all your support and kind words. Have a great Sunday folks.

Saturday, October 20, 2012

Presented Without Comments

Problem With Comment Publish

For some reason I am unable to publish all the comments in Blogger.
But I want to acknowledge and say thanks to all of you for expressing your support.

Friday, October 19, 2012

51 Shades Of Red.

50 shades for the market, 1 for me.

In the morning call of Friday morning I wrote the following:

As I wrote last night, DOW has been down last 6 straight and 7 of the last 8. That should tell us that we should expect the market to close in red. How deep the colour of the Red is to be seen. It would be foolish to venture an opinion on OpEx day.

It now turns out that the shade of the Red was very deep indeed. It now seems that the indices are making a triple top, if there is something like that in the dictionary of TA. But fear not. It is not the start of the waterfall that we all are waiting for. It is just a symptom of a sick market. Sometime back I wrote that a complex topping process is going on. And because of these weekly ups and downs, it is impossible to trade let alone invest in this market. That is why my conclusion in Friday morning was; Trade Safe, Invest not.

I have done this hop on hop off trade in the past. This is not swing trade. For a swing trade we need somewhat longer term trend which is absent from June. If anyone tells you that s/he is making money in this market day trading or swing trading, s/he is either lying or lucky. My guess, it is the former.

Readers know that we were expecting a pull back since last two days but the degree of pull back surprised everyone, including me. Now we have to see if the low of last week holds. Today’s sell off was triggered by earnings or lack of it. (Although I would say Cycles) let us hope next week the earnings come out better.(because cycles are up till 25th October). So far the DOW and SPX have stopped at 50 DMA as if that’s all the bears are allowed. The Fed has said that they will prop the market no matter what and $40 billion a month have just started coming in.

After the cycle top around 25th October, the next short term low is around end of October. And the important cycles all go up from there. That also matches with the Bradley Date and the COT Euro dollar chart of Tom McClellan. I do not want to guess how low the market can or will go from here till 30th October, but I may take a swing at some longs between end of October and Mid-November. If you remember, I am on the sideline, neither long nor short.  By the way, despite the sell-off, there is no confirmed sell signal from the major indices yet. It may change if we have more selling next week but we will cross the bridge when we come to it.

That made your 50 shades of red market. Now, my 1 shade of red.

In the morning Google very kindly notified that my Adsense account has been closed. Naturally I was very disappointed. But out of 1000s of readers, so far 10 have stood by me and have said that they will support me in every whichever way. Thank you ladies and gentlemen. I have never met you in person and yet you have extended your generosity to an unknown blogger. That I have 10 unknown souls by my side, makes me realize how lucky and blessed I am. I feel that I have achieved my goal.

But God has a funny of showing love. When s/he closes one door, s/he opens ten others. Blogging was never going to be my profession or livelihood. I do it because I love it and as I had some more time in hand, I started spending that here. Making my work of love a paid or subscriber model, will not give me sufficient money to justify my time yet it will alienate most of the readers. Charging $15 per month to 50 or even 100 readers will not allow me to live and yet that will tie me up with huge responsibility. So I have decided to let the blog be as it is. Free for all.

I have signed up with another company called BidVertiser who do the same thing as google but on a scale of 1 to 1000000. So I will do whatever I can to generate Ad revenue and then there is Amazon link which I hope readers will use during the holiday season.

I will be making my regular evening post and sharing my views on investments and market. The Weekly Market report (WOF+) is going for a premature death because readers don’t think it is worth any money. Let life continue as it was, without any bells and whistle.

That sums up the eventful week and the 51 shades of red. Have a great weekend folks.

After the ACA: Freeing the market for health care

This is an essay, based on a talk I gave at the conference, “The Future of Health Care Reform in the United States,” at the University of Chicago Law School. The pdf version on my webpage may be easier to read than this version, which is a bit long for a blog post. Also, I'll update the pdf over time as I collect comments, but not this blog post.

Update 2/6/2013 I revised the essay on my webpage which is now better than this one. 

Clearly, two important items on the policy agenda are, if we could get rid of the ACA and Dodd-Frank, what would we replace them with? This essay thinks about ACA, I'll be back on Dodd-Frank. Here goes:

After the ACA: Freeing the market for health care
John H. Cochrane1
October 18 2012

Most of the current policy debate, and the optimistically-named “Affordable Care Act,” focuses on health insurance. I think we need to move on to think about the economics of health care. If the ACA is repealed, we still have a mess on our hands, and just fixing insurance will not be enough to clean up that mess.


I’ve written a lot about how to fix health insurance, so I won’t repeat that all here.2 To summarize briefly, health insurance should and can be individual, portable, life-long, guaranteed-renewable, transferrable, competitive, and lightly regulated, mostly to ensure that companies keep their contractual promises. “Guaranteed renewable” means that your premiums do not increase and you can’t be dropped if you get sick. “Transferable” gives you the right to change insurance companies, increasing competition.

Insurance should be insurance, not a payment plan for routine expenses. It should protect overall wealth from large shocks, leaving as many marginal decisions unaltered as possible.

Preexisting conditions, lack of insurance by the young and healthy, and spiraling insurance costs– the main problems motivating the ACA -- are neatly addressed by this alternative. Why do we not have a system? Because law and regulation prevent it from emerging. Before ACA, the elephant in the room was the tax deduction and regulatory pressure for employer-based group plans. This distortion killed the long-term individual market and thus directly caused the pre-existing conditions mess. Anyone who might get a job in the future will not buy long-term insurance. Mandated coverage, tax deductibility of regular expenses if cloaked as “insurance,” prohibition of full rating, barriers to insurance across state lines – why buy long term insurance if you might move? – and a string of other regulations did the rest. Now, the ACA is the whale in the room: The kind of private health insurance I described is simply and explicitly illegal.

So, the alternative is clear. Getting there will be a long hard road. It’s not a simple matter of “deregulation,” given how deep and widespread the offending restrictions are, and the many legitimate purposes which they purport to serve, and sometimes do. We need to construct a different, but wiser, legal and regulatory regime. I know an interest group when I see one: Don’t worry, there will be lots of jobs for health economists, policy analysts, and lawyers.

Problem solved? Not really. Solving health insurance – who pays -- will not solve the evident inefficiencies and absurd cost of our health care markets.

Health care supply

We all agree what we’d like to see: Health care needs to become efficient, innovative, and provide high quality care at lowest possible cost.

Cost reduction and innovation: some examples

How will this happen? Well, we have before us many good examples. Walmart and Home Depot revolutionized retail. Airlines are dramatically cheaper than in the 1970s. Consumer electronics, telecommunications, computers, and even cars are much better and cheaper, for what you get, than ten or twenty years ago.

These revolutions are not just about technology. In most of these cases, we see process innovation, reorganizing activities to deliver complex services at lower cost and with better and more uniform quality. This process efficiency is most glaringly absent in health care .

Southwest Airlines turns a plane around in 20 minutes, and has finally figured out how to get people on it without the chaos at United and American. Walmart and Home Depot are as much about organizing and standardizing the motion of people and inventory as they are about adopting technology, outsourcing supply, or negotiating lower prices. Honda assembles a car with 30 hours of labor. As Atul Gawadne puzzled4 in the New Yorker, the Cheescake Factory delivers a complex service-oriented product with remarkable quality, efficiency and cost. Why can’t hospitals do the same?

Beyond stories: Amitabh Chandra and Jonathan Skinner5 summarized the academic literature, writing “there is increasing evidence of the potential for cost-saving technologies (with equivalent or better outcomes) in the management and organization of health care to yield substantial productivity gains. But these types of innovations are unlikely to diffuse widely through the health care system until there are much stronger incentives to do so”

But our hopes for health care go beyond the obvious need to streamline of process and delivery and adopt cost-saving technology. We don’t want 1950s care at cheaper prices. Technical innovation is, fundamentally, why we can be so much healthier than our grandparents. Health care markets need to bring that innovation as fast as possible-- and then diffuse it quickly down to the mass market.

My example industries are also great at technology innovation and diffusion. Health care is a paradox, that innovation is widely reviled as a cause of increased costs, where by any economic definition the opposite is true. The answer that you’re mistaking “cost” for “price,” and that a new $500,000 treatment represents a reduction in cost over a less effective but still available $50,000 older treatment is correct as a matter of economics. But it’s unsatisfying, because we all see the monstrous inefficiencies in health care.3

Why does Moore’s law not apply to medical devices? Why has the price of cell phones, GPS, and computers come down so fast relative to the prices of medical technology? Where is the home MRI? There is nothing deeply different about medical and other technology. The answer is that supply and demand – in the current highly regulated system – is not producing the Moore’s law incentives.

In my examples, innovation doesn’t always mean lower cost. I paid $1500 in 1982 for an IBM PC with 16 k and one floppy disk drive. I paid about the same (nominal) for my most recent laptop, with vastly more power. Nissan is going to sell6 $3,000 cars in China and India – with no airbags. We have chosen much better cars for slightly higher prices.

In each case, however, the industry has done a good job of pushing the cost/innovation/quality frontier out to its limits, and then discovering where people really want to be. If we “spend more” today, we know we’re getting a good deal, and simply choosing a different point on a far better frontier than we faced 20 years ago. What we need in health care is to push that quality-cost-innovation frontier back. If we then choose higher cost, it will indeed be cause for celebration, not hand-wringing.

These industries do not cut costs by selling shoddy products. Instead, they provide consistent quality on the dimensions people turn out to really care about, and save on those that people don’t really care about. Southwest gets you where you want to go at convenient times, with a good on-time record, and admirable safety. And seats 27 inches apart, feeding you peanuts. The iphone error rate is a lot lower than the medical error rate. Walmart shirts use inexpensive materials, and they are sold in environments far less sexy than Michigan Avenue boutiques, but it’s rare to find one torn, or missing buttons. The fear, so often expressed in medical contexts, that unregulated competitive suppliers will pawn off shoddy merchandise on consumers seems exactly false. Restaurants tremble at a poor yelp review. The corporatization and standardization, which we to some extent bemoan, is a good part of their ability to deliver consistent quality. If each airplane and pilot were a different practice, quality would vary a lot more!

How will this change come about? My examples share a common thread: Intense competition by new entrants, who put old companies out of business or force unwelcome and disruptive changes. Microsoft displaced IBM, and Google is displacing Microsoft. Walmart displaced Sears, and may displace Wal-Mart. Typewriter companies didn’t invent the world processor, nor did they adapt. The post office didn’t invent FedEx or email. Kodak is out of business. Toyota gave us cheaper and better cars, not Ford/GM/Chrysler competition. When the older businesses survive, it is only the pressure from new entrants that forces them to adapt.

My examples share another common thread. They remind us how painful the cost-control, efficiency, and innovation processes are. When airlines were regulated, artificially high prices didn’t primarily go to stockholders. They went to unionized pilots, flight attendants and mechanics. Protection for domestic car makers supported generous union contracts and inefficient work rules, more than outsize profits. A look at a modern hospital and its supply network reveals lots of similar structures. “Bending down cost curves” in these examples required cleaning out these rents, through offshoring, elimination of union contracts and work rules, mechanization, pressure on suppliers, and internal restructurings.

The fact that so much cost reduction comes from new entrants, not reform at the old companies, is testament to the painfulness of this process, and the ability of incumbents to protect the status quo. The big 3 still take 40 hours to build a car relative to Toyota’s 30. And two of them went bankrupt, while Toyota sits on a cash reserve. American and United are still struggling to match Southwest’s efficiencies, after 30 years. The parts of Kodak invested in film simply couldn’t let the company exploit its technical knowledge in optics and electronics. Chicago’s teacher unions are fighting charter schools tooth and nail. And a quick look at a modern hospital, and its suppliers, suggests just how wrenching the same transformations will be.

Supply and Competition

So, where are the Walmarts and Southwest Airlines of health care? They are missing, and for a rather obvious reason: regulation and legal impediments.

A small example: In Illinois as in 35 other states7, every new hospital, or even major purchase, requires a “certificate of need.” This certificate is issued by our “hospital equalization board,” appointed by the governor (insert joke here) and regularly in the newspapers for various scandals. The board has an explicit mandate to defend the profitability of existing hospitals. It holds hearings at which they can complain that a new entrant would hurt their bottom line.

Specialized practices that deliver single kinds of service or targeted groups of customers cheaply face additional hurdles, as they undermine the cross-subsidization provided by “full service” hospitals. For example, the Institute for Justice is bringing a major suit8 by a specialty colonoscopy practice in Virginia, which local “full service” hospitals managed to ban.

This is exactly the form of regulation put in place by the Civil Aeronautics Board until the late 1970s, which produced airline prices much higher than they are today. Airlines had to show “need” for a new route, and incumbents defended monopoly rents on the grounds that they cross-subsidized service to small airports. Its removal is pretty much centrally what brought us cheap airlines now.

Revealingly, CON laws were an earlier round of “cost containment,” and were federally mandated for a while. The idea was sensible enough, and you could imagine it echoing through conferences such as this one. On a fee-for-service system, there can be an incentive to buy too many MRI machines, and then prescribe “needless” scans, which insurance companies and the government would be forced to pay for. Well, said an earlier round of health-policy experts, we’ll patch that up by having a regulatory board review the “need” for major investments or hospital expansion to avoid “needless” overinvestment. Even if the theory is true, it’s an interesting story how an attempted regulatory patch to one broken system (poor incentives in fee-for-service reimbursement) turned in to a barrier to competition and wound up increasing costs.

How occupational licensing is captured to restrict supply and push up prices should be obvious by now – Milton Friedman wrote his PhD dissertation on it. If you’re a parent, you’ve been through it. It’s 2 am in a strange city. The kid has an ear infection. He needs amoxicillin, now. Getting it is going to be a 3 hour trip to an emergency room, hundreds of dollars, so a “real doctor” can peer in his ear, then off to the pharmacy to fill the prescription. A nurse practitioner at the Wal-clinic could handle this in 5 minutes for $15.

I’m not arguing that we have to get rid of licensing. But licensing for quality does not have to mean restriction of supply to keep wages up, including state-by-state licensing, restriction of residency slots, or restrictions that encourage overuse of doctors where they are not needed.

Einer Elhauge 9 examines “fragmentation” of medical care in detail, the fact that even in hospital settings care is bought essentially from different doctors and specialists rather than in an integrated manner, as, say airline travel is, where you do not separately purchase pilot, flight attendant, fuel and baggage services. My examples suggest a consolidation, integration, and corporatization of overall health service provision, as restaurant chains displace individual stores. What stops this defragmentation? He surveys research concluding that nothing in the nature of health care seems to require this structure, as hospitals in other countries have salaried doctors, and concludes instead (p. 11):

The dominant cause of fragmentation instead appears to be the law, which dictates many of the fragmented features described above and thus precludes alterative organizational structures.

He lists a long string of legal impediments, including Medicare reimbursement rules, laws against corporate medicine and tort doctrines. Referring to private insurance (p.12):

…State laws generally make it illegal for physicians to split their fees with anyone other than physicians with which a physician is in a partnership. More important, alternative payment systems, such as paying a hospital (or other firm) to produce some health outcome or set of treatments, would make sense only if it has some control over the physicians and other contributors to that outcome and treatments. And other laws preclude such control, as detailed in the chapters by Professors Blumstein, Greaney, Hyman, Madison, Cebul, Rebitzer, Taylor, and Votruba. The corporate practice of medicine doctrine provides that firms—whether hospitals or HMOs—cannot direct how physicians practice medicine because the firms do not have medical licenses, only the physicians do. Although some states allow hospitals to hire physicians as employees, that change in formal status does not help much if the employer cannot tell the employee what to do. Even if the law did not prohibit such interference, tort law generally penalizes firm decisions to interfere with the medical judgments of individual physicians, making it unprofitable to try, as Professor Blumstein observes. Further, hospital bylaws usually require leaving the medical staff in charge of medical decisions, and those bylaws are in turn required by hospital accreditation standards and often by licensing laws. By dictating autonomy for the various providers involved in jointly producing health outcomes, these rules largely dictate separate payments to each autonomous provider.

Private insurer efforts to directly manage care have likewise been curbed by the ban on corporate practices of medicine and the threat of tort liability. In addition, states have adopted laws requiring insurers to pay for any care (within covered categories) that a physician deemed medically necessary, banning insurers from selectively contracting with particular providers, and restricting the financial incentives that insurers can offer providers.
My cost-cutting examples are all for-profit companies. About 70% of hospitals and 85% of health-care employment is in non-profits,10 whose legal and regulatory treatment protects much inefficiency from competition.

If United didn’t have to pay taxes, Southwest’s job would have been that much harder.

Maybe for-profit companies pay too much attention to stock prices. But non-profits can go on inefficiently forever, with no stockholders to complain. The whole point of a non-profit is to pursue goals other than economic efficiency.

More importantly, if a for-profit company is inefficiently run, another company or a private-equity firm can buy up the stock cheaply, replace management, and force reorganization. Non-profits (and their management especially) are protected from this “market for corporate control11.”

Many non-profit hospitals are too small or, by definition unable to issue equity, undercapitalized.

Recognizing some of these pathologies, there is a wave of mergers, and transfers between for-profit and not-for-profit status. But there is lots of gum in the works. When a nonprofit is sold or converts to for-profit, the state attorney general and courts can weigh in on the sale; legally to ensure that the proceeds benefit a charitable cause related to the non-profit’s original mission. This is a great opportunity for competitors to block the change.1

The FTC is ramping up antitrust action against hospital mergers.13 Hospitals need economies of scale for expensive, specialized modern medicine and to comply with the avalanche of regulatory and insurance regulation. The FTC worries about local monopolies able to raise prices, especially given the inelastic demand by insurers and government reimbursement. So here we have the government forcing small size in order to boost competition with one hand, stopping entry to protect hospitals from competition with another, trying to force larger “networks” through “Affordable Care Organizations” to obtain the needed economies of scale with the third, but laws preserving doctor independence with the fourth.

On reflection, it’s amazing that computerizing medical records was part of the ACA and stimulus bills. Why in the world do we need a subsidy for this? My bank computerized records 20 years ago. Why, in fact, do doctors not answer emails, and do they still send you letters by post office, probably the last business to do so, or maybe grudgingly by fax? Why, when you go to the doctor, do you answer the same 20 questions over and over again, and what the heck are they doing trusting your memory to know what your medical history and list of medications are? Well, this is a room full of health policy wonks so you know the answers. They’re afraid of being sued. Confidentiality regulations, apparently more stringent than those for your money in the bank. They can’t bill email time. Legal and regulatory roadblocks.

So, medical records offer a good parable: rather than look at an obvious pathology, and ask “what about current law and regulation is causing hospitals to avoid the computer revolution that swept banks and airlines 20 years ago,” and remove those roadblocks, the government adds a new layer of subsidies and contradictory legal pressure.

The impediments to supply-side competition go far beyond formal legal restrictions. Our regulatory system has now evolved past laws, past simple, explicit, and legally challengeable regulations, to simply hand vast discretionary power to officials and their administrative bureaucracy, either directly (“the secretary shall determine..” is the chorus of the ACA) or through regulations vague enough to let them do what they want. Witness the wave of discretionary waivers to ACA handed out to friendly companies. Those administrators can easily be persuaded to take actions that block a disruptive new entrant, and with little recourse for the potential entrant. (Lobbying government to adopt rules or take actions to block entrants is legal, even if those actions taken directly would violate anti-trust laws, under the Noor-Penington doctrine.)

Forget about Wal-clinics; Chicago and New York kept the food and clothes part of Wal-Mart out for years, at the behest of unions and competitors, by denying Wal-Mart all the necessary permits and approvals. So many citizens, especially our poor and vulnerable, continue to live in employment and retail deserts.

The increasing spread of medical tourism to cash-only offshore hospitals is a revealing trend. Why does this have to occur offshore? What’s different about the hospital location? Answer: the regulatory regime.

So, what’s the biggest thing we could do to “bend the cost curve,” as well as finally tackle the ridiculous inefficiency and consequent low quality of health-care delivery? Look for every limit on supply of health care services, especially entry by new companies, and get rid of it.

The reregulation path

Now, this is of course not the way of current policy. The ACA and the health-policy industry are betting that new regulation, price controls, effectiveness panels, “accountable care” organizations, and so on will force efficiency from the top down. And the plan is to do this while maintaining the current regulatory structure and its protection for incumbent businesses and employees.

Well, let’s look at the historical record of this approach, the great examples in which industries, especially ones combining mass-market personal service and technology, have been led to dramatic cost reductions, painful reorganizations towards efficiency, improvements in quality, and quick dissemination of technical innovation, by regulatory pressure. I.e., let’s have a moment of silence.

No, we did not get cheap and amazing cell phones by government ramping up the pressure on the 1960s AT&T. Southwest Airlines did not come about from effectiveness panels or an advisory board telling United and American (or TWA and Pan AM) how to reorganize operations. The mass of auto regulation did nothing to lower costs or induce efficient production by the big three.

When has this ever worked? The post office? Amtrak? The department of motor vehicles? Road construction? Military procurement? The TSA? Regulated utilities? European state-run industries? The last 20 or so medical “cost control” ideas? The best example and worst performer of all,..wait for it... public schools?

It simply has not happened. Government-imposed efficiency is, to put it charitably, a hope without historical precedent. And for good reasons.

Regulators are notoriously captured by industries, especially when those industries feature large and politically powerful businesses, with large and politically powerful constituencies, as in health insurance or as in most cities’ hospitals. In turn, regulated industries quickly become dominated by large and politically powerful businesses. See banks, comma, too big to fail. (Several insurance companies were bailed out in the financial crisis, so too-big-to-fail protection is not a distant worry.) This is not to say that regulators are not well-meaning and do not put great pressure on many industries. But the deal, “you do what we want, we’ll protect you from competition” is too good for both sides to resist.

Needless to say, price controls have been an unmitigated disaster in every case they have been tried. Long lines for gas in the 1970s are only the most salient reminder. Their predictable result is, vanishing supply. Try finding a doctor who will take new Medicare or Medicaid patients.

The current regulatory approach is not really well described as simple price controls, e.g. $3 per gallon of gas, but rather as fiddling with a payment system of mind-numbing complexity and endlessly discovered unintended consequences. The past record of “cost control” and “incentive” efforts should warn us of how likely adding more complex rules is to work.It seems instead to be a challenge to the next generation of planners.14

But that’s only the beginning. Real cost reduction is a hard process, as my examples remind us.

Can a regulator in a democracy really become a union-buster, force painful concessions on workers, suppliers, and other “stakeholder” beneficiaries of rents? Can a regulator realistically demand that jobs be outsourced or replaced by software? Can a regulator really preside over a wave of turnover in which new businesses send old ones to the dustbin, firing their management?

Consider a small example now in the news. Hospitals are starting to outsource the reading of x rays, even to India. This is still heavily regulated – the radiologists are still US trained and certified. But already it’s a cause celebre for the potential to cost jobs. When the obvious happens – Hmm, we have some good Indian doctors who can read the x rays just as well – you can imagine the scandal. And doesn’t every American deserve the best – a US radiologist on staff and present 24 hours a day, ready to consult with the doctor? Personal-injury law firms are already lining up to sue based on the “inferior quality” of outsourced readings, with requisite horror stories.15 How could a regulator demand outsourcing radiology and using Indian doctors?

My examples also do a remarkable job of getting rich people to voluntarily pay through the nose, covering fixed costs for medium-income consumers. Two words: Business Class. A politician who proposed taxing people this way to provide air travel would be hanged as a socialist. And a regulator who consigned middle-income patients to seat 25d while wealthier patrons got business class would be hanged as a fascist.

Our current system tries to accomplish such cross subsidies, but at massive inefficiency: to cross-subsidize Medicare, Medicaid and emergency rooms, we overcharge cash customers and private insurance, and protect inefficient hospitals from competition.


Now by being concrete, and therefore realistic, I invite obvious complaints. What, I like airlines and Walmart? Have I been to an airport lately or shopped at Walmart? (Yes to both, incidentally.) But I think the examples are good to remind us what efficiency looks like, how it is achieved, and to keep us from fantasies about what health-care can look like and what outcomes regulators are likely to be able to achieve.

We love to complain about airlines. But aside from the TSA’s security theater and air traffic control – both run by the government – what we really want is 1970s service at 2010 prices. Sorry, we can’t afford private-jet medicine for everyone. Southwest medicine has to be the goal.

Shop at Walmart? Walmart is putting all those cute mom and pop stores out of business. It’s putting pressure on union jobs, the main reason Chicago kept it out all these years. It pushes suppliers relentelessly. It buys from China. Aren’t I being heartless?

No. I’m being realistic. The lesson from all our experience with other industries is that “cost control” and innovation are a hard and brutal process.

Many of you are probably still squirming in your seats. You want some other way. You want to keep unionized jobs, “living wages,” “worker protections,” or “keep our community hospitals going.” Perhaps you mourn the bank tellers replaced by ATM machines, and jobs sent to China.

More deeply, you are probably squirming in your seats at my observation that quality varies enormously in efficient industries: some fly economy middle seat, and some fly in private jets. Some get shirts from Walmart and some get shirts from Macys. Surely, doesn’t every American deserve the best when it comes to health care?

If so, you’re not serious about reducing costs, i.e. finding the efficient point on the quality-cost curve. This is simply a fact: you’re adding other goals to the mix, so you’re accepting rising costs to fund those other goals. Or you’re fantasizing that you can have it both ways.

And if you’re having trouble putting those other considerations aside and accepting a Walmart / Southwest airlines model for health care, imagine how unlikely it is that the department of health and human services will force that model to emerge through its regulatory power.

Health-care demand

The demand side of the health care market is also severely distorted.

Most basically, with either government provision or private insurance, health care is bought in “payment plan.” You pay a tax or a premium, then your expenses are “covered.”

We all understand that when somebody else is paying, people don’t economize on expensive services shop for better deals, or accept less convenient but cheaper alternatives. More importantly, I think, demand affects supply: it’s a lot harder for new entrants to attract business in the current payment system.

Is there something about the nature of health care, as an economic good, that necessitates payment-plan provision? Thinking about it, I think the opposite is true: Health care, as an economic good, is a particularly poor candidate for payment-plan provision.

I think people have in mind a simple wound, or a broken arm. Even if it’s free, nobody is going to overuse that—nobody will have a good arm put in a cast or have stitches just for fun. Pretty much any qualified doctor can handle it; you don’t need to find one that’s “really good at setting bones” but charges a higher price. So, the “good” is well defined, it’s a pretty generic commodity, the demand curve is very steep, and what you “need” is clearly observable.

But this is a very misleading anecdote. The actual demand curve for health care is incredibly elastic. When provided at low cost, people consume prodigious amounts of health-care services. Every cost estimate for government provision or subsidy, from the UK NHS, to medicare, medicaid, and beyond has missed the mark by orders of magnitude. And, though it’s common to disparage “overuse,” in health policy circles, the elastic demand curve is real. These are real people, with painful illnesses, and the “extra” test or visit to the specialist might just be the one to finally help them. Conversely, when asked to pay more, consumers economize rapidly, refusing “too much” care in the judgment of the medical community.

So, we have attempted payment plans with limits – insurance rules, managed care, effectiveness panels, “affordable care organizations” and so on – to cut off the flat demand curve. Ezekiel Emanuel, Neera Tanden, and Donald Berwick, writing in the Wall Street Journal 16 explained the idea: “Instead of paying a fee for each service, providers should receive a fixed amount for a bundle of services or for all the care a patient needs.”

Hmm. “From each according to his ability, to each according to his need.” It has a nice ring to it. Why do I feel a certain foreboding?

Would this work for clothes? Your employer gives you “access” to clothes by including it in your benefits. Then your primary style consultant will determine how many shirts you “need,” which you can pick from the preferred provider network (K mart). Home repair? The home-repair effectiveness board will conduct peer-reviewed research on material for kitchen counters. Sorry, granite is off the approved list, you don’t “need” it.

Health care? For many patients, just getting through the diagnosis to decide what treatment they might try is an expensive and inconclusive nightmare. How much diagnosis do you really “need” in these circumstances?

Many diseases are chronic, requiring widely-varying and individual-specific treatment plans. Nothing really works, and we’re trading off different options with different bad side effects, and needing different levels of commitment from the patient.

End-of-life care, care for elderly, infirm, and handicapped, are very expensive, and all lie on a long string of quality vs. quantity choices. Does grandma really “need” a 5 star nursing home, a helper (a highly personal service! – could insurance or government “provide” housecleaning services successfully?) or just support from family? Does “need” without considering cost, i.e. willingness to pay, really even begin to describe the economics of this decision? Should a family that decides to provide care, saving the nation hundreds of thousands, receive no benefit?

I had a back pain episode recently. (Somehow health policy always ends up with here’s-where-it-hurts personal anecdotes!) Did I “need” an MRI to really see the structural problem? Cortisone shots? Surgery? Physical therapy, or just a Xerox of recommended exercise? Therapy at the hospitals here, or at the specialty sports-rehab clinic that patches up the Bears? Or just a handful of ibuprofen and let it heal? Did my planned trip to Europe matter in this medical “need?”

And now the dirty little secrets. For most patients, “stop smoking, exercise and lose some weight” is the best advice they could take. Patient’s awful compliance is an open secret. How much drugs and treatment do patients “need” who won’t stop smoking, lose weight, exercise, do the physical therapy, or comply with drug regimes?

Another dirty little secret: Quality, both actual and perceived, varies enormously. Rates of medical errors, infection rates, rates of success in difficult procedures, just getting basic diagnoses right, or even washing hands often enough, vary widely. The quality of service provided, including everything from waiting times to convenience of making an appointment and whether the doctor answers emails varies as well. Concierge medicine is emerging really targeted to people tired of the whole runaround. And medicine is not perfect. For a range of conditions, we have imperfect treatments, and scientific knowledge of what works or doesn’t is changing fast.

If only it were so simple to determine “need.” If only people like me went away quickly when told we don’t “need” an MRI to find out why our backs hurt. Or if people with hard to diagnose illnesses like food allergies quietly went away rather than hold out hope that the next specialist will figure out the problem.

So what does “need” really mean for services like this? The only sensible economic definition I can think of is that “need” is the bundle of services you would choose if you were paying with your own money at the margin. You “need” that MRI to make sure your back pain won’t just heal after 6 weeks of ibuprofen if you’d be willing to shell out $1,000 of your own money to get it. (I am!) And you “need” it delivered at a convenient hour, tomorrow, rather than next week across town if you’re willing to pay that extra cost.

“At the margin” is important because intuitive thinking soon mixes up “what you’d rather spend money on with “what you can ‘afford.’” Suppose we offered each patient the choice, “well, your doctor prescribed this MRI. You can have the MRI or you can have $1000 in cash.” You “need” the MRI if you forego the cash and go through with the MRI.

This is an important and unsettling conceptual experiment. If I offer the cash and the patient decides if he wants to take the treatment or find a cheaper alternative, you can’t argue the patient “can’t afford” treatment. It’s unsettling, because we may suspect lots and lots of people would take the cash. So there is a lot of paternalism in health care, which we might be more upfront about.

In any case, once defined, it’s pretty clear that this “need” is essentially impossible to measure externally for a personal service with so much variety, and imperfection, as health care.

Moreover, many more people would “need” MRIs if competition and innovation drove the price down to $50, by any definition of “need.”

So, we’re just arguing about who makes the cost/benefit decision. What you “want” is where you make the cost/benefit decision. What you “need” is what I – or some panel of bureaucrats -- think you should get.

I think the word “need” also has a moral tone, “what society owes you.” This seems even harder to define or measure. How much back treatment did society owe me?

(A little digression for economists: You could quibble with my definition of “need” as “what you are willing to pay for,” because I left out income effects. Perhaps “need” can mean “what you would be willing to pay if you earned $500,000 a year?” Alas, we, as a society don’t have the resources to pay for that definition of “need.” We simply cannot all fly on private jets.

So, while private jet stories are fun, given the budget constraint, the relevant question is whether someone earning $50,000 a year would give a much different answer than someone earning $80,000 per year. And remember that the question is on the margin, with an insurance payment, voucher other lump-sum subsidy to offset income effects. Care for the very poor and indigent is a separate question, which I discuss below.

Now it’s not so obvious that income is the greatest source of variation in “willingness to pay,” in this relevant range. Variation across people within income categories is far greater for every other good, and complex service, so is likely to be greater for health care as well. So, while a relevant quibble, in the end I think an argument based on income effects in the definition of “need” is distraction.)

Bottom line

In sum, health care is a complex, highly varied personal service, not a simple well-defined commodity. The demand curve is as elastic as any in economics. When, where, how, how much, by who are vital components of that service. Objective and subjective quality, and corresponding cost, varies tremendously. The distinction between “need” and “want” is at best unmeasurable and at worst simply meaningless. The broken arm is a horrendously misleading anecdote.

But health care is an economic good. Health care is not that different from the services provided by lawyers, auto mechanics, home remodelers, tax accountants, financial planners, restaurants, airlines or college professors.

Payment-plan provision, with rationing by some external determination of “need,” is based on the opposite and false assumptions and thus pretty hopeless for health care. No planner can mimic the market outcome in which what you need is what you’re willing to pay for.

To some extent, private unregulated insurers can offer high quality vs. generic plans to sort patients ex-ante by quality vs. wiliness to pay. But regulation makes that sorting much harder: Once we force guaranteed issue at the same price, it’s next to impossible for insurers to maintain bare bones vs. fancy plans. The minute a bare-bones customer gets sick, he will demand to be issued a fancy plan at the same cost as everyone else. And health insurers will respond by tailoring plans to attract healthy consumers – free health club benefits – and discourage sick ones. The whole guaranteed issue + mandate arrangement assumes that health insurance is a generic good, not one with good-better-best quality and price points. Or it will soon be forced to be generic! And regulatory rationing cannot say that anyone should shop at Walmart.

The whole stated point of regulation is to ensure quality, of course, but it does a poor job on the dimensions we care about. Regulators can impose minimum standards, requiring degrees, certification, inspections, etc. and keep out really dangerous quacks. But beyond that they are terrible at pushing for higher quality, especially when quality is so much in the experience of a customer in a service-oriented business. Restaurant regulation keeps restaurants reasonably safe, but there’s no pressure for Joe’s Tacos to use better cuts of beef, let alone to adopt molecular gastronomy. Yelp ratings do that in a way no regulator can hope to do.

I conclude that at the margin, the consumer needs to be paying a lot closer to full marginal cost of health care, or, equivalently, receiving the full financial benefits of any economies which he is willing to accept.

The health-care market – supply and demand

The obvious problem here is that the cash market is dead. Making people pay, and shop, is unrealistic.

If you walk in to the University of Chicago Hospitals and say, “I don’t have insurance. I have a bank account. I’ll be paying cash,” their eyes will light up. “We’ll pay for 100 Medicare patients with this guy.” That’s like walking up to United Airlines and saying “I want to go to Paris, first class. Sell me a ticket.” Actually, it’s worse – at least United will quote you a price up front and on its website, and let you compare with American. So, insurance companies now function as purchasing agents, negotiating complex deals on our behalf.

Nobody in this room really needs health insurance for anything less than catastrophes. We pay for transmission repairs, leaking roofs, and vet bills out of pocket. Most people in this room send our kids to private schools, throwing away our right to expensive public education. We could easily “afford” most of our routine medical expenses, and even pretty big unplanned expenses, especially if we were paying commensurately lower health-insurance premiums.

But we all have health insurance, and deal with the paperwork nightmare.

Why? You don’t need an “insurance” company to negotiate your cellphone contract, home repair and rehab, mortgage, airline fare, legal bills, or clothes, and pay as we do for health. Why do you and I need a professional negotiator masquerading as an insurance company? Moreover, Dr. Jones is in Humana’s network, Dr. Smith is in Blue Cross’. What economic principle means I shouldn’t see Jones, just because some arcane negotiation took place behind the scenes? And what about the new low-cost specialty clinic that Dr. Thomas is setting up, which can’t get into either network?

The answer: we’re missing robust supply-side competition. Hospitals would never get away with obscure pricing, hidden rebates, or massive cross-subsidies if they were facing serious competition from new entrants who could peel you away – and peel you away from your expensive “price negotiator” as well.

The cash market is also dead because of the demand-side distortion: too many people have payment plans. Competing for cash customers just does not make enough money to keep a hospital going, and the pool of such customers is a lot sicker.

And a hospital must choose, basically to be all insurance or all cash. If it offers clear transparent prices to consumers, it can’t also play the game with insurance companies. (The spread of “concierge medicine,” the equivalent of private schools for people so fed up they just throw away health insurance, is an interesting phenomenon. But it’s still too small to affect the overall market. There aren’t any concierge, cash-only hospitals. That business seems to have to be off-shore. )

In a vicious circle, the absence of a functional cash market lies at the heart of many insurance and government “cost control” problems. Insurance functions best when it is a small part of a market, in which prices are set by “marginal consumers” paying cash, and competitive businesses supplying them.

With little price discovery left in health care, health insurers have to do all the price negotiation in a vacuum.

Airlines, restaurants, and car repair work reasonably well even though in each case a large fraction of consumers are not paying with their own money. Each has competitive supply, and a remaining fraction of consumers who feel marginal decisions, enough to allow price discovery and competitive pressure for efficiency.

The cash market is also dead, because of the vast system of cross-subsidies and implicit taxes in our health-care markets. Medicare and Medicaid pay less than cost. Protected insurance companies go along with partially cross-subsidizing them. The poor solvent cash customer cross-subsidizes everyone else.

Part of the reason for phony pricing is that hospitals know most “cash” customers won’t end up paying, so they will end up negotiating charity care. Nicholas Kristof’s story17 in the New York Times, of the travails of an uninsured friend who got cancer, unwittingly illustrates my point beautifully. The article cites completely ridiculous prices, then explains how his friend applied for charity care and had a $5500,000 bill knocked down to $1,339. But, just to reiterate how ridiculous the cash pricing is, wanted to charge $1,400 for an ambulance ride.

In sum, freeing up either supply or demand without freeing up the other will do little good. Increasing copays can help to ration expensive or overpriced services, but does not stimulate supply or efficiency as long as new entrants can’t come in and compete for business. And allowing new entrants in doesn’t do any good as long as few consumers are able to vote with their money.

We need to free up supply, demand, and health insurance!

Health Insurance

If cash markets were functional, health insurance could become what it should be: a way of protecting lifetime wealth from catastrophic shocks, like life insurance. Such insurance would, of course, be a lot cheaper. It would not have to be a negotiator and payment plan for routine expenses.

“Access” should mean a checkbook and a willing supplier, not a Federally Regulated payment plan. Insurance means your large-scale standard of living isn’t enormously impacted by rare events.

If there were functional cash markets, health savings accounts could substitute for much of the necessarily cumbersome functions of insurance. Health borrowing accounts, i.e. HSAs with a preapproved line of credit, which you can tap for unexpected expenses but are not insurance in the sense of transferring overall wealth, would help even more. Without functional (competitive) cash markets, HSAs are not that helpful.

Generic objections

The idea that health care and insurance can and should be provided by deregulated markets, and that existing regulations are the main source of our problems, is, perceived to be fairly radical within the current policy debate. Let me deal with a few of the standard objections.

The poor

“What about the homeless guy with a heart attack?”

Let’s not confuse the issue with charity. The goal here is to fix health insurance for the vast majority of Americans –people who buy houses, cars, and cell phones; people who buy insurance for their houses and life insurance so their families.

Yes, we will also need charity care for those who fall through the cracks, the victims of awful disasters, the very poor, and the mentally ill. This will be provided by government and by private charity. It has to be good enough to fulfill the responsibilities of a compassionate society, and just bad enough that few will choose it if they are capable of making choices. I wish it could be better, but that’s the best that is possible. For people who are simply poor, but competent, vouchers to buy health insurance or to refill health savings accounts make plenty of sense.

But supplying decent charity care does not require a vast “middle-class” entitlement, and regulation of health insurance and health care for everyone in the country, any more than providing decent homeless shelters (which we are pretty scandalously bad at) or housing subsidies for the poor (section 8) requires that we apply ACA style payment and regulation to your and my house, Holiday Inn or the Four Seasons. To take care of homeless people with heart attacks, where does it follow that your and my health insurance must cover first-dollar payment for wellness visits and acupuncture? The ACA is hardly a regulation minimally crafted to solve the problems of homeless people with heart attacks!

The straw man

There is a more general point here, which will appear time and again as I answer each criticism. The critics adduce a hypothetical anecdote in which one person is ill served, by a straw-man completely unregulated market, which nobody is advocating, with no charity or other care (which we’ve had for over 800 years18 , long before any government involvement at all). They conclude that the anecdote justifies the thousands of pages of the ACA, tens of thousands of pages of subsidiary regulation, and the mass of additional Federal, State, and Local regulation applying to every single person in the country.

How is it that we accept this deeply illogical argument, or that anyone in making it expects it to be taken seriously? If you can find one person who falls through the cracks, the government gets to regulate the whole market, not that we craft a minimal solution to fix that person’s problem.

But wait, will not one person fall through the cracks or be ill-served by the highly regulated system? If I find one Canadian grandma denied a hip replacement, or someone who can’t get a doctor to take her as a medicare patient, why do I not get to conclude that everyone must be left to the market?

Adverse selection

We all took that economics course, in which asymmetric information makes insurance markets impossible due to adverse selection. Sick people sign up in greater numbers, so premiums rise and the healthy go without. George Akerlof’s justly famous “Market for lemons” proved that used cars can’t be sold because sellers know more than buyers. Interestingly, Car Max is still in business.

Does a patient, with knowledge of aches and pains, really know so much more about likely cost than an insurance company, armed with a full set of computerized health records and whatever tests it wants to run? Life, property, and auto insurance markets at least exist, and function reasonably well despite the similar theoretical possibility of asymmetric information. Life insurance is also “guaranteed renewable,” meaning you are not dropped if you get sick.

Now, the “adverse selection” phenomenon, that sick people are more likely to buy insurance, and healthy people forego it, is a big problem. But the insurance company charges the same rate, not because it can’t tell who is sick – a fundamental, technological, and intractable information asymmetry. The insurance company charges the same rate because law and regulation force it not to use all the information it has. If anything, we have the opposite information problem: insurers know too much.

This source of adverse selection is a legal and regulatory problem, not an information problem, and easily solved. If insurance were freely rated, nobody would be denied. Sick people would pay more, but “Health status” insurance shows how to solve that. See footnote 2 for references.

Shopping paternalism.

Defenders of regulation reiterate the view that markets can't possibly work for health decisions,19

“A guy on his way to the hospital with a heart attack is in no position to negotiate the bill.” “One point I cannot agree with is that competition can work in health care, at least as it does in other markets. I cannot fathom how people faced with serious illness will ever make cost-based decisions”

“What about those who currently don't have the background and/or the economic circumstances to consume health care, (e.g. take anti-hypertensive medicine instead of [buying] an iphone)?”

Ezra Klein,20 trying to understand why health-care prices are so high and so obscure,

Health care is an unusual product in that it is difficult, and sometimes impossible, for the customer to say “no.” In certain cases, the customer is passed out, or otherwise incapable of making decisions about her care, and the decisions are made by providers whose mandate is, correctly, to save lives rather than money.

In other cases, there is more time for loved ones to consider costs, but little emotional space to do so — no one wants to think there was something more they could have done to save their parent or child. It is not like buying a television, where you can easily comparison shop and walk out of the store, and even forgo the purchase if it’s too expensive. And imagine what you would pay for a television if the salesmen at Best Buy knew that you couldn’t leave without making a purchase.

New York Times columnist Bill Keller put it clearly, in “Five Obamacare Myths:21

[Myth:] The unfettered marketplace is a better solution. To the extent there is a profound difference of principle anywhere in this debate, it lies here. Conservatives contend that if you give consumers a voucher or a tax credit and set them loose in the marketplace they will do a better job than government at finding the services — schools, retirement portfolios, or in this case health insurance policies — that fit their needs.

I’m a pretty devout capitalist, and I see that in some cases individual responsibility helps contain wasteful spending on health care. If you have to share the cost of that extra M.R.I. or elective surgery, you’ll think hard about whether you really need it. But I’m deeply suspicious of the claim that a health care system dominated by powerful vested interests and mystifying in its complexity can be tamed by consumers who are strapped for time, often poor, sometimes uneducated, confused and afraid.

“Ten percent of the population accounts for 60 percent of the health outlays,” said Davis. [Karen Davis, president of the Commonwealth Fund] “They are the very sick, and they are not really in a position to make cost-conscious choices.”

Now, “dominated by powerful vested interests and mystifying in its complexity” is a good point, which I also just made. But why is it so? Answer: because law and regulation have created that complexity and protected powerful interests from competition. And is the ACA really creating a simple clear system that will not be “dominated by powerful vested interests?” Or is it creating an absurdly complex system that will be, completely and intentionally, dominated by powerful vested interests?

But the core issue is these consumers who are “passed out, or otherwise incapable of making decisions about her care,” ”strapped for time, often poor, sometimes uneducated, confused and afraid,” and “not really in a position to make cost-conscious choices.”

Yes, a guy in the ambulance on his way to the hospital with a heart attack is not in a good position to negotiate. But what fraction of health care and its expense is caused by people with sudden, unexpected, debilitating conditions requiring immediate treatment? How many patients are literally passed out? Answer: next to nothing.

What does this story mean about treatment for, say, an obese person with diabetes and multiple complications, needing decades of treatment? For a cancer patient, facing years of choices over multiple experimental treatments? For a family, choosing long-term care options for a grandmother?

Most of the expense and problem in our health care system involves treatment of long-term, chronic conditions or (what turns out to be) end-of-life care, and involve many difficult decisions involving course of treatment, extent of treatment, method of delivery, and so on. These people can shop! We actually do a pretty decent job with heart attacks.

And even then... have they no families? If I’m on the way to the hospital, I call my wife. She’s a heck of a negotiator.

Moreover, health care is not a spot market, which people think about once, at 55, when they get a heart attack. It is a long-term relationship. When your car breaks down at the side of the road, you’re in a poor position to negotiate with the tow truck driver. That’s why you join AAA. If you, by virtue of being human, might someday need treatment for a heart attack, might you not purchase health insurance, or at least shop ahead of time for a long-term relationship to your hospital?

And what choices really need to be made here? Why are we even talking about “negotiation?” Look at any functional, competitive business. As a matter of fact, roadside car repair and interstate gas stations are remarkably honest. In a competitive, transparent market, a hospital that routinely overcharged cash customers with heart attacks would be creamed by Yelp reviews. Competition leads to clear posted prices, and businesses anxious to give a reputation for honest and efficient service.

It’s not even a realistic anecdote.

OK, some conditions really are unexpected, and incapacitating. Not everyone has a family. There will be people who are so obtuse they wouldn’t get around to thinking about these things, even if we were a society that let people die in the gutter, which we’re not, and maybe some hospital somewhere would pad someone’s bill a bit. But now we’re back to the straw man fallacy. The idea that ACA is a thoughtful, minimally designed intervention to solve the remaining problem is starting to look more and more ludicrous.

Take a closer look at Keller and Davis’ statement, ”strapped for time, often poor, sometimes uneducated, confused and afraid,” and “not really in a position to make cost-conscious choices.”

We’re talking about average Joe and Jane here, sorting through the forms on the insurance offerings to see which one offers better treatment for their diabetes-related complications. If Joe and Jane can’t be trusted to sort through this, how in the world can they be trusted to figure out whether they want a fixed or variable mortgage? Which cell phone or cable plan to buy? To deal with auto mechanics, contractors, lawyers, and financial planners? How can they be trusted to sign marriage or divorce documents, drive, or ... vote?

We have a name for this state of mind: legal incompetence. Keller, Davis, and company are saying that the majority of Americans, together with their families, are legally incompetent to manage the purchase of health insurance or health care. And, by implication, much of anything else.

Yes, there are some people who are legally incompetent. But straw man again, Keller and Davis are not advocating social services for the incompetent. They are defending the ACA, which applies to all of us. So, they must think the vast majority of us are incompetent.

This is a breathtaking aristocratic paternalism. Noblesse oblige. The poor little peasants cannot possibly be trusted to take care of themselves. We, the bien-pensants who administer the state, must make these decisions for them.

Let me ask any of you who still agree, does this mean YOU? When you are faced with cancer, do you really want to place your trust in the government health panel? Or is this just for the benighted lower classes, and you, of course, know how to find a good doctor and work the system?

And choice is always between alternatives. Sure, some people make awful decisions. The question is, can the ACA bureaucracy and insurance companies really do better? Yet you would not trust them to buy your shirts?

Really? Does this entire bureaucratic garganuta follow, not on the proposition that there is some fundamental economic market failure, but because…Americans are no good at shopping?

If anything, the opposite seems to be true. Where is it easier to shop, Southwest Airlines, or your average hospital? In the name of the consumer, who finds it hard to shop, we have created an arcane system where it is, in fact, nearly impossible to shop.

No. It’s not “health is too important to be left to the market.” It’s “health is so important --and so varied, so personal, and so subjective – that it must be left to the market.” If you don’t trust the vast majority of people to make the most important decisions of their lives, you’re a devout patrician, not a “devout capitalist.”

Theory and experience

I’m often told, “Well, fine, but this is just theory. Free market health care hasn’t been tried in a modern economy. All countries regulate health care or governments provide it.”

That’s the point of my extensive examples of other industries. As an economic good, there really isn’t much difference between health care and other complex personal services such as auto repair, legal services, home repair and remodeling, or college education. Yet these markets no not require “insurance” for access, nor must bureaucracies decide what every American “needs” even though the providers have considerably more expertise than the customer. Once upon a time all governments had monarchies. That observation didn’t prove monarchy was a better system.

Moreover, the pockets of health care that are out of the insurance system and allowed relatively competitive free entry operate reasonably well. Plastic surgery and dentistry are not disasters. Radial keratotomy (corrective eye surgery) is a good example, as specialization and competition has led both to lower costs and increased quality. I am not the first dog owner to notice how easy and relatively inexpensive cash-and-carry veterinary medicine is compared to the same treatment for humans. Concierge medicine is taking off.

If anyone is guilty of theorizing, it would seem to be the faith that the next round of brilliant ideas for layering on ACA-style regulation will lead finally to successful “cost control” that is not simply rationing, or will induce the radical quality improvement and innovation that we need, where the past ones have all failed.

Realistic freedom, help and vouchers

I do not require that you follow me to some unrealistic libertarian nirvana. “The unfettered free market,” where the improvident die in the gutter is another ridiculous straw man. Southwest’s pilots have FAA licenses. Walmart’s products pass the consumer product safety commission. We can argue about this stuff, but we don’t have to. A little freedom will go a long way. The market can survive a lot of regulation, even silly regulation.

In addition to the need for genuine charity care, there can stlll be lots of help in various places.

But a central principle of economics is, “don’t transfer income by distorting prices, or providing services.” The vast majority of any help and transition-smoothing can and should be given in the form of on-budget, lump-sum subsidies or vouchers, leaving marginal incentives intact.

When we transition to freely-rated lifelong individual insurance, individuals who are already sick face high premiums. That problem is easily solved with a voucher, or a lump-sum payment to their health savings accounts

The same principle applies to genetic diseases. Economics has long recognized the principle that insurance can’t insure events that have already happened, so lump-sum transfers are appropriate. But one-time, lump-sum transfers based on clearly defined events over which no one has control, such as a DNA marker, are much less distorting, or subject to abuse, than perpetual regulation and intervention in a market.

If we want to subsidize health care or insurance for old or poor people, give them a voucher. There is no reason the government should try to run an insurance company, and less reason to do it pass an implicit tax, by mandating that businesses “provide” insurance.

If we want to subsidize emergency rooms, let’s just do it. That will be much more efficient than forcing a big cross-subsidy scheme and blocking competition to keep them afloat. (Letting Walmart set up clinics would be a lot cheaper too!)

If you think people don’t get enough checkups when paying with their own money, give them a voucher. That’s much easier than passing a mandate that every company must provide first-dollar health payments with a long range of mandated benefits.

More generally, there is an income paternalism at work in health care policy, somewhat more reasonable than the “they can’t shop” paternalism I decried above, worth making explicit. Most people, when spending their own money at the margin, are likely to choose less health care than we, the self-appointed advisers to “policy-makers” would like. Already, they evidence tradeoffs that imply less health than we would like – they drink sugared sodas, eat fast foods, and don’t exercise enough. In my example that patients were offered an MRI or $1,000 in cash, I think we suspect that a lot of patients would choose the cash.

A good libertarian would say, well, let people choose more iphones and less health if that’s what they want. But we don’t have to have this argument. If you think people will spend too little on health overall, give them vouchers in a health-savings account. This maintains the efficiency of patient-driven choice, distorts the overall health vs. non-health price, without distorting relative prices or writing ten thousand pages of regulations and supply-side restrictions that gum up the entire system.

Now, you might object, that all these subsidies and vouchers will raise “costs” on the budget. But this happens simply because of phony accounting. If the government mandates that cardiac patients cross-subsidize emergency rooms this is exactly the same as a tax on cardiac services and an expenditure on emergency rooms. Actually, it’s a lot worse because the distortion of the current system is much greater. So any economically relevant accounting would recognize that we save money overall. Fixing the accounting is a lot better and cheaper project than keeping our ridiculously inefficient health care system.

"Politically feasible"

Well, my typical critic concludes, maybe you’re right about all this as a matter of economics, but it’s not politically feasible.

No, not now. But the alternative is not economically feasible, a sterner taskmaster. And what was not feasible today, can quickly become feasible tomorrow if it is correct, and once people understand it, and understand there is no option. Our job as economists is to figure out what works and explain it, not to bend reality to some notion of what today’s politicians are willing to say in public.

Our political conversation is truly lunatic. It is taken for granted in policy discussion that no American can be asked to “pay for” (directly, rather than through taxes) one cent of health cost risk. While they routinely pay for broken and crashed cars, destroyed houses, suffer huge risks in the job market, and shoulder housing, transport and other expenses much greater than the cost of health care. Yet while pretending nobody should pay for things, unfortunates who fall through the cracks can be handed ridiculous $550,000 bills for cancer treatment.

We can start by saying, out loud, health care is a good like any other. It is ok to ask Americans to pay for it, and to allow American companies to competitively supply it, just like any other. It is ok for insurance to retreat to its proper role, of protecting people from large shocks to wealth, rather than being a hugely inefficient payment plan. As car insurance does not pay your oil changes – after you fax in the forms in quintuplicate, obtain permission from your mechanic, go to the in-network mechanic, and wait 6 weeks, and answer a 20 page questionnaire about your repair history and driving habits.

Bottom line

Health care is a complex personal service, with wide variation in quality, both along measures of health outcomes and along more subjective dimensions of satisfaction. Its demand curve is very elastic – people will consume a lot at subsidized prices. The distinction between “want” and “need” is conceptually fuzzy, and nearly impossible to measure.

The big improvements in health care come from better technology. But big improvements in its delivery and average quality are also attainable. They come from much better human organization, as has happened recently in many other industries that have witnessed revolutionary supply competition. Yet achieving those improvements will displace lots of entrenched interests.

From these observations, simple conclusions follow.

Health care markets need a big supply-side revolution, in which the likes of Southwest Airlines, Walmart and Apple enter, improving business practices, increasing quality and transparency, and spurring innovation. And disrupting the many entrenched interests and cross-subsidies of the current system.

I outlined a long string of restrictions on competition that can be repealed, or modified to allow competition. At a minimum, every new regulation should be evaluated by its effect on competition by new entrants, or protection of incumbents, a consideration not even spoken in policy discussion today.

Health care is singularly ill-suited to payment-plan provision, either by government directly or by heavily regulated insurance by a few large well-protected businesses. A functional cash market must exist in which patients can realistically feel the marginal dollar cost of their treatment, or (equivalently) enjoy the full financial benefits of any economies of treatment they are willing to accept, and are not patsies for huge cross-subsidization and rent-seeking by an obscure system negotiated behind the scenes between big insurance companies, hospitals, and government.

Both supply and demand must be freed. Without supply competition, asking consumers to pay more will do little to spur efficiency. Without demand competition, new suppliers will not be able to succeed.

The alternative, doubling down regulations on an already highly regulated system, full of protected and politically connected incumbents and rent-seekers, has little chance of achieving these goals. Whether in the post-office model (government provision), or the 1950s-style regulated airline, utility or bank model (the ACA) this effort will just produce less efficiency, more costs, and another generation of bright ideas dashed. Oh ye reformers, remember that the last 20 bright ideas did not fail simply because the people in charge weren’t as smart as you are, or as well-meaning!


1 John Cochrane is a Professor of Finance at the University of Chicago Booth School of Business, Adjunct Scholar of the Cato Institute, Senior Fellow of the Hoover institution and Research Associate of the NBER. Address: 5807 S. Woodlawn Chicago IL 60637,, This is an expanded version of remarks given at the conference, “The Future of Health Care Reform in the United States,” at the University of Chicago Law School, October 12 2012. I am grateful to Anup Malani for extensive and very helpful comments.
2 “Health-Status Insurance.” Cato Institute Policy Analysis No 633.(2009); “Time-Consistent Health Insurance” Journal of Political Economy, 103 (1995), 445-473; "What to do about pre-existing conditions Wall Street Journal August 14 2009; “Forget about the mandate” Bloobmerg Business Class July 12 2012; What to do on the Day after Obamacare Wall Street Journal April 2 2012; “The Real Trouble With the Birth-Control Mandate” Wall Street Journal February 9 2012; all available on my website, see footnote 1.
3 If personal experience is not enough to remind you how inefficient the current system is, I recommend Jonathan Rauch’s YouTube video, “If air travel worked like health care” Hat tip to Einer Elhauge who showed it at the conference.
4 Gawadne, Atul, 2012, “Big Med: Restaurant chains have managed to combine quality control, cost control, and innovation. Can health care?” New Yorker (August 13)
5 Chandra, Amitabh, and Jonathan Skinner, 2012, “Technology growth and expenditure growth in health care,” Journal of Economic Literature 50, (September 2012) 643-680.
9 Elhauge, Einer, ed. (2010) The Fragmentation of U.S. Health Care -- Causes and Solutions Oxford: Oxford University Press, quotes from the introductory chapter available at
10 Lakdawalla, D., and T. Philipson (2006), “Non-Profit Production and Industry Performance”, Journal of Public Economics, v 90 (9), 1681-98.
11 Fama, Eugene F. and Michael Jensen, 1983, “Agency Problems and Residual Claims” Journal of Law and Economics, 26, 327-349. Fama and Jensen note that the presence of donors on boards of directors is an imperfect substitute for knowledgeable insiders and market discipline.
12 For a description of the process, with however a view that it needs more not less regulation, see, Horwitz, Jill R. 2012, “State Oversight of Hospital Conversions: Preserving Trust or Protecting Health?” The Hauser Center for Nonprofit Organizations, The Kennedy School of Government,
13 For an example of recent news coverage see “Regulators Seek to Cool Hospital-Deal Fever” Wall Street Journal, March 18, 2012.
14 At the conference, Meridith Rosenthal gave a wonderful presentation highlighting a wide range of complex payment schemes, and how they didn’t work out, a wider range of bright new ideas, and how little we know about how they work. Her conclusion was that lots more research will lead to something workable to patch up each leak. Mine was that jiggering health payment systems is the best modern example of the hopelessness of central planning. You can get some idea from Rosenthal, Meredith B., 2009, “What Works in Market-Oriented Health Policy?” New England Journal of Medicine 360, 2157-2160 (May 21) And especially the table in Rosenthal, Meredith B., 2008, “Beyond Pay for Performance — Emerging Models of Provider-Payment Reform,” New England Journal of Medicine 359, 1197-1200 (September 18, 2008)
15 For example,, complete with a link, “Read the tragic story of a now brain-damaged young woman who had 2 sets of x-rays - yet no one diagnosed her brain abscess,” and “Outsourcing radiology abdicates 3 of 4 of the core responsibilities of radiologists.
17 Kristof, Nicholas D. “A Possibly Fatal Mistake,” New York Times October 12 2012, Sunday Review,
18 One reference: Founding of the Misericordia charitable hospital in Florence, 1244.
19 These quotes are from commenters on my blog, not a very authoritative source, but they put the view so clearly I couldn’t resist.
21, July 15 2012